Monetary policy and the yield curve slope

A month or so ago there was a great flurry of media coverage when the US interest rate yield curve “inverted”.  In this case, long-term government security interest rates (10-year government bond yield) moved below short-term government security interest rates (three month Treasury bill yield).   This was the sort of chart that sparked all the interest.

US yield curve

The grey bars are US recessions, and each time the long rate has been less than the short-term rate a recession has followed.   This chart only goes back to 1982 but it works back to at least the end of the 1960s.    There haven’t been any recessions not foreshadowed by this indicator, and there haven’t been times when the yield curve inverted and a recession did not come along subsequently (sometimes 12-18 months later).   Who knows what will happen this time.  It is, after all, a small sample (seven recessions, seven inversions since the late 1960s), and there is nothing sacrosanct (or theoretically-grounded) in using a 10 year bond rate.  Use the US 20 or 30 year government bond yields and right now the curve wouldn’t even be (quite) inverted.

But there are good reasons why changes in the slope of the yield curve might offer some information.  A long-term bond rate isn’t (usually) controlled by the central bank or government and might have a fair amount of information about what normal or neutral interest rates are in the economy in question. By contrast, short-term rates are either set directly or very heavily influenced by the authorities.    When the short-term rate is unusually far away from the long-term rate one might expect things to be happening to the economy, whether by accident or design.

Back in the day, when we were trying to get inflation down in New Zealand (late 80s, early 90s), the slope of the yield curve was for several years, off and on, a fairly important indicator for the Reserve Bank.  At times we even set internal indicative ranges for the slope of the yield curve (at the time, the relationship between 90 day commercial bill yields and five year government bond yields), and for a while even rashly set a line in the sand of not allowing the short-term rate to fall below the long-term rate.      We used this indicator because neither we nor anyone else had any idea what a neutral rate (nominal or real) would prove to be for New Zealand, newly liberalised and then post-crash, money supply and credit indicators didn’t seem to have much content, and we didn’t want to take a view on the level of the exchange rate either.  But whatever the longer-term interest rate was, if we ensured that short-term rates stayed well above that long-term rate, we seemed likely to be heading in the right direction –  exerting downward pressure on inflation and, over time, lowering future short-term rates as well.

But what about the New Zealand yield curve slope now?     Here is the closest New Zealand approximation to the US chart above, using 90 day bank bill yields and the 10 year (nominal) government bond yield.  I’ve shown it the other way around – 90 days less 10 years –  because that is the way we did it here (partly because of the long period, until 2008/09, when short-term interest rates were normally higher than long-term ones, rather different to the US situation).

nz yield curve 1

I can’t easily mark NZ recessions on the chart, but there were recessions beginning in 1987, 1991, 1998, and 2009, and each of them was preceded by this measure of the yield curve slope being positive,  But, for example, the slope was positive for four years in the 00s before there was a recession.    Against this backdrop, there isn’t really much to say about where we are right now (just slightly positive).   And take out whatever credit risk margin there is a bank bill yield (20 basis points perhaps?) and the slope of the curve would be dead flat.

But what about a couple of other possibilities.  Unlike the 90 day bill rate, term deposit rates  and bank lending rates directly affect economic agents in the wider economy, and as I’ve shown previously the relationship between the 90 day bill rate and term deposit (and floating mortgage) rates has changed a lot since 2008/09. margins

In this chart (constrained by data availability to start in 1987), I’ve taken the six month term deposit rate (from the RB website) and subtracted the 10 year government bond yield).

nz yield curve 2.png

That starts looking a bit more interesting.  The level of this variable –  even after the recent Reserve Bank OCR cuts –  is close to a level which has always been followed by a recession.   (It is a small sample of course; even smaller than in the original US chart).

What about the relationship between the floating residential first mortgage interest rate and the 10 year bond rate?  Here is the chart.

nz yield curve 3

The only times this indicator has been higher than the current level –  even after the recent OCR cuts are factored in, as they are in the last observation on the chart – have been followed by pretty unwelcome economic events (the 1991 recession wasn’t strongly foreshadowed by either this indicator or the previous one).

It is a small sample, of course, and there are no foolproof advance indicators.   But if I were in the Reserve Bank’s shoes right now, I would take these charts as yet further warning indicators.

On which count, it is perhaps worth keeping a chart like this in mind.

NZ yield curve 4

We’ve had 75 basis points of OCR cuts this year but only about 45 basis points of cuts in the indicative term deposit rate (latest observations from interest.co.nz).  It is not as if these retail interest rates are at some irreducible floor –  retail deposit rates in countries with much lower policy rates are also much lower than those now in New Zealand.  It is a reminder that, against a backdrop of a very sharp fall in New Zealand long-term interest rates (real and nominal) –  even after the recent rebound the current 10 year rate is still more than 100 basis points lower than it was in December –  monetary policy adjustments have been lagging behind.   Long-term risk-free rates have fallen, say, 110 basis points (almost all real), and short-term rates facing actual firms and households are down perhaps 40-60 points (floating mortgage rates nearer 60).

The Reserve Bank cannot (especially after a decade of persistent forecast errors) have any great confidence in any particular view of neutral interest rates for New Zealand.  With inflation still persistently below target and (as the Governor and Assistant Governor have recently highlighted) falling survey measures of inflation expectations, there isn’t a compelling case for the Bank to have lagged so far behind the market, allowing short-term rates to rise further relative to long-term rates.   The Governor has appeared to suggest that the Bank will only seriously look again at further OCR cuts at the next Monetary Policy Statement in November.  I reckon there is a much stronger case than is perhaps generally recognised for a cut at the next OCR review next week.

 

 

Monetary policy effectiveness

When commenting a couple of weeks ago on the Reserve Bank’s Monetary Policy Statement I observed that

there was some rhetoric from the Governor at his press conference that I quite liked, including the reaffirmation of the effectiveness of monetary policy

I’ve not seen any reason to doubt that monetary policy remains pretty effective for now (although the lower limits of conventional monetary policy are approaching), and if I’ve had a criticism of the Bank over the decade it is that it has been too reluctant to use monetary policy as it should be, transfixed as they long were by outdated views on the level of neutral interest rates and a consequent view (shared by many of their peers abroad) that with interest rates this low, inflation would surely rebound soon.  In short, central banks –  ours included –  materially overestimated the amount of monetary stimulus actually being provided.

In the wake of the Governor’s comments, I was interested to see that last Friday the Reserve Bank released a short Analytical Note reporting the work staff had done to underpin the Governor’s claim about effectiveness.  It was good to see, both because public agency transparency is a good thing in itself, and because on several occasions in the past it has turned out that bold claims the Governor had made in press conferences were backed by precisely no supporting analysis.

The summary of the work done in the published note reads as follows

We use three different models to evaluate monetary policy transmission. These models show that a 25 basis point cut in the Official Cash Rate (OCR) leads to an increase in inflation and GDP growth, and that this response is as big today as it was before the GFC. This implies that the recent OCR cuts by the Reserve Bank will lead to – all else equal – higher inflation and GDP growth, and help support maximum sustainable employment (MSE).

Using data since 1993 they estimate models up to the end of 2007 and then add new data quarter by quarter and see if there are any changes in the estimated effect of a monetary policy change on inflation and GDP growth.   The short answer –  on these measures –  is “not much”.  Here is their chart.

AN.png

In this exercise they are using the 90 day bill rate as the instrument of monetary policy (the OCR wasn’t introduced until 1999).   And they recognise that you cannnot simply look at what happens after the 90 day bill rate changes, because the bill rate changes (or OCR changes now) are often reflective of stuff going on in the economy or inflation.  Thus, in their words,

In order to disentangle the effect of monetary policy on the economy, our analysis uses modelling devices commonly known as monetary policy ‘shocks’. These shocks help isolate the effect of a move in the OCR that cannot be explained by the state of the economy.

Which is just fine, in principle, but then a great deal depends on how well the authors were able to identify the “shocks”.    And we don’t know the answer to that, including because they don’t show us the data (which quarterly changes do the models treat as “shocks”, and to what extent).

The authors note only two limitations to their work.  The first is the standard caveat: the models are linear and can’t easily cope with any non-linear behaviour.  The second –  really a ritual bow to their new statutory mandate –  is that they chose not to look at labour market effects, but as they note employment changes are pretty closely correlated to GDP changes so it isn’t much of a limitation at all.

Much as I’m pleased to see the paper published, and am inclined to share the Bank’s judgement about policy effectiveness, I think there several other limitations or caveats that leave me not really that convinced that the reported model results are as persuasive as the Bank would like to believe.

The first caveat is that we simply don’t have much data for the more recent period.   Here is a chart of short-term interest rates (data from the RB website) for the period being studied.

short-term rates

There was a great deal of volatility in the first six years of the period (pre-OCR), considerable variability in the subsequent decade, but since the crisis cuts came to end in April 2009, very little variability at all (from April 2009 to earlier this month the OCR had been in a range only 200 basis points wide).   The two tightening cycles the Bank inaugurated both had to be reversed in pretty short-order, before anything like the full effects (on inflation and GDP) of those policy changes could be seen.

Now, as I understand these models, you don’t need to have had an OCR change to have had a “monetary policy shock”: sometimes the data will have changed and the OCR will have been left unchanged, and the model will tell you that there is a “shock” there –  the OCR wasn’t changed when, in some sense, it perhaps should have been.   But that isn’t really very helpful, since almost always when the policymakers left the OCR unchanged they had in mind unchanged policy (as did markets and firms/households), and the empirical exercise is trying to deduce answers from what the models think of as policy mistakes, but policymakers at the time did not.    From a policymaker’s perspective, not much was done with monetary policy in the decade after 2009.  With a small sample, you simply can’t answer many questions.

The other caveat is that the Bank’s modelling uses the 90 day bill rate (more recently as proxy for the OCR).   That is fine –  it is very close to the instrument the Bank has direct control over.  But that isn’t the rate most people –  firms or households – transact at.  This chart shows the margins between the 90 day bill rate and the three retail rates for which the Bank publishes long time series.

margins

For most of the pre-recession period –  and particularly the first years of the OCR period –  the margins were very stable.   Through most of the 00s, you could look at monthly changes in floating mortgage rates, term deposit rates, business overdraft rates, the OCR, or 90 day bill rates and get almost exactly the same answer.   In that environment, a simple model with only a single interest rate made a lot of sense.  But the picture has been quite a bit different since then –  not just the levels change in these spreads during the crisis period itself, but even in the subsequent decade.   The OCR/90 day rate may still be a significant influence on the exchange rate –  not something mentioned in the Bank’s paper at all – but changes in it (including estimated “shocks” to it) seem unlikely to mean the same thing in respect of domestic borrowing, investment etc, as it did in the pre-2008 decade.

To repeat, I’m inclined to agree with the Bank that monetary policy remains pretty effective.   Perhaps what the Bank has done is the best that could be done for now. But I’m sceptical that these particular results should provide as much comfort as the Bank would appear to like us to take.     The authors end the paper this way

AN conclusion.png

Which, frankly, seems a bit glib and over-confident.   It is, after all, now almost a decade since core inflation was as high as 2 per cent –  the target midpoint the Bank was charged to focus on.   They might well be right about monetary policy being as effective as ever, but if I’d undershot my target for a decade I don’t think I’d be selling my wares under a “business as usual” slogan.  The important distinction is that, quite probably, monetary policy is as effective as ever, but using it well depends on the Bank’s understanding of the inflationary processes (ie decent backwards analysis and forecasting).  They didn’t do that very well for some considerable time.  Whether things have now improved –  moving on from “business as usual” –  remains at very least an open question.

As it happens, this morning the Bank released the text of a short speech by Assistant Governor, Christian Hawkesby, which also touched briefly on some of these issues.   He made reference to the research results in the Analytical Note (see above) but personally I found his less formal remarks resonated more:

Finally, it fits with recent experience that monetary policy does still have bite even in this low interest rate world.

In New Zealand, we lifted the Official Cash Rate by 100 basis points over the course of the first half of 2014 to head off an expected increase in inflationary pressure. When this did not arrive as expected, the tightening in monetary policy ended up being one factor that contributed to the slowing in the economy into 2015. Internationally, we have also seen the US Federal Reserve tighten monetary policy through to 2018, and this is one factor that has contributed to the moderation in US growth and inflationary pressure into 2019. These are ongoing examples of monetary policy continuing to play a key role in inflation dynamics.

To that, I would add the pick-up in New Zealand core inflation following the OCR cuts in 2015 and 2016.

I don’t want to say much else about Hawkesby’s speech, but there was some interesting commentary on the recent decision to cut the OCR by 50 points at once.    The bits that really caught my eye were this

As part of the assessment, our discussion also touched on the decline that had occurred in both survey measures of inflation expectations and market-based measures, such as nominal and inflation linked bonds in global markets

This was new: there was no mention of expectations derived from indexed bonds in either the MPC minutes or in the MPS itself – in fact, in discussing inflation expectations over the last five or more years, Bank officials have steadfastly refused to engage with those market-based indicators (currently suggesting 10 year average inflation expectations of about 1 per cent for New Zealand). I hope this isn’t the only time they engage.

And (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.

Which was interesting both because the Bank has spent considerable effort over the last couple of years telling us that inflation expectations were now just fine (“firmly anchored at 2 per cent” became something of a catchphrase).   If you are using policy to try to lift inflation expectations –  as they should be, among other things –  it is a public acknowledgement that things were not quite as they should be.

I really hope that on this matter Hawkesby really is speaking for the MPC as a whole (there is no disclaimer on the speech suggesting they are just personal views).  All else equal, if inflation expectations (survey and market measures) don’t rise, it would provide underpinning for further cuts to the OCR, whether or not the local or global economic data deteriorate from here.

 

 

Reserve Bank MPS – part 2

This morning I wrote about the choice to cut by 50 basis points and the issues it raised, in context, about the Bank’s communications (non-existent speeches being only the most obvious omission).   In this post, I want to focus on a few other specific issues that came up in the Monetary Policy Statement itself or in the Governor’s press conference.

The first was around fiscal policy.  The Governor is clearly a big fan of the government spending more –  “of course the government has to be spending more”.   As a centre-left voter, I guess that is his personal prerogative, but it isn’t clear that it is his place to use his official office to weigh on highly political issues for which he is not charged with responsibility.  Imagine, if you will, that he was calling for cuts to government spending.  It would be equally inappropriate.

But, much as we shouldn’t just slide past the way he abuses the constraints on his office to advance personal causes, that wasn’t really what bothered me yesterday.   The much bigger concern was the way the Governor blatantly misrepresented the actual fiscal situation.  He claimed to be concerned only that the government wouldn’t be able to spend fast enough (given “capacity constraints”), which might reasonably have prompted a question of why, if government activity would be crowded out, he and his colleagues were slashing the OCR by 50 points in one go.

In fact, it prompted the perfectly reasonable question from Bernard Hickey about whether fiscal policy was actually very stimulatory at all.   The standard reference here is The Treasury’s fiscal impulse measure.  This is the chart from the Budget documents

fisc impulse.png

It isn’t a perfect measure by any means, and in particular one can argue about some of the historical numbers. In my experience, it is a pretty useful encapsulation of the fiscal impulse (boost to demand) for the forecast period. In fact, the measure was originally developed for the Reserve Bank –  which wanted to know how best to translate published forecast plans into estimated effects on domestic demand/activity.

And what do we see.  There was a moderately significant fiscal impulse in the year to June 2019.  That year ended six weeks ago.  For current and next June years, the net fiscal impulse is about zero, and beyond that –  which doesn’t mean much at this stage –  the impulse is moderately negative.    All using the government’s own budget numbers.  And consistent with this, operating revenue in 2023 is projected to be higher as a share of GDP than it is now, and operating expenses are projected to be lower (share of GDP) than they are now.    The Budget is projected to be in (fairly modest) surplus throughout.

And yet challenged on this, the Governor seemed to be just making things up when he claimed that we had a “very pro-active fiscal authority” and that “the foot is on the fiscal accelerator”.    It just isn’t.  Orr must know that (after all, he had Treasury’s Deputy Secretary for macro sitting as an observer in this MPS round).  One even felt a little sorry for the Bank’s chief economist spluttering to try to square the circle, but basically acknowledging that Hickey’s story was right, not the Governor’s.   Perhaps, you might wonder, the Bank thinks the fiscal impulse measure is materially misleading and has its own alternative analysis of the government’s announced fiscal plans. But that can’t be so either: there is no discussion of the issue in the Monetary Policy Statement.

(Incidentally, on Morning Report this morning Grant Robertson tried the same sort of line, only for the presenter to point out to him the fiscal impulse measure, reducing the Minister to spluttering “but we are spending more than the last lot”.  That is true, but the material overall fiscal boost was last year –  and growth and activity were insipid even then, inflation still undershooting the target.)

Was he being deliberately dishonest or simply making stuff up as he went protraying things as he’d like them to be?  You can be the judge, but neither alternative puts our central bank Governor in a good light.

Another joint act –  coordinated or not –  from the Minister and Governor was around investment.  As a nice change, the Bank included a chart of nominal investment as a share of nominal GDP (the approach favoured on this blog)

bus investment RB.png

As I’ve noted here repeatedly, business investment never recovered strongly from the last recession, and if anything (as share of GDP) has been falling back again in the lasdt few years, even as population growth remained strong.    It was good to see the Bank focus on the issue.

But despite the feeble business investment performance, the Bank expects business investment to recover from here.  There is no hint as to why they believe that is likely –  there is talk of more capacity pressure, and yet their output gap forecasts don’t change much from where we’ve been (on their reading) for the last couple of years.  If there is any basis for their beliefs it seems to be little more than the repeated claim by the Governor and the Minister that it is “a great time to invest” in New Zealand.  But firms didn’t think so over the last five years –  even with unexpected population shocks –  and surely the reason the Bank is cutting the OCR has quite a bit to do with deteriorating conditions and investment prospects here and abroad?  In a country that has had almost no productivity growth for the last five years, and with an exchange rate not forecast to change much from here over the forecast period, and with a deteriorating global backdrop (their own words were “global economic activity continues to weaken”) it seems little more than wishful thinking to expect a resurgence in business investment.

Ah yes, productivity, or the rather the lack of growth in it.   Here is my chart, using the two official GDP measures and the two official hours measures.

GDP phw mar 19

The orange line in the average for the last five years.  There is next to no aggregate productivity growth in New Zealand.

And yet somehow the Bank manages to conjure it up. They report a “trend labour productivity” growth variable, which they claim has grown steadily every year since 2012 (averaging perhaps 0.8 per cent per annum growth), and they forecast that productivity growth will continue –  and even accelerate a bit –  from here (averaging in excess of 1 per cent per annum growth).   It hasn’t happened, and it seems most unlikely to start now –  absent any big favourable change in policy or the big relative prices facing firms (eg the exchange rate).   The investment opportunities –  profitable ones –  just don’t seem to be there.   But I guess acknowledging that would upset the Governor’s spin about the “great condition” the country is in.

A wise person would then be very sceptical of the Bank’s  projections that economic growth picks up from here.  In fact, with net migration projected to continue to slow –  and with it population growth – it is hard to see why GDP growth over the next year should get even as high as 2 per cent (even assuming the rest of the world doesn’t fall into a hole).

My final point relates to the prospects for policy if the outlook continues to deteriorate.   I thought it was quite right for the Governor to note that when you are starting from here then, whatever your central forecast, it wouldn’t be too much of a surprise if the OCR were to need to be set at a negative rate at some stage in the next couple of years.  Forecasting just isn’t any more precise than that.

That degree of openness is welcome.  What is much less so is the Bank’s secrecy  –  and perhaps lack of straightforwardness/honesty – around possible options if the limits of conventional monetary policy are reached.    As the ANZ pointed out in a note this morning, just three weeks ago the Reserve Bank responded to an OIA request about unconventional tools by (a) stonewalling, and (b) claiming that the work “is at a very early stage”.  And yet yesterday, the Governor claimed they were “well-advanced” in their work.  Both simply can’t be true (bearing in mind that the last two weeks will have been taken up with this MPS).   Which is true I wonder?  Who were they trying to deceive?

But again, perhaps worse than playing fast and loose were two things that should bother people more.  The first is the way the Bank is keeping all this close to their chest.  Responding to that OIA they refused to release anything (“very early stage” or whatever) on the grounds that to release anything would prejudice the “substantial economic interests of New Zealand” –  one of those OIA grounds the Ombudsman simply doesn’t have the competence or confidence to challenge agencies on.  Yesterday, we were told it all had to be kept very confidential to the Bank, because it was “market-sensitive”.

I’m with the ANZ economists who in a useful note this morning (worth reading, but I can’t see on the website to link to) observed

Let’s hope that a possible plan for unconventional monetary policy is shared publically soon, so that financial market participants and households can be confident of a smooth rollout of extra stimulus. And with the recent cut to 1%, and an even lower OCR widely expected, the clock is ticking.

This isn’t like the situation the Fed faced in late 2008, rushing to make policy on the fly in the middle of crisis, deploying things almost as soon as they were dreamed up.   This is contingency planning.   No one (I imagine) is wanting the Reserve Bank to tell us exactly what conditions would trigger the use of which instrument (the Bank themselves won’t know anyway, and things will be event-specific) but it is highly desirable that the work on options that the Bank and Treasury are doing should be socialised more broadly, so that (a) it can be challenged and scrutinised (officials have no monopoly on wisdom) and (b) as the ANZ says, to help reinforce confidence –  including holding up inflation expectations –  going into any serious downturn.  The Governor tried to claim again yesterday that the Bank was highly transparent around monetary policy, but this is just another example of how they cling closely to anything of much value (as I’ve put it before, they are usually happy to tell us things they don’t know –  eg three year ahead macro forecasts –  but not what they do now, such as background analysis papers that feed into monetary policy, or detailed work on options if the nominal lower bound is reached).

Personally –  and here I might part company from the ANZ – I remain very uneasy about the potential for unconventional instruments. The Governor has consistently talked up the possibilities, but he has never shared any research or analysis to give us confidence about what difference such tools would make to macro outcomes (have I mentioned that he has given no speeches about monetary policy?).   As I’ve noted before just look at how slow the recoveries were in the countries that deployed these unconventional instruments –  not issues of underlying productivity growth, but simply closing output and unemployment gaps –  and you should be very sceptical too.   That is why I keep hammering the point –  in yesterday’s post again –  that the Bank, the Treasury, and the Minister should be doing work on making the lower bound less binding, and taking the public and markets with them to prepare the ground.  All indications are that they are doing nothing.  If that is not so, it would be very helpful if they told us –  it is, after all, official information and in this context the “substantial economic interests of New Zealand” are being jeopardised by them either not doing the work, or doing it and not telling us.

On which note, it is extraordinary that in an entire 52 page Monetary Policy Statement there is not a word about any of these issues and options.  The Governor is right to highlight that we could soon face negative policy rates (as ANZ points, yesterday one of the government indexed bonds almost traded negative – real yield), but he is remiss not to be engaging the public, markets, MPs, and other affected parties (firms and households) on how best to think about handling such an eventuality. “Trust us, we know what we are doing” is a mentality that was supposed to be consigned to history decades ago, but bureaucrats  –  including ones with a poor track record of achievement – will hoard their little secrets and (it seems) ministers will cover for them.  Grant Robertson promised that the reformed Reserve Bank would be more open and accountable. There is little sign of it so far.

 

Mixed feelings, but the MPC really needs to improve its communications

I’m still not entirely sure what to make of yesterday’s OCR decision by the new Reserve Bank Monetary Policy Committee.

This was my first reaction yesterday afternoon.

If I have a problem, it isn’t with the OCR now being at 1 per cent.  At the time of the last OCR review in late June I was mildly critical of the Bank for not having cut the OCR then

Data have weakened here and abroad, inflation is – and has persistently been – below target, the exchange rate is holding up, and there is little real prospect of a sustained reacceleration of growth or of inflation pressures. Oh, and market measures of medium-term inflation expectations are around 1 per cent, not 2 per cent. In that climate, being a little pro-active and cutting the OCR now looks to have been the better choice. It isn’t clear what the risks to moving would have been. It is only six weeks until the next MPS, but (a) the MPC won’t have a lot more domestic information between now and then…and (b) the way the global situation is going one can’t rule out the possibility that another cut could have been warranted by then.

And so half of me is inclined to give the Bank some credit for catching up (I don’t think there is any sense in which they have now got ahead of the game).  It was certainly a fairly courageous call –  although whether that is more in the Sir Humphrey sense perhaps remains to be seen –  when the easier path would have been to have cut by 25 basis points yesterday and strongly signalled the likelihood of a 25 basis point cut in September.

And there was some rhetoric from the Governor at his press conference that I quite liked, including the reaffirmation of the effectiveness of monetary policy, the emphasis on the very low global nominal interest rate environment (which everyone just has to learn to work with) and a sense of being serious about getting core inflation back to 2 per cent, observing that there was worse things in the world to worry about than if the Bank were to look back 18 months from now and see inflation and inflation expectations rising.  In my words, after a decade of undershooting the target, you probably shouldn’t aim to overshoot, but the harm if you happen to is likely to be small.  I also liked the Governor’s affirmation of the point that cutting relatively energetically now may (probably slightly) reduce the risk of serious constraints on conventional monetary policy a bit down the track (by helping to hold inflation expectations up).

And yet conventions and communications matter.

50 basis point moves in interest rates used to be fairly normal (in our first ever tightening cycle. almost 20 years ago now. the OCR was raised by 50 basis points on three separate occasions).  But both here and abroad moving in 50 basis point bites went out of fashion (and I use the word deliberately –  it is a choice, on which not that much hangs, but it was one most advanced country central banks defaulted to).  In New Zealand, we had some very large individual OCR cuts during the international financial crises and recession of 2008/09 when not only was the hard economic and financial data deteriorating very rapidly, but bank funding margins were rising (so that OCR cuts were partly offsetting those incipient higher market rates).  And we cut the OCR by 50 basis points in the immediate wake of the February 2011 earthquake, explicitly as a pre-emptive precautionary strike against the possibility of a very sharp drop-off in confidence and economic activity –  explicitly noting that the cut was likely to be temporary.  And that was it. Until yesterday.  Even when Graeme Wheeler was setting out determined to raise the OCR by 200 basis points, he didn’t do so in 50 basis point bites.

As I noted the choices are partly about fashion and convention (including the choice –  pure choice –  to do things in multiples of 25 basis points: we and most advanced countries do that but in India yesterday they cut by 35 basis points).    Fashions and conventions can change, but roadmaps and markers to observers then take on a fresh importance.

And there were no signals whatever from the Bank that it was shifting to a mode of operating, and setting monetary policy, in which 50 basis point adjustment were back on the table in what are still relatively normal times (from a NZ macro perspective).    Perhaps it is tiresome to make the point again, but the Governor has given not a single substantive speech on monetary policy in the 17 months he has been in office.  No senior official of the Bank, including the new external MPC members, has given a speech this year, let alone in recent months, marking out how they think about the economy, about what is actually going on, about transmissions mechanisms, reaction functions etc, or even how they approach the more tactical issues around timing and magnitude of OCR adjustments.   That isn’t good enough, especially from a Bank which boasts –  as the Governor did yesterday (and wrongly) –  about how transparent the Bank is.

I recall that when the OCR system was introduced Adrian Orr –  then the Bank’s chief economist –  was vocally opposed to having, or using, OCR reviews other than those tied to the release of a Monetary Policy Statement.    I thought that approach was nuts (with 4 MPSs a year, even moving in 50 point bites it restricted us to 200 basis points of changes a year), and the original design (8 serious reviews a year) prevailed).  Is part of the explanation for yesterday’s surprise move –  and when no one picked your move, you should ask again just how transparent you are –  that the Governor still doesn’t like the idea of moving outside the context of a Monetary Policy Statement?    Perhaps not, but they have just not communicated with us, until they emerge with the surprise decree from the mountain-top.

And what makes it a bit more concerning is that it is pretty clear the Bank itself wasn’t intending to move by 50 basis points even a few days ago.  The projections they published yesterday were finalised on 1 August (last Thursday).   On those numbers, the projections for the OCR (quarterly average) were:

September quarter 2019    1.4 per cent

December quarter 2019     1.2 per cent

March quarter 2020            1.1 per cent

With the next OCR review in late September and the following one in md-November, those projections –  adopted by the whole MPC – clearly envisaged not getting to a 1 per cent OCR even by the end of the year.

The bulk of the Monetary Policy Statement itself is written in the same relatively relaxed style, with no hint of a change in policy approach, and thus no proper articulation of the reason for it, or (hence) for how we should think about how the Committee will react, in principle, at future OCR reviews.   The Bank has added to uncertainty around policy, not reduced it.    In a similar vein, there is a new two page Box A in the statement on “monetary policy strategy”, intended to run each quarter, which is so general as to add nothing to the state of understanding of what the MPC and the Bank are up to.

And you will look in vain for any real insight from the minutes of the MPC meeting.   We are told

The members debated the relative benefits of reducing the OCR by 25 basis points and communicating an easing bias, versus reducing the OCR by 50 basis points now. The Committee noted both options were consistent with the forward path in the projections. [a claim that demonstrably isn’t true –  see above] The Committee reached a consensus to cut the OCR by 50 basis points to 1.0 percent. They agreed that the larger initial monetary stimulus would best ensure the Committee continues to meet its inflation and employment objectives.

But nothing about the considerations Committee members took into account in belatedly lurching to a 50 point OCR cut, or how they think about the conventions and signalling around using 25 point moves vs 50 point moves (when things aren’t falling apart here –  and it was the Governor yesterday who announced, oddly, of New Zealand that “the country is in a great condition”).

The press conference also offered few insights into what the Bank was up to.   The external members weren’t invited to say anything, and showed no sign of offering to (at least some of them were there), and the staff MPC members the Governor did invite to comment were no more forthcoming or enlightening: they couldn’t or wouldn’t tell us what persuaded the Committee to move by 50 points, beyond handwaving about “the whole story, domestic and foreign”, even as the Assistant Governor noted that it was unwise to react too strongly to any particular piece of news (true, but……you seem to have).   And how seriously are we supposed to take the idea of “consensus” decisionmaking, when allegedly all seven of them suddenly shifted to a quite unexpected –  out of the mainstream – OCR call in just the last few days?

In the end perhaps none of it matters too much. On my reckoning, the OCR ends up where it probably should have been –  just less smoothly than it should have been –  and on the reckoning of some of the more dovish market commentators, it ends up now where they thought it would be next month.   The substance isn’t unduly affected.  But this episode won’t help the Reserve Bank’s reputation for being a steady pair of hands on the tiller.   Observers abroad will look at them oddly –  are things really that bad in New Zealand? –  those at home will be less sure how to read the Reserve Bank, and the Bank must have known it would feed fairly silly stories (from National that the 50 bps cut shows how bad things are, from Labour that the 50 bps cut shows what a great time it is to invest in New Zealand).  They really should do better than that.

If the Reserve Bank’s Board was actually interested in doing its job, rather than covering for their appointees (something of a conflict of interest surely?) they would be asking hard questions now about just what went on: why the Bank didn’t move in July, why they chose to act so unexpectedly yesterday, why they couldn’t have waited until September for the second 25, why the projections are so out of step with the decision, why the MPS itself gives little articulation of the case, and why serious speeches on the economy and monetary policy seem now not to be a thing at the Reserve Bank of New Zealand.   The Governor has an ambition for the Bank to be the best central bank.  On the evidence of yesterday they are very far from that (ridiculously unrealistic) objective.

I have various points on other aspects of the MPS and the press conference but will save them for a separate post.

Keep the focus on monetary policy

As we approach the OCR decision this afternoon and as some market economists are now talking about the possibility that the OCR could be below 1 per cent before too long, there has been more and more talk about whether fiscal policy should be brought to bear, to stimulate demand and (in some sense) assist monetary policy in its macroeconomic stabilisation role.  Just this morning there was an editorial in the Herald, a column on Stuff, and a comment from Bernard Hickey at Newsroom.   Some of the discussion is about what should be done now, and the rest is about contingency planning –  what happens when the next serious recession happens if the OCR is still constrained.

Much of the discussion seems to stem from people on the left who aren’t that happy with the government’s fiscal policy.  As someone not on the left, it has always seemed strange to me that Labour and the Greens pledged themselves to keep much the same size of government (and much the same debt) as National –  especially when, at the same time, you were running round the country talking about severe underspending on this, that, and the other thing.   I’m also of the view that structural budget surpluses are a bad thing, in principle, when net government debt is already acceptably low (on the OECD measure of net general government financial liabilities, New Zealand is now about 0 per cent of GDP, which seems like a nice round number – an anchor – to target).  There is an argument there –  whether from left or right – for some fiscal adjustment (taxes or spending), which might have the effect of a bit more of a boost to demand.

But those arguments really have almost nothing to do with the situation facing monetary policy.    They are fiscal and political arguments that should be made, and scrutinised, on their own merits: the arguments would be as good (or not) if the OCR was still 2.5 per cent as they are now, and you can be pretty sure that people on the left would have been making them then anyway?   The Governor of the Reserve Bank, for example, (a pretty staunch representative of the centre left) seemed keen on more infrastructure spending a year ago.  I guess he is a voter to so is entitled to his opinion, but it really doesn’t have much to do with monetary policy.

The general arguments that led countries around the world to adopt monetary policy more exclusively as the primary stabilisation policy tool have not changed.  Monetary policy can be adjusted quickly (to ease or tighten), operates pervasively (gets in all the cracks, without making specific distributional calls), is transparent, and so on.  If we had a fixed exchange rate –  as individual euro area countries largely do –  it would be a bit different (individual countries don’t have the monetary policy option any longer) but we have a floating exchange rate system which, mostly, works well for New Zealand.

To the extent that there is a monetary policy connection to the current calls for fiscal policy to be used (or the ground prepared to use it), it has to do with the looming floor on nominal interest rates.  International experience suggests that, on current laws and technologies, short-term nominal interest rates can’t be reduced below about -0.75 per cent without becoming ineffective (as more and more people shifted from other financial instruments into physical cash).  We don’t know quite where that floor is, as no central banks has been willing to take the risk of going further, but there is a fair degree of consensus (and it has long been my view too).

But that still means that in a New Zealand context there is 200 basis points of OCR cuts that could be used if required.    That isn’t enough for a typical New Zealand recession (rates have often been cut by 500bps), but is still quite a degree of leeway if what we are entering were to turn out to be a fairly mild slowdown in New Zealand.  It could (I’m not hedging here).   That capacity should be used energetically, not timorously.   So the issue –  monetary policy needing “mates” deployed now –  is not immediate.  It is about preparing the ground.

And there, the best macro stabilisation option remains the one the Reserve Bank –  and other central banks –  have done nothing active about, but really should.  Authorities (and it probably needs political support to do so) should be moving to make the effective floor on short-term nominal interest rates much less binding than it is.   It binds because the practice of central banks –  perhaps backed by law – has been to sell banknotes, in unlimited quantities, at par.   That practice can be changed.  It could be as simple as putting an (adjustable) cap on the volume of notes in circulation (quite a bit above the current level, but not at a level that would be transformative) and then, say, auctioning the right to buy additional tranches of bank notes from the Reserve Bank.  In normal times –  with the OCR at, say, current levels – the auction price would be at par.  If the OCR were cut to, say, -3 per cent (and be expected to stay there for some time) the auction price would move well above par, acting as a disincentive on people to attempt to make the switch from deposits to cash.  There is a variety of other ideas in the literature, as well (no doubt) as much less efficient regulatory interventions that could prevent really large-scale conversions happening.

Unusual as such options may sound, this is where the authorities –  here and abroad –  should really be concentrating their energies: giving monetary policy more leeway, in ways that will buttress market confidence that monetary policy will do the job when it is required.  At present, by contrast, when market participants contemplate a severe downturn they look into an abyss wondering what, if anything, will eventually be done, by whom, and for how long.  In a serious downturn that will just worsen the problem, driving down inflation expectations as economies slow (note that in the RB survey out yesterday, medium-term inflation expectations fell away quite noticeably –  and this while we still have conventional monetary policy to use).   And if there are objections that all this is somehow “unnatural”, bear in mind that had the inflation target been set at zero (rather than 2 per cent), as was the normal average inflation rate for centuries, we’d already have run into these practical limits, and been unable to get real interest rates even as low as they are now.

So there is plenty to be done with monetary policy, and the work programme to do it should be something open and active, drawing in the Bank, the Treasury, the Minister, and other interested parties.  The time to do preparation is now, not in the middle of a surprisingly severe downturn.

I have a few other reasons –  than “it shouldn’t be necessary” –  to be wary of calls for large scale fiscal stimulus now.  Just briefly:

  • there would be little agreement on what should be done –  these are inherently intensely political issues.  There is lots of talk of infrastructure gaps etc, but no agreement on what those are, let alone recognition of the twin facts that (a) the best projects, with the highest economic returns, have probably already been done, and (b) New Zealand government project evaluation is not such as to inspire confidence that new projects would add economic value.    And suppose there were attractive roading projects –  perhaps central Wellington and the second Mt Vic tunnel? – we know the attitude of the government’s support partner to new major roads.  Not a thing.  So what should we then spend on?  Uneconomic new railway lines?  Or what?  Perhaps some just favour more consumption or transfers spending – which might be fine if you are a lefty who believes in permanently bigger government, but if you aren’t the issue has to be addressed of how programmes once put in place are unwound later.
  • I don’t rule out the possible case for discretionary fiscal stimulus in the event of a new severe recession (especially if the authorities refuse to address the monetary policy issues above) but my prediction is that (in many ways fortunately) the political appetite for large deficits would not last very long, and that therefore we should preserve the option for when it might really be needed.  It isn’t now.   I take much of the rest of the world after 2008 as illustrations of my point: in late 2008 all the talk was of fiscal stimulus, but within two or three years all the political pressure was to pull deficits back again.  I don’t see why New Zealand would be any different (and that is to our credit, since low and stable debt has become established as a desirable baseline).
  • And thirdly, a point we don’t often hear from champions of more fiscal stimulus, relying more on fiscal policy and less on monetary policy to support economic activity and demand will, all else equal, put more upward pressure on the real exchange rate, further unbalancing an already severely-unbalanced economy (see yesterday’s long-term chart of the real exchange rate).  In a severe recession –  when the NZD tends to plummet –  that isn’t a particular problem, but it should be a worry now (when the TWI is still a bit higher than it was a year ago, let alone thinking about the longer-term imbalances.

Perhaps the Governor and the (experts-excluded) Monetary Policy Committee will proactively address some of these issues this afternoon. I do hope so. If not, I hope some journalists take the opportunity to push the Governor on why he (and the Minister and Treasury) aren’t actively pursuing work to make the lower bound on nominal interest rates much less binding, in turn instilling confidence in the capacity of New Zealand policy to cope conventionally with a severe downturn if/when it happens.

Oh, and I do hope some journalists might also ask the Governor this afternoon about the justification for ruling out from consideration for appointment to the Monetary Policy Committee

“any individuals who are engaged, or who are likely to engage in future, in active research on monetary policy or macroeconomics”

The Governor is, after all, a Board member and was one of the three person interview panel.    What was it that he –  or the Board generally –  were afraid of?    Expertise?  An independent cast of mind?  Of course, it isn’t only active researchers who have such qualities –  indeed, not all of them do either –  but it simply seems weird, and without precedent in serious central banks elsewhere in the advanced world, to simply disqualify from consideration for the (part-time) MPC anyone with the sort of background that many other central banks (Australia, the UK, the euro area, Sweden, the United States, and so on) have found useful, as one part of a diverse committee.

MPC appointments: prioritising sex over expertise

The lawlessness of the Board of the Reserve Bank of New Zealand never ceases to amaze me,  Just in recent years, there was clear evidence that the Board simply ignores the requirements of the Public Records Act.   There was their facilitation of what was almost certainly an unlawful appointment of an “acting Governor” in the run up to the election (decent outcome in the abstract, but unlawful nonetheless).   And, of course, they play fast and loose with the Official Information Act, apparently confident that the Ombudsman is largely toothless.  It is all the more extraordinary in that since 2013 the Bank’s Board has had a senior lawyer as a member.  I’d not paid much attention to him, not knowing anything about him, but when I finally met him last week –  where he told us he “trains judges” – it reignited my interest in just how a senior lawyer makes himself party to so much questionable –  borderline at least – conduct by a public agency.

We’ve seen a repeat of this sort of “the law doesn’t really apply to us” mentality around the release of papers relating to the appointment of the new statutory Monetary Policy Committee.  I wrote about that here.   I’d lodged requests with both the Minister of Finance and the Bank’s Board.  The Minister took a while to respond, but his responses were within timeframes allowed by law (a single extension of time, if that extension takes the deadline beyond the usual statutory 20 days).  The Board, on the other hand, extended, extended, and extended again –  quite unlawfully (Ombudsman advice makes that interpretation quite clear) –  before finally releasing some material a couple of weeks ago.      They did have a fairly junior person apologise for the delay, but that is pretty meaningless (no penalty on them –  even after I complained to the Ombudsman –  and no sense of any serious intention to amend their ways).   And yet these people – the Board –  are supposed to keep the Governor in check (and the government is now proposing to give them even more formal powers).

But this post is mostly about the substance of the MPC appointments.  There are two releases.  The Board’s response is here, and the Minister of Finance’s release is here.

Grant Robertson OIA release on MPC appointments

I know for a fact that neither release is comprehensive (including things I’ve been told privately, things alluded to in what has been released, and rather obvious omissions –  are we really supposed to believe that, eg, the Board chair did not brief the Board on his discussions with the Minister?) but what has been released does quite a lot to flesh out a picture of a process that doesn’t really seem to put anyone involved in a particularly good light.  There are even signs that the Board is taking the Public Records Act a bit more seriously than they did around the appointment of the Governor.   My earlier post on the new MPC is here: these releases answer some of the issues I raised there, mostly leaving me more concerned than I was previously.

One of my longstanding concerns about the new regime would be that it would largely replicate the dominance the Governor had in the old legislative model (where the Governor was, by law, the single decisionmaker).  Part of the reason for that concern was the statutory majority of internal members of the MPC.   All those internal members owe their day jobs to the Governor, who also decides on internal resource allocations, pay etc.  A really strong Governor might encourage diversity of perspective and challenge. There has never been any suggestion Adrian Orr is that sort of person, indeed rather the contrary.   And the external members are appointed on the Board’s recommendation, but…..the Governor himself is a member of the Board.  And instead of distancing himself from the process, and leaving recommendations to the non-executive directors, the Governor was one of the three man interview panel for the external MPC nominees.    Throw in the code of conduct the Board (Governor a member again) devised and clearly no one remotely awkward was going to get through the screening process.  (Consistent with that, in the four months since the MPC took office, not one of the externals has said a word – that might, in part, be because no media have asked them questions, but there is nothing to stop a more proactive approach.)

Consistent with all this, the Board released the set of questions they used for their interviews with potential MPC appointments.  There wasn’t much sign, from the questions, that the Board was looking for excellence (in anything), but there was certainly nothing in those questions to suggest they were looking for MPC members who robustly challenge, and offer markedly different perspectives over time to, the Governor and staff.

But it was much worse than that.  This is from a Treasury note to the Minister, released by the Minister (note that the Board itself kept this secret)

MPC 1

This is simply staggering, or should be in a country with good quality competent institutions.  And I know Treasury isn’t misinterpeting things, because I was told about this restriction some time ago by a person who was rejected on exactly these grounds –  that they might be interested and knowledgeable enough about monetary policy to be doing some research on it.   By this standard, I guess the Board and Minister (presumably aided and abetted by the Governor) would disqualify (a New Zealand) Ben Bernanke, Janet Yellen or (right now) John Williams, the head of the New York Fed and someone who –  while serving on the FOMC –  has continued to undertake research on monetary policy.   I realise that expertise is going out of the fashion at the ECB (Makhlouf, Lagarde) but their new Chief Economist –  former Irish Governor –  Philip Lane has been an active researcher and writer.  Or one could think of Andrew Haldane at the Bank of England, or….or….or.  Is it now considered a negative –  perhaps a disqualifying consideration  –  if the Reserve Bank’s chief economist was doing research on monetary policy, or does the disqualification only apply to externals, over whom the Governor has less control?  It almost beggars belief that the Minister and Board would get together and disqualify anyone with specific serious expertise in monetary policy from a new Monetary Policy Committee.   Sceptical as I was of the new committee in principle, even I was stunned when I learned of this prohibition.

(And, to be clear, I am not one of those who thinks an MPC should be stacked full of research macroeconomists –  I’d be happy to have a couple of people, of the sort who ask hard questions and have good judgement, with little or no formal economics background at all – just that such people shouldn’t be ruled out in advance.  As it is, the current MPC looks odd in that among its seven members there is not a single one who could really be considered to have a long record of depth of expertise in monetary policy and the New Zealand economy.)

So if the Board, the Governor, and the Minister weren’t looking for in-depth expertise, and weren’t looking for anyone to rock the boat, what were they looking for?   The short answer – suffusing both sets of releases – is women.     In none of the material released to me is there is any discussion about the sorts of expertise that might be sought, or how to build a committee with complementary sets of skills, but there is a great deal of unease –  particularly channelled from the Minister’s office –  about getting women selected (even to point, in some places, where there seemed to be attempts to strongly encourage the Governor to select a woman as his chief economist).  There are records of early approaches by the Board Secretary to get possible women (and Maori) candidates (and a Treasury response which points out that there really aren’t that many adequately qualified women –  not that surprising given how many women did (say) economics honours or masters programmes in New Zealand 30 years ago (in my own honours course at Victoria, the number was either one or zero out of about 15)).    As it is, despite all the huffing and puffing, they ended up with only one women on the shortlist.

There were a couple of other things that were striking.  The Board’s release records various email mentions of trying to identify candidates with legal backgrounds.  This is almost a complete mystery to me, as the MPC has no regulatory responsibilities and the legislation it operates under is pretty straightforward (and the Bank has internal and external legal advisers if things do require any clarification).  The MPC is about cyclical macroeconomics management, and communications thereon.  Someone of a particularly suspicious cast of mind might suggest that a legally-qualified MPC member would be one less knowledgeable person for the Governor to have to bother about.   I’m just genuinely puzzled.

The Board’s release also recorded various exchanges among senior Bank managers about what sort of person might be suitable as an external MPC appointee (they were looking for names to suggest to the Board).  What took me by surprise was the aversion to overseas appointees.  As regular readers know, I do not think we should have (say) a foreign Secretary to the Treasury (or a foreign Chief Justice, or a foreign Governor) but I was always among those at the Bank who saw one of the advantages of moving to a statutory MPC is that it could allow the appointment of one foreign person, bringing a slightly different expertise and perspective to New Zealand monetary policymaking.   It was never clear how feasible this would be –  distance, and relatively low New Zealand salaries being an obstacle –  but it has been tried, and appeared to work, in some other countries.

But that clearly wasn’t the view of the senior management last year.  The then Chief Economist, John McDermott (for example) is quoted as saying

“overseas members would be a logistical nightmare and what is their interest in looking after New Zealand welfare and monitoring the NZ business cycle on a continuous basis? So no from me.”

There is no sign of any of his colleagues or bosses dissenting and no reference to possible overseas appointees later in the any of the documents.  As it is, it isn’t clear how much “continuous monitoring” of the New Zealand economy the MPC members are actually doing (a recent conversation I was party to suggests not much in at least some cases).

Management also debated the issue of whether former RB staff or Board members should be considered (I suspect some might have liked to have Arthur Grimes appointed).  The consensus seems to be (reasonably enough) that there needs to enough distance for such a person to be genuinely external.  For groupies, one can try to guess which names are deleted in this paragraph

MPC 2

Disconcertingly, there are signs that management was open to have serving public servants appointed provided they didn’t currently work for agencies too close to things macro.  There should be an absolute prohibition on anyone working for a government department or Crown entity (other than as an academic) being considered for a part-time external MPC appointment in an (operationally independent) central bank.

The final point I wanted to touch on answered one of my questions from a few months ago.  Writing about the externals I noted

One area where I do have some concern is around the role of the Minister of Finance in these appointments.  In principle, I think the Minister should be relatively free to appoint his or her own preferred candidates, and should be fully accountable for those choices (including through the sort of non-binding “confirmation hearings” –  of the sort UK MPC members face – that I’ve proposed for New Zealand).  As it is, on paper the Minister has no say at all (can reject Board nominees, but nothing more).

But then I’m a bit troubled by the way in which the Board –  all but one appointed by the previous government – ended up delivering to the Minister for his rubber stamp a person who was formally a political adviser in Michael Cullen’s office when Cullen was Minister of Finance (Peter Harris) and another who appears to be right on with the government’s “wellbeing” programme.     They look a lot like the sort of people that a left-wing Minister of Finance –  one close to Michael Cullen –  might have ended up appointing directly.     I don’t think Peter Harris is grossly unqualifed for the role, but I am uneasy that one of the very first external appointees is a former political adviser to a former Minister of Finance of the same party as the one making the appointment.   …. (I don’t think former political advisers should be perpetually disqualified, but it might be more confidence-enhancing had they been appointed by the other party from the one for which they used to work –  thus Paul Dyer, former adviser in Bill English’s office, would probably be better qualified for the MPC roles than any of the recent external appointees.)

I’m left wondering what sort of behind-the-scenes dealings went on to secure these appointments.  I hope the answer is none.  I’d have no particular problem if, while the applications were open, the Minister had encouraged friends or allies to consider applying. I’d be much less comfortable if he had involvement beyond that, prior to actually receiving recommendations from the Board.  It isn’t that I disapprove of politicians making appointments, but by law these particular appointment are not ones the Minister is supposed to be able to influence.    So any backroom dealing is something it is then hard to hold him to account for.

The relevant provision of the Act says just this (buried in a schedule)

Appointment of internal and external members
The Minister must appoint the internal and external members on the recommendation of the Board.

It is very similar to the provision governing the appointment of the Governor.  That provision has been sold consistently as a model under which the Board puts forward a name, and the Minister can either accept or reject the person, but cannot interpose his own nominee.  If the Minister rejects the Board’s nominee, the Board has to go back and come up with another name.  The provision was explicitly intended to leave almost no discretion to the Minister.  (It isn’t a framework I approve of, but it is New Zealand law).

You will recall that in that earlier post I wondered quite how it was that the new MPC just happened to contained two obvious left-wing people, one a former political adviser in the office of a Labour Minister of Finance.  The material released to me answers that question pretty clearly.

I’d assumed that the Board had put up three names to the Minister and he had either accepted them all, or perhaps (though unlikely) had vetoed one name and the Board had then come up with another.   But that wasn’t what happened at all.  Instead, the documents disclose that the Board put up seven names to the Minister for the three external appointeee positions, not ranking or prioritising them at all, and giving the Minister complete leeway to choose any three of the seven.   Actually, they went further than that, in that the Board told the Minister that they had interviewed nine people, and listed the names of each of them, more or less inviting the Minister to suggest that if he didn’t like the seven names the Board recommended he could probably have one of the spare two (since it described all nine as “appointable”).

The documents also make clear that Caroline Saunders was the only woman on the shortlist (or certainly of the recommended seven).    Since Saunders has no background in macroeconomics or expertise in monetary policy, and given that strong focus in the documents on getting women nominees, it is unfortunately hard to avoid the suggestion that she was a “diversity hire” –  chosen for her sex rather than for the expertise she would bring to the MPC.  In the circumstances, how could the Minister not have chosen her?  One would hope it wasn’t so, but –  and this is problem with quasi-quotas –  it is impossible for us, or for her, to be confident that it wasn’t so.  Perhaps over time she will fully justify her selection on the substance, but at present there is no data either way.

Perhaps specialist lawyers will have a different interpretation, but I struggle to see how offering the Minister a list of seven – or even nine  – names and saying “choose any three” is the plain meaning and intention of the legislative text (would offering a list of 50 and saying “choose three” –  if so, the provision is gutted of any meaning and protection?).  The pool of potential MPC members really isn’t that deep in New Zealand and yet –  despite the fact that the law puts the onus on the Board –  we don’t even now know whether we have the best three external people on the MPC.  If this approach is lawful, it must be borderline at best.  (There was, for example, no sign of them adopting that approach to the internal MPC appointees –  there the Minister was given a list of two names for two vacancies, the approach envisaged in the law.)

My own preferrred model remains (the more internationally common) one in which the Minister of Finance is free to appoint whomever he or she prefers to the MPC.  I would complement that with non-binding confirmation hearings of the sort used in the UK.  Under that model, responsibility for the appointment rests clearly with the Minister of Finance, and there is scope for proper parliamentary scrutiny before people take up a powerful role.      Where this (brand new) legislation ended up is that the Minister can appoint his mates, within limits (but pretty broad limits) while pretending that the real choices were made by the Board.

In the end, after months –  not at all consistent with the spirit of the OIA let alone the letter – we did get a fair bit (by no means complete) of information offering insight on the MPC selection and appointment process.  Unfortunately that information tends to cast another shadow over the process, and suggests that the Board –  whose members have no real expertise in relevant areas –  continues to see its primary role as being to accommodate and humour the Governor and, now perhaps, to accommodate and humour the Minister, all behind closed doors.

And there is, of course, also the extraordinary secrecy as to how much these (possibly) second or third XI externals are being paid.  So much for openness and transparency.

 

 

Thoughts prompted by the OCR review

When I read yesterday’s OCR review release from the Reserve Bank, my first thought was actually about process.   This was the first interim –  ie between full Monetary Policy Statements – OCR review since the new Monetary Policy Committee took over responsibility.

The actual statement from the committee was about 175 words long.   It was accompanied by the summary record of the meeting (“the minutes”) that was about 530 words long.     That looks anomalous.   When there is a full MPS (with projections), the minutes are – in normal times –  not much more than a modest supplement.   But when there are no numbers and the press release itself is so short, the minutes are always likely to be the main event.    Given the way the Minister of Finance has chosen to set up the new system –  “minutes” released simultaneous with the policy decision (not done in plenty of other countries), and minutes not generally conveying individual views –  I wonder what the point is of having both statements on the occasion of interim OCR reviews.    There is nothing in the press release that couldn’t quite easily have been included in the minutes (almost all of it is there anyway) and having two documents just opens up risks of conflicting wording or differences of emphasis (in this case, the minutes are clearer on the likelihood of another cut than the statement is), for no obvious benefit.    It isn’t a big issue, but if I were in their shoes I’d be taking another look in the light of experience.    As it is, when one document has three times as many words as the other, the focus of attention is likely to fall on the longer fuller document.

Having said that, (with a sample of only two cases admittedly) experience is already confirming that the summary record of the meeting is really just a long-form version of the policy statement (whether the OCR review one, or the first page of the MPS).    I get that, for largely inexplicable (and unexplained) reasons, the Minister of Finance was keen on encouraging consensus decisions –  not an approach we take, for example, in the appellate courts, when individual judges are responsible for their own views and free to express them –  but the minutes we’ve so far really add nothing.   Take the possibility of an OCR cut yesterday.  This what they said, all of it.

The Committee discussed the merits of lowering the OCR at this meeting. However, the Committee reached a consensus to hold the OCR at 1.5 percent. They noted a lower OCR may be needed over time.

Wouldn’t a useful summary record have given some indication of the arguments members (perhaps only some) found persuasive in favour of a cut and the considerations that led them (by consensus) to conclude that it wasn’t an appropriate decision right now.  There is no sense of richness to the discussion, no insight into the thought processes or arguments or models being used, just nothing.       And this is early days, when presumably the Committee wants to put the best foot forward, to suggest real change, real gains in transparency.    It was predictable that the new-look committee would probably become little more than a slightly different front window for the Bank’s longstanding preference to tell us only what they think we need to know, only when they want to tell us.  It could have been different, even under the severe limitations of this legislation, but it would have been an uphill battle even with the right people  –  and there is now documentary evidence that several of the likely best people were simply excluded from consideration from the start. MPC members are free to speak publicly, but thus far none has.   It is a shame, but it is what I pointed out in my submission on the legislation last year, that the monetary policy reforms always appeared more cosmetic than real.

As for the actual OCR decision, I think it was the wrong decision (although I wouldn’t make too much of the point).  Data have weakened here and abroad, inflation is –  and has persistently been – below target, the exchange rate is holding up, and there is little real prospect of a sustained reacceleration of growth or of inflation pressures.  Oh, and market measures of medium-term inflation expectations are around 1 per cent, not 2 per cent.   In that climate, being a little pro-active and cutting the OCR now looks to have been the better choice.   It isn’t clear what the risks to moving would have been.   It is only six weeks until the next MPS, but (a) the MPC won’t have a lot more domestic information between now and then (eg the labour market data come out only 27 hours before the next release, and won’t be properly incorporated –  or in the projections at all) and (b) the way the global situation is going one can’t rule out the possibility that another cut could have been warranted by then.   Then again, markets strongly anticipate central banks.

Perhaps the saddest bit of the press release was this plaintive, orphaned, line

Inflation is expected to rise to the 2 percent mid-point of our target range,

The Bank has been saying this for years. December 2009 was the last time annual core inflation (on the Bank’s sectoral factor model was as high as 2 per cent).  There is no support offered for their view, either in the press statement or in the minutes, and no evidence even of any discussion to risks around the story.  I guess anything is possible, but it simply doesn’t seem the most likely story any longer.   The Bank’s former chief economist used to argue that they had to say this (that inflation was heading back to 2 per cent) because if they didn’t, it meant they should have been changing the OCR.  Well, quite.  But in these circumstances, the line should just have been quietly dropped –  or some more analysis/argumentation provided to support their beliefs.

Earlier in the week, the NZIER released their Shadow Board exercise, in which a group of economists and business people offer their advice, and their range of views, on where the OCR should be set (conditioned on the target the Bank is given).  I know various readers are dismissive of the exercise –  and it does appear to be limping on towards eventual termination, rather than helping shape the debate –  but I’ve always had a geeky interest in exercises like this, even while noting that the Shadow Board tends to adjust into line with the Reserve Bank, rather than providing much collective leadership or independence of perspective.  This was in evidence in the NZIER press release this week

NZIER’s Monetary Policy Shadow Board has adjusted their recommendation in the wake of the Reserve Bank’s OCR cut in May.

It is strange that experts would adjust their view of what the OCR should be just because the Reserve Bank –  with no monopoly on knowledge and huge margins for error –  changed its view.   But here were the individual views of the panellists.

shadow board 19

I’ve always been puzzled too by how anyone could be 100 per cent confident of their view of where the OCR should be.   When I was on the Reserve Bank’s OCR Advisory Group (a forerunner to the MPC), we introduced a survey of this sort, where each member’s advice to the Governor had to include a probability distribution (summing to 100 per cent) on what the OCR should be (eg 50% 1.5 per cent, 25% 1.25 per cent, 25% 1 per cent).  Being a bit stubborn, and reminded of the breadth of the historic confidence intervals in OCR forecasts, I always tried to discipline myself to spread my probabilities over perhaps six alternative OCR settings, with not too high a probability on the OCR I actually recommended.  Apart from anything else, it was a helpful prompt to think about what would invalidate my central view.   Most of these respondents don’t seem to do anything similar.  For what it is worth, my current distribution might look something like this

0.5 or less 5
0.75 10
1 20
1.25 35
1.5 17.5
1.75 7.5
2 or more 5

The most interesting view in the chart (setting aside how tightly bunched his views were) is that of former Reserve Bank chief economist Arthur Grimes, who indicated a 50 per cent probability that the OCR now should still be 1.75 per cent. In his comments he notes

Conditions imply no need to change the OCR right now, but that has to be balanced against the unnecessary (and unwise) cut to the OCR at the last decision. Hence it is a 50:50 call as to whether the cut should be restored or whether to leave the OCR as is.

It is an interesting stance, more “hawkish” (for example) than the (typically) most hawkish of the local banks (BNZ), and it is a shame no media seem to have asked Arthur to elaborate on his view.  He must hold it strongly –  the words are much more forceful than just the numbers would have been –  and it would be interesting to read his fuller reasoning.  After all, although my central view appears to be substantially different to his, the margins of error/uncertainty in this game are quite large enough that he could prove to be correct (my own probabilities – above –  overlap with his).     Perhaps it is just that Arthur is downplaying the target midpoint, even though it is highlighted in the target given to the committee, and in that case it is just a personal policy preference.  But if it is a genuine difference of model, of making sense of current or prospective economic or inflation developments, it would be interesting to see his reasoning.

But for me, the downside risks, and the asymmetric nature of the consequences of being wrong –  surprising high inflation means getting into the top half of the target range for the only time in more than a decade, while the approaching limits of conventional monetary policy mean that any further slippage in inflation expectations could really aggravate the next significant downturn, arguing for erring –  if it all –  on the side of a lower OCR.