Svensson and Labour’s monetary policy

In 1999, having been out of office for nine years, the Labour Party campaign platform included promises about monetary policy.  They undertook to change the Policy Targets Agreement –  and they did, adding the words (still) requiring the Bank to “seek to avoid unnecessary instability in output, interest rates and the exchange rate”.

But they also promised an independent inquiry into the operation of monetary policy.    It was then 10 years since the Reserve Bank Act had been passed, and we’d gone through both a wrenching but successful disinflation, and through one full business cycle since something like price stability had been established.    Some of elements of the management of that cycle hadn’t been the Reserve Bank at its finest:  use of the Monetary Conditions Index to guide short-term policy management had given us a (relatively short) period of quite astonishing interest rate volatility, not helped by being slow to appreciate the significance of the Asian financial crisis.

I don’t suppose Michael Cullen was ever a great fan of Don Brash’s.  But Brash had already been reappointed for a third term in 1998 (arguably fortunate that the reappointment was done before the nature of the MCI debacle was fully appreciated).   And Cullen was clearly uneasy about the volatility in New Zealand interest rates, and about the big cycles in the exchange rate.   There were also suggestions that he was a bit uneasy about the rule of a single unelected technocrat at the Reserve Bank of New Zealand, and Labour at times seemed to look longingly across the water at the Reserve Bank of Australia (with a higher target, more flexible rhetoric, and a reputation for being a steady hand).    And, of course, Labour was coming into government with Jim Anderton as Deputy Prime Minister.  Anderton had still not been reconciled to the Reserve Bank Act framework at all.   So it was, all round, opportune to have an inquiry.

But of course whenever one sets up an independent inquiry, the name of the person appointed to conduct the inquiry tells one a lot about what the appointer is looking for.    There were all sorts of names bandied about at the time, including (for example) Bernie Fraser who had until recently been Governor of the Reserve Bank of Australia, and whose centre-left sympathies were not exactly unknown.  But the government settled on Swedish academic Lars Svensson.  Perhaps being Swedish  –  home of centre-left big government – lulled some on the left of New Zealand politics.  But, more importantly, Svensson was also a leading academic author on aspects of the (then still relatively new) theory and practice of inflation targeting.  He’d also spent some time in New Zealand a couple of years earlier, as the Reserve Bank professorial fellow.    In other words, it was never likely to be a terribly radical report.

And it wasn’t.    Which is not to say that it wasn’t a useful exercise, or that Svensson did not make some useful recommendations.  He did.  Some of the less important recommendations –  eg around the make-up of the Bank’s Board, and the publication of a Board Annual Report –  were even adopted.    Some others that should have been adopted –  for example, the introduction of a monthly CPI –  still, unfortunately, haven’t been.  Svensson also proposed legislating for committee decision-making for monetary policy, but his proposal of a committee of insiders (including the role I then held) went nowhere: among other reasons no doubt, Michael Cullen hadn’t come into politics to give statutory power to more Reserve Bank pointy-heads.

I was quite heavily involved in the review, both in contributing to the Reserve Bank’s own substantial submission to the inquiry and –  along with a couple of Treasury economists –  as part of the secretariat to the inquiry itself.  For an inquiry into the Bank, it was a bit of an odd arrangement  –  shortly after the inquiry began I was promoted into one of the half dozen top policy/management roles in the Bank and did the two roles in tandem –  but I guess it is a small country, and there was never much doubt about the overall favourable stance Svensson was likely to take.  He was a big fan of Don Brash, and the conclusions were his not those of the secretariat (in fact, flicking through notes stapled in my copy of the report yesterday I noticed that in some places we –  and the Bank –  urged Svensson to toughen up his comments, lest the report look in places a bit like a whitewash.)

But the main point of this post isn’t about history.  It was initially prompted by an observation in a column in the Sunday Star-Times the other day, in which their resident right-wing columnist was quoting Svensson from 2001.  Damien Grant, in commenting sceptically on Grant Robertson’s proposals,

Robertson might find it useful to know that when Cullen became finance minister he commissioned a review of the Reserve Act by Swedish economist Lars Svensson who concluded:

“It is beyond the capacity of any central bank to increase the average level or the growth rate of real variables such as GDP and employment.”

The understanding that monetary policy can only influence the value of money and nothing else is one of the few untarnished successes of modern economic thought. It is deeply disturbing that Grant Robertson does not seem to appreciate this.

As a commenter observed yesterday, no mainstream economist believes that monetary policy can change the long-term level of employment/unemployment/real GDP or whatever.  In the long-term monetary policy can only affect nominal variables.   Svensson certainly believed that then and believes it now.   I don’t know whether Grant Robertson does, but I expect so.

But equally, not many mainstream economists believe that active monetary policy typically has no effect (short to medium term) on real variables.   There is pretty general acceptance, I think, that the depth and severity of the Great Depression was in substantial part a matter of monetary mismanagement.  That’s a deliberately extreme example, but it both illustrates the point and (historically) provides some of the backdrop to modern more active discretionary monetary policy.  In earlier decades, adjustments in central bank interest rates (where central banks existed at all) were mostly about maintaining the gold (or silver) convertibility of the currency.  Domestic economic conditions didn’t play much of a role.    Really bad experiences like the Depression, along perhaps with the rise of universal suffrage (the more marginal got a say in politics), helped change that focus.

Writing in 2001, reviewing New Zealand policy, Lars Svensson had no doubt about the importance of real variables in the management of monetary policy.   He didn’t question section 8 of the Reserve Bank Act –  the focus on price stability.  But his articulation of flexible inflation targeting –  what the Reserve Bank saw itself practising – involved short-term trade-offs between pursuit of the inflation target, and the variability of the real economy.  At the time, as an academic, he focused explicitly on the trade-off with variability in the output gap (the gap between actual and potential output), and devoted several pages of the report to a discussion of the issue, describing it not just as a very short-term matter, but as a “short and medium term” issue.    (For anyone interested, the full report and associated documents are here.)     What he was talking about wasn’t at all inconsistent with the 1999 addition to the PTA, quoted above, about seeking to “avoid unnecessary instability in output”).    And there was only one tool –  the OCR.

Standing back from his more theoretical perspective, there was good reason why one might want explicit consideration of real variables in the official articulation of what an independent central bank was asked to do.   One doesn’t need active monetary policy if all one is concerned about is long-term stability in the general level of prices –  something passive like the Gold Standard would do it.    But the Reserve Bank Act –  and other comparable legislation abroad –  was about a regime for governing the discretionary active use of monetary policy.   We had –  and have –  such a policy because it was believed that discretionary monetary policy could make a difference, over meaningful horizons, to real economic outcomes (GDP, unemployment or the like) even if not to the trend or potential levels of those variables.

Some years later Lars Svensson himself became a policymaker, as a fulltime member of the executive board of Sweden’s Riksbank.  The Executive Board makes the monetary policy decisions in Sweden.    Many of my old Reserve Bank colleagues don’t agree, but I think Svensson proved to be an ideal person to have on a monetary policy decisionmaking committee.   He had strong expertise in the subject – albeit initially at a rather abstract level –  and a cast of mind which meant that he wasn’t just going to fall into line with the preferences of the Governor and the long-term staff advisers.  He strongly and opened argued against the Riksbank’s strategy, adopted several years back in the wake of the global recession of 2008/09, of trying to use monetary policy to lean against the accumulation of household debt, even at the expense of inflation undershooting the target (and unemployment remaining very high).   It was a costly failed experiment, which the Riksbank eventually abandoned.

His experience as a policymaker led Svensson to recraft how he thinks about the objective of the central bank and explicit role that unemployment should have in that thinking.   He hasn’t, of course, changed by one iota his belief that in the long-term the level of real variables is determined by a whole bunch of regulatory, demographic etc factors, but not by monetary policy.    He reflected on these issues a couple of years ago in a lengthy lecture, Some Lessons from Six Years of Practical Inflation Targeting (of which only the first 10 pages are directly relevant to this post), and in another article How to weigh unemployment relative to inflation in monetary policy?

He notes

Flexible inflation targeting involves both stabilizing inflation around an inflation target and stabilizing the real economy.  A clear objective for monetary policy contributes to monetary policy being systematic and not arbitrary. Furthermore, for central-bank independence to be consistent with a democratic society, it must be possible to evaluate monetary policy and hold the central bank accountable for achieving its objective. This requires that the degree of achieving the objective can be measured. A numerical inflation target allows target achievement with regard to inflation to be measured and the central bank to be held accountable for its performance regarding inflation stabilization. But if monetary policy also has the objective of stabilizing the real economy, that part of the objective must also be measurable, in order for monetary policy to be evaluated and the central bank be held accountable. Given this, how should stabilization of the real economy be measured?

and

Stabilization of the real economy can be specified as the stabilization of resource utilization around an estimated sustainable rate of resource utilization, accepting the conventional wisdom that the sustainable rate of resource utilization is determined by nonmonetary factors and not monetary policy and therefore has to be estimated. But how should resource utilization be measured? More precisely, besides inflation, what target variable (or variables) should enter the monetary-policy loss function? One can answer this question by interpreting the legislated mandate for monetary policy and by examining what economic analysis suggests about a suitable measure of resource utilization.

In Sweden, the Riksbank’s own act mentions only price stability.  But

 The Riksbank’s mandate for monetary policy follows from the Sveriges Riksbank Act 1988:1385 and the preparatory works of the Act, the Government Bill 1997/98:4 to the Riksdag (Swedish Government 1997) that contained the proposal for this legislation. In Sweden, the preparatory works of laws carry legal weight, since they contain guidance on how the laws should be interpreted. According to the Riksbank Act, the objective of monetary policy is “to maintain price stability.” The Bill further states (p. 1): “As an authority under the Riksdag, the Riksbank should, without prejudice to the objective of price stability, support the objectives of the general economic policy with the aim to achieve sustainable growth and high employment.”

(I didn’t know this when in 2014 we wrote a Reserve Bank Bulletin article on the statutory goals for monetary policy in a range of countries, the Swedish entry in which thus should thus be discounted, or read in the light of these Svensson comments.)

Svensson continues

The idea in the Bill is hardly that there is any conflict or tradeoff between sustainable growth and high employment. Furthermore, for many years Swedish governments have emphasized full employment as the main objective for general economic policy.  Also, in this context, high employment should be interpreted as the highest sustainable rate of employment, if we accept that monetary policy cannot achieve any level of unemployment and that the sustainable rate of employment is determined by nonmonetary factors. According to this line of reasoning, the Riksbank’s mandate for monetary policy is price stability and the highest sustainable rate of employment.

In practice, he argues that the unemployment rate –  and in particular the gap between the actual unemployment rate and the long run sustainable rate of unemployment (LSRU, determined by those non-monetary factors) should be the focus.   15 years ago his focus was on the output gap but

What does economic analysis say about the output gap as a measure of resource utilization? Estimates of potential output actually have severe problems. Estimates of potential output requires estimates or assumptions not only of the potential labor force but also of potential worked hours, potential total factor productivity, and the potential capital stock. Furthermore, potential output is not stationary but grows over time, whereas the LSRU is stationary and changes slowly. Output data is measured less frequently, is subject to substantial revisions, and has larger measurement errors compared to employment and unemployment data. This makes estimates of potential output not only very uncertain and unreliable but more or less impossible to verify and also possible to manipulate for various purposes, for instance, to give better target achievement and rationalizing a particular policy choice. This problem is clearly larger for potential output than for the LSRU.

and

Compared to potential-output estimates, estimates of the LSRU are much easier to verify, more difficult to manipulate and can be publicly debated. Independent academic labor economists can and do provide estimates of the LSRU and can verify or dispute central-bank estimates. Several government agencies have labor-market expertise and provide verifiable estimates of the LSRU. One could even think of an arrangement where an independent committee rather than the central bank provides an estimate of the LSRU that the central bank should use as its estimate, to minimize the risk of manipulation by the central bank. Furthermore, unemployment is better known and understood by the general public than output and GDP.

He concludes

Most importantly, it has much more drastic effects on welfare. As expressed by [academic labour economist, and former Bank of England Monetary Policy Committee member]   Blanchflower (2009):

Unemployment hurts. Unemployment has undeniably adverse effects on those unfortunate enough to experience it. A range of evidence indicates that unemployment tends to be associated with malnutrition, illness, mental stress, depression, increases in the suicide rate, poor physical health in later life and reductions in life expectancy. However, there is also a wider social aspect. Many studies find a strong relationship between crime rates and unemployment, particularly for property crime. Sustained unemployment while young is especially damaging. By preventing labour market entrants from gaining a foothold in employment, sustained youth unemployment may reduce their productivity. Those that suffer youth unemployment tend to have lower incomes and poorer labour market experiences in later life. Unemployment while young creates permanent scars rather than temporary blemishes. 

When unemployment rises, the happiness of both workers and non-workers falls. Unemployment affects not only the mental wellbeing of those concerned but also that of their families, colleagues, neighbours and others who are in direct or indirect contact with them.

Thus, I think there are strong reasons to use the gap between unemployment and an estimated LSRU as the measure of resource utilization that the central bank should stabilize in addition to stabilizing inflation around the inflation target.

Svensson proposes reduces all this to a “loss function”, to which, in principle at least, central bank monetary policy decisionmakers can be held to account, with formal weights attached to each of the inflation gap (from target) and the unemployment gap (from the LSRU).

Personally, I think he is rather unrealistic in supposing such a formulation is possible, at least as the basis for formalised accountability.    But if it is practically challenging (or even impossible), the sort of analysis he advances here isn’t unorthodox or out of the mainstream.  It is simply one plausible extension of the conventional economics of modern monetary policy, from one of the leading contributors to the academic literature (and someone who has himself been exposed to the real world challenges of policymaking).

I don’t know specifically what Svensson would make of the current debate in New Zealand, or of what the Labour Party (at quite a high level of generality) is proposing.    What we do know is that Labour is proposing nothing nearly as specific or formal as Svensson argues for: there would be no numerical unemployment target or an official external assessment of the NAIRU (or LSRU).  My impression would be that his reaction would be along the lines of “well, of course the unemployment rate –  and short to medium term deviations from the long-run level, determined by non-monetary factors – should be a key consideration for monetary policymakers; in fact it is more or less intrinsic to what flexible inflation targeting is”.   He might suggest there are already elements of that in the PTA, but that making it a little more high profile, with an explicit reference to unemployment, might be helpful.     I might be wrong about, but it could be worth Robertson or his advisers getting in touch with Svensson –  who retains an interest in New Zealand, and gave a paper here only a couple of years ago –  and asking.

 

Cosmetics (can) matter: Labour’s monetary policy proposals

I’ve already written a bit about Labour proposals on monetary policy (here and here) and, for now at least, I don’t want to write anything more about the proposed changes to the decision-making process or the plan to require the Monetary Policy Committee to publish its minutes.  If there are all sorts of issues around the details of how, I haven’t seen anyone objecting to the notion of moving from a single decisionmaker model to a a legislated committee, or objecting to proposals to enhance the transparency of the Bank’s monetary policy.    The Bank was once a leader in some aspects of monetary policy transparency, but is now much more of a laggard.

Where there has been more sceptical comment is around Labour’s proposal to add full employment to the statutory monetary policy objective.    At present, section 8 of the Reserve Bank Act reads as follows:

The primary function of the Bank is to formulate and implement monetary policy directed to the economic objective of achieving and maintaining stability in the general level of prices.

Responding to this aspect of Labour’s announcement hasn’t been made easier by the lack of any specificity: we don’t know (and they may not either) how Labour plans to phrase this statutory amendment.    There are some possible formulations that could really be quite damaging.  But there are others that would probably make little real difference to monetary policy decisionmaking quarter-to-quarter.  Probably each of us would prefer to know in advance what, specifically, Labour plans.  But this is politics, and I’m guessing that there is a range of interests Labour feels the need to manage.  In that climate, specificity might not serve their pre-election ends.  One could get rather precious on this point, but it is worth remembering that there are plenty of other things that may matter at least as much that we currently know little about.  Under current legislation, who becomes the Governor of the Reserve Bank matters quite a lot to shorter-term economic outcomes, and we have no idea who that will be.   The details of the PTA can matter too, and under the governments of both stripes the process leading up to the signing of new PTAs has been highly secretive (often even after the event).  For the moment, we probably just have to be content with the “direction of travel” Labour has outlined.

In some quarters, Labour’s plans for adding a full employment objective have been described as “cosmetic”, as if to describe them thus is to dismiss them.    That is probably a mistake.  When I went hunting, I found that cosmetics have been around for perhaps 5000 years (rather longer than central banks).   People keep spending scarce resources on them for, apparently, good reasons.     Why?  They can, as it were, accentuate the positive or eliminate the negative –  highlighting features the wearer wants to draw attention to, or covering up the unsightly or unwanted marks of ageing.    They (apparently) accomplish things for the wearer.

What is the relevance of all this to monetary policy?  Well, there has been a long-running discontent with monetary policy in New Zealand, especially (but not exclusively) on the left.  In the 28 years since the Act was passed there has not yet been an election in which some reasonably significant party was not campaigning to change either the Act or the PTA.  We haven’t seen anything like it in other advanced countries.   Personally, I think much of the discontent has been wrongheaded or misplaced –  the real medium-term economic performance problems of New Zealand have little or nothing to do with the Reserve Bank –  and many of the solutions haven’t been much better (in the 1990s, eg, Labour was campaigning to change the target to a range of -1 to 3 per cent and NZ First wanted to target the inflation rates of our trading partners, whatever they were).     But that doesn’t change the fact that there has been discontent –  and more than is really desirable.

I’m quite clear that there is no long-run trade-off adverse trade-off between achieving and maintaining a moderate inflation rate (the sorts of inflation rates we’ve targeted since 1990) and unemployment.  And since something akin to general price stability generally helps the economy function better (clearer signals, fewer tax distortions etc) there is at least the possibility that maintaining stable price might help keep unemployment a little lower than otherwise.  Milton Friedman argued for that possibility.

But I don’t think that is really the issue here.

Because it is not as if there are no other possible connections between monetary policy and unemployment.   Pretty much every analyst and policymaker recognises that there can be short-term trade-offs between inflation and unemployment (or excesss capacity more generally –  but here I’m focusing on unemployment).   Those trade-offs aren’t always stable, even in the short-term, or predictable, but they are there.    Thus, getting inflation down in the 1980s and early 1990s involved a sharp, but temporary, increase in the unemployment rate.  That was all but inescapable.  And when the unemployment rate was extremely low in the years just prior to 2008, that went hand in hand with core inflation rising quite a bit.  Monetary policy decisions will typically have unemployment consequences.    Unelected technocrats are messing, pretty seriously, with the lives of ordinary people.   It is all in a good cause (and I mean that totally seriously with not a hint of irony intended) but the costs, and disruptions, are real –  and typically don’t fall on the policymaker (or his/her advisers).

And it isn’t as if monetary policymakers are typically oblivious to the pain.   There was plenty of gallows humour around the Reserve Bank in the disinflation years, a reflection of that unease.  And yet often the official rhetoric is all about inflation –  as if, in some sense, what look like relatively small fluctuations around a relatively low rate of inflation, matter more than lives disrupted by the scourge of unemployment.

So perhaps that is why cosmetics can matter, and serve useful ends even in areas like monetary policy.     There isn’t that much difference, on average over time, in how the Reserve Bank of New Zealand, the Reserve Bank of Australia, or the Federal Reserve (or various other inflation targeting advanced country central banks) conduct monetary policy.   They each tend to react to incoming data in much the same way (again, on average over time).   In the financial markets, they probably each have much the same degree of “credibility” (people think the respective central banks are serious about their stated inflation targets).   And yet my impression is that the Federal Reserve, for example, talks much more about unemployment than the Reserve Bank of New Zealand does.   The Fed gives the impression that (a) it is aware, and (b) that it cares.  In the last decade or so at least, that has been much less so here.

In New Zealand, the problem has been compounded by a sustained period when the Reserve Bank turned out to have run monetary policy too tightly (including two tightening phases that had to be quickly reversed).  Over that period –  and today –  the unemployment rate (the number of people unemployed  – the phrase I always used to encourage staff to prefer when we replied to correspondence) has been persistently above estimates of the NAIRU (non-accelerating inflation rate of unemployment).

The Reserve Bank is entrusted with a great deal of discretion, in an area riddled with uncertainty and imprecision.  We don’t know exactly what the NAIRU is (nor does the Bank).  We don’t even know what “true” core inflation is, let alone what it will be over the 12-24 months ahead, the sort of period today’s monetary policy decisions affect. That makes signalling and symbols perhaps more important than otherwise.

It is also why lines like

“It is mathematically impossible to target two variables with one instrument.” 

while formally true, aren’t really the point here.   Voters –  or some subsets of them –  simply want to know that those other things matter –  and matter quite a lot –  to the people wielding the power.    And as there is quite a connection between monetary policy choices and fluctuations in the numbers of people unemployed, they aren’t irrational to do so.    After all, they might well note that the old argument –  “well if unemployment is too high, inflation will undershoot the target and the Bank will quickly correct that” doesn’t sound so compelling after years of an undershoot, and years when unemployment has lingered quite high.

There is a whole variety of ways to send the signals:

  • one can tinker with the PTA again (most of the changes of 28 years have had this quality about them –  including for example the current references to unnecessary variability in output, interest and exchange rates),
  • one can choose a Governor who is known to care (although typically technocrats won’t be much known at all),
  • one could require the Bank to publish estimates of the NAIRU and report regularly on how monetary policy was affecting the gap between actual unemployment and the NAIRU,
  • the Bank could regularly write about, or give speeches, highlighting the importance of unemployment (gaps) in its thinking, and expressing discomfort whenever unemployment has to be temporarily high.

Or one could tinker with section 8 of the Act and add a full employment reference.

Perhaps Labour actually has a combination of these sorts of approaches in mind.  Amending the Act is isolation might not do much (even in signalling and symbolism) in isolation, but it might encourage the appointment of a Governor who took seriously the concern (after all the Bank’s Board has to operate under the Act), and it might encourage the Governor, the Bank, and any future Monetary Policy Committee to address these issues more directly in their own communications.

And at a political level, if they are serious about prioritising full employment as one  over-arching goal of economic policy (which seems a worthy goal to me, even if there are good and bad ways of pursuing it), a change to the Reserve Bank Act might also signal –  what the monetary policy analysts already know – that in the medium to longer-term monetary policy and the Reserve Bank are no obstacle to full employment.

As I noted last week, in 1950 the incoming National government amended the Reserve Bank Act to specify an objective for monetary policy as follows

[The Bank] shall do all such things within the limits of its powers as it deems necessary or desirable to promote and safeguard a stable internal price level and the highest degree of production, trade, and employment that can be achieved by monetary action.

Something similar, in today’s language, seems at worst unobjectionable to me.  At best, it might strengthen public confidence in the Bank and encourage the Bank and its incoming Governor and Deputy Governor to convey with more conviction how seriously they take the overall economic environment –  real firms, real people –  within which the Bank exercises its considerable discretionary power.

Reflecting on all this over the weekend, another parallel struck me.  In wartime, the priority is to win the war.  In many ways it is as simple as that.  A single objective.   And yet combat generals, delegated power by political leaders, who become known as reckless with the lives of their men eventually forfeit trust, corroding the loyalty of those who serve them (and those who appoint them).   Wars involve losses of life, often heavy losses. No general can take on the role without being ready to see young men lose their lives, perhaps in very large numbers.  And yet –  at least in a free society –  we don’t want generals who are indifferent to the cost.  We want them to spend lives as if each one were precious.  Soldiers who believe that of their generals probably fight with more conviction and determination.  And societies give leeway and respect to those generals, allowing them to lead the battles that, in time, win the war.   It isn’t a dual objective –  in the end societies do what they need to to survive and prevail –  but it isn’t irrelevant either.

 

Possible Reserve Bank reforms: some reactions

Some of the media reaction to talk –  from both the government and the Labour Party –  of possible changes to the Reserve Bank Act  has been a bit surprising.  One leading journalist behind a paywall summed up both the review Steven Joyce has requested and Labour’s proposals as “utter balderdash”, apparently just because there are more important issues politicians should be addressing.  No doubt there are –  housing, the languishing tradables sector, non-existent productivity growth and so on –  but competent governments, backed by a large public service, can usually manage more than one thing at a time.    And although there are plenty of details to debate on Reserve Bank governance, they aren’t exactly divisive ideological issues.   A parliamentary under-secretary or Associate Minister handled most of the details of the 1989 Reserve Bank Act, in a government that did a great deal of other (often more important) stuff.

Bernard Hickey’s story on the government’s review and Labour’s proposals is headed Monetary Policy Reforms a Mirage.     That could be so.  If National is re-elected, they might advance no governance reforms.  Or they might just legislate for something very like the sort of internal committee that, in various shapes and forms, has been the forum in which the Governor made OCR decisions ever since the OCR was introduced.  But apparently at his post-Cabinet press conference, the Prime Minister –  who had rejected earlier Treasury advice in this area in 2012 –  opened up the possibility of a committee not just composed of insiders.

Meanwhile, English hinted Treasury might look at whether a rate-setting committee could include non-Reserve Bank personal. That would be a matter for the review, he said.

Beginning a process of discussing reform options tends to put a range of issues and options on the table.

The sort of decision-making and governance reforms being advanced by Labour and the Greens would be most unlikely to be “simply a mirage”.     There are number of concerns that what Labour is proposing does not go far enough, but again they are probably best seen as the starting point for a more detailed review if/when Labour and the Greens take office.  There is a risk that it could all come to not very much.   After all, even over the last 15 years the Reserve Bank has had a couple of Governor-appointed outsiders involved in the advice and decisionmaking process –  the Prime Minister’s brother is one of them at present –  and that hasn’t made much difference at all.  And requirements to publish minutes/votes can be subverted too.      But that it is why the appointment of the new Governor is so important.  If Labour and Greens are serious about reforming the way the Reserve Bank operates,  then if they become government they need to move quickly to find a person (perhaps a top team) they have confidence in, to work with The Treasury and the government to implement legislative reforms, and to lead the internal process changes to make the new, more open, vision a reality.    If they are serious about greater openness, they need to ensure they have a Governor who shares that reforming vision.   Such a Governor could make a considerable difference even if, for example, the new Monetary Policy Committee (MPC) were to have a majority of executive members.

In some ways, much the same goes for the, less substantively important, proposal to add some sort of full employment aspiration/objective to the statutory goal for monetary policy.    I’ve described it as virtue-signalling, but on reflection that might be slightly unfair.  In the narrow context of the Reserve Bank Act, it is probably about right –  if the Bank has had things a bit tight over the last few years, leaving unemployment higher than it needed to be, then often enough over the life of the Act, the unemployment rate has been below the NAIRU.   Changing the words of section 8 of the Act in isolation won’t make much difference. After all, Australia and the United States have wording Labour prefers, and yet the cyclical behaviour of their economies hasn’t, on average over time, been much different from New Zealand’s.

So I’m sure there is a bit of pure product-differentiation about Labour’s proposal in this regard.  That isn’t unusual. Most changes to the Policy Targets Agreements over the years –  from both sides of politics –  have been more about product differentiation than substance, about scratching itches rather than making much difference to how monetary policy is actually run.  For Labour there is probably is some perceived need to differentiate, and a desire to campaign (and govern?) on a whole-of-government commitment to promoting and facilitating full employment.   That is an unquestionably worthy goal.    If monetary policy choices aren’t going to make very much difference to the medium or long-term rate of unemployment, they can (and have) made quite a difference in the shorter term.  So one way of telling Labour’s story is that they want the word to get out to the public that they are committed to (medium-term) full employment, and they want the public to know that the Bank isn’t in any sense an obstacle to that, and to hear the Bank talking of the importance of the issue.  These are real people’s lives.   I noted yesterday

So the problem typically hasn’t been that the Reserve Bank doesn’t care about unemployment –  although they don’t mention it often, and there is little sense in their rhetoric of visceral horror at waste of lives and resources when unemployment is higher than it needs to be.

They probably should be talking about it more, with conviction.  The legitimacy of independent public agencies depends on part of people believing that those entities have the public interest at heart.  And everyone knows –  central banks acknowledge –  that in the shorter-term their choices do have (sometimes painful) implications for the numbers of people unemployed in New Zealand.  At a bloodless technocratic level, I’ve suggested Labour could amend the Act to require the Bank to regularly report on its estimate of the NAIRU, and how monetary policy is affecting the gap between the actual unemployment rate and the NAIRU.  But this isn’t just a bloodless technocratic concern.

So again, getting the right Governor matters –  someone who will talk convincingly and engagingly as if what they are about affects ordinary people, including those at the margins (vulnerable to unemployment and the resulting dislocation to their lives).

So, from the perspective of both strands of the Labour reform proposal, my concrete suggestion to them is that if they lead a new government after the election, they should quickly pass a one (substantive) clause amendment to the Reserve Bank Act.

Section 40 of the Act at present reads

40 Governor

(1) There shall be a Governor of the Bank who shall be appointed by the Minister on the recommendation of the Board.

(2) The Governor shall be the Chief Executive of the Bank.

Simply deleting “on the recommendation of the Board” would make our practice much more consistent with that in most other countries.  It would remove the controlling influence of a Board appointed entirely by the previous government, and it would allow Labour to have in place to lead the rest of their Reserve Bank reforms, someone of their choosing, someone in whom they have confidence.  That is how other advanced democracies do things.  It isn’t about appointing party hacks –  it is how Janet Yellen, Mark Carney, Ben Bernanke, Glenn Stevens and Phil Lowe were all appointed; capable people who commanded the confidence of the government that appointed them.

(Although it isn’t a priority for me, making this change might actually strengthen the effectiveness of the Bank’s Board in holding the Governor to account.  At present, when the Board (in effect) appoints the Governor they have a strong interest in backing their own judgement, and providing cover for the Governor.   If they were responsible for monitoring the performance of a Governor directly appointed by the Minister, they’d have less vested interest in the individual, and perhaps be more ready to represent the interests of the Minister and of the public).

As I was finishing this post, I noticed a highly critical article on interest.co.nz by Alex Tarrant.  Although he isn’t quoted, it reads in part as if Tarrant has been interviewing his father, Arthur Grimes, one of the designers of the current Reserve Bank Act monetary policy provisions, and former chair of the Reserve Bank Board.   There is a lengthy discussion of time-inconsistency issues –  a regular theme of Grimes’s.    I’m not going to attempt to respond in any detail now, but would just observe that whatever the explanations for the rise of inflation in the 60s and 70s (and I’m not persuaded by the story Tarrant quotes), what Labour seems to be proposing is something not far removed from the sorts of formal wording, and policy rhetoric, routinely used at the Reserve Bank of Australia and the Federal Reserve.  One can debate whether it makes much sense to use such langugage, or whether the formal statutory provisions in those countries make much difference, but it is hard for any detached observer to suggest credibly that the Reserve Bank of Australia or the Federal Reserve have suffered greater difficulties with credibility, or with the willingness of the public and markets to take their words seriously, than the Reserve Bank of New Zealand has faced with the current section 8 wording.   If anything, the Reserve Bank of New Zealand has had rather more problems –  odd experiments like the MCI, and two quickly-reversed tightening cycles in the last decade –  even if those particular mistakes and problems don’t have their roots in the wording of section 8.  And unlike other inflation targeting countries, there has never been an election since the Act was introduced in which some party or other (and not just the remnants of Social Credit) has not been campaigning for changes to the Reserve Bank Act or the PTA.  You don’t find anything like it in other inflation targeting countries.

Grant Robertson made my day

In an address at Victoria University at lunchtime, Labour’s finance spokesperson Grant Robertson launched his party’s monetary policy reform programme.   In an interesting move, the incoming Acting Governor, Grant Spencer, who would have to manage (for the Bank) the early stages of Robertson’s reform process if Labour leads the new government, attended, sitting very visibly in the front row.

The two main aspects of Labour proposal are:

  • broadening the objective from just price stability “to also include a commitment to full employment”
  • changing the decision-making structure for monetary policy, so that a committee would have legislated responsibility.  That committee would comprise four internals (including the Governor) and three external experts who would be appointed by the Governor (but in consultation with the Minister of Finance).

Labour would also require the Bank to release the minutes of the Monetary Policy Committee, including the results of any votes, within three weeks of the relevant OCR decision being announced.

I was interested to note a press release from the Greens in which they state

Labour plans to change the way we do monetary policy in New Zealand and the Green Party supports them fully. We’re now of a single mind on this.

The Greens have previously favoured the Reserve Bank Board –  whose members are mostly non-experts –  making OCR decisions, so I’m not clear if the “single mind” James Shaw refers to extends to that level of detail, or just to a shared commitment to (a) reform, and (b) a decision-making committee that would involve non-executive outsiders.

Bill Rosenberg of the CTU and I were discussants following Robertson’s address.   I wrote this morning a fuller version than I could use of my thoughts on the Labour proposal.

Reflections on Grant Robertson on the RB VUW 10 April 2017

I opened observing that when I got an outline late last week of what Robertson was going to say, I had blurted out that “Grant Robertson has just made my day”.  I’ve been arguing for governance reform for at least 15 years, and between the report the Minister of Finance has commissioned, and the shared commitment to reform of the Greens and now Labour, it looks as though change might finally happen.   There was a certain logic to the current single decision-maker system in 1989, but if it had a logic then –  in how we understood monetary policy, and the nature of the Bank’s functions –  it simply looks wrong today.  Other countries don’t do things that way.  We don’t either in other areas of public life.

What I’m most encouraged by is the commitment to involve outsiders, not just to cement-in a position for insiders.  Having said that,  I raised two main areas of concern:

  • the first is the Robertson proposal that the Governor should continue to be (in effect) appointed by the Board (in turn appointed by the current government), and that all the other voting members (inside and out) would be appointed by the Governor.  He qualifies this by noting that these appointments would be made in consultation with the Minister of Finance.    But that is a recipe that risks the Governor surrounding him or herself, deliberately or unconsciously, with people who think like the Governor, and will be reluctant to challenge the Governor too much.   The Minister might raise a few questions about a proposed appointee, but will be reluctant to second guess the Governor, and cannnot overrule him in this model.   Frankly, it is a model with a yawning democratic chasm and not a model I’m aware of being used in any other country.  It is one thing to delegate operational decisions to independent boards, but the members of those Boards should be appointed by those whom we elect –  ministers –  and whom we can toss out.
  • the second concern is that under the proposed model there would be four insiders and three outsiders.  That is the wrong way round, and most likely would be a recipe for the marginalisation of the outsiders (since the insiders have no independent status, and all work for, and have their pay etc set by the Governor, they can easily caucus and out-vote the externals).   I’d prefer two internals and three externals, all directly appointed by the Minister of Finance.

In response, Robertson noted that he was open to looking again at the ministerial appointment option.  He noted that it was awkward as putative Minister to be talking of giving himself such extensive appointment powers.  Perhaps, but that is the way most public sector boards work.  If he wants Labour precedent, Gordon Brown introduced the Bank of England statutory Monetary Policy Committee, to which the Chancellor appoints most of the members directly, and has to be consulted on the remaining two.

Robertson explained that he preferred to keep a majority of insiders because one of his priorities was to preserve the operational independence of the Bank. I was, and am, puzzled by that response. I noted to him that the RBA has a substantial majority of outsiders on its decision-making Board, and that they had operational independence.  The same goes for Sweden’s Riksbank.  I’m less optimistic about a re-think there, as Robertson also stated that he did not envisage allowing MPC members to make speeches or comments on monetary policy without the explicit prior consent of the Governor.  It seems he still has in mind an excessively Governor-dominated institution, and one in which it would be hard to ensure transparecny and the regular injection of fresh perspectives and alternative views.  If so, that would be unfortunate.

I noted some unease about his proposal that all the external appointees would be “expert”, and perhaps had that concern somewhat allayed when he stressed that in this context he did not intend “expert” to mean simply a narrow expert in specific aspects of monetary economics or the like.

My other main observation in this area is that the Labour proposal (deliberately and consciously) does not yet address the governance and decisionmaking for the Bank’s extensive financial regulatory functions.

But the most important omission seems to me to be the governance provisions for the Reserve Bank’s extensive financial stability and regulatory functions, under various different pieces of legislation.   There is no precedent anywhere for so much regulatory power to be in one person’s hands.  It wasn’t even an outcome that was consciously deliberated on by Parliament –  rather it grew up with a succession of amendments to the Act, and changes in regulatory philosophy over the years. And whereas a regulating Cabinet minister can be reshuffled or dumped whenever the Prime Minister chooses, a Governor of the Reserve Bank is secure for five years.

If individuals matter in monetary policy, even with something like the PTA, they are likely to matter hugely in the financial regulatory area, where there is nothing like the PTA to constrain or guide the Bank/Governor.  The economic impact of regulatory choices can be as large –  if less visible –  than those around monetary policy.  I really hope that Labour will be thinking hard about how to extend their governance reform ideas into the financial regulatory field.  Personally I think there should be three strands to that:

  • Removing some of the high level policy-setting power back to the Minister of Finance (so that the RB applies the rules etc and mostly doesn’t make the high level rules),
  • Move responsibility for the various pieces of legislation out of the Reserve Bank, probably to Treasury. This matter is already being touched in the Rennie review commissioned by the current Minister of Finance, and
  • Establishing a Financial Policy Committee, paralleling the Monetary Policy Committee, as the entity empowered to exercise whatever policymaking powers reside with the Reserve Bank. Again, a five-person committee (Governor, Deputy Governor, and three externals seems like a feasible solution).  The FPC would also be responsible for Financial Stability Reports.

Robertson acknowledged the deliberate omission and talked of it being “part of the conversation” moving forward.  I hope so.    This is the opportunity for a full overhaul of the governance model, not just tacking on an MPC to a model that doesn’t work that well in other areas either.

The other half of the address was about the idea of adding full employment to the goals for monetary policy.  I was (and am) much more sceptical, and nothing that was said in response to questions really clarified things much.    I get that full employment is an historical aspiration of the labour movement, and one that the Labour Party wants to make quite a lot of this year.  In many respects I applaud that.  I’m often surprised by how little outrage there is that one in 20 of our labour force, ready to start work straight away, is unemployed.  That is about two years per person over a 45 year working life.  Two years……     How many readers of this blog envisage anything like that for themselves or their kids?

But still the question is one of what the role of monetary policy is in all this, over and above what is already implied by inflation targeting (ie when core inflation is persistently  below target then even on its own current terms monetary policy hasn’t been well run, and a looser monetary policy would have brought the unemployment rate closer to the NAIRU (probably now not much above 4 per cent)).

I noted that I’m sceptical that the wording of section 8 of the RB Act is much to blame.  After all, for several years prior to the recession, our unemployment rate was not just one of the lowest in the OECD, it was also below any NAIRU estimates.  And when I checked this morning, I found that our unemployment rate this century has averaged lower than those of Australia, Canada, the US and the UK, and our legislation hasn’t changed in that times.  Robertson often cites Australia and the US.

The last few years haven’t been so good relatively speaking.  But if the legislation hasn’t changed and the (relative) outcomes have, that suggests it is the people in the institution who made a mistake –  they used the wrong mental model and were slow to recognise their error and respond to it.  Getting the right people, and a well-functioning organisation, is probably more important than tweaking section 8.

Robertson disputed my past characterisation (as “virtue signalling”) of his talk of adding a full employment objective.  But I still don’t see in what way I am wrong in that description.  It would send a single to key constituencies that Labour “feels the pain” and has an integrated commitment to advancing full employment, but what difference would it make to the Governor and his committee?  There wouldn’t be a numerical definition of full employment in the PTA, and since Robertson remains committed to the accountability framework of the Act, it is very hard to see how or why any given Governor would react much differently given a specific inflation target and a vague injunction to promote “full employment”.  A different Governor might make a difference –  hence, choose carefully –  but that sort of wording is unlikely to.

If they form a government later in the year, Labour (and the Greens) clearly will need to add some words to the PTA.  I drew the attention of those present to the 1950 amendment to the Reserve Bank Act, under which

[The Bank] shall do all such things within the limits of its powers as it deems necessary or desirable to promote and safeguard a stable internal price level and the highest degree of production, trade, and employment that can be achieved by monetary action.

I quite like it (and not just because a relative of mine was the responsible Minister of Finance).  It recognises that monetary policy doesn’t exist in a vacuum, and that people (voters and politicians) care about other stuff.  In fact we don’t pursue price stability simply for its own sake, but for a better life for New Zealanders. But note the key phrase  “the highest degree of…employment that can be achieved by monetary action”.  That might not be much, at least once the unemployment rate is back near the NAIRU.

As today’s chair –  economic historian Gary Hawke –  noted the 1950 change was largely about signalling too, and it isn’t obvous it made an awfully large difference to actual monetary policy.  But that was my point.  If you want words –  or signals – it is easy enough to craft elegant formulations that express those aspirations, and even articulate a place for monetary policy in overall economic management. It is a quite different thing to expect a central bank, however governed, with a single instrument capable only of affecting nominal variables in the longer-run, to make much material difference over time in achieving the wider –  and laudable –  government goal of full employment.

Politically, it doesn’t help at all to make that distinction.  But analytically it looks pretty clear.  Well-crafted words –  a modern version of that 1950 formulation –  would do no harm, and I’d have no real problem  with them, but they won’t make much substantive difference either. But sometimes, I guess, symbols matter quite a lot.

Agreeing with the Governor

If I go on finding myself agreeing with Graeme Wheeler, there won’t be much point writing about OCR announcements.  But, as it happens, he has only three more to deliver.

I could quibble about a few details in this morning’s announcement, but the only one I wanted to highlight briefly was this proposition

Monetary policy will remain accommodative for a considerable period.

In six months and a few days, the Governor will have moved on.  We’ll then have an acting Governor, with no Policy Targets Agreement, for six months.  And not until this time next year will we have in place a monetary policy decisionmaker, with an agreed target, who can make moderately credible statements about possible monetary policy decisions over the medium-term.    So to be strictly accurate,  that sentence should probably have read something like

“If the forecasts underpinning today’s decision are roughly right, and if my successors have (a) the same target I do, and (b) the same interpretation of that target, and the same reaction function, then monetary policy will remain accommodative for a considerable period.”

But in this post, I’m backing the Governor, and one line I was particularly pleased to see was this one (emphasis added)

Global headline inflation has increased, partly due to a rise in commodity prices, although oil prices have fallen more recently. Core inflation has been low and stable.

I made that point here a while ago, so I was pleased to see the Reserve Bank also highlight the  point.    Here is what I mean, using the OECD’s data on CPI inflation ex food and energy –  the one readily available and consistently compiled core inflation measure.

OECD inflation ex food and energy

I’m using monthly data, to be as up-to-date as possible, and New Zealand and Australia don’t have monthly CPI data.  But the comparable quarterly chart doesn’t look materially different.

I’ve shown two lines.  The first is the median core inflation rate for all individual OECD countries (with monthly data).  But that includes 19 euro countries (plus Denmark) that have only one monetary policy.  So the second line is the median core inflation rate for the distinct monetary policy countries/areas –  ie delete the individual euro area countries, and replace them with an inflation rate for the euro area as a whole.  I’d probably tend to emphasise that measure.

But on neither measure is there any sign that core inflation has been picking up at all.  And although the US has been raising its policy interest rate to some extent, there have been more cuts in policy interest rates in the last 18 months or so (the sort of time it takes policy to work) than increases.

Of course, that is only actual inflation outcomes.  Perhaps there is more inflation just ahead of us –  a story markets seem to have taken a fancy to.

For what it is worth, international agencies still thought there was a negative output gap across the advanced world last time they looked (the OECD thought it was -1.4 per cent last time they updated their published forecasts).

The unemployment picture –  another read on excess capacity and resource pressures -is a bit different.    For the G7 countries as a whole, the unemployment rate is now a touch below the troughs reached at the peak of the last boom.    For the OECD group as whole – even including places like Greece –  it is only around 0.7 percentage points higher than at the peak of the last boom.  For the median OECD country, the unemployment rate now only about half a percentage points above the average for the last boom year (2007).

Here are the unemployment rates for the largest OECD economies

U rates big countries

The unemployment rates have been falling for some considerable time, and there has been no pick up in inflation yet.  For each fall, of course, the respective NAIRUs must be getting closer, but it is probably safer to wait and see that core inflation has actually begun to rise –  especially in view of the low starting level –  than to simply assume that it must happen soon.

Of course, when one looks at unemployment rates what does tend to stand out is how little the unemployment rates in New Zealand and Australia have come down.

U rates NZ and AusIn both countries the current unemployment rate is around 1.5 to 1.7 percentage points higher than it was in the year or so prior to the global downturn.  And neither country was troubled by a domestic financial crisis, nor did they run out of room to use conventional monetary policy.  The monetary policy authorities should have been able to do better.   If I look across the monetary areas in the OECD (again replacing individual euro area countries with the region as a whole), the only places with a worse record on this score –  unemployment rates now compared to the pre-recession levels – are:

  • the euro area as a whole (visible in the first chart above) where they did run out of conventional monetary policy options,
  • Norway, and
  • Turkey, not a paragon of economic management or political stability.

Core inflation measures have been picking up a little here, as they should have after the sharp cuts in the OCR the Reserve Bank had to implement.    But our unemployment record –  at a time when much of the rest of the advanced world has been able to run unemployment rates back near pre-recessionary levels without (yet) seeing signs of core inflation rising –  is one reason why I think the Governor is quite right not to express any bias about the direction of the next change in interest rates, however far away (and delivered by a person yet unknown) that might be.

Labour on monetary policy

Alex Tarrant of interest.co.nz had an interesting article earlier this week on the approach the Labour Party plans to take on monetary policy and Reserve Bank issues.    It seems that we should take it as a reasonably authoritative description, even though the formal policy has yet to be released. Labour’s finance spokesman Grant Robertson  described it thus

Useful write up from Alex Tarrant on monetary policy in NZ, including some thinking from yours truly.

From the article

Labour’s stance that the Reserve Bank of New Zealand’s (RBNZ) price stability goal should be accompanied by a focus on employment will not see it propose a specific, nominal employment or unemployment figure for the central bank to target, finance spokesman Grant Robertson told interest.co.nz.

Meanwhile, Labour is set to follow the US example of not outlining which of price stability or employment the central bank should prioritise if the two goals were to clash at any point, he said.

Being picky, one might hope that Robertson appreciates the difference between real and nominal targets:  ‘nominal’ is usually a term referring to price measures, money supply measures, or even nominal GDP (the dollar value of all the value-added in New Zealand), while “real” usually refers to quantities/volumes, or to a price-change adjusted for the movement in the general level of prices (eg real house prices, or real interest rates).    Employment or unemployment are “real” variables, not nominal ones.

Mostly I don’t have too much concern if a Labour-led government were to seek to amend the Reserve Bank Act, or to put words in the policy targets agreeement for the new Governor next March, that made some reference to employment or unemployment.  So long, that is, as no one thinks it will make any difference.

No one seriously doubts that monetary policy choices can affect employment/unemployment in the short-term.  But, equally, no one seriously thinks that monetary policy can make much difference to those variables over the longer-term.

Monetary policy affects employment/unemployment in the shorter-term to the extent it affects economic activity.  And thus, when the Policy Targets Agreement states, as it has since 1999 when the incoming Labour Minister of Finance inserted the words, that the Bank should avoid “unnecessary instability in output”….

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

….it was already enjoining the Bank to be concerned about the shorter-term employment/unemployment implications of its monetary policy choices.  And in inserting those words it was really just describing –  to help make it better understood to a wider audience –  what it was the Reserve Bank had been doing anyway.  Those considerations were the reason why, from the very first Policy Targets Agreement, price stability had been something to be pursued over the medium-term, with explicit provision for various shocks to prices.  If the Reserve Bank had attempted to fully offset those shocks –  GST increases, or petrol price increases for example –  it would have come at a cost of unnecessarily disrupting output and employment.

So one option for Labour could simply be to add in “employment” or “unemployment” to the existing list of things the Bank should try to avoid unnecessary instability in.

It is also worth noting that Policy Targets Agreements have long opened with descriptions of what a monetary policy focused on low and stable inflation is trying to achieve –  again, mostly an opportunity to remind people that price stability isn’t just an end in itself.   Under the current government, those words have read

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

Although it isn’t stated explicitly, presumably high employment/low unemployment is part of that mix.

But under the previous (Labour-led) government, it was explicit.  These words were added to the PTA in 2002 by Michael Cullen when Alan Bollard took office

The objective of the Government’s economic policy is to promote sustainable and balanced economic development in order to create full employment, higher real incomes and a more equitable distribution of incomes. Price stability plays an important part in supporting the achievement of wider economic and social objectives.

Of course, those words made no discernible difference to how the Bank ran monetary policy. But then they weren’t really meant to: it was more a matter of “virtue-signalling”: “we care, and monetary policy isn’t just some Don Brash thing”.

And so a challenge that should be put to Grant Robertson and his colleagues is to clarify whether they think that adding a “focus on employment”, whether to the Act or the PTA is intended to make any substantive difference whatsover, and if so how?

In his interview, Robertson refers to the example of the United States, where the Federal Reserve is often described as having a dual mandate.   In fact, in statute that isn’t really true.  Here is what the Federal Reserve Act says of the objectives of monetary policy

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

The goal, in the somewhat outdated language of the 1970s, is to “maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production”.    All the rest of it is simply a description of outcomes that, over time,  pursuing that nominal (money and credit) target can help achieve.

Of course, you won’t often hear Federal Reserve officials highlight that statutory goal –  and they will often talk of “dual objectives” –  but it does highlight that there isn’t an easy off-the-shelf model of legislative wording for Labour to adopt.

A few years ago, recognising that these issues were now the subject of active debate in New Zealand, the Reserve Bank did a Bulletin article collecting and classifying the statutory and sub-statutory (eg PTA type documents) monetary policy objectives for a variety of advanced countryies  If I say so myself, it remains a useful reference (partly in highlighting the different roles that different ways of framing objectives can play –  some are explicitly aspirational, some more accountabilty focused, some language is old and some new etc).  In many of the countries, employment pops up somewhere or other –  but mostly, apparently, in that same sense that we’ve seen in New Zealand, or in the US statutory objective, that a well-run monetary policy will contribute over time (perhaps in quite small ways) to a well-functioning economy, and labour market.

Robertson has also talked about the statutory language in Australia.  The Reserve Bank of Australia Act specifies (as it has since 1959)

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

a.the stability of the currency of Australia;

b.the maintenance of full employment in Australia; and

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

But surely the challenge for Robertson is “so what”?    Is there any evidence he can point to suggesting that, over time, the Reserve Bank of Australia (or the Federal Reserve) have run monetary policy materially differently from the Reserve Bank of New Zealand?    Past research the Reserve Bank has done looking at exactly that issue suggested not.

Perhaps this might seem a curious stance for me to be taking.  I’ve been repeatedly critical of the Reserve Bank’s conduct of monetary policy over the last couple of years  at a time when the unemployment rate that has lingered well above estimates of the NAIRU  (while, curiously, Robertson has often been a defender of the Governor).    But it is most unlikely that any sort of weak reformulation of the statutory goal would make any material difference, especially when  according to Robertson

Labour is set to follow the US example of not outlining which of price stability or employment the central bank should prioritise if the two goals were to clash at any point, he said.

and

He told interest.co.nz that Labour is not going to tell the RBNZ whether one is more important than the other.

The Bank’s failures over the last few years, to the extent that they can be seen as such, have been mostly about forecasting, combined with some over-confident priors, not about policy preferences, or an aversion to seeing high employment/low unemployment.

But if Labour really wants to give the Reserve Bank two objectives, and not even subordinate one to the other (on, for example, the basic grounds that in the long run nominal instruments –  monetary policy –  can only really achieve nominal targets), it is simply fairly explicitly abdicating what are inherently political choices to unelected technocrats.    The strongest case for an independent Reserve Bank is when there is a widely-accepted single target.

Then again, perhaps what is really going on is just “virtue-signalling”.  I’m sure Labour has access to plenty of people who can tell them that the RBA, the Fed, the Bank of England and the Bank of Canada –  all with different ways of phrasing monetary policy goals –  don’t do things much differently from each other, or from the Reserve Bank of New Zealand.  Each will make mistakes at times, each with have idiosyncrasies, and from time to time each might have poor decisionmakers, but there is just no evidence that the framing of the New Zealand target keeps the Reserve Bank from making good policy.  But promising to tinker with the central bank goals probably sounds good in certain quarters –  suggesting that the speakers aren’t dreaded “neo-liberals” and might be “sound” on other stuff.

The Tarrant article also confirms that Labour is looking at governance changes for the Reserve Bank.  Sadly not the right ones.

If Labour leads the government after the 23 September general election, it will immediately launch a review into its proposals. This will also include a look at a Labour preference of taking sole rate-setting responsibility from the RBNZ Governor in favour of a rate-setting board that includes the Governor, his deputies and potentially other voices within the bank.

I hope Robertson and his colleagues bear in mind that governance reforms along exactly those lines –  entrenching a legislative role for internal technocrats –  was rejected by the previous Labour government in 2001.  I thought they were right to do so then (even though at the time I held a role that Labour’s independent reviewer, the academic expert Lars Svensson, thought should be a statutory member of the decisionmaking monetary policy committee), and I hold to that view.

At very least, a decisionmaking committee comprised of internal line managers would necessitate wider changes.   Since the case for moving away from a single decisionmaker is to reduce the risks associated with one person, one shouldn’t just move to a system where that one person, together with people s/he appoints/remunerates, make the decisions.  In the right hands, it might work fine, but we build institutions to protect us against bad outcomes and people who turn out to be poor appointees.  The sort of Governor one might have to worry about isn’t likely to be appointing people who will systematically differ from him/her.  If deputy or assistant governors are to be given statutory decisionmaking powers, those appointments (and that of the Governor) need to be ministerial appointments.  But I’m not aware of any other New Zealand government agency where a group of line managers get to make key policy decisions (perhaps Robertson is?).  Far better to use line managers to service (provide the research and analysis to) a decisionmaking committee, appointed by the Minister of Finance, and made up of a mix of internal and external people (as in Australia or the UK, and –  in a different system of government –  the US).

Although I don’t agree with their specific solution, on this issue I think the Green Party is much closer to proposing a good model than Labour (at least on the evidence of this article) is.  The same goes for enhancing the openness and transparency of the Reserve Bank –  another issue Labour seems not greatly interested in.  On that score, one option perhaps the parties on the left could think about is to require the Reserve Bank to publish, at least six-monthly as part of a Monetary Policy Statement, its estimates of the NAIRU (and perhaps other medium-term trend real variables, such as the natural rate of interest, and the projected trend rate of labour productivity).

There are plenty of aspects of the Reserve Bank legislation and practice that warrant review and reform.  Time has moved on, the Bank’s responsibilities have changed gradually etc.   If Labour is in the position to lead a government after the election, I hope they would be open to setting the terms of their review sufficiently broadly to encompass those issues (eg decision-making, appointment procedures, transparency, openness, the allocation of prudential policymaking powers between the Bank and the Minister etc).  I doubt any of these are really vote-winners, but they are the sort of issues that a modern responsible competent government would put on its agenda, for a tidy-up and modernisation.

Perhaps there are votes in promising to rearticulate the monetary policy objectives. But if so, it is more likely to be through “virtue-signalling”, than through the likelihood that  the sort of stuff Labour is talking about would make any material difference at all either to how monetary policy is actually run, or to the resulting economic outcomes.  Surely Labour must know that.  But does it bother them?

New Zealand has serious long-term structural economic underperformance challenges that need to be grappled with.   Sadly, the current government seems largely indifferent to them.  One can only hope that as policy programmes emerge over the next few months, the opposition parties will be offering some serious alternatives.  At present, there doesn’t appear to be much reason for hope on that score.

 

The new tightening cycle?

“When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose it to mean—neither more nor less.”

This chart shows the Reserve Bank’s projected future OCR tracks from last November’s MPS and the track from yesterday’s MPS.

ocr-projections-feb-17-and-nov-16

Using the definition of an “easing cycle” they appear to have adopted yesterday, to try to provide some cover for their 2014 misjudgements, this must surely mark the beginning of a new “tightening cycle”?     And, yes, the forward track was revised up very slightly.  Given that the Bank usually moves in increments of 25 basis points, the first actual OCR increase is currently expected in 2020 (this is the first time we’ve had projections for 2020).

But, of course, you didn’t hear the words “tightening cycle” from the Governor, or his offsiders, to describe what they’d done yesterday.  (I missed the start of the press conference, but I’ve seen no references anywhere to the words, or ideas).  And that is because it wasn’t the start of a “tightening cycle”.  Indeed, if one takes the projections seriously, one must assume there is about as much chance of another OCR cut in the next year to two, as of an increase.

And the Bank’s own official words back up the idea that this wasn’t the start of a tightening cycle.  Here are the key final sentences from the press release for the November MPS when, you’ll recall, they cut the OCR.

Monetary policy will continue to be accommodative. Our current projections and assumptions indicate that policy settings, including today’s easing, will see growth strong enough to have inflation settle near the middle of the target range. Numerous uncertainties remain, particularly in respect of the international outlook, and policy may need to adjust accordingly.

and here are the sentences from yesterday’s statement.

Inflation is expected to return to the midpoint of the target band gradually, reflecting the strength of the domestic economy and despite persistent negative tradables inflation.

Monetary policy will remain accommodative for a considerable period.  Numerous uncertainties remain, particularly in respect of the international outlook, and policy may need to adjust accordingly.

Parse it as you will, in substance those statements are all but identical.  If one wanted to be picky, one could highlight the addition of the words “for a considerable period” –  but it was probably aimed at those market participants who the Bank thinks (rightly in my view) have got a bit ahead of themselves in their enthusiasm for OCR increases later this year.

It would simply be nonsensical to claim that yesterday’s MPS was the start of a “tightening cycle”. It clearly wasn’t.  The Bank didn’t present it that way, and neither markets nor media have interpreted in that way.

It was even more nonsensical for them now to attempt to rewrite history and suggest that they began an easing cycle in June 2014.  They didn’t, they didn’t think that was what they were doing at the time, no one else did then (here, for example, was one of Wheeler’s bigger fans’ own quick assessment at the time) , and no one else does now.  They should be embarrassed.

Perhaps some readers will think I’ve made too much of the point.  But Parliament has given a great deal of power to the Governor, who has openly argued that the Bank is highly accountable.  One of the vehicles for that accountability –  a statutory vehicle –  is the Monetary Policy Statement.   Reasonable people can and do differ over the conduct of policy in 2014, and it is healthy to have the debate –  human beings learn from considered reflection and examination.    But attempting to twist language to try to rewrite the historical memory isn’t the sort of thing we should be expect from public servants who wield so much power.   And while Wheeler himself will soon be history, he has been keen to argue that he governs collegially –  emphasising the role of his deputies and the assistant governor.  Of them, the deputy chief executive will succeed Wheeler as Governor for six months, and most lists of potential candidates for the next permanent Governor seem to include both the other deputy governor, Geoff Bascand, and the assistant governor John McDermott.  The Governor signs the MPS, but McDermott’s department generates the document –  text and supporting analysis.   An excellent central bank –  doing policy well, producing strong supporting research and analysis, being open and accountable (rather than just playing political games), should be doing a lot better than this.

I was also struck by another of the Bank’s attempts in yesterday’s MPS to smooth over its record.  They noted in chapter 2 that

“Annual CPI inflation has averaged 2.1 per cent since the current target range was introduced in 2002”.

Which is true, but not particularly revealing.    For a start, during the Bollard decade, it averaged 2.5 per cent (excluding the direct effects of the higher GST) and in the Wheeler years it has averaged so far 0.8 per cent.  Lags mean Brash (and the old target) was responsible for the first year or so of the Bollard results, and Bollard was responsible for the first year or so of the Wheeler results, so here is a chart showing a three-year moving average of annual CPI inflation (again ex GST).  I’ve started from September 2005, so that all the data cover periods when the inflation target midpoint was 2 per cent.

cpi-inflation-3-yr-ma

It isn’t exactly a record of keeping inflation near the midpoint, even on average.  If the Bank seriously wants to argue that its performance should be evaluated over 15 year periods, they should abandon any pretence that there is serious accountability embedded in the system. Or, they could just play it straight, recognise their own (inevitable) limitations, and participate in some thoughtful, rather than propagandistic, reflections on the past conduct of policy and lessons for the future.  We should be wanting –  the Minister and Board should be seeking –  a Governor who has that sort of open-minded self-confidence.

When I exchange notes with other former Reserve Bank people one common line that comes up is a sense that the analysis in the Bank’s Monetary Policy Statements is often rather tired, and adds little of value to the reader.    Someone went as far yesterday as to send me a 20 year old MPS as a standard for comparison.  I often caution people that each generation is prone to view their successors that way, and insert the caveat that I hesitate to claim much for a period in which the Reserve Bank had the MCI (and a key senior manager, who fortunately didn’t last long, who often nodded off, just across the table from the Governor, in Monetary Policy Committee meetings).  Nonetheless, I can’t help coming to the same conclusion myself.    There are defences –  for a small central bank, four full MPSs a year is probably too many –  simply cranking the handle to churn out the documents take a lot of resource.  But it is the Bank that chooses that model –  Parliament only requires two statutory MPSs a year.  It could be argued also too that most of the value in the document is in the one page press release and a single table  –  but then why produce 30 to 40 pages?   And sadly, even when they do try to introduce new material, I often don’t find it very persuasive or enlightening.  And sometimes, the emphases seem quite politically convenient –  productivity, for example, (or the complete lack of it in New Zealand’s case) appears not at all in the text of yesterday’s MPS.

I wanted to touch on just two examples from yesterday’s document.  A year or so ago, the Reserve Bank introduced LUCI –  the labour utilisation composite index, an attempt to provide a summary measure of resource pressure in the labour market.    It was interesting innovation, if not fully persuasive as an indicator.  They ran the chart in yesterday’s document

luci

In the text, the Bank simply notes that labour market tightness increased over 2016.  But if this indicator is supposed to be a measure of that, how seriously can we take the claim?  After all, this index appears to suggest that in the Bank’s view the labour market is now almost as tight as it was at the peak of the previous boom (late 2004?) and materially tighter than it was over say 2006 and 2007 –   a period when the unemployment rate averaged less than 4 per cent, and when wage inflation was quite high, and increasing further.

Over the last year, however

  • the unemployment rate was basically flat (actually 2016q4 was higher than 2015q4, but lets treat that as possibly just noise),
  • wage inflation was flat or falling,
  • and in the Bank’s Survey of Expectations, expectations of future wage inflation were flat as well (actually down a bit in the latest survey)

And all this when the unemployment rate has been persistently above the Bank’s own estimate of the NAIRU (which appears to still be around 4.5 per cent), let alone Treasury’s which is around 4 per cent.  There is little to suggest anything like the degree of labour market pressure that was apparent in the pre-recession years.

No doubt, there are good answers to some of these questions and apparent contradictions.  But the Bank has made no attempt to address them, even though other labour market developments –  around immigration – receive a lot of focus.  The public, and readers of the MPS, deserve better analysis than that.

The Bank’s immigration analysis has also been rather tortured.  Historically, they have worked on the basis, and produced research to support, the common view that the short-term demand effects of immigration exceeded the supply effects.    There shouldn’t be anything surprising, or very controversial, about that –  immigrants (or non-emigrants) need to live somewhere, and need all the attendant private and public infrastructure of a modern economy.  Those pressures tell one nothing about the pros and cons of immigration policy.

But in the last couple of years, the Bank has been going to great lengths to try to suggest that this time things are different: this time the composition of the immigrants is so different (than in every previous post-war cycle) that, if anything, the supply effects outweigh the demand effects, and that high net PLT immigration is part of what is keeping inflation down.

It isn’t totally impossible of course.  Fly in labourers, house them in disused prisons, forbid them from spending anything locally, and employ them only in very labour-intensive roles and the supply effects might outweigh the demand effects.  But that isn’t the modern New Zealand immigration story  (and in case anyone wants to be obtuse, obviously nor should it be).

The Bank likes to illustrate their case with charts like this one, produced again in the MPS yesterday.

plt-by-age

It uses PLT net migration data to purport to show (a) record immigration, and (b) that that record influx is hugely concentrated among young people who, it is claimed, add more to supply than to demand, dampening inflation pressures.  The contrast is supposed to be particularly stark with the last big influx in 2002/03.  The Bank explicitly states “young migrants and those on student visas represent a much higher share of migration than in previous cycles”.

I’ve covered much of this ground before, especially in this post.   The limitations of the PLT data are well known, both in principle and in practice.    At my prompting, with the full knowledge of my then RB superiors, Statistics New Zealand produced a research note on the issue a couple of years ago.  In that document they showed how the PLT data had materially misrepresented the actual long-term migration inflow to New Zealand in the 2002/03 period (not wilfully –  just the limitations of the timely measure).  This was their chart.

plt-methods

So the best later estimates are that the 2002/03 influx was around 50 per cent larger than the PLT data (including the age breakdown data) the Bank is constantly citing.

We don’t have current estimates from this improved methodology for the current cycle, but one can see the point in just comparing the net PLT inflow with the net total passenger arrivals. It is a more volatile series –  things like World Cups and Lions tours help introduce volality.

migration-per-cent-population-feb-17

But you can see the big difference between the two series over 2002/03 –  and SNZ estimated that much of that difference wasn’t very short-term tourists, it was people who ended up staying longer.  Jump forward to the current cycle: contrary to the mythology the influx of people this time round, as a share of the population,  hasn’t been larger than it was then.  The peaks are around the same, and the peak this time (at least so far) was shorter-lived than it was in 2002/03.

And what of the student story?  Well, it doesn’t really hold up either.  Here is the MBIE data on the number of people granted student visas each year, as a share of the population.

student-visas-feb-17

The peak isn’t as high as it was in 2002/03, and the extent of the increase is much much smaller this time.   Foreign students add to demand –  as all exports do.  (Of course, there have been some  –  somewhat controversial  – changes in student work rules, which might have mitigated the demand effects, but curiously the Bank doesn’t invoke that effect as part of its story.)

My point here is not to argue whether my conclusion (net migration tends to boost demand more than supply in the short-term) is right, or the Bank’s (this time is different) is.   And as it happens, we see eye-to-eye right now on the current stance of monetary policy.   I’m mostly concerned that the Bank seems to just ignore inconvenient data that just isn’t hard to find or use.    There might well be good counterarguments to the data points I’ve highlighted here, but instead of making those arguments, the Bank simply ignores them.  One might, sadly, expect that sort of standard from political parties and lobby groups.  We shouldn’t expect, or tolerate, it from powerful well-resourced public agencies.  The Bank’s argument is certainly fairly politically convenient: it keeps the focus off that unemployment rate that is still above the NAIRU (a gap that might be expected to be constraining inflation) and the near-complete absence of productivity growth, which might be deterring new investment (also dampening inflation pressures in the short-run).

There are plenty of complex issues around in making sense of what is going on. I certainly don’t claim to have a fully convincing story myself. But given the level of public resources put into the Reserve Bank, we should expect a lot more from them –  not just answers, but evidence of genuine intellectual curiosity, and a desire to evaluate arguments from all possible angles.  Their current policy stance is fine, but there doesn’t seem to be a strong and robust organisation, of the sort that would underpin consistently good policy through time, judged by the strength of its analysis and its openness to debate.   Yesterday’s MPS is just one more example of that.   Turning around that weakness should be one of the key challenges for the new permanent Governor.