In the government’s Budget, the Treasury projects that on current policies the government will be running an operating deficit for six straight years (while in the 7th the surplus is so tiny that even if it were not for Eric Crampton’s point about tobacco excise revenue we might as well just call it a coin toss as to whether, if the economy played out as Treasury projects we’d see a surplus or a deficit that year).
People have from time to time pointed out that under the previous National government there was also a spell of six straight years of deficits. In fact, here is a chart. The blue lines shows actual fiscal balances from the last surplus (year to June 2008) to the first surplus again (year to June 2015), while the orange line shows actual and Treasury forecasts from the year to June 2019 (last surplus) to the first (tiny) projected surplus (year to June 2026)
In each period, there was one really really large deficit year. In the earlier period that was the year to June 2011, which captured much of the cost to the Crown resulting from the Canterbury earthquakes. In the more recent period, the peak deficit was the year to June 2020, the period encompassing the first and longest Covid lockdown (huge wage subsidy outlays and all).
If these forecasts come to pass we”ll have had an operating surplus (or balance) in five of the last seventeen years.
What about context? In both periods there was a very big exogenous event: earthquakes in the one period and Covid (lockdowns) in the other. Both were, almost necessarily, very expensive for the government. Few people have much problem with meeting many of the direct costs as fiscal obligations.
But….there was a really important difference between the two periods. In the first, the economy headed straight into a fairly deep recession (partly domestically-sourced – our inflation rate had got above the top of the target band – and partly the global downturn associated with the 2008 financial crisis. It was all aggravated by the fact that the 2008 Budget was very expansionary – and yes, that was extravagant and it was election year, but the Treasury advised them that such an approach would not push the budget into deficit over the forecast horizon. It wasn’t one of Treasury’s better calls.
By contrast, at the end of 2019, the unemployment rate was low and, notwithstanding the brief but severe interruption to output around the lockdowns, has mostly remained very low since. When there isn’t excess capacity in the economy, tax revenue tends to come flooding in.
Here is a comparative chart of the unemployment rates in the two periods.
That difference in the unemployment rates makes quite a big difference to the fiscal outcomes, for any set of spending choices. You might criticise the previous government for doing nothing about a Reserve Bank that let unemployment linger well above the NAIRU for so long, as you might criticise the current government for doing nothing about a Reserve Bank that had the economy so overheated for so long. But the economic backdrops to those paths of fiscal deficits were simply very different: with an overheated economy and lots (and lots) of fiscal drag, the revenue was flooding into Treasury over recent years. There was simply no good macroeconomic reason for having operating fiscal deficits at all in an overheated economy, especially once the big direct Covid spending had come to an end (which it had a year ago). By contrast, the earlier government presided over a very sluggish recovery – and so weak, relative to target, was inflation that there was barely any fiscal drag. Even if the Budget was structurally balanced, cyclical factors would have left a small deficit (on Treasury and Reserve Bank numbers there was a negative output gap every year through to 2016).
If the unemployment rates and output gaps give a sense of the cyclical slack (or overheating), labour force participation rates are also valuable context
A materially larger share of the population is now in the labour force now than in the period of that previous run of deficits (and given that unemployment rates have been lower this time, the difference in employment rates is even larger. Revenue has been abundant.
I’m not really convinced there was an overly strong case for the previous government having continued to run operating deficits in the last couple of years of their stretch of six. Had the Reserve Bank been doing its job better, perhaps they wouldn’t have (the economy would have been more fully employed and inflation would have been nearer the target).
But I’m quite convinced there has been no good economic case at all for operating deficits in 22/23. 23/24, or 24/25. Take 22/23 (the year just ending) as an example: on Treasury estimates there has been a positive output gap, and the unemployment will have averaged about 3.5 per cent (well below anyone’s estimate of NAIRU). And with 6-7% inflation, fiscal drag has been a big revenue raiser. And if there has been any residual direct Covid spending (a few vaccinations?), the amounts involved must have been vestigial indeed. So cyclically the revenue was flooding in, but they still ran a deficit: it was pure choice to undertake routine operational spending without the honesty to go to the electorate and raise the taxes to pay for that spending.
The cyclical position is less favourable over the next couple of years – the recesssion (as indicated by the 2 percentage point rise in the unemployment rate) required to get inflation back down again – but the government has chosen to adopt discretionary new giveaways with borrowed money.
It isn’t just some idiosyncratic Reddell view that operating budgets should be balanced (none of this is about capital spending or arguments about infrastructure). It is there in the Public Finance Act
Now, if I was writing the Public Finance Act, I wouldn’t word things quite that way. But……the Public Finance Act is something both main parties have signed up to. It may make sense to borrow to fund useful longer-term investment, but it makes no sense to be borrowing to pay the groceries, especially in times when income has been more abundant than usual.
Just two more Budget charts. The first is one I showed on Twitter yesterday
Now, there is plenty of scope for political argument about the appropriate size of government spending, and left-wing parties will typically be keener on higher numbers than right-wing parties. My own interest here is more about fiscal balances, but it is worth being conscious of just how much larger a share of the economy is now represented by Crown operating spending than was the case even five or six years ago. Those were the days of the pre-election Labour/Greens budget responsibility rules
Next year’s spending at 33 per cent of GDP is not quite at the previous peaks (Covid and the earthquake years) but nor might one really have expected it to be. But there is an election to win I guess.
And finally, inflation. Treasury doesn’t run monetary policy but (a) the Secretary sits as a non-voting MPC member, and (b) Treasury are the Minister’s advisers on the Bank’s performance, so they aren’t just any forecaster. On the Treasury numbers, it isn’t until the year to June 2027 that CPI inflation gets back to the middle of the target range (the 2 per cent midpoint the MPC is supposed to focus on).
This chart uses Treasury’s annual numbers to illustrate what a difference the monetary policy mistake has made, and is making, to the price level
The blue line is the actual (annual) data and the Treasury forecasts. The orange line is what the price level would have looked like in a stylised scenario in which the MPC had delivered 2 per cent inflation each year over this period. The difference is substantial: the price level in the blue line is almost 13 per cent higher than in the orange line by the end of the period. The Minister of Finance appears to be quite happy for the current gap (about 10 per cent) to keep widening for the next five years. He shouldn’t be.
We do not run a price level targeting regime. That means bygones are treated as bygones and we don’t attempt to pull the actual inflation rate back down to the orange line having once made the policy mistake that pushed it so far above. It does not – or should not – mean indifference to the arbitrary redistributions that big unexpected changes in the price level impose, strongly favouring borrowers (especially those with nominal debt and long-term fixed interest rates) and heavily penalising financial savers (holders of real assets can be largely indifferent over time). Inflation – and especially unexpected inflation – is deeply damaging, and there were good reasons for reorienting monetary policy to deliver medium-term price stability. But now the powers that be appear unbothered by 7 years in succession of inflation above the target midpoint. It seems about on a par with being happy to set out to deliver six successive years of operating deficits. Poor fiscal policy, poor monetary policy, poor performance from both the Governor and MPC and the Minister of Finance (the latter not only having direct responsibility for fiscal policy, but overall responsibility for monetary policy and the people he appoints to conduct it). It will be interesting to compare the Reserve Bank (considerably more up to date) forecasts next week.
I’m going to be away for the next couple of weeks so there won’t be any new posts here until after King’s Birthday.
There have been a few posts here recently about Professor Caroline Saunders, whose initial term on the Reserve Bank MPC expired at the end of March and who was eventually, belatedly, and with no announcement at all, appointed by the Minister of Finance to a short second (and final) term on the MPC. The most recent of those posts was here.
When there was no announcement before the Saunders term expired, I had lodged OIA requests with both the Reserve Bank and the Minister of Finance for material relating to her reappointment (or otherwise). Responses to both emails have now come back.
If it is now clear that the bottom line reason why Saunders was not reappointed before her term was expired was administrative slackness (between the Minister’s office and Treasury mainly), the documents that were released don’t put any of those involved in a particularly good light.
My request to the Bank was fairly broadly phrased
I am writing to request all and any material (including any advice to the Minister) relating to the expiry of the MPC term of Caroline Saunders and any discussions or decisions to reappoint her (or not) or to extend her term
and since the Bank says it has not withheld any documents, it seems fair to assume that what I have is all there is.
This was the first document they released, from the minutes of the Reserve Bank’s 7 December 2022 Board meeting/
In other words, there was no paper analysing the record of the MPC or the personal contribution to the MPC made by Saunders, even though the decision to recommend reappointment was being made in the midst of the worst monetary policy failure in the decades since the Reserve Bank was given operational independence around monetary policy. There was also apparently no paper discussing the best balance of the MPC in the period ahead, or the appropriate length of time for a reappointment (not even, apparently, a discussion as to why the recommendation is for an extension of “up to three years” when the law would allow up to a four year second term. There is also no sign in those minutes of any substantive discussion or hard questions being posed by Board members (unsurprisingly perhaps given the lack of relevant background of all but the chair, who presumably had any conversations with the Governor in private, unminuted).
It was, it should be noted, no better when the other two external MPC members were reappointed (for terms from 1 April 2022), but the inadequacy of the process is all the more glaring by late 2022 when the extent of the monetary policy failure, for which MPC members are responsible, was much clearer than perhaps it was to the previous Board in late 2021.
The Board chair then seems to have moved fairly expeditiously, sending a letter of recommendation to the Minister dated 16 December 2022.
although it is not entirely clear whether this was sent directly (it is signed and dated) or only as an attachment to a memorandum to the minister from Quigley dated 9 January 2023. This is the entire substance of that memo
Note several things
(trivially) there is actually a mistake in the letter (Buckle’s second term expires in March 2025 not September 2025
there is no advice (not a word) to Minister about the contribution Saunders had made over her (by then) 3.75 years on the MPC, a period in which (a) the regime was new, and (b) monetary policy was sorely tested.
despite explicitly noting to the Minister that Saunders could be reappointed for four years, the Board chair offers the Minister no information as to why the Board thinks the extension should be only “up to” three years.
presumably after discussions with Treasury, the Minister is told that the process for reappointment should take about two months (this in a document submitted on 9 January). Elsewhere in the formal recommendations the Minister is asked for a decision by 23 January.
And then there are no other documents (and the Minister has also not indicated that he has withheld whole documents) for more than two months. The next document is dated 8 March, only three weeks before the Saunders term expires.
In any country with serious scrutiny of the MPC – and a belief that external MPC members made any difference whatever – serious questions would have been being asked by now, by market participants and by journalists. After all, on paper MPC members wield a great deal of power, and things hadn’t been going that well with monetary policy. But there weren’t.
In an internal Reserve Bank email (to the Governor) we learn that on 2 February “the MoF’s office asked for a clarification to be made to the letters/report which we provided (that CS be reappointed ‘up to 3 years’ subject to the preference of the MoF”.
And again nothing until 4 March when the timeline in this same email records that “MoF’s office call Neil Quigley to seek clarification on Caroline Saunders’ reappointment. On 6 March, the Reserve Bank learns “from MoF’s office that the recommendation will go in the weekend bag….and we should get an outcome early next week”.
And they did
which is strange again, because while the Minister is reported as favouring staggered terms for MPC members (and very sensibly so) he deliberately, and with no officials’ recommendation plumped for a term for Saunders which will mean that the terms of all three external members expire between 31 March 2024 and 31 March 2025. It would have been easy to have given Saunders a three year term or even a four year term and really stretched things out. But he did not, and there is no indication why in any of the papers.
Quigley reverts to the Minister accepting the general idea and a very short extension to 30 June 2024 is agreed. Quigley observes that “Caroline’s term ending at that time is entirely workable from my point of view. As you say, the search for a replacement can still be part of the same search that we undertake to fill the other vacancy from 1 April 2024”. Since it is already May, one might suppose that a new search process – since both Saunders and Harris cannot be reappointed again – will be getting underway fairly shortly.
At this point it is realised that they are too late to get the Saunders reappointment confirmed before her term expires (it needed to go through the Cabinet Appointment and Honours Committee and to be confirmed by the full Cabinet) but nobody seems very bothered by this. As the documents note, and as I initially missed, the (dubious) statutory provisions for MPC appointments allow an MPC to stay in place after their term ends unless advised otherwise by the Minister. But there is no sense of urgency, no sense (perhaps accurately) of any likely media or market interests (despite the on-paper power these positions wield), at least until I wrote a post on 3 April, which prompted the Reserve Bank comms staff to (a) prepare a draft statement if at that late point there were to be any media questions (which there weren’t) and (b) quickly update their website to make clear that members could remain in office after the expiry of their term,
There is no hint in any of the papers released as to why the Minister of Finance chose not to announce formally the reappointment of Saunders (or the extension of Harris, to get around election timing) and rather leave the fact to be discovered either by chance or by assiduous readers of the Gazette.
In the grand scheme of things, perhaps none of this matters a great deal, but the promise was, in reforming the Reserve Bank Act, that MPC members really would matter, and would make a difference. Over four years, there has not been the slightest evidence for it.
But it still seems to be a very bad look, given that the government chose to keep on with the curious appointment model in which the Minister can only appoint people his hand-picked (and not for relevant expertise) Board recommends, that there is no evidence the Board itself engaged in (or received) any serious analysis or review of Saunders’ contribution to the MPC through such a challenging period, and that there is no evidence that any serious substantive advice was being provided to the Minster on her contributions, strengths and weaknesses. It doesn’t reflect much better that there is no sign that the Minister cared, or sought such advice (despite how far outside the target range core inflation has been). The Minister’s office processes seem to have been slack, to say the least. No doubt he is a busy man, but he has a fully staffed office, and there is much justification for sitting doing nothing for two months on a recommendation for an appointment that really should be somewhat market sensitive.
As for Saunders, were she really making a stellar contribution to the MPC (a) the Board might have been expected to have highlighted that and recommended a full four year term extension, and (b) the Minister might have been expected to have enthusiastically agreed (she was after all his preference four years ago). Instead, nothing, and about the shortest credible extension it was possible to have given her.
Finally, there are some issues for any incoming government later this year. As I often point out, a new government that was unhappy with how the Reserve Bank and MPC have been operating cannot simply get rid of the Governor. They can however make appointments around him (including Board and MPC members). Any different government has been given quite a gift by Robertson, in that all the external MPC member positions will expire by 31 March 2025 and all have to be replaced. The Board chair’s own term expires on 30 June 2024 (he was given only a two year (presumably final, transitional) term on the new Board. Given the mediocre appointments to date, and lack of evidence of serious scrutiny and review, if an incoming government really cares about making things better at the Reserve Bank, they will need to take the issue in hand early and make it clear to the Board – themselves quite unqualifed to judge – just what sort of people the Minister will consider appointing (removing, for example, and one would hope, the current blackball on anyone actually engaged now or in future in any serious macroeconomic analysis and research). It is most unlikely that better outcomes (people, process, policy) if Orr and Quigley are simply left to do things as they’ve been done for the last four years.
The question of course is whether the Opposition parties really do care. It is easy to run lines now about “cost of living crises” and high inflation, but (core) inflation is a Reserve Bank outcome and the Minister of Finance is ultimately responsible for, and wields more than a few levers over, the Reserve Bank (people, processes, budgets, and policy goals).
In the meantime, what this little episode reveals again is the empty charade the new MPC is, and always was. We have a minister who was interested in the appearance of change rather than the substance of change, and who has shown no interest at all in holding policymakers to account for signal policy failures. And a Governor who could live with (perhaps even embrace the rhetoric of ) the appearance of change so long as his actual dominance of the process and institution was left substantively unchallenged. A double coincidence of wants, just not one well aligned with the wider public interest.
The incoming Australian Labor government last year established an independent review of the Reserve Bank of Australia’s monetary policy functions, structures and performance. The review panel (chaired by a former Bank of Canada Deputy Governor) reported a few weeks ago and their full report is here. Periodic reviews of this sort aren’t uncommon, and are often triggered by episodes of discontent around the performance of the respective central bank (in New Zealand, the 2001 review conducted by Lars Svensson was an example).
There is no clear-cut single preferred way to organise policy functions that society (as represented by government and parliament) wishes to delegate decision-making responsibility to. That is true whether one thinks globally, or just of the subset of advanced economies that countries like New Zealand and Australia usually use as benchmarks or experiences/structures that might offer insight.
If this proposition is true generally, it is no less true of monetary policy specifically. And that shouldn’t really be surprising, including because monetary policy is really quite a recent thing. In New Zealand and Australia the transition to a market-based financial system and a floating exchange rate is not quite yet 40 years old, and even among larger economies floating exchange rates more generally date back only 50 years or so. Modern monetary policy is a cyclical management function (leaning against cyclical macroeconomic fluctuations subject to a constraint of keeping the inflation rate in check), and yet our data sets are really quite limited (since 1984/85 New Zealand has had 4 or 5 business cycles, and the creation of the euro means there are really only perhaps 15 or so advanced-country monetary policy agencies). We simply do not know with any degree of confidence that one form of monetary policy governance etc structure will produce better results over time than another. Instead we (all, including the RBA review panel) argue from small select samples, from specific historical incidents (where multiple influences are always likely to have been at work), and from the mental models we carry round (some likely to have achieved a professional consensus, others not).
None of which is to suggest that such reviews should not take place. Of course they should, and with good people and a government that is interested in good future structures (as distinct, say, from just being seen to having had the review – there were dimensions of the latter around the review then then New Zealand government commissioned from Lars Svensson) useful insights, outcomes, and reforms can often emerge. There will always be aspects of current practice or legislation than benefit from someone standing back and concluding that it is really time for an update, even if in practice the old arrangements were working tolerably adequately.
But one should also be cautious about expecting too much from any particular review or any particular set of reforms.
The current RBA model is not one anyone would prescribe today if they were setting up a central bank from scratch. A fair bit of the legislation dates back to the founding in 1959, including this
It has been interpreted, stretching language and concepts to a considerable extent, as encompassing the way monetary policy has been run for the last few decades, but really it was written for an age of (among other things) fixed exchange rates. No one would write it that way now.
And the governance? The Reserve Bank of Australia Board makes the monetary policy decisions (back in the day in practice the Treasurer did) and is much as constituted decades ago. The Governor, Deputy Governor, and the Secretary to the Treasury are ex officio members and there are six non-executive directors appointed by the Treasurer. The non-executive members have typically been (often quite prominent) business figures, but over recent decades it has been normal for one of the six to be a professional economist. It is a very unusual model these days for the conduct of monetary policy, although note that the sort of people appointed as non-executive directors is a matter of political choice (successive Treasurers) and I can’t see anything in the legislation that would have prevented six technical experts being appointed.
If the relevant bits of the legislation haven’t changed a lot over the decades, practice has. Monetary policy decisions are clearly made independently by the RBA, in pursuit of a target that is in practice agreed in advance with the Treasurer, they are announced transparently, there are minutes of a sort published, as well as the quarterly Statements on Monetary Policy. Senior managers appears before parliamentary committees and have fairly extensive and serious speech programmes. The RBA is a modern inflation targeting advanced country central bank, but operating on quite old legislative foundations. As an organisation, over the decades it has had considerable strengths, including typically a strong bench of very capable senior managers, and people coming up behind them. Successful organisations in many fields tend to promote mainly from within: that has been the RBA approach (and is very much in contrast, say, to the RBNZ). Note here that promoting from within is not itself a basis for a successful organisation, simply one feature that already successful organisations, continually refreshing themselves, often display.
I was an admirer of the RBA for a long time, and 20+ years ago when the Svensson review was underway (when I was both part of the small secretariat and a senior manager at the RB) thought that New Zealand should look to adopt elements of the structure and culture of the Reserve Bank of Australia. They tended to produce more stable outcomes, produce better research, communicate more effectively, and have a stronger sense of legitimacy than our “Governor as sole decisionmaker” system had achieved (or than Svensson’s preference, of a small internal decision-making committee (of which the position I then held would have been a member) was likely to be able to achieve. The RBA on the other hand saw us as somewhat strange, not always entirely fairly. I recall a time when Glenn Stevens as Assistant Governor and he came over to observe our monetary policy and forecasting week leading up to an MPS (shortly after we had started publishing forward interest rate projections), and he emerged from the week genuinely surprised that our approach was far less mechanical, nay mechanistic, than he had been led to expect. Or a visit from David Gruen, then head of research at the RBA, suggesting that the fact that our interest rates averaged higher than those in Australia suggested we had monetary policy consistently too tight (in fact prior to 2009 New Zealand inflation typically averaged in the top part of the target range).
Over recent decades, Australia has enjoyed a reasonable degree of macroeconomic stability (the review report includes a table showing the standard deviation of real GDP growth less than for any other country shown), this in any economy exposed to very big swings in the terms of trade. As noted above, the samples are small but there is nothing obvious to suggest that overall the Australian approach to monetary policy has delivered worse than other advanced country central banks. But there have been troubling episodes, notably including the one in the years running to Covid when Australian core inflation ran consistently well below target (much more so than anything seen at the time in other countries, including New Zealand where core inflation by then was getting close to the target midpoint). There are also more recent episodes of concern – about specifics of the RBA Covid response and latterly about the sharp rise in core inflation – but through that period it is perhaps hard to differentiate the RBA’s failure (underperformance) from that of a wide range of other advanced country central banks (themselves with a wide range of governance models).
This was one of the things that troubled me about the review report. The first substantive chapter is focused specifically on these recent episodes. It is easy to highlight areas where things could have been done better in (almost any) specific episode – and some of the material cited is pretty disconcerting – but that is almost certainly true of every central bank, and there is no attempt I saw in the report to illustrate that anything would have been very much different with a different governance/committee structure. We might hope it would have been, but the panel offers little reason (and realistically they couldn’t offer more) that it would have been. New Zealand, after all, has introduced a committee, and the panel notes favourably (too favourably) the expertise of its members relative to RBA external board members, but many or most of the same mistakes or weaknesses the panel highlight in Australia over the last three years were also evident in New Zealand – as far as we can tell, as less material has been released here than there, us not having had a recent external review and the Reserve Bank’s own review was largely defensive and unenlightening in nature). Should there have been a proper cost-benefit analysis, and serious questioning from the Board, before the RBA bond-buying programme was launched? No doubt (and the review report is properly critical about the absence, and the likely weak case) but there is no evidence of anything even slightly better in New Zealand. Or, as far as I’m aware, in any or many other advanced countries. Perhaps the RBA case was less excusable, since they started bond buying a lot later, rather than in the heat of the crisis, but the practical difference ends up being slight.
The review panel proposes a new model with these important features
monetary policy decisions would in future be made by a Monetary Policy Board (with a separate RBA governance board, and the existing Payment Systems Board),
the MPB would have nine members, the Governor, the Deputy Governor, the Secretary to the Treasury, and six expert non-executives appointed for non-renewable terms of five years, extendable for up to one year)
non-executive members would be expected to devote about one day a week to the role (around eight monetary policy decisions a year)
there would be a press conference for each decision,
votes would be disclosed but not attributable (ie a decision might be made 7:2, but the two would not be identified by name)
non-executive members would be expected to do at least one public engagement or speech a year,
non-executive vacancies would be advertised, but recommendations to the Treasurer (who would make the final appointments) would be by the Governor, the Deputy Governor and a third person (presumably to be chosen – altho by whom, Treasurer or the officials? – from time to time).
If you were starting from scratch, one could think of worse systems. But this proposal seems to have a number of weaknesses and reason to suspect that unless a strong political consensus developed early around making things work really differently (rather than differently in appearance) it is far less good a system than could have been devised. Even then, I would not be overly optimistic. More generally, my impression is that the report tends to underweight the relative importance of the Governor and very senior management to how central banks operate.
Starting with the small stuff, as the report notes it is highly unusual for the Secretary to the Treasury to be a full voting member of a central bank monetary policy decision-making body. It was one thing in 1959 – at that time New Zealand also had the Secretary to the Treasury as a full member of the (largely toothless) central bank board – but it is 2023. Other countries – including the UK and New Zealand – have preferred the model of a non-voting Treasury observer, which seems bit suited to (a) the desire to ensure at the highest levels that information flows freely between monetary and fiscal agencies) and (b) the Secretary’s own primary responsibilities and loyalties. The report proposes amending the legislation to make clear that the Secretary is voting his/her own judgement, but if so that tends to defeat the purpose of their place on the Board (being there solely ex officio), and in times of tension – and one should build system for resilience in tough times, not for when everyone is getting on fine and everything is going swimmingly – will likely complicate the Secretary’s own position (including as adviser to the Treasurer in holding MPB members to account for performance).
In general I am in favour of a model in which external members outnumber executives, but 6:3 in a nine person board doesn’t feel right (even if it parallels current numbers). 4:3, with the third executive being the Assistant Governor responsible for economic policy, seems a better size overall, and also more realistic about the ability of the system to continue to generate a steady stream of able people to fill (only) five year non-executive terms. And a 7 person committee is more likely to limit the risk of free-riding by individual non-executives.
It is difficult to see how a “day a week” model is likely to work IF the goal really were one having a powerful role, including as expert counterweight to staff, if non-executives were devoting only one day a week to the role. I am not aware of any precedents for such a small contribution, which seems to sit closer to the current RBA Board model (might such board members devote 2 days a month to the role, one to the meeting, one to the papers?) than to other advanced country MPCs. At the Bank of England MPC, probably still the best model, non-executives are paid for 3 days a week work, and at a rate that (least by academic standards would be a reasonable fulltime income). On a day a week model, not only is the actual amount of time any member can devote to RBA matters limited, but the remuneration would that for any non-retired person it would have to be just one part of the member’s employment/income. Most plausibly, they would be current academics, who might otherwise not spend a vast amount of time keeping track of data or of the literature in the specific fields relevant to central banking. We might assume that people will not be disbarred (as is NZ) for doing ongoing research in relevant fields, but even in Australia the numbers of such people are not limitless. One day a week looks like a recipe for an ongoing dominance of management and staff. Consistent with this, while the report suggests that externals should have direct access to staff, if they do not have dedicated analytical support staff of their own their ability to make a difference and shape what is in front of the MPB is likely to be limited. This is, incidentally, one argument for a quite different system – as in Sweden or the US – in which outsiders become full insiders while they are MPC members.
The appointment process is also a concern. One of the weaknesses of the New Zealand MPC system is that the Governor exercises considerable effective control on who serves on the MPC. A really good Governor would have a strong interest in promoting genuine diversity of view and real ongoing intellectual and policy challenge. Real world bureaucrats, running their own bureau, perhaps less so. No doubt there will be arguments about “fit” etc, but the value of outsiders is often in the extent to which they are willing to bring fresh thinking and not be easily deterred by management flannel and weight of paper. With a strong “third person”, perhaps it would work out okay, especially if a Treasurer was clearly committed to viewpoint diversity, challenge etc, but many potential “third persons” might be inclined just to defer to the perceived expertise of the Governor and Secretary.
Accountability does not appear to be a key element in the RBA reform proposal. That seems unfortunate – perhaps especially coming hard on the heels of the massive financial losses central bankers have run up and the scale of their inflation forecasting and policy mistake. If as a society we delegate great discretionary power to unelected officials – and that is what we do in MPCs – accountability is a key counterbalance, including in maintaining the long-term legitimacy of the model. At very least, MPB members should be required to have their named votes recorded and disclosed. Ideally – but it is probably only an ideal – people should be able to be removed from office for non-performance. In fact, one of the other weaknesses of the proposed single term model for externals is the complete absence of accountability. Their views don’t have to be disclosed, their votes don’t have to be disclosed, and since they can’t be reappointed, there is really no accountability at all. Lack of accountability doesn’t exactly encourage members to devote intense energies to getting things right. Some no doubt will, but it will be all too easy to defer to management and treat membership of the MPB as a prestige appointment (like being on the RBA Board now), this time narrowed down to being for economists, rather than a role in which one will make a difference and expect to be held to account.
As I said earlier, there is no one ideal structure. In the end, one is trying to combine technical expertise, experience, judgement, ability to communicate, and something around accountability to produce good policy outcomes taken in ways consistent with our open and democratic societies and under structures that are resilient to bad times and to bad people All in a field where uncertainty is pervasive.
Many of these requirements might well be met with no outsiders at all. You won’t see it highlighted in the review report but the Bank of Canada is one in which, formally and legally, the Governor himself wields the monetary policy powers (akin in that feature to the RBNZ system pre-2019). But in practice the BoC has built a strong internal culture and an effective system where a Governing Council of senior internal managers makes monetary policy decisions by consensus. I don’t think it is ideal – there is no individual accountability except (presumably) to the Governor – but the BoC has built partially compensating mechanisms with extensive research programmes, self-review programmes, and extensive engagement with academic and other wider communities. Indeed, the Bank of Canada model – which I do not champion – highlights just how important the quality of staff and internal processes are. It isn’t necessarily a problem if decisionmakers typically defer to staff and management expertise – in fact it is what you would expect in a normal corporate board – so long as those decisionmakers can continually assure themselves that staff and management have robust and resilient processes in place, including those that encourage, generate and accommodate, genuine diversity of view and openness to alternative perspectives. In that sort of context, some expert external MPC members can be very helpful (especially if they are familiar with, engaging with, perhaps contributing to) emerging literature, but they aren’t the only type of member who could add value. The willingness to actually ask the idiot question, and never to be content with management bluster, is valuable in any governance context. Thus, in an RBA context, one might wonder whether it is really worth having a whole new Board (especially when the RBA is not a “full service central bank” (doing prudential supervision)), when one could have left the RBA Board responsible for monetary policy but with a requirement say that several members should have directly relevant professional expertise. One could argue that being a board member, responsible for all the RBA functions and governance, might make for a person better able to contribute effectively as a monetary policy decisionmaker (and note that there is plenty of role for outside expert advisers anyway, and the report does suggest a more active macro research programme for Australia generally). And of course, in all our systems Ministers of Finance – rarely very expert at all – make major contentious economic policy decisions in climates of extreme uncertainty, drawing on expert advisers but rarely handing decision-making power to such experts.
Overall, I can’t help feeling that if the Australian government goes ahead and legislates all these changes, none of them (not all taken together) will matter quite as much as who gets appointed as Governor, and the sort of internal culture and people, the Governor (and his/her successors) build. That is a critical choice – in Australia, in New Zealand, probably anywhere – and is likely to far outweigh any potential difference that a few day-a-week academics, cycled through the decisionmaking system on five year terms, might make. A great Governor (and we can’t build systems that assume one) will build and maintain a culture that delivers most of what the review panel (often rightly) seems to be looking for.
This post has gone on long enough. It is about someone else’s country so why my interest? Two reasons I think. First, it is a significant report on a central bank in the midst of troubled times, and there are few of those yet. And second because the choices Australia makes are always likely to be an important backdrop to any future reforms in New Zealand. We have had extensive reforms, clearly designed to look different rather than be different, and any new government needs to look to do over quite a few of the aspects of the New Zealand model.
I was going to engage specifically with the AFR article last Friday by Ian Macfarlane, former RBA Governor, criticising the review (and I thank the two readers who sent me copies). Time and space is limited, so I won’t. It is worth reading, and he makes some fair points (some less so), but it is perhaps worth remembering that Macfarlane was Governor at the peak of the RBA’s past standing. The starting point now is less favourable.
Finally, one of the background papers for the review was commissioned from Professor Prasanna Gai at Auckland University (and ex BOE). Gai currently serves on the FMA board, but probably should be one of those considered for our MPC, but……he would be disqualified by our Governor and Board on the grounds of an ongoing active interest in areas the MPC would actually be responsible for. Anyway, his paper is quite a good read on international models around the governance of monetary policy, and he pulls few punches about the weaknesses of the New Zealand model.
Over the last few days I’ve been reading a few pieces on UK monetary policy and high inflation. The first was a speech from the Deputy Governor responsible for economics and monetary policy, Ben Broadbent (over there senior central bankers actually give serious and thoughtful speeches on things the Bank has responsibility for), and the second was a new paper by long-term adviser, analyst and researcher Tim Congdon. There is a lot of overlap because Congdon’s paper is broader (“Why has inflation come back”) but his analytical approach has tended to emphasise the monetary aggregates, while Broadbent’s speech which is narrower in focus is specifically on the question of what information value for monetary policymakers there is (or isn’t) in the monetary aggregates over the longer term and in the specific context of the inflation of the last couple of years. Both are worth reading.
My own view on the monetary (and credit) aggregates is, I think, pretty much the same as that of most central bankers these days, that the indicator value of these aggregates is typically fairly limited in the world we inhabit (low or – at present – moderate inflation), that any really serious breakout of inflation (think, eg, Argentina) is likely to be accompanied, in some sense or other, by rapid growth in the quantities of money, and that for now while one should never ignore any indicator there isn’t much about inflation developments of the last couple of years that is best explained through the lens of monetary aggregates. Specifically, if bond-buying programmes like the LSAP did anything much to boost inflation, it was not primarily (or at all) through a monetary quantities channel.
Here is some New Zealand data (and an RB chart) on the growth rates of the monetary and credit aggregates over the period since September 2002 when the current inflation target was adopted.
At the Reserve Bank we always used to put more weight on credit developments than on money measures, and credit growth dipped quite materially in the early months of the pandemic, but no model using either monetary or credit aggregates is isolation would have given policymakers (or other forecasters) reason for serious concern about an outbreak of core inflation to rates unprecedented for decades, Indeed – and since we don’t run a price levels targeting system, and thus bygones are treated as bygones – an analyst looking solely or mainly at these indicators would have noticed by mid 2021 that all the annual growth rates were back to around 5 per cent. No one was going to be sounding inflation alarms if their analysis was based largely on those growth rates. Even in the short period when annual money growth exceeded 10 per cent, the growth rates were not very much higher than had been seen not infrequently over 2011-2016 when core inflation was materially undershooting the target.
Each country’s data and experiences are a bit different but as a general proposition I’d be surprised if many central bankers have become any more positive on the short-term indicator value of the monetary aggregates in the last couple of years.
As one final money aggregate chart, here is the level of the New Zealand broad money series relative to the trend over the pre-Covid period since the 2 per cent inflation target was set. Over that almost 18 year period, core inflation averaged 2.2 per cent. At present, broad money is sitting below the trend, and although views currently differ on how much disinflationary pressure is now in the system I’m not aware of anyone who thinks we are about to have a 8-10 per cent drop in the price level, to get back to price levels consistent with long-term average inflation of around 2 per cent.
The UK has become a bit of a poster boy for bad inflation outcomes. Some of the headline numbers have been very bad (up around 10 per cent), but some of that is what happens when a gas price shock hits you (and no monetary policy framework tells a central bank it should try to offset the direct price effects of such a shock). But if we use a common measure of core inflation (CPI ex food and energy), the UK is far from the worst of the advanced economies and has a bit less-bad core inflation outcomes at present than New Zealand (or Australia).
If their central bank hasn’t done a great job, ours has done a bit worse. And the diverse outcomes in this chart remind us – as Congdon explicitly does in his paper – that inflation outcomes are ultimately national in nature, choices by central banks and (by default usually) their political masters. That we have similar core inflation to several countries on the chart – but quite different outcomes to sound and responsible countries towards either ends (Switzerland, Korea, Sweden, Czech Republic eg) – speaks more to similar mistakes made by respective central banks than to anything that was out of the control of the Bank of England or the Reserve Bank of New Zealand.
Two charts in Broadbent’s speech caught my eye. The second (which I’ll come to in a minute) was directly relevant to the inflation mistake. But this was the first on the interest rate effects of central bank bond purchase programmes. The Bank of England, like the RBNZ, believes that QE has macroeconomic effects primarily through interest rate effects (rather than the quantities of fully-remunerated settlement cash balances that are created in the process).
Broadbent reckons that bond purchase programmes have a material announcement effect (what is measured here) when markets are very illiquid. That is no surprise, and probably everyone would agree. But what caught my eye was those “Other QE announcements”. The average of the interest rate effects of those nine announcements is close to (and not significantly different from) zero. Perhaps this particular estimation is wrong, but wouldn’t it be nice if our central bank was producing such charts, and the research supporting them, rather than just handwaving estimates of large number effects, that often conflate March 2020 (and the effects of what the Fed was doing at the same time) with the rest of their highly risky and costly programme?
The other Broadbent chart that caught my eye was this one
Broadbent is using it primarily to make the point that the BOE actually forecast growth in real private consumption stronger than would have been implied by a model incorporating data from the monetary aggregates. But what interested – surprised – me was that they had ended up materially over-forecasting real consumption growth (from the point where the UK’s last lockdown ended). Normally, over-forecasting a key component of domestic demand would probably have been associated with over-forecasting inflation. But not this time (and the biggest error was before, not after, the severe adverse terms of trade shock associated with the Ukraine war)
That got me wondering about the Reserve Bank of New Zealand’s forecasting.
Here are their successive MPS forecasts for real private consumption, starting from the August 2020 MPS which was done after the first and worst national lockdown was over.
The errors in the forecasts for 2022 being made in late 2020 are really huge (for consumption, which is not a particularly volatile component). By mid-2021 (when those BoE forecasts above were done) there were still quite big errors, but not so much about the medium term forecasts but about what the level of consumption spending was at the time the forecasts were being done.
What about real residential investment?
Their forecasts for late 2020 and 2021 undertaken in late 2020 were miles off the mark, substantially understating the level of activity happening already and in the following few quarters. More recently, actuals have undershoot the forecasts done in the second half of the period, probably because of the much higher interest rates that proved to be needed relative to what the Bank had expected a couple of years ago.
And here is real business investment
The Bank was badly misjudging the recent and contemporaneous situation in their August 2020 forecasts. That gap had closed substantially by the November 2020 MPS (a key date because the Bank then had such extremely low medium term inflation forecasts), but as with the private consumption chart shown earlier the forecasts for 2022 were still miles too low. Those errors probably go together, since high consumption demand and activity is typically likely to support high business investment spending. What is interesting is that business investment continued to surprise the Bank on the upside right through to the forecasts being made early last year.
I won’t clutter the post with a comparable GDP chart, but will quote just one illustrative number. In May 2021 I found myself in the curious position: for the first time in a decade, I had become more hawkish than the Bank. With hindsight it is abundantly clear that they should have been raising the OCR by then (and earlier). But their GDP forecasts made in May 2021 for December 2022 proved to be off (under-forecasting) by almost 3.5 per cent. Those are big mistakes.
If there is some mitigation for the BoE in having actually over-forecast the private consumption bounceback (one would want to know more about other components on demand) there is nothing like that in the New Zealand numbers. The Reserve Bank simply misjudged (badly) the strength of key components of domestic demand (and you’d see something similar in for example the unemployment rate forecasts and outcomes), and with it core inflation. One could fairly point out (and I have in previous posts) that many (perhaps almost all) private forecasters made similar mistake. But we – taxpayers and citizens – don’t employ private forecasters to keep core inflation near target; we employ and mandate the Reserve Bank (Governor and MPC) to do so, and they failed.
Which brings me back to those UK papers that started this post. One of the best bits of the Congdon piece was the call for some serious accountability for central bankers.
No one forced top central bankers to take their jobs (most would probably have had little problem getting other roles), and if they thought the mandates they had been given (in both the UK and NZ the finance minister sets the goal) were unachievable or unrealistic they were free to have said so and, if they felt strongly enough, to have resigned. Nobody was compelled to take on a task they believed was simply unachievable. And yet we’ve ended up with (core) inflation well outside target ranges in quite a wide range of countries, including both the UK and New Zealand, with no apparent consequences for any individual central bankers
Congdon proposes (in the UK context) that when inflation is sufficiently far outside the target range, both the Governor and the Deputy Governor should be required to offer their resignation. He doesn’t say so explicitly, but I presume he must mean this as more than the sort of pro forma charade one could imagine it descending to (“of course, I have to offer my resignation but we all know you Chancellor have no intention of accepting it”), involving actual departure from office. And one could, and probably should, broaden the expectation of real sanctions to include all the MPC members. There is (a lot) more scope already in the UK model for individual MPC members to express and record their disagreement with the majority view, but there is room for more, and the serious threat of sanction helps to sharpen incentives to think differently and not simply to (as is an easy incentive in any committee context) to hide behind the committee, and the (in recent cases) badly wrong consensus or majority view. In New Zealand, we have no idea whether any MPC member ever seriously questioned where the Bank’s forecasting and policy were going in 2020 and 2021. We should.
Perhaps what grates most about central bankers (and their masters, who go along with this behaviour) is the utter refusal of almost all of them to ever accept any serious personal responsibility. Here, Orr has repeatedly run his “no regrets” line and when he occasionally departs from it it is just to say that he is sorry New Zealand faced a pandemic and the Ukraine war (ie nothing about anything he or his colleagues are responsible for). He and his chief economist have also tried the line that they couldn’t have done much different – of course raising the OCR one meeting earlier wouldn’t have made much difference, but that isn’t the appropriate test – and there is quite a hint of that sort of defence in Broadbent’s recent speech (where he uses a straw man alternative of looking at what it would have taken to keep headline inflation at target, when the policy focus has never been primarily on headline).
The other day someone sent me a column from a UK newspaper in the wake of various recent BoE comments. The column ended thus
In the spirit of openness that an independent Bank of England is supposed to represent, it should offer a full and frank apology for letting down the British people.
Well, quite. And exactly the same could be said for our Governor and MPC. They made a really big and costly series of mistakes, which cost us (but not them particularly) a great deal of disruption and real economic loss. They failed in a mandate they had voluntarily chosen to accept (and been well-remunerated for). I’m a Christian and so contrition and repentance are pretty central to my world view, and whatever mistakes have been made in the past contrition and repentance go a long way. In public life – and nowhere more than among central bankers – it now seems alien and inconceivable that people could simply front up and acknowledge their mistakes, acknowledge the costs and consequences of those mistakes, and ask for forgiveness.
Instead, we pay the price – massive redistributions, big fluctuations in real purchasing power, overfull employment and then a probable recession, (oh, and don’t forget the $10bn of LSAP losses – an amount that would otherwise have more than covered the Crown’s recent cyclone costs) – and the central bankers just sail onwards enjoying their position, status, salary and so on, not even offering a serious accounting, let alone serious engagement, or any personal loss . Great power (which is what central banks wield) misued with no personal consequences whatever is a very long way from the model of delegated responsibility and accountability that shaped the design of both the UK and New Zealand central banking reforms in recent decades. In New Zealand, that isn’t just the responsibility/failure of Orr and the MPC, but of the Bank’s Board (appointed by the Minister supposedly to serve the public’s interest), the Minister of Finance, and ultimately – as with everything important in a system of government like ours – the Prime Minister.
I was on Newstalk ZB this morning to talk about the ASB recession forecasts and this article on the Herald reporting some recent statistical analysis from Treasury staff that attempted to provide another perspective on what has caused New Zealand’s high inflation rate.
I don’t want to add anything on the ASB forecasts other than to say that (a) their story and numbers seem quite plausible, but (b) macroeconomic forecasting is a mug’s game with huge margins of uncertainty and error, so not much weight should be put on anyone’s specific forecast ever (with the possible exception of a central bank’s forecast, which may be no more accurate than anyone else’s but on which they may nonetheless act, with consequences for the rest of us).
The Treasury staff analysis was published a couple of weeks ago as a 2.5 pages Special Topic in their latest Fortnightly Economic Update. You can tell from the Herald headline why one of their political journalists might have latched onto this really rather geeky piece
But there is less to the analysis than the headline suggests. The term “government spending” doesn’t appear in the Treasury note at all (I think “fiscal policy” gets one mention). The focus of the paper is an attempt to better understand the relative contributions of demand and supply factors to explaining inflation, and while fiscal policy is one (at times significant) source of demand shocks and pressures, there is no effort in the paper to distinguish the relative roles of fiscal and monetary policy (or indeed, to distinguish either of those policy influences from other sources of demand pressures). That isn’t a criticism of the paper. The technique staff used, introduced for those purposes a few months ago by a Fed researcher (his paper is here), isn’t designed for that purpose.
Loosely speaking, the technique uses time series modelling techniques to look at both prices and volumes for (most of) the items included in the CPI. When there are surprises with the same sign for both a price and the corresponding volume that is (in their words) suggestive of a demand shock (increased demand tends to lift prices and volumes) and when the surprises have opposite signs this is taken as suggesting a supply shocks (disruptions in supply tend to see lower volumes and higher prices go together). It is a neat argument in principle.
But it doesn’t look to be a very good model in practice. Here is The Treasury’s summary chart. the source of the line that (on this analysis) demand and supply shocks may have contributed roughly equal amounts to inflation over the last year, and that demand shocks were more important back in the early stages of the surge).
Not only is a large chunk of recent inflation not able to be ascribed to either demand or supply shocks, but there have been periods even in the quite short span shown here when the identified demand and supply shocks don’t explain any of the then-current inflation at all (eg 2019).
This is even more evident with some of the sub-groups they show results for. Thus, home ownership (which in the CPI is mostly construction costs)
For most of the decade, neither (identified) demand or supply shocks explain the inflation, and that is so again in the most recent data. And if the model suggests that sharp rises in construction cost inflation in recent times have little to do with demand at a time when house-building has been running at the highest share of GDP in decades, so much the worse for the model.
Services make up a large chunk of the economy, and a fair chunk of the CPI too. Here is the chart for that group
Not only are there periods when neither demand or supply shocks (as identified by the model) explain any of services inflation, but how much common-sense intuition is there is the idea (which the chart suggests) that for most of the period what services inflation can be explained is all either supply shocks or demand shocks and not some combination.
The Treasury paper notes some overseas comparisons, in particular that for the US
The results for New Zealand show lower supply-side contributions to inflation than estimates for the US and Australia. In the US, supply-side drivers account for about 60% of the annual change of the PCE deflator that the model can explain (Figure 7).4
(the footnote is to the original Fed paper)
and they show this US chart which I assume comes from the same model
Note, first, that the PCE deflator has a materially different treatment of home ownership – using imputed rents – than either the NZ or US CPIs.
But perhaps more importantly, in the original Fed paper there is this line
And here is a relevant chart from the same paper (grey-ed periods are NBER recessions)
Not only does it show the entire period since 1990 (one of my uneases about the New Zealand work by Treasury is showing only the last 10 years), but it also illustrates that, as defined for the purposes of these models, both supply and demand factors are large influences, almost always positive, over the entire 30+ years. In other words, if there is anything unusual about the current situation it is not the relative contributions of supply and demand influences but simply that inflation is high (both demand and supply influence). It simply doesn’t seem to add much value in making sense of why things unfolded as they did over the last couple of years. (Although it is interesting how different the last 10 years of the chart look for the US, as opposed to New Zealand in the first chart above.)
What these US charts also illustrate is that supply and demand shocks/drivers here don’t mean the same as they typically do when thinking about monetary policy. Monetary policymakers will (rightly) talk in terms of generally wanting to “look through” supply shocks – the classic example being spikes in world oil prices, which not only flow through to the CPI almost instantly (faster than monetary policy could react) but also make us poorer. The focus instead is on whether these headline effects flow through into generalised inflation expectations and price-setting more broadly. Climate-induced temporary food price shocks (from storms or droughts) are seen in the same vein.
Those sorts of shocks are generally thought of as being as likely to be negative influences on headline inflation as positive ones. Oil prices go all over the place, up and down. Much the same goes for fruit and vegetable prices. These are the two main things excluded in that simplest of core inflation measures, ex food and energy. Some of the Covid-related disruptions are probably more one-sided: there aren’t really obvious favourable counterpoints to severe supply disruptions (even if such disruptions themselves generally unwind over time). But even taken altogether they aren’t the sorts of things that will produce positive influence on core inflation over single year for over 30 years (as in the US core inflation chart immediately above).
When macroeconomists think of inflation they often do so with a mental model in their heads in which this period’s inflation is a function of inflation expectations, some influence from the output/employment gap, and then any residual (supply shock) types of items. Those supply shocks can run in one direction for a couple of years in succession (and probably did in the last couple) but the expected value over long periods of time is generally thought to be pretty close to zero. Monetary policy determines core inflation – monetary policy shapes expectations and influences and responds to developments in the output (or employment) gap. Of course, monetary policy takes account of trend supply developments – adverse shocks may not only raise headline inflation, and risk raising inflation expectations, but can lower both actual and potential output (many positive supply shocks work in the opposite manner).
I don’t want to be particularly critical of The Treasury. We should welcome the fact that their analysts are trying out interesting different approaches and keeping an eye on emerging literature, and even that they are making available some of that work in generally low-profile publications. That said, Treasury is not some political babe in the woods, and I’d have thought there should have been some onus on them to have provided a bit more context and interpretation in their write-up. For example, whereas the US is often treated as a closed economy, New Zealand clearly isn’t. I don’t have a good sense as to how general imported inflation – or that reflecting exchange rate changes – is going to affect this sort of decomposition. If, as I believe, a wide range of central banks made very similar policy mistakes, we’ll be seeing more inflation from abroad (if our Reserve Bank takes no steps to counter it) not tied to demand pressures in particular domestic sectors. I’m also not really clear how the lift in inflation expectations that we observe in multiple surveys fits into this sort of decomposition exercise.
Oh, and it was perhaps convenient that of the CPI groups Treasury showed, motor fuels was not one of them. Headline inflation currently is held down quite a bit by the NZ Cabinet shock – holding down petrol excise taxes etc.
My own approach to the question of where the responsibility lies for core inflation (and note that Treasury focuses on headline not core) tends to be simpler. When this century the unemployment rate has dropped below about 4 per cent core inflation has tended to become quite a serious problem (mid-late 00s and now). The Reserve Bank itself has been quite clear in its view that employment is running above the “maximum sustainable employment” (itself determined by other government policies), and thus, by implication, the unemployment rate – at near-record lows is below sustainable levels. That is a function of excess demand relative to the ability of the economy to supply. Core inflation – the bits we should most worry about, because we could usefully do something about them – is an excess demand story, risking spilling over into embedded higher inflation expectations.
And when ZB’s interviewer asked me this morning whether Mr Robertson or Mr Orr was to blame (fiscal or monetary policy), I was quite clear that the answer was monetary policy (Orr and the MPC). That isn’t because monetary policy loosenings in 2020 were necessarily the biggest source of stimulus to demand, but because the model is one in which (a) fiscal policy is transparent, and (b) monetary policy moves last, with the responsibility to keep core inflation at/near target. You might think (I certainly do) that less should have been done with fiscal policy, but it isn’t up to the MPC to take a view on that, it is their job simply to have a good understanding of how the whole economy, and the inflation process in particular, works, and to adjust monetary policy accordingly. In extremis, fiscal policy can overwhelm the best efforts of central banks, but that wasn’t an issue or a risk here, or most other countries, in recent years. Central banks simply got things wrong. (They had company in their mistake, but they were/are paid to get these things right.)
I obviously haven’t seen, or read, the best advice expert commentators have been providing to their wholesale market clients over the last 24 hours but in what I have heard and read I’ve been struck by how little attention seems to have been paid in the more popular/accessible part of the market to this from the MPC’s statement (emphasis added). Looking at some of the changes in market prices, it isn’t clear how much weight markets have put on it.
Below, by contrast, are the “bias statements” (comments about what might happen next) from the OCR decisions back to August 2021. Yesterday’s statement – for all the gung-ho 50 basis point move – ends on a very different note. They seem genuinely open minded on whether the next move might be up or down, and whether any such move might be soon or far away. The MPC are no better at forecasting than anyone much else, but since they get to set rates what they think might happen next, and what they do next (whether with hindsight those are the right views or calls) matters. It is a curious change of direction, without a full set of forecasts, and with no real idea what has happened to inflation or unemployment more recently than as at mid-November. But a change of direction it appears to be.
The Reserve Bank of Australia yesterday left its policy rate unchanged at 3.6 per cent. The Reserve Bank of New Zealand’s MPC is generally expected to today raise its OCR by another 25 basis points to 5 per cent.
In the broad sweep of decades it isn’t an unusually large gap. Most of the time, New Zealand short-term nominal interest rates are at least a bit higher than those in Australia (Australia’s inflation target is a little lower than New Zealand so the real interest differential tends to be a bit larger).
Sometimes economic circumstances in the two countries are very different. Thus, that period a decade or so ago when the RBA cash rate was higher than the RBNZ OCR coincided with the later stages of the Australian mining investment boom, for which there was nothing comparable in New Zealand.
But over the last two or three years, the similarities have seemed more evident. Both countries of course went through Covid, with overall quite similar virus/restrictions experiences. Prolonged closed borders affected both countries, notably the important tourism and export education sectors. Both had very expansionary macro policies. In the scheme of thing, both opened up at about the same time. Both have been characterised by labour shortages and very low rates of unemployment. And both have seen inflation sky-rocket, whether on headline or core measures.
There are differences of course. Take commodity prices as an example. If world prices have recently been falling for both countries, relative to levels just a couple of years back Australian incomes are still being supported much more by the high level of commodity prices.
What of the respective unemployment rates? Both are very low, but if anything Australia’s seems lower relative to (a) history and (b) likely NAIRU. Australia’s current unemployment rate is a half percentage point lower than the previous cyclical low, and has not yet shown any sign of lifting.
New Zealand’s unemployment rate (quarterly only) seems already to be off its trough and is now about the same as the unsustainably low level reached late in the 00s boom.
One can’t make much of that difference – and the unemployment rate isn’t the only relevant labour market indicator – but the comparison doesn’t obviously point to the RBA needing to do less than the RBNZ. As far as I can see, business survey measures suggest that difficulty of finding labour may have been easing a bit more in New Zealand than is yet apparent in Australia.
What about (core) inflation measures themselves? Bear in mind that the Australian inflation target is centred on 2.5 per cent and the New Zealand one is centred on 2 per cent.
Here is the annual trimmed mean measure of core CPI inflation for the two countries
And here are the annual weighted median measures
Core inflation started higher in New Zealand than in Australia (the RBA had been badly undershooting the target in the late 10s) but on both annual measures (a) New Zealand annual core inflation appears to have levelled out and (b) Australian core CPI annual inflation now appears to be higher than that in New Zealand. The differences between the two countries core inflation rates in the most recent quarter are more or less in line with the differences in the respective inflation target.
What about the quarterly measures? Here there is some difficulty because the ABS produces seasonally adjusted measures and SNZ does not. Eyeballing the New Zealand series there appears to be some seasonality, although not terribly strong.
Here are the quarterly trimmed mean inflation rates
and here are the weighted medians
The latest observations for the two series for Australia are quite similar (1.6 and 1.7) but there is quite a divergence in the two NZ series (0.9 and 1.3). But in both series there are signs the NZ peak has passed (if you worry about seasonality, even the latest quarterly observations are lower than those a year earlier), while there is no such sign in the Australian quarterly data. And while one can’t meaningfully annualise these data, the differences in the quarterly inflation rates look like more than is really consistent with the differences in the respective inflation data.
I’m not here running a strong view on whether one of these two central banks is right and the other wrong. But it remains a challenge to see how both can be right at present. The two central banks tend to articulate somewhat different models (I’m always surprised at the weight the RBA appears to continue to place on wage inflation, in rhetoric that sometimes seems misplaced from the 1980s), central banks are shaped by their past (the RBA was badly undershooting the inflation target pre-Covid), the political climates are now different (the RBA Governor’s term expires shortly, and governance reforms are in the wind) and there are other material differences in the demand pressures in the two economies that I’ve not touched on here (eg New Zealand has had a bigger housebuilding boom and may be exposed to a deeper bust).
Neither central bank has handled the last three years particularly well – or we wouldn’t have that unacceptably high core inflation – and I am far from being the RBNZ’s biggest fan, but for now my sense is that they are probably closer to right than the RBA is. That may, of course, mean that the near-inevitable recession is nearer at hand here than in Australia.
In September last year, former Bank of England Deputy Governor Sir Paul Tucker published a substantial discussion paper suggesting paying a sub-market, or zero, interest rate on some portion of the huge increase in bank deposits at the central bank that had resulted (primarily) for the large-scale asset purchase programmes central banks had been running (in the Bank of England’s case since the 2008/09 recession, but in some countries – including New Zealand and Australia – just since 2020).
In late October, I wrote about Tucker’s paper, and you will get the gist of my view from the title of that post, “A Bad Idea”. The Herald’s Jenee Tibshraeny picked up on that post and the following day ran an article on the Tucker tiering proposal, with sceptical quotes from several people including me. There was a difference of view in those quotes. As in my post, I argued that such an approach could be adopted without impeding the fight against inflation but should not be adopted, while others (as eminent as the former Deputy Governor, Grant Spencer) suggested that not only that it should not be done, but could not (ie would tend to undermine the drive to lower inflation).
The essence of my “it could be done” line was the same as Tucker’s: monetary policy operates at the margin, and so what matters for anti-inflationary purposes is that the marginal settlement cash balances receive the market rate, not that all of them do. There was precedent, in reverse, in several (but not all) countries that ran negative policy rates, where the central bank applied the negative rate only to marginal balances, while continuing to pay a higher rate on the bulk of balances (thus supporting bank profits, although the argument made at the time was that doing so would help support the monetary transmission mechanism).
So far, so geeky. But it turns out that after Tibshraeny’s first article, the Minister of Finance sought advice on the Tucker proposal, not just once but twice (first from The Treasury and then later from the Reserve Bank). In yesterday’s Herald, she reports on the two documents she got back from an Official Information Act request to the Minister. She was kind enough to provide me with a copy of the material she obtained.
The Treasury advice, dated 6 December 2022, does not explicitly say that it was in response to a request from the Minister, but it seems almost certain that it was. Treasury is unlikely to have put up advice off its own bat on a matter that is squarely a Reserve Bank operational responsibility without formally consulting with the Reserve Bank and including some report of the Reserve Bank’s views in its advice. We can assume the Minister asked Treasury for some thoughts, and Treasury responded a few weeks later with four substantive pages.
I don’t have too much problem with The Treasury’s advice on a line-by-line basis. Their “tentative” view was that some sort of tiering arrangement could be introduced without undermining the effectiveness of monetary policy.
There were a couple of interesting things in the note nonetheless. For example, it was good to have this in writing
and it was also interesting to read that “in previous discussions with the Bank they have indicated that they would consider introducing a zero-interest tier if the OCR were negative”.
Treasury highlighted that a zero-interest tier in the current environment (large settlement cash balances, fairly high OCR) would be in effect a tax on banks with settlement accounts.
but strangely never engage with the question as to whether it would be appropriate for the Reserve Bank to impose such a tax (or whether they had in mind special legislation to override the Reserve Bank on this point).
They also note some potential reputational issues
but could have added that these might be particularly an issue if New Zealand was to adopt such an approach in isolation (they neither mention, and nor have I seen, any indication any other authorities have seriously considered this option).
The Treasury note ends recommending not that the issue be closed down and taken no further, but that if the Minister wanted to “pursue this option” he should seek advice from the Reserve Bank and they offered to help draft a request for advice.
And so the Minister turned to the Reserve Bank for further advice, and on 2 February 2023 they provided him four pages of analysis (plus a full page Executive Summary which is more black and white than the substantive paper itself). The Bank seems pretty staunchly opposed to the tiering idea, but on occasions seems to overstate its case. And, remarkably, they never even attempt to engage on the question as to whether the market-rate remuneration of the large settlement cash balances created by their LSAP (and Funding for Lending) programmes are any sort of windfall gain to the banks (a key element of Tucker’s argument).
But much of what they say is reasonable. From the full paper
There is no real doubt that it can be done, and they draw comparisons between regimes in some other countries, more common in the past, where some (legally) required reserves were not remunerated at all.
I largely agree with them on this
departing from them on that final sentence of paragraph 25 (any tier could, and sensibly would, be set on the basis on typical balances held prior to any announcement or consultation document), and in the first sentence of paragraph 26 (since, from the Bank’s perspective, benefits from the LSAP are supposed to be a good thing – the Governor repeatedly champions them – not bad).
The Bank attempts to play down the amounts at stake, suggesting any potential gains to the Crown (and thus, presumably, costs to those subject to the “tax) would be modest. But they include this
I guess when your MPC has thrown away $10bn of taxpayers’ money, $900m over four years doesn’t seem very much (and these calculations are materially biased to the low end of what could be raised without adversely affecting monetary policy) but…..$900m over four years buys a lot of operations, or teacher aids, or whatever things governments like spending money on.
It is also a bit surprising that although the Bank notes that such a tiering tax would be likely to be passed through to customers, they provide no substantive analysis as to how or to what extent, and thus what the likely incidence of such a tax would be. It isn’t that I disagree with the Bank, but the analysis isn’t likely to be very convincing to readers not already having the same view as them (tiering is a bad idea).
They make some other fair and important points, notably that hold a settlement account with the Reserve Bank would be likely to be less attractive if doing so was taxed, in turning providing an advantage to non-settlement account financial institutions (broader settlement account membership is generally a good thing, conducive to competition and efficiency). But then they over-egg the pudding. This line is from the Executive Summary – and draws on nothing in the body, so has the feel of something a senior person inserted at the last minute
One of the points commentators on central banks often have to make to less-specialist observers is that banks themselves have no control over the aggregate level of settlement cash balances. Individual bank choices – to lend or borrow more/less aggressively – affect an individual bank’s holdings but not the aggregate balances in the system. And thus banks cannot materially impede future LSAP-type operations since there is no reason why the Reserve Bank’s purchases need to be constrained only to entities that already hold settlement accounts at the Bank. If the Reserve Bank buys a billion dollars of NZ government bonds at premium prices from overseas investors/holders, the proceeeds will end up in NZ bank settlement accounts whether the local banks like it or not. Same goes for, say, large fiscal operations like the wage subsidy. What might be more accurate – and I made this point in my original post – is that a tiering model carried into the future might motivate local banks to lobby harder against renewed LSAPs. From a taxpayers’ perspective that would probably be a net benefit, but one can see why the Reserve Bank might have a different view.
While I don’t really disagree with the thrust of either the Reserve Bank or Treasury advice neither could really be considered incisive or decisive pieces. Perhaps the Bank’s piece was enough to persuade the Minister (although there is no indication in the OIA material or in Tibshraeny’s article that the Minister has abandoned interest). A tiering regime of the sort discussed in the RB/Tsy advice would be an opportunistic revenue grab, representing either an abuse of Reserve Bank power or a legislative override of monetary policy operational independence, with truly terrible signalling and precedent angles. It could be done – so could many many bad things – but it shouldn’t.
(If you want a typically-passionate opposing view, try Bernard Hickey’s column yesterday, from which I gather he has removed the paywall.)
Big mistakes were made. The LSAP was unnecessary, ill-considered, risky, and (as it turns out) very expensive. The Funding for Lending programme continued all the way through last year was almost incomprehensible (if cheaper and less risky). Mistakes have consequences and they need to be recognised and borne, not pave the way for still-worse compensatory fresh interventions.
I’m going to end repeating the last couple of paragraphs from my original post
It is, perhaps, a little surprising that neither set of official advice shows any sign of engaging with Tucker’s paper itself, or with the author, a very well-regarded and experienced figure.
It was something of a (perhaps minor) landmark event last Thursday when the Reserve Bank’s chief economist Paul Conway gave an on-the-record speech on inflation. It was only Conway’s second on-the-record speech (the first was on housing, something the Bank has little or no responsibility for) and thus only the second speech from a Reserve Bank chief economist for almost five years. Five years in which chief economists have become statutory decisionmakers (members of the MPC), in which monetary policymakers have dealt with a huge and expensive shock, and in which inflation – prime focus of central bank monetary policy – has been let run amok in ways never seen previously (arguably never envisaged) in the first 30 years of inflation targeting. And when (a) external MPC members are barred from research/analysis, and (b) barred from speaking or disinclined to do so, and (c) the chief economist’s own boss has no qualifications/background in economics or monetary policy, we should be able to look to the Bank’s chief economist for incisive and insightful analysis and perspectives on the macroeconomic dimensions of the Bank’s responsibilities. If not him then who?
Sadly, the answer to that seems to be no one at all.
There have been worse things from the Reserve Bank on monetary policy in recent years. The most egregious have been the (apparently) unscripted one-liners from the Governor. One could think of his claims – never backed by any analysis at all – that the economic gains from the LSAP programme were “multiples” of the $10.5bn (Treasury estimate) direct fiscal loss from the LSAP, or the preposterous spin he tried on Parliament’s Finance and Expenditure Committee just a few months ago
Not even arguable, just false.
There is nothing quite so egregious in Conway, mercifully (he is a more earnest, less flamboyant – or worse – character).
But what is there in his speech is far from the sort of standard we should expect from a senior policymaker addressing the biggest monetary policy failure in decades. And it is not as if his speech was delivered to a bunch of high schoolers or the Gisborne U3A (no offence to either) but to an (at least) expert-adjacent group at the ANZ-KangaNews New Zealand Capital Markets Forum.
Item 3 is easy. The only thing the Bank can do is raise the OCR and hold it higher for long enough. Although Conway never acknowledges this, it is hard to be very confident in their view (or anyone else’s) on how high or how long might be required, not just because there are always new shocks, but because neither the MPC nor others really yet have a compelling story for why core inflation went so high so quickly.
So much of the speech is made up of plaintive pleas to the public to believe the MPC when they say they are serious, and to act accordingly, without giving us any basis to believe the MPC really knows what it is doing. After all, not much more than 18 months ago Conway’s predecessor was telling the Reserve Bank’s Board there was no hurry and no real need to worry, and their published forecasts were telling us they expected inflation would be almost bang in the middle of the target range by now. It would have been a bad (and costly) idea for people to have based their plans on those forecasts and the contemporaneous rhetoric. You might have hoped that if he really wanted to jawbone us, and have people take seriously his rhetoric, that the Bank’s chief economist (of all people) would be presenting persuasive analysis that they understand what they got wrong and reasons to think they are better now. But there is none of that in the speech, and it refers us to no serious supporting analysis or research either.
Instead there is lots of spin.
One of the most striking things in the speech was something that wasn’t there. Central bankers often, and rightly, pay a lot of attention to measures of core inflation. But in a major (rare) speech about inflation, there is but one (passing) mention of the term (or cognate terms), simply noting in the final few sentences that core inflation is about middle of the pack among OECD countries/economies.
Instead, we get a great deal about “the pandemic, the war, and floods”, which seems to be a slightly more sophisticated attempt at distraction than his boss’s claims quoted above.
No doubt, as Conway notes, the floods will put some pressure on resources over the next few years (particularly to the extent losses are covered by offshore reinsurers, as distinct from being net NZ wealth losses), as the 2010/11 and 2016 events did, and may result in some direct price pressures (some fruit and vegetable prices) in the next couple of quarters. But, thanks to New Zealand’s infrequent and badly lagging CPI, none of that is in the published inflation numbers yet.
What of the pandemic? It is clear that here Conway is not talking about the (with hindsight) gross macroeconomic mismanagement (the RB MPC being the last mover, and thus primarily responsible) that delivered us, several years on, really high core inflation, but the direct price effects of pandemic-driven supply chain disruptions several years ago. Some of those effects may have been material contributors to headline inflation back in 2020 and 2021, but it is now 2023, and if we could do a good decomposition (a good topic for some RB analysis) it seems likely that if anything the unwinding of those disruptions is probably holding headline inflation down a little now (eg global freight costs have fallen a lot). Perhaps he has in mind airfares – where capacity has been slow to return – but that is a good reason to look at, and cite, analytical core inflation measures.
And then there is “the war”. At the Reserve Bank, they are very keen on “the war” as distraction and cover.
We all know world oil prices shot up quite a bit in the immediate wake of Russian’s invasion last February. But not only are world oil prices now lower than they were (real and nominal terms) prior to the invasion, but New Zealand headline annual CPI inflation is still held down artificially at present by the kneejerk petrol excise “temporary” remission put on last March and still in place (strangely, Conway never mentions this). Where else might we find these “war” effects in New Zealand inflation? Wheat prices also rocketed upwards initially, but again they are lower now than they were at the start of last year. I guess fertiliser prices are still higher than they were, but it hardly seems likely to add up to much in NZ CPI inflation. Especially when we know – although Conway never mentions – that core inflation had already risen a lot, to quite unacceptably high levels, well before the invasion.
Conway does acknowledge that monetary policy should have started to tighten earlier (and doesn’t even fall back on the silly line he and Orr have previously used, that a slight difference in timing would have made only a slight difference to inflation – well of course, but the real problem, with hindsight, was not “slight” differences in timing), but engages in a fairly sustained effort to leave readers thinking there really was not an evident problem in 2021, just a few “one-offs”. But this is where analytical measures of core inflation come in. Trimmed mean and weighted median measures are pretty standard parts of many monetary policy analysts’ toolkits.
The big increase in quarterly core inflation took place in 2021.
The sectoral core factor model, like all models of its class, has end-point issues and estimates prone to revision, but the best guess now is that core inflation had already doubled (to in excess of 4 per cent) by the end of 2021.
But none of this mentioned at all in the speech. Nor is the fact that by late 2021 the unemployment rate – best simple measure of changes in excess capacity – was dropping rapidly to below levels anyone regarded as sustainable.
Many of these events took the Reserve Bank (and others by surprise), but they are the ones paid to get these things right. We live with the consequences when they don’t. But nowhere in the speech is there any acceptance of responsibility.
We also get attempts to suggest there is nothing the MPC can do about inflation sourced from abroad…….in a speech where the exchange rate gets no substantive (and only one formal) mention at all.
There is a chart in the speech which purports to illustrate the problem, showing tradables inflation as a share of headline inflation, without any acknowledgement that if tradables tend to average 0% and non-tradables 2.5 per cent (loosely the case pre-Covid) and then tradables average 2% and non-tradables 4.5% tradables would make up a larger share of headline inflation even though nothing about the relationship between tradables and non-tradables had changed at all. Yes, tradables inflation has increased relative to non-tradables but if we look at the core components of each the recent change isn’t unprecedented, tradables didn’t lead non-tradables, and (in any case) the Reserve Bank’s own past analysis has tradables as a typically fairly small component in the overall sectoral core inflation measure.
If – as happened – other countries run high inflation, the job of the Reserve Bank of New Zealand is to tighten monetary policy here to lean against importing that inflation. That will generally occur through a higher-than-otherwise nominal exchange rate.
I’m not going to spend any more time on the jawboning rhetoric. No doubt it feels good inside a central bank – I’ve run plenty of it in my time, in writing and in speeches – but it is really a distraction from the core issues (MPC responsibilities) and less persuasive now – when, with the best will in the world, the central bank has just messed up badly – than perhaps it might have been decades ago when we first trying to transition from high inflation to low inflation, with a newly-independent central bank.
Conway’s speech was made just a month on from the latest Monetary Policy Statement. In that flagship MPC document, there was a substantial four page section on “The International Dimension of Non-Tradables Inflation”. No doubt, the analysis in that section came from Conway’s own Economics Department. But in a flagship speech on inflation just a few weeks later there is no mention, not even a reference, to that analysis at all. In my MPS commentary (last few paras) I briefly identified a number of apparent weaknesses in the analysis. Perhaps on reflection Conway accepted the issues I had raised, but whatever the explanation it seems odd to have such analysis feature prominently one month and simply disappear from consideration the next.
These were two of the last three paragraphs of the speech (emphasis added)
At one level, it is hard to argue. It all sounds good. Except….where is the substance to back up the words? The Bank’s own published research output has slowed to a trickle, there is no serious analysis or insight in the speech, and we know that the Minister of Finance has reaffirmed only last year his commitment (in league with Orr and Quigley) to ban anyone with an active or even future interest in serious research or analysis from serving as external MPC members. Oh, and the Reserve Bank has the least-qualified deputy chief executive responsible for macroeconomic and monetary policy of any advanced country central bank (and probably most emerging and many developing countries as well). Nothing we’ve seen so far suggests any particular reason to treat these words as anything other than spin.
I was mildly hopeful (prone to naive optimism perhaps) when Conway was appointed. Perhaps things are about to change. There is, after all, a position on the MPC that comes vacant next week, currently held by someone who has no relevant subject expertise, who has never explained her views on monetary policy in four years in the job, and who was (so the papers confirm) pretty clearly appointed mostly because she was a woman. Replacing her with a more serious appointee, and overhauling the protocols in a way that encouraged or compelled externals to be individually accountable, would be a small start in the right direction. If Orr, Robertson, and Quigley were serious. I am not, however, holding my breath.
The contrast between Conway’s speech and those of his peers in other advanced central banks once again leaves the New Zealand institution looking well off the pace. Just the slides published for an ECB Board member’s talk yesterday have considerably more substance than Conway’s full speech (and she speaks often). I’ll leave you with this chart, inspired by one of Schnabel’s slides
Terms of trade fluctuations – “direct price effects of the war and the pandemic” – just aren’t a big macroeconomic issue in New Zealand.
The New Zealand Initiative has a new report out this morning, written by Bryce Wilkinson, under the heading “Made by Government: New Zealand’s Monetary Policy Mess”. (Full disclosure: I provided fairly extensive detailed comments on an earlier draft.)
It is a curious report. There is a lot of detail that I agree with (and the report draws quite extensively on various criticisms I have made in recent years) but it ends up having the feel of a bit of a muddle.
(It is perhaps not helped by the Foreword from an Otago academic who seems wedded to a fiscal theory of the price level that doesn’t exactly command widespread support anywhere, and which would appear on the face of it to have predicted that New Zealand would have had one of the lowest inflation rates anywhere. His approach appears to absolve the Reserve Bank of responsibility for the high inflation: “the key reason why we have high inflation rates is fiscal policy and not monetary policy” and “even if the RBNZ had not made mistakes, I doubt that it could have avoided high inflation”.)
The title of the report is clearly supposed to suggest that what has gone on is primarily the government’s responsibility (and specifically that of the Minister of Finance). And there are plenty of things one might reasonably blame the Minister for:
changing the Bank’s statutory mandate (if you think this was a mistake, or mattered to macro outcomes, which I don’t)
reappointing Orr despite the opposition of the two main opposition political parties, having himself changed the law to explicitly require prior consultation with other parties in Parliament,
going along with the Orr/Quigley preference to prevent experts from serving as external MPC members (which still seems incredible, no matter how times one writes it),
appointing a weak Board with barely any subject expertise, the same board being primarily responsible for Governor and MPC appointments and for holding the MPC to account,
being indifferent to serious conflicts of interest in people he was appointing to the board,
prioritising a person’s sex in making key appointments,
for bloating the Bank’s budget, and
never once have shown any sign of unease about the massive losses the MPC-driven LSAP has run up, about the Orr operating style, or any urgency around better understanding what has gone on (you will search letters of expectation in vain for any suggestions from the Minister that, for example, more/better research capability and output might be appropriate, or that speeches more of the quality seen from other advanced country central banks might be appropriate)
and so on. Robertson has been both an active and passive party in the serious decline in the quality of our central bank over recent years, and given that Orr has been reappointed and seems disinclined to acknowledge the validity of any criticisms, only the Minister of Finance – current or future – can make a start on fixing the institution. Institutional decline – and it isn’t just the Reserve Bank – has been a growing problem in New Zealand, and the current government’s indifference has only seen the situation worsen: one might think too of the Productivity Commission.
But, for better or worse, when most people think of a “monetary mess” at present they probably primarily have in mind inflation. And the way the report is structured it would seem that both the author and the Foreword writer also put a lot of emphasis on the bad inflation outcomes. No doubt rightly so.
But there simply isn’t any compelling evidence, or really even any sustained argumentation that would stand scrutiny, that any or all of the many things one can criticise Robertson for really go anywhere towards explaining how badly things have gone with inflation (or even with the massive losses on the LSAP). I’m not, of course, one of those who believe the Bank should escape blame – that somehow for example (as per one of the Governor’s ludicrous attempts at distraction) we can blame it all instead on Putin or “supply chain disruptions”, as if they somehow explain the most overheated economy and labour market in decades.
But how confident can we really be that a better Reserve Bank – on the sorts of dimensions the NZI report rightly draws attention to – really would have made much macroeconomic difference? As just a small example (and from a country with a similar pandemic experience) the report rightly draws attention to the better academic qualifications of the Governor and senior figures at the Reserve Bank of Australia. But nothing about Australian inflation outcomes – or LSAP losses for that matter – suggests that the RBA has done even slightly better than the RBNZ in recent years. If anything, I (the Bank’s “most persistent and prolific” critic, as the report puts it) reckon the RBA has done a little worse, even if there is a better class of people and some more thoughtful speeches. One could extend the comparisons. As I’ve highlighted here, New Zealand’s core inflation outcomes have been bad, but about middle of the pack among OECD countries/regions. Fed Governors do lots of good speeches, the institution does lots of interesting research, experts are allowed to be decisionmakers, but…..core inflation outcomes are little or no better and the Fed was even slower than the RB to get started with serious tightening. And so on, around most of the OECD.
There is – as the report notes – no absolute defence for Orr and the MPC in other countries’ inflation records. We have a floating exchange rate to allow us to set our own path on inflation, and just because other countries’ policymakers messed up should not absolve ours of responsibility. But to me the evidence very strongly suggests that what happened over the last two to three years was that (a) central banks badly misunderstood what was going on around the macroeconomics of Covid, (b) so did almost all other forecasters, here and abroad, and (c) there isn’t much sign that central banks with better qualified more focused people or more open and contested policy processes did even slightly discernibly better than the others. I wish it wasn’t so. With all the many faults in the RBNZ system and personnel, it would be deeply satisfying to be able to tie bad outcomes to those choices (active and passive). But I just don’t think one really can. All those governance and style matters etc matter in their own right – we want well-run, expert, open, engaged, accountable, learning institutions, especially ones so powerful. And weak institutions are likely over time to produce worse outcomes in some episodes. But there is little sign yet that this is one of those episodes.
And it is clear when one gets to his conclusion that Wilkinson more or less knows this, as he struggles to connect the very real concerns about the Bank, and what Robertson has initiated or abetted, with the most unfortunate macroeconomic/inflation outcomes.
I was going to say that it isn’t really clear either who the report is written for. But in fact I think that is wrong, and that the primary intended audience is Nicola Willis, her boss, and her colleagues/advisers. Thus we find this
Talk about deferential and accommodating.
And the entire report ends this way
In terms of fixing the institution that seems largely right. It could be fixed, but it will need ministers/governments that care and that are willing to devote sustained attention to using the levers they have to gradually right the ship. As Bryce notes, many of these changes can’t be effected quickly, but mostly because the laws are deliberately (and appropriately) written to make it not easy for new governments of either stripe to make sudden or marked changes. That is helpful when the institution is working well, but quite an obstacle otherwise, and may – if a new government were to care enough – need legislative change.
(I wrote a post here last year with some thoughts on what a new government could and could not do.)
As you watch the interactions between Orr and Nicola Willis at FEC – in which Orr is routinely scornful and dismissive – you wonder how in decency he could possibly continue to serve under a National-led government, But perhaps if he were that sort of person – staying in his lane, acknowledging mistakes, open and engaging etc – the concerns would not exist in the first place. As it is, it would be hard (all but impossible under current law I’d say) to get him out if he wants to stay, and so reform efforts will need to go around him, including progressively replacing the Board with able people and ensuring that the external MPC members are both able and expected to be individually and publicly accountable for their own views and analysis. But do all that and we – and other countries – will still be at risk of really bad macro forecasting errors, and central banks unable to live up to their rhetoric, albeit we might hope for no repeats for another generation or two.
croaking cassandra 