Doomed to repeat history…..or not

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

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

Frankly, it all seemed a bit overwrought.

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

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

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

There are some weird claims.

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

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

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

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

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

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

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

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

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

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

policy rate to aug 08

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

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

policy rate to aug 09

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

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

Eaqub also takes the government to task

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

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

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

To which I’d make several points in response:

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

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

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

gross govt debt

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

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

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

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

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

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

psc to gdp

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

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

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

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

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

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

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

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

LVRs, interest rates and so on

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

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

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

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

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

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

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

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

I wondered if there were offsetting factors but:

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

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

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

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

 

Three Governors and monetary policy

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

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

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

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

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

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

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

targets and outcomes

There are several things to notice:

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

In terms of average deviations

Brash 0.5
Bollard 0.5
Wheeler 0.6

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

CPI ex G7

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

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

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

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

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

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

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

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

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

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

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

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

 

Consistent to the end…..sadly

Consistent to the end, the outgoing Governor of the Reserve Bank today both refused to accept that he’d made any mistakes, while refusing any comment at all on some of the more searching questions.

The news conference was on the occasion of the release of his statutory monetary policy accountability document, the Monetary Policy Statement.    It was the last opportunity journalists will get to question him.  And yet faced with questions about the Toplis affair (his use of public resources, including his senior managers, to attempt to close down critical commentary from an employee of an organisation the Bank regulates), he simply refused to comment.   I’m sure he is now feeling quite embattled and defensive, but surely it should be unacceptable for a powerful public official to simply refuse all comment on such a chilling example of abuse of executive office?   If he doesn’t think it is an abuse, and thinks somehow people shouldn’t be allowed to aggressively criticise him, he should at least have the decency to say so openly.   I hope members of Parliament use their opportunity this afternoon to ask questions on this matter, and to insist on answers.

The Governor also tried to avoid most questions about his term in office (but was happy to provide a long answer to a curious question about risks around North Korea, on which he has (a) no accountability, and (b) no more knowledge than the rest of us).  Apparently there is a speech coming –  which may be interesting, but it provides no opportunity for follow-up challenge or scrutiny.   Asked if his critics have been fair, and if at times their criticism may have clouded his judgement in decisionmaking, he claimed he will cover that in his speech.  If so, that should be interesting.      Asked also about:

  • what surprised him about the economy in the last five years,
  • about his inflation record in the last five years, and
  • what his successor should worry about

he refused to provide any answers, and simply referred everyone to the forthcoming speech.

One journalist finally voiced a widespread concern and asked if the Governor had been open enough with the media, noting that the Governor appeared not to have given a single live interview in five years.     The Governor claimed to have been pretty open, citing the press conferences he holds.  He also claimed that his colleagues do interviews, but simply never engaged with the fact that he personally is legally responsible for the exercise of a great deal of power –  not just monetary policy, but in regulatory policy areas –  and simply doesn’t face up, ever, to anything but soft-ball interviews.  A press conference, with 20 other media and where the Governor gets to decide whose questions to take when, is simply very different from a sustained searching interview –  whether on Morning Report or one of the TV current affairs shows.

Towards the end of the interview, the Governor seemed to change tack a little.  After repeated questions about his stewardship, he came out claiming that things have actually gone pretty well really over the last five years, and that the Reserve Bank deserves credit for that.   It was like a performance straight from the National Party advertising unit.  Growth had, we were told, averaged 3 per cent and there had been plenty of employment growth.  Even house price inflation was somehow claimed as to their credit (I think the fact that it is temporarily low in Auckland).   Oh, and core inflation averaging 1.5 per cent –  when he had explicitly accepted a task of keeping it around 2 per cent –  was also apparently just fine.    These results should, apparently, dispel any suggestion that, even with hindsight, monetary policy had on average been too tight.

He did acknowledge in passing that there hadn’t been much productivity growth –  which isn’t his fault –  but there was no mention at all of the weak per capita GDP growth (by comparison with earlier recoveries), no mention of an unemployment rate that has been above even the Bank’s too-high NAIRU estimate for eight years now, and no mention of a very high labour underutilisation rate.   And even on the inflation front, he seemed to want to blame all the problems on the rest of the world: low tradables inflation, as if a persistently high exchange rate had nothing to do with that.  He attempted to claim that non-tradables inflation (averaging around 2.2 per cent) had been just fine, when everyone recognises that getting core inflation near 2 per cent would have required non-tradables inflation rather nearer 3 per cent (which shouldn’t really have been hard amid a big building boom).  And non-tradables is what the Reserve Bank has the greatest degree of medium-term influence over.  If the Bank deserves credit for the last five years –  whether for style and communications, or for specific policy – it can only have done so relative to a particularly low benchmark.

Even now, said the Governor, he was quite comfortable with his decisionmaking in 2014 and 2015 –  when he unnecessarily raised the OCR by 100 basis points, and then was slow and reluctant to reverse those cuts.    I’m not sure what he thinks he gains by never ever conceding any mistakes.  He’s human surely.  We all make mistakes.

All in all it was a pretty disappointing, if not overly surprising, performance.  Whoever takes up the job of Governor next year will surely face a huge challenge, in shifting the organisational culture –  which must have been infected by Wheeler’s approach –  and lifting performance.

And all that was before even getting to the content of this Monetary Policy Statement.  

There was the odd good thing I noticed.  LUCI, the ill-fated Labour Utilisation Composite Index –  sold for a year or so as a measure of absolute tightness in the labour market, before they finally realised that it was mainly an indicator of changes in that tightness (a difference that matters quite a lot) –  seems to have quietly exited the stage.

But there were various more troubling points:

  • they were at pains to note that their estimate of the neutral OCR has carried on falling.   But, as in the chief economist’s speech a couple of weeks ago, there was no attempt to translate that into estimates of how neutral mortgage rates, or neutral deposit rates have changed.  As I noted then, widening spreads between the retail interest rates and the OCR suggest that if we take the Bank’s neutral OCR estimates seriously, their implicit estimates of neutral retail rates have been rising.   That seems seriously implausible.   It matters because the Bank keeps talking –  and forecasting –  on the basis that monetary policy is highly stimulatory. It almost certainly isn’t.
  • and although they did note that mortgage interest rates are higher than they were last year, there was no attempt anywhere in the document to explain why the Bank considers that monetary conditions need to be tighter now than they were last year (especially as growth and core inflation have been surprising on the low side).
  • it was quite surprising how upbeat they appeared to be on the global economy.  In fact, their upside scenario is one in which global inflation picks up quite a bit.   That migth have seemed a plausible possibility a few months ago, but with US inflation ebbing and no real signs of any increase in core inflation anywhere else, it looks (frankly) a little desperate.  Perhaps it is a reflection of the Governor’s continued conviction that global monetary policy is highly accommodative/stimulatory?   Were it actually so, one might have expected an increase in inflation before now.
  • the Bank seems focused on the idea that the labour market is almost at capacity.  Their projections have the unemployment rate levelling out at 4.5 per cent, suggesting that is their estimate of the NAIRU.  Between demographic factors on the one hand, and wage inflation outcomes on the other, that seems unlikely.

But perhaps my biggest puzzle is where all the forecast growth is coming from.

Over the next six quarters, the Bank projects that quarterly GDP growth will average just over 0.9 per cent. This chart shows six-quarter moving average of GDP growth (in turn, averaging the production and expenditure measures).

GDP growth qtrly

The orange dot shows the forecast for the next six quarters.  Their projections suggest that the economy will grow more rapidly over the next 18 months than it has managed on a sustained basis at any time in the current recovery.   You might not think that the difference looks large, but:

  • the Bank already recognises that monetary conditions are tighter than they were last year,
  • the Bank is forecasting a substantial reduction in the net migration inflow, and no one seriously doubts that unexpectedly rapid population growth has been the biggest single driver of headline GDP growth in recent years.  However much immigration adds to supply, it adds a lot to demand.

So why are we to expect a sustained growth acceleration from here?   Although it isn’t stated in the document, I hear that the Bank is invoking the expected fiscal stimulus (from promised measures announced in the Budget).  In isolation that might make some sense, but against the projected halving in the net migration inflow and the actual tightening in monetary conditions, it doesn’t really ring true.     If anything, the risk now has to be that over the next 18 months, headline GDP growth averages lower than we’ve seen in the last couple of years.

In many respects, the MPS is just another production in the long line of Reserve Bank documents that hold out the promise of higher medium-term inflation, but with little reason to expect it to happen.     But I was interested in one line in the policy section of the document. Often the Bank sounds quite complacent about non-tradables inflation, suggesting that everything is under control.  But this time they explicitly note that “a strong lift in non-tradables inflation is necessary for inflation to settle near the target midpoint in the medium-term”.   That, for central-bank-speak, is a pretty strong statement.    It might seem to argue for a more aggressive easing.

But they seem torn.  On the one hand, they go on to note that even “higher levels of growth may not be accompanied by significant increases in inflationary pressure”.   On the other, there is another strong statement about wage inflation: “increasing capacity pressure is likely to support wage growth in the near term“.    I guess that is quite a benchmark they’ve set for themselves –  and quite a surprising one after all these years of one-sided forecast errors.  If it doesn’t happen, and there seems little obvious reason why it should start now, I hope the Governor’s successors will be revisiting the stance of policy.

You might be wondering, so why not just cut the OCR and “give growth a chance”?  The Governor’s response to that is

an easing of policy, seeking to achieve a faster increase in inflation, would risk generating unnecessary volatility in the economy

I’m not quite sure what standards he is judging “unnecessary” by here?  It isn’t as if growth has ever been particularly rapid in this recovery (see chart above).  It isn’t as if unemployment has ever dropped, even temporarily, below the NAIRU.  It isn’t as if inflation has been surprising on the upside.  It isn’t as if productivity has been rocketing away.   It is as if the Bank is simply allergic to taking any steps that might possibly run a risk of (core) inflation going over 2 per cent, after all these years below.  In practice, it looks a lot like 2 per cent inflation represents a practical ceiling, rather than a target midpoint.

The Governor concluded his press release claiming that “monetary policy will remain accommodative for a considerable period”.  Fortunately, he will have no say in that matter.  Unfortunately, since we know neither who will be making the decisions, or what PTA they will be working towards –  recall that Labour, with the support of eminent economists like Lars Svensson, favour adding an explicit unemployment objective (to help make clear why we have active monetary policy in the first place) –  there isn’t really much information in that statement at all.   Much of the uncertainty is inevitable –  no one knows the future –  but quite a bit would be avoidable if we had a better statutory mechanism for Reserve Bank decisionmaking.

The search for the new Governor presumably goes on (the Reserve Bank Board would, on normal schedule be meeting next week).  Should the Opposition parties win power, I hope that one of their first actions (because time is pressing) will be a quick amendment to the Reserve Bank Act, to give the Minister of Finance the power almost all his overseas peers have, to appoint directly as Governor someone with whom he is comfortable, not someone the outgoing government’s Board delivers up to him.  In fact, it would be a sensible change whichever group of parties forms the next government.

 

 

Monetary policy, the Governor etc

In a post a couple of weeks ago I highlighted the extent to which monetary conditions appeared to have been tightening over the last few months, even as the OCR has been kept steady at 1.75 per cent.  Specifically, retail interest rates (lending and deposits) have increased, and the exchange rate has risen.  In addition, but less amenable to easy statistical representation, credit conditions have tightened, through some mix of Australian and New Zealand regulatory interventions and banks’ own reassessments of their willingness to lend.    Over this period there has been no acceleration in economic growth and inflation (whether goods or labour) hasn’t been increasing.  If anything, core measures of inflation –  already persistently below target –  have been falling away.

Yesterday the Reserve Bank released the results of the latest Survey of (business and economists’) Expectations.    The Reserve Bank has recently changed the survey, dropping a number of useful questions altogether, and missing the opportunity to plug some key gaps (eg there are no surveys in New Zealand of expected net migration).  They’ve also added some useful new questions, but for the time being are refusing to release the results of those questions –  including those around OCR expectations, house price expectations, and longer-term inflation expectations.

But one set of questions I was a little surprised that they left unchanged were those around monetary conditions.  I like the questions but it is a long time since I’ve seen anyone else write about the results.   Respondents are asked to indicate what their perception of current monetary conditions is (on a seven point scale, where four is neutral).  And then they are asked the same sort of question about expectations for the end of the following quarter and a year hence.

Broadly speaking, respondents tend to describe monetary conditions –  or at least changes in them –  as one might expect.   Here is the perception of current monetary conditions, dating back to the start of 1999 when the OCR was introduced.

mon condtions current

The peak in the series was right at the peak of the last OCR cycle, where the OCR was raised to 8.25 per cent.   Since then, although the Governor likes to describe monetary policy as extraordinarily accommodative, respondents have never thought that monetary conditions have been (or are) anywhere as easy as they were tight in 2007/08.  (When I completed the latest survey, I described current conditions as just a bit tighter than neutral.)

Note that latest observation.  Respondents reckon that monetary conditions have tightened.   The increase doesn’t look that large, and does come after a fall in the previous quarter.    But, the larger increases tend to occur either when the OCR is actually being raised, or when the Reserve Bank is talking hawkishly about the probable need for further OCR increases (thus, you can see the two big increases in 2014, when the Bank was in the midst of what it was talking of as 200 basis points of OCR increases).

But perhaps more interesting is that respondents also expect conditions to be quite a bit tighter by the end of the year, and again by the middle of next year –  and all that with no Reserve Bank encouragement at all.    And –  I would argue –  none from the underlying economic data either.

mon conditions ahead.png

The scale of the increase in the last few quarters is comparable in magnitude to the increase in 2013/14 when the Reserve Bank was talking up, and delivering, significant OCR increases.

Quite why respondents –  completing the survey in late July –  are expecting so much tighter is a bit of a puzzle.  But if it isn’t down to the Reserve Bank itself, or to the underlying economic/inflation data, perhaps it is reflecting trends respondents are observing –  the rising retail interest rates, high exchange rate and tightening credit conditions –  and that they are assuming that those things won’t reverse themselves, and may even intensify.

Personally, I think the case for somewhat easier monetary conditions is relatively clear at present: weak inflation, unemployment still above NAIRU, weak wage inflation, and a housing market that seems weaker than the toxic mix of land use restrictions and continued rapid population growth would warrant.  (To be clear, I’m not making a positive case for higher house prices inflation – though more housebuilding would be welcome –  just noting that the housing market is where, if overall conditions were about right (for the economy as a whole), we should be seeing continuing high inflation.)

Against that backdrop, I think it would be highly desirable for the Reserve Bank to make the point explicitly on Thursday that the economy has not needed, and does not now appear to need, tighter monetary conditions, and that some easing would be welcome and appropriate.    As I noted in the earlier post, I’m not sure it would really be appropriate for the Governor to cut the OCR –  given that (a) he hasn’t foreshadowed such a move, and (b) that this is his last OCR decision.    In a well-governed central bank –  such as almost every other advanced country has –  a change of Governor is less important: however influential the Governor’s views are, in the end he or she has only one vote in a largish committee.  All the other voters will still be there the next time an interest rate decision is made.

The problems here are compounded by the (a) the forthcoming election, so that no one knows what regime (what PTA) monetary policy will be being made under in future, (b) by the fact that we only have an acting Governor –  an illegal appointment at that – for the next six months, and people in acting roles are often loath to do anything they don’t strictly have to, and (c) by the lack of transparency in the Reserve Bank’s systems and processes.  When, say, Janet Yellen or Phil Lowe took up their roles as head of the respective central banks we knew a lot about how they thought about monetary policy.  Same goes for Mark Carney –  even though what we knew about him was from another country.    There is almost nothing on record as to how Grant Spencer these days thinks about monetary policy.  Even if he is to operate –  illegally –  under a (purported) PTA that is the same as at present, the PTA captures only a small amount of what is important to know: what matters as least as much is how the individual thinks about and reacts to incoming data.  With no speeches, no published minutes, no published record of the advice he has given the Governor on the OCR we know very little at all.

It is a model that badly needs fixing.  We simply shouldn’t be in a position where one person holds so much power, and hence their departure leaves such a vacuum (especially when, as will inevitably happen from time to time, such changes occur around election time).    We know that the Opposition parties are promising change –  roughly speaking in the right direction, although the details need a lot of work –  but what the National Party has in mind remains a mystery.   Treasury is refusing to release any of the versions of Iain Rennie’s report on central bank governance, claiming that the matter is under active consideration by the Minister of Finance.  That is a dodgy argument anyway –  since Rennie’s report to The Treasury is not the same as Treasury’s advice to the Minister (something I haven’t requested) –  but since they’ve had the final report for months now,  it shouldn’t be unreasonable to expect some steer from the Minister as to what his response might be.  As I’ve noted before, with the process of choosing a new Governor underway, at present neither candidates nor the Board have any real idea what a key aspect of the job might be.

The problems around “one man governance” aren’t restricted to monetary policy.   The Deputy Governor, Grant Spencer, gave a thoughtful speech the other day on “Banking Regulation: Where to from here?”.  But in a sense, the problem was in the title.  The Governor personally makes the policy decisions, and the Governor is leaving office next month.  Spencer will be minding the store –  illegally –  for a few months, and then retires early next year.  As we’ve seen in the past, the particular person who holds the role of Governor can make a big difference to the character and specific direction of regulatory policy –  LVR restrictions, for example, were (for good or ill) a legacy of Graeme Wheeler personally (and the earlier hands-off disclosure driven model, a legacy of Don Brash personally).  So in many respects it makes no more sense for Grant Spencer to be giving speeches on “where to from here” for bank regulation than it does for Steven Joyce to give such a speech on where to from here with tax policy.  In Joyce’s case, at least it is a campaign speech –  he hopes to still be in place next year, whereas Wheeler and Spencer will both be gone.  Neither they nor we know what their successors’ inclinations might be.

Again, that isn’t good enough.  We’ve personalised control of a major area of policy, when the general practice, here and abroad, is that when technocratic agencies exercise regulatory power they do so through boards that provide considerable continuity through time.  Individuals come and go, but they do so one at a time, and in a way that doesn’t dramatically change the balance of the board in the short-term.  That provides stability and predictability for both the institution itself, for those we are regulated (or indirectly but materially affected by regulation) and for those –  citizens –  with a stake in the agency.     We are well overdue for significant governance reforms to the Reserve Bank legislation.  And to say that is not to criticise the individuals –  Wheeler, or Spencer – who have to operate with the law as it stands it present, inadequate as it is.   The responsibility for the inadequate legislation  –  the iunadequacies of which have been brought into sharper relief in the last few years –  rests with ministers and with Parliament.

In closing, I do hope that when journalists get to question the Governor, and when later in the day FEC members get the same opportunity, they will not overlook the egregious and inexusable behaviour –  not sanctioned by any legislation –  by the Governor, his deputies, Geoff Bascand and Grant Spencer, and his assistant John McDermott –  in attempting to silence Stephen Toplis when they disagreed with some mix of the tone or content of his commentaries on them.     The intolerance of dissent, and the abuse of office, on display then aren’t things that can simply be let go silently by.   I’m as appalled as anyone by the lack of contrition Metiria Turei has displayed over her acknowledged past benefit fraud.  But bad as that is, abuse of high office by senior incumbents is, in many respects, a rather more serious threat.  Our elites seem to have become all too ready to do hardly even the bare minimum to call out, and expose, unacceptable behaviour by the powerful.  Here, we’ve seen no contrition, we’ve seen a Treasury advising the Minister to ignore the behavour, and a Minister of Finance –  legally responsible for the Governor –  happy to walk by on the other side, saying it is nothing to do with him.

(It was nonetheless interesting to read the BNZ’s preview pieces for this week’s MPS.  Perhaps they were just chastened by the data having not gone their way, or perhaps the heavy-handed pressure from the Governor really did work, because the tone (and spirit) of these latest commentaries is very different from what we saw –  and what so riled the Governor  –  in May.   Personally, I thought –  and think –  that the Governor’s May monetary policy stance was more appropriate than the BNZ’s, but that isn’t the point.  Our system is supposed to thrive on vigorous debate, and one isn’t supposed to lose the right to challenge the powerful just because in this case the Governor happens to regulate the organisation employing the critic.)

 

 

 

A radical alternative to macro policy?

Last Friday, an outfit called Strategy2040 New Zealand, together with Victoria University’s School of Government, hosted a lunchtime address by an Australian academic, Professor Bill Mitchell of the University of Newcastle.   He is a proponent of something calling itself Modern Monetary Theory, but which is perhaps better thought of as old-school fiscal practice, with rhetoric and work schemes thrown into the mix.

Mitchell attracted some interest on his trip to New Zealand.  He apparently did two substantial interviews on Radio New Zealand and attracted perhaps 150 people to the lunchtime address –  a pretty left-liberal crowd mostly, to judge from the murmurs of approval each time he inveighed against the “neo-liberals”.    In fact, the presence of former Prime Minister Jim Bolger was noted –  he who, without apparently recanting any specific reforms his government had put in place, now believes that “neo-liberalism has failed New Zealand”.     Following the open lecture, 20 or so invitees (academics, journalists and economists –  mostly of a fairly leftish persuasion) joined Mitchell for a roundtable discussion of his ideas.   Perhaps a little surprisingly, I didn’t recognise anyone from The Treasury or the Reserve Bank at either event.

Mitchell has it in for mainstream academic economics.   Quite probably there is something in what he says about that.  Between the sort of internal incentives (“groupthink”) that shape any discipline, and the inevitable simplifications that teaching and textbooks require, it seems highly likely there is room for improvement.   If textbooks are, for example, really still teaching the money multiplier as the dominant approach to money, so much the worse for them.   But as I pointed out to him, that was his problem (as an academic working among academics): I wasn’t aware of any floating exchange rate central banks that worked on any basis other than that, for the banking system as a whole, credit and deposits are created simultaneously.  He quoted the Bank of England to that effect: I matched him with the Reserve Bank of New Zealand.    And if very few people correctly diagnosed what was going on just prior to the financial crises in some countries in 2008/09, that should be a little troubling.  But it doesn’t shed much (any, I would argue) light on the best regular approach to macroeconomic management and cyclical stabilisation.  Perhaps especially so as (to us) he was talking about policy in Australia and New Zealand, and neither country had a US-style financial crisis.

He seemed to regard his key insight as being that in an economy with a fiat currency, there is no technical limit to how much governments can spend.  They can simply print (or –  since he doesn’t like that word – create) the money, by spending funded from Reserve Bank credit.     But he isn’t as crazy as that might sound. He isn’t, for example, a Social Crediter.    First, he is obviously technically correct –  it is simply the flipside of the line you hear all the time from conventional economists, that a government with a fiat currency need never default on its domestic currency debt.     And he isn’t arguing for a world of no taxes and all money-creating spending.  In fact, with his political cards on the table, I’m pretty sure he’d be arguing for higher taxes than New Zealand or Australia currently have (but quite a lot more spending).  Taxes make space for the spending priorities (claims over real resources) of politicians.  And he isn ‘t even arguing for a much higher inflation rate –  although I doubt he ever have signed up for a 2 per cent inflation target in the first place.

In listening to him, and challenging him in the course of the roundtable discussion, it seemed that what his argument boiled down to was two things:

  • monetary policy isn’t a very effective tool, and fiscal policy should be favoured as a stabilisation policy lever,
  • that involuntary unemployment (or indeed underemployment) is a societal scandal, that can quite readily be fixed through some combination of the general (increased aggregate demand), and the specific (a government job guarantee programme).

Views about monetary policy come and go.   As he notes, in much academic thinking for much of the post-war period, a big role was seen for fiscal policy in cyclical stabilisation.  It was never anywhere near that dominant in practice –  check out the use of credit restrictions or (in New Zealand) playing around with exchange controls or import licenses –  but in the literature it was once very important, and then passed almost completely out of fashion.  For the last 30+ years, monetary policy has been seen as most appropriate, and effective, cyclical stabilisation tool.  And one could, and did, note that in the Great Depression it was monetary action –  devaluing or going off gold, often rather belatedly – that was critical to various countries’ economic revivals.

In many countries, the 2008/09 recession challenged the exclusive assignment of stabilisation responsibilities to monetary policy.  It did so for a simple reason –  conventional monetary policy largely ran out of room in most countries when policy interest rates got to around zero.   Some see a big role for quantitative easing in such a world.  Like Mitchell – although for different reasons –  I doubt that.    Standard theory allows for a possible, perhaps quite large, role for stimulatory fiscal policy when interest rates can’t be cut any further.

But, of course, in neither New Zealand nor Australia did interest rates get anywhere near zero in the 2008/09 period, and they haven’t done so since.    Monetary policy could have been  –  could be –  used more aggressively, but wasn’t.

As exhibit A in his argument for a much more aggresive use of fiscal policy was the Kevin Rudd stimulus packages put in place in Australia in 2008/09.   According to Mitchell, this was why New Zealand had a nasty damaging recession and Australia didn’t.  Perhaps he just didn’t have time to elaborate, but citing the Australian Treasury as evidence of the vital importance of fiscal policy –  when they were the key advocates of the policy –  isn’t very convincing.   And I’ve illustrated previously how, by chance more than anything else, New Zealand and Australian fiscal policies were reamrkably similar during that period.   And although unemployment is one of his key concerns –  in many respects rightly I think –  he never mentioned that Australia’s unemployment rate rose quite considerably during the 2008/09 episode (in which Australian national income fell quite considerably, even if the volume of stuff produced –  GDP –  didn’t).

On the basis of what he presented on Friday, it is difficult to tell how different macro policy would look in either country if he was given charge.   He didn’t say so, but the logic of what he said would be to remove operational autonomy from the Reserve Bank, and have macroeconomic stabilisation policy conducted by the Minister of Finance, using whichever tools looked best at the time.  As a model it isn’t without precedent –  it is more or less how New Zealand, Australia, the UK (and various other countries) operated in the 1950s and 1960s.  It isn’t necessarily disastrous either.  But in many ways, it also isn’t terribly radical either.

Mitchell claimed to be committed to keeping inflation in check, and only wanting to use fiscal policy to boost demand where there are underemployed resources.    And he was quite explicit that the full employment he was talking about wasn’t necessarily a world of zero (private) unemployment  –  he said it might be 2 per cent unemployment, or even 4 per cent unemployment.     He sees a tight nexus between unemployment and inflation, at least under the current system  (at one point he argued that monetary policy had played little or no role in getting inflation down in the 1980s and 1990s, it was all down the unemployment.  I bit my tongue and forebore from asking “and who do you think it was that generated the unemployment?” –  sure some of it was about microeconomic resource reallocation and restructuring, but much it was about monetary policy).   But as I noted, in the both the 1990s growth phase and the 2000s growth phase, inflation had begun to pick up quite a bit, and by late in the 2000s boom, fiscal policy was being run in a quite expansionary way.

I came away from his presentation with a sense that he has a burning passion for people to have jobs when they want them, and a recognition that involuntary unemployment can be a searing and soul-destroying experience (as well as corroding human capital).  And, as he sees things, all too many of the political and elites don’t share  that view –  perhaps don’t even care much.

In that respect, I largely share his view.

Nonetheless, it was all a bit puzzling.  On the one hand, he stressed how important it was that people have the dignity of work, and that children grow up seeing parents getting up and going out to work.   But then, when he talked about New Zealand and Australia, he talked about labour underutilisation rates (unemployment rate plus people wanting more work, or people wanting a job but not quite meeting the narrow definition of actively seeking and available now to start work).   That rate for New Zealand at present is apparently 12.7 per cent –  Australia’s is higher again.     Those should be, constantly, sobering numbers: one in eight people.      But some of them are people who are already working –  part-time –  but would like more hours.  That isn’t a great situation, but it is very different from having no role, no job, at all.  And many of the unemployed haven’t been unemployed for very long.  As even Mitchell noted, in a market economy, some people will always be between jobs, and not too bothered by the fact.  Others will have been out of work for months, or even years.   But in New Zealand those numbers are relatively small: only around a quarter of the people captured as unemployed in the HLFS have been out of work for more than six months (that is around 1.5 per cent of the labour force).       We should never trivialise the difficulties of someone on a modest income being out of work for even a few months, but it is a very different thing from someone who has simply never had paid employment.  In our sort of country, if that was one’s worry one might look first to problems with the design of the welfare system.

Mitchell’s solution seemed to have two (related) strands:

  • more real purchases of good and services by government, increasing demand more generally.  He argues that fiscal policy offers a much more certain demand effect than monetary policy, and to the extent that is true it applies only when the government is purchasing directly (the effects of transfers or tax changes are no more certain than the effects of changing interest rates), and
  • a job guarantee.    Under the job guarantee, every working age adult would be entitled to full-time work, at a minimum wage (or sometimes, a living wage) doing “work of public benefit”.     I want to focus on this aspect of what he is talking about.

It might sound good, but the more one thinks about it the more deeply wrongheaded it seems.

One senior official present in the discussions attempted to argue that New Zealand was so close to full employment that there would be almost no takers for such an offer.   That seems simply seriously wrong.    Not only do we have 5 per cent of the labour force officially unemployed, but we have many others in the “underutilisation category”, all of whom would presumably welcome more money.     Perhaps there are a few malingerers among them, but the minimum wage –  let alone “the living wage” – is well above standard welfare benefit rates.   There would be plenty of takers.   (In fact, under some conceptions of the job guarantee, the guaranteed work would apparently replace income support from the current welfare system.)

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

The motivation seems good, perhaps even noble.  I find quite deeply troubling the apparent indifference of policymakers to the inability of too many people to get work.   The idea of the dignity of work is real, and so too is the way in which people use starting jobs to establish a track record in the labour market, enabling them to move onto better jobs.

But do we really need all the infrastructure of a job guarantee scheme?  In countries where interest rates are still well above zero, give monetary policy more of a chance, and use it more aggressively.   For all his scepticism about monetary policy, it was noticeable that in Mitchell’s talks he gave very little (or no) weight to the expansionary possibilities of exchange rate.    But in a small open economy, a lower exchange rate is, over time, a significant source of boost to demand, activity, and employment.    And winding back high minimum wage rates for people starting out might also be a step in the right direction.

And curiously, when he was pushed Mitchell talked in terms of fiscal deficits averaging around 2 per cent of GDP.  I don’t see the case in New Zealand –  where monetary policy still has capacity –  but equally I couldn’t get too excited about average deficits at that level (in an economy with nominal GDP growth averaging perhaps 4 per cent).  Then again, it simply can’t be the answer either.    Most OECD countries –  including the UK, US and Australia –  have been running deficits at least that large for some time.

It is interesting to ponder why there has been such reluctance to use fiscal policy more aggressively in countries near the zero bound.   Some of it probably is the point Mitchell touches on –  a false belief that somehow countries were near to exhausting technical limits of what they could spend/borrow.      But much of it was probably also some mix of bad forecasts –  advisers who kept believing demand would rebound more strongly than it would –  and questionable assertions from central bankers about eg the potency of QE.

But I suspect it is rather more than that –  issues that Mitchell simply didn’t grapple with.  For example, even if there is a place for more government spending on goods and services in some severe recessions, how do we (citizens) rein in that enthusiasm once the tough times pass?  And perhaps I might support the government spending on my projects, but not on yours.  And perhaps confidence in Western governments has drifted so low that big fiscal programmes are just seen to open up avenues for corruption and incompetent execution, corporate welfare and more opportunities for politicians once they leave public life.  Perhaps too, publics just don’t believe the story, and would (a) vote to reverse such policies, and (b) would save themselves, in a way that might largely offset the effects of increased spending.      They are all real world considerations that reform advocates need to grapple with –  it isn’t enough to simply assert (correctly) that a government with its own currency can never run out of money.

I don’t have much doubt that in the right circumstances expansionary fiscal policy can make a real difference: see, for example, the experience of countries like ours during World War Two.    A shared enemy, a fight for survival, and a willingness to subsume differences for a time makes a great deal of difference –  even if, in many respects, it comes at longer term costs.

But unlike Mitchell, I still think monetary policy is, and should be, better placed to do the cyclical stabilisation role.    That makes it vital that policymakers finally take steps to deal with the near-zero lower bound soon, or we will be left in the next recession with (a) no real options but fiscal policy, and (b) lots of real world constraints on the use of fiscal policy.  Like Mitchell, I think involuntary unemployment (or underemployment for that matter) is something that gets too little attention –  commands too little empathy –  from those holding the commanding heights of our system.  But I suspect that some mix of a more aggressive use of monetary policy, and welfare and labour market reforms that make it easier for people to get into work in the private economy,  are the rather better way to start tackling the issue.   How we can, or why we would, be content with one in twenty of our fellow citizens being unable to get work, despite actively looking –  or why we are relaxed that so many more, not meeting those narrow definitions, can’t get the volume of work they’d like  –  is beyond me.   Work is the path to a whole bunch of better family and social outcomes –  one reason I’m so opposed to UBI schemes –  and against that backdrop the indifference to the plight of the unemployed (or underemployed), largely across the political spectrum, is pretty deeply troubling.

But, whatever the rightness of his passion, I’m pretty sure Mitchell’s prescription isn’t the answer.

 

 

 

Uncle Philip comes to visit

I wasn’t really planning a post today.  I’m in the middle of preparing a speech/presentation on the Reserve Bank and the housing market (working title “Intervening without understanding”).     But the Reserve Bank yesterday released some (a) comments on their forecasting review process and some aspects of monetary policy, prepared by a former BIS economist, and (b) the Bank’s spin on those comments.  Various people got in touch to say that they were looking forward to my reaction.

When an old uncle or family friend is in town and comes for dinner, the visitor will usually compliment the cook, praise the kids’ efforts on the piano, the sportsfield, or in dinner table conversation, and pass over in silence any tensions or problems –  even burnt meals –  he or she happens to observe.    Mostly, it is the way society works.  No one takes the specific words too seriously –  they are social conventions as much as anything.  One certainly wouldn’t want to cite them as evidence of anything much else than an ongoing, mutually beneficial relationship.

Philip Turner is a British economist who has recently retired from a reasonably senior position at the Bank for International Settlements.  The BIS is a club for central banks, and a body that has been champing at the bit for much of the last decade, encouraging central banks to get on and raise interest rates again.    Turner himself spent his working life in international organisations –  before the BIS he spent years at the OECD, where he developed a relationship with Graeme Wheeler (who was The Treasury’s representative at the OECD for six years or so).  He has never actually been a central banker, or involved in national policymaking.

Back in 2014, Graeme asked Turner to review the Reserve Bank’s formal structural model of the economy (NZSIM).   I didn’t have much to do with him on his visit then, but my impression (perhaps wrongly) was of someone now more avuncular than incisive (albeit with the odd interesting angle).   Having left the BIS last year, the Governor invited him back to New Zealand earlier this year, during which he sat through, and offered some thoughts on, the three-day series of forecast review meetings the Bank undertakes in the lead-up to each Monetary Policy Statement.  

There is nothing particularly unusual about that.  Perhaps twice a year the Bank has someone in who does something similar –  often a visiting academic or foreign central banker who was going to be in Wellington anyway.  It is an interesting experience for the visitor –  I will always remember the time Glenn Stevens (subsequently the RBA Governor) participated, and came out declaring that he now realised we were much less mechanistic than we seemed –  and usually there is the warm fuzzy feeling of mutual regard.  The visitors – friends of the Reserve Bank to start with –  get closer to the monetary policy process than is typically permitted in other central banks, and they are usually suitably appreciative.   Their reports, typically passed on to the Board, typically convey the sense of how good the process is, but sometimes there are even quite useful specific suggestions.    I’m not aware that such reports have ever previously been made public –  and I suspect that had someone asked for them under the Official Information Act, the Bank would have been as obstructive as ever.   Perhaps Turner’s report was particularly generous, perhaps the Governor was feeling particularly beleagured –  eg after the Toplis censorship attempts – but for whatever reason they have both released his report, and attempted to spin it well beyond what it warrants.

Actually, for those not familiar with the Reserve Bank’s internal process, the report may be of mild interest.   The description of the three days of meetings Turner sat through rang true –  and was interesting to me because it suggested things are still much as they were when I was last involved 2.5 years ago.  It will complement some of the other material the Bank itself has released on its processes.

In its press release, the Reserve Bank claims that Turner “commended the Reserve Bank’s forecasting and monetary policy decision-making processes”.  In fact, he did nothing of the sort.   He had no involvement in observing the preparation of the draft forecasts (the background work undertaken by the staff economists), he was not apparently invited to observe the Governing Committee discussions where the Governor makes his final OCR decision, and he engaged in no attempt to assess the Bank’s track record in forecasting or policy.  That isn’t a criticism of Turner.  He wasn’t asked to do those things.  Instead, he will have been handed a binder of background papers, and sat through perhaps 8 to 10 hours of meetings where those papers are discussed and issues around them identified.

That said, there is no doubt he is effusively positive about that process.

This process, which takes advantage of the small size of the central bank, avoids a problem that affects many other institutions. This is that unpopular or unorthodox opinions can get filtered out by successive levels in the hierarchy, as it is only more senior staff who make the presentations to Governors……

The open working-level culture is a credit to the RBNZ. Junior staff are given their voice. Views or arguments expressed by colleagues are challenged in a constructive and professional way. This is essential if the policy blind spots of a few individuals are to be avoided.

In my (rather long) experience there was an element of truth to all this.  The Bank is unusual in having very junior staff presenting directly to Governors.  That is generally good for them, and sometimes works well.  Then again, the Bank is a small organisation.  But it often involves people with quite limited experience or perspectives who can be quickly at sea when taken just slightly off their own safe ground or the established “model”.   It is an operational model that has some strengths, in staff development, but strongly prioritises (by default –  it is usually what 22 year old economists can do) fluent updates on the status quo.

There was also typically plenty of opportunity for people to chip in with unthreatening questions or clarifications.

But as for unpopular or unorthodox views being welcomed and heard……..

Perhaps things have changed a lot for the better in the last 2.5 years,  but it hadn’t been my impression of the Bank’s processes for quite some considerable time.   I largely stay clear of Reserve Bank people these days  (for their sake as much as anything) but nothing I hear through others suggests that the institutional culture has improved.  And how likely is it when the Governor is so outraged by external critical comments that he enlists each of his top managers to try to shut Stephen Toplis up, and when that fails he tries heavy-handed approaches to the CEO of the BNZ, a body the Governor himself regulates?  Whatever Turner’s (no-doubt genuine impressions) of the meetings he sat through, I suspect he saw what he wanted to see.      He formed a good impression of the Bank decades ago, his friend Graeme is now the boss and invites him over for a spot of post-retirement consulting, and when everything is presented as rosy, everyone is happy.

As a reminder, the Governor is so scared of diversity of view that he refuses to release –  even years after the event –  background papers, the balance of the advice he receives on particular OCR decisions, or the minutes of Governing Committee meetings.  But apparently Uncle Philip says all is good, and that should really be enough for us.

Turner saw what he thought he saw in the meetings he sat through.  Then again, he will have little or no familiarity with the New Zealand data, issues, or context.

And on that count what was perhaps more surprising was the rather strongly-worded declarations he offered on monetary policy (substance not decisionmaking process) in New Zealand in recent years.    One might suppose that such conclusions –  not just offered in passing over a drink, but now as an officially-authorised publication of the Reserve Bank – might require engaging with the data, with the details of the Bank’s mandate, with alternative perspectives, and so on.  But there is no evidence of any of that.

What specifically bothers me?  Well, for a start there is no mention of the fact that the Reserve Bank of New Zealand is unique in having run two quickly-aborted tightening cycles since the end of the 2008/09 recessions.  Then again, as I noted earlier, the BIS has long looked rather askance at low global interest rates, and has been keen –  with no mandate whatever –  to have advanced country interest rates raised again.  So was the Governor –  who keeps talking about how extraordinarily stimulatory monetary policy is.  But as an experiment, raising interest rates didn’t work out that well here.  And, at bottom, however good the process looked, the substance of the forecasts was repeatedly wrong.

Turner also gets into selective quotation of the Policy Targets Agrement.  He argues that

Clause 4(b) adds further that “the Bank shall implement monetary policy in a sustainable, consistent and transparent manner, have regard to the efficiency and soundness of the financial system, and seek to avoid unnecessary instability in output, interest rates and the exchange rate”. I have italicised these words because they describe a mandate that is realistic about what monetary policy can achieve. This mandate would not have been fulfilled in recent years, given the large shocks to international prices, by trying to keep the year-on-year inflation rate in New Zealand at close to 2 percent. To have achieved this, interest rates would have had to move by more than they have in recent years, and this would have created the unnecessary instability in output and the exchange rate that the RBNZ is enjoined to avoid.

Of course, no one has ever argued that headline CPI inflation should be kept at 2 per cent each and every year, so to that extent he is addressing a straw man.   Perhaps, charitably, he means keeping core inflation near target, something the Bank has failed to do for years.    But even then Turner omits a key phrase: the Bank is asked to avoid ‘unnecessary instability”, but only “in pursuing its price stability objective”.  The inflation target is paramount, and “unnecessary” variability here is clearly intended to  be distinguished from the necessary variability required to achieve the inflation target.    It isn’t an independent goal in its own right.

In fact, the whole of Turner’s quotation is pretty extraordinary once one remembers that this was the same Bank that marched the OCR  up the hill in 2014, only to have to smartly march it back down again in 2015 and 2016.  If that wasn’t “unnecessary variability” it is hard to know what would have been.  And quite what leads Turner to think that a stronger economy, getting inflation back to target, would have led to “unnecessary variability” in output –  when per capita growth (and even total GDP growth) has been anaemic by the standards of past cycles – is beyond me.  But no doubt Graeme and his acolytes told Philip so.

In his conclusion, Turner observes

The main conclusion is that the monetary policy process at the Reserve Bank of New Zealand works well. This is hardly a surprise given the RBNZ’s distinction as a pioneer in much of modern central banking (e.g. the inflation-targeting framework, the careful attention given to an accountability regime for the central bank that actually works) and given its high standing today among its central banking peers.

As I said, he seems to have formed a favourable impression of the Reserve Bank 25 years ago, and at this late stage isn’t minded to reassess.    If the Reserve Bank of New Zealand is still highly regarded among its “central banking peers” –  which frankly I doubt –  it can only mostly be because of that historical memory, of the pioneering days when –  for better and worse –  the Reserve Bank was genuinely innovative in monetary policy institutional design and banking regulation reform.  Frankly, I doubt many overseas central bankers pay much attention to New Zealand economic data, or to the publications and speeches of our central bank.  Why would they?  And no doubt Graeme is fluent enough when he turns up at BIS meetings.      Perhaps the biggest clue to what is wrong with that paragraph is the idea that we have “an accountability regime that actually works”.  No one close to it thinks so (however good it looked on paper 25 years ago).

Turner’s final paragraph is as follows

A final remark, in conclusion. Results over the past few years speak for themselves. The RBNZ has helped steer its economy through several large external shocks. Because it has done so without becoming trapped at a zero policy rate and without multiplying the size of its balance sheet by buying domestic assets, it has retained more room to pursue, if needed, a more expansionary monetary policy than is available at present to many central banks of other advanced economies.

This is simply almost incomprehensibly bad.     Inflation has been well below target, even in a climate of no productivity growth and lingering high unemployment.  If New Zealand isn’t “trapped” by the zero bound, it is entirely because we’ve persistently had neutral interest rates so much higher than those almost anywhere else –  which is neither to the credit nor the blame of the Reserve Bank –  and so were able (belatedly) to cut interest rates more than almost anyone else.  Because neutral interest rates are still, apparently, materially higher than those elsewhere, the Reserve Bank does have a bit more policy leeway than most other central banks when the next recession hits.  But, contra Turner, it is no cause for complacency –  no advanced country has enough room now –  and no credit to the Reserve Bank.

It is a shame the Reserve Bank is reduced to publishing, and touting, a report like this in its own defence.  When good old Uncle Philip, a fan of yours for years, swings by, it must be mutally affirming to chat and exchange warm reassuring thoughts.  But as evidence for the defence his rather thin thoughts, reflecting the favourable prejudices of years gone by, and institutional biases against doing much about inflation deviating from target, isn’t exactly compelling evidence for the defence.    Sadly, getting too close to Graeme Wheeler as Governor seems to diminish anyone’s reputation.  It is a shame Turner has allowed himself to join that exclusive club.