Scattered monetary bits and pieces

I wasn’t quite sure how the economic recovery was going when this morning I walked past five outlets offering coffee and food, within the current “Level 3” rules, and counted three customers between them.   Time will tell.

I’ve accumulated a few monetary bits and pieces over recent days that haven’t naturally fitted into any other post, so thought I’d use today’s post to cover them, although without any specific connecting thread. But it is, after all, the Reserve Bank’s Monetary Policy Statement tomorrow.

First, if the determination of the Reserve Bank to avoid any substantive transparency weren’t so serious –  monetary policy being, after all, the key cyclical stabilisation tool and New Zealand now being in a savage recession –  it can sometimes be so absurd as to be almost funny.   In early April I lodged an OIA request for material the Bank had generated or received in March around issues relating to negative interest rates.  March, you’ll recall, was when the MPC suddenly told us negative interest rates were off the agenda for the next year, and management told us it was because “the banks weren’t ready”.  This has always been a fishy excuse, particularly as it never seems to have been advanced by central banks anywhere else in the world.

I finally got their response last Friday, in the last hour of the last day it was due.   They’d decided to interpret “generated” as meaning (only) “already published”, and so refused to release anything, other than the slightly-enlightening but not very specific paper they’d given to the Epidemic Response Committee, and which Parliament had published, during April.  Quite where you find a dictionary that equates “generated” with “published” is anyone’s guess, but for the Bank’s purposes it doesn’t really matter –  they either close down the request or see it kicked to the Ombudsman and the latter is unlikely to deal with it inside a year.  And yet they like to boast about how transparent they are.  Oh, and they also claimed that finding and collating what they’d received on these narrow specific points –  in March, just a few prior to my request –  would take so much time and work, and they were so busy, they just could not answer, not even with an extension of the deadline.  But they’re a transparent central bank……they claim.

(It was a bit like the Bloomberg article I saw this morning in which the Reserve Bank is reported as saying that after a year of operation they had been just about to make external MPC members available to the media, when unfortunately the coronavirus intervened.  Perhaps they really were just about to open up, but it was reminiscent of the “the dog at my homework” or “the cheque’s in the mail” sorts of line that few take very seriously.)

On a more analytical note, I saw a nice piece from Willem Buiter – former Bank of England MPC member, former Citibank chief economist. former monetary academic –  on “The Problem with MMT” in the current context.  I know some readers have an interest in so-called Modern Monetary Theory, and I regularly refer people to a post I did on it a few years ago when the chief academic champion visited New Zealand.

In the current context. some are advocating that governments –  in countries with their own currencies – can spend just as much as they like, financed –  directly or indirectly –  by central banks.

As a technical matter, of course they can.   As Buiter notes

To be sure, some parts of MMT make sense. The theory views the treasury (or finance ministry) and the central bank as components of a single unit called the state. The treasury is the beneficial owner of the central bank (or, put another way, the central bank is the treasury’s liquidity window)…

MMT holds, correctly, that because the state can print currency or create commercial bank deposits with the central bank, it can issue base money at will.

And in current circumstances, doing so is unlikely to be troublingly inflationary – and, if anything, given the falls in inflation expectations were are observing, a bit more support for inflation near target would not be unhelpful.   Banks are currently voluntarily holding $29 billion of settlement cash, up from the $7 billion of so they willingly hold in normal circumstances.

But even in the current climate, the demand for base money at (or very near) zero interest is not without limit.  More importantly, things can’t sensibly be assumed to remain like this forever.    As and when interest rates need to start rising, either the Reserve Bank will have to pay much more interest on those settlement cash deposits or do some other market operations (eg sell government bonds back to the market) that have the same effect.

This is the relevance of my comment yesterday, which happens to overlap with Buiter’s above, that what happens between the government and the Reserve Bank is really of second-order importance at most –  inter-divisional transfers.  I’ve had people ask about the potential for the Reserve Bank to simply write-off all the government bonds it is buying.  It could probably do so, but it would make no substantive difference to anything.  The branch of government we call “the Reserve Bank” would have huge negative equity, but as a technical matter central bank capital really doesn’t matter that much at all (I once worked for a central bank where not only was the capital deeply negative but the accounting/computer systems were so bad we couldn’t even produce a proper balance sheet….and yet we got inflation properly under control.)  What matters is how much the government (as a whole) is borrowing from the private sector as a whole –  and what changes that is fiscal deficits/surpluses –  and whether the government (as a whole, including the Reserve Bank) is willing to do what it takes to keep inflation around target.

As it happens, we already have an indication of how much very long-term non-repriceable zero interest lending people are willing to do each year to the New Zealand government (as a whole).


And although bank notes don’t have a maturity date they are –  at present – redeemable at par, anytime the buyer chooses to sell them back.  It took the fear of a pandemic and lockdown to get net new demand up to $1 billion a year –  and in all probability next year’s number will be a lot lower again.

Somewhat related to this, there is a great enthusiasm at present –  particularly it seems among bank economists –  for the Reserve Bank’s large scale bond purchase programme, widely expected to be substantially increased tomorrow.  It isn’t clear to me quite why market economists are so keen on this activity which –  in a New Zealand context in particular, where there is little long-term fixed interest rate private borrowing –  seems largely irrelevant from a macroeconomic perspective.     Expect the Reserve Bank tomorrow to wave around fancy estimates suggesting some equivalence to really large OCR cuts, but judge for yourself: is the exchange rate down much, are retail or wholesale real interest rates down much, is voluntary credit growth up much, were banks constrained by inadequate stocks of settlement cash?  If not, you can safely conclude that whatever value the bond purchase programme might have in helping secondary market liquidity, it isn’t do much to stabilise or improve the economy.  If asset purchase programmes are still doing something useful for bond market liquidity –  and there is some public interest in supporting this –  actually cutting the OCR and doing bond purchases simply don’t need to be alternatives (as the Bank and many private economists keep doing).

One of the incidential curiosities of the bond purchase programme is that at times like this you hear a great deal of talk about how it is a wonderful time to borrow and the government can lock in very cheap long-term funding.  And yet what do really large scale central bank bond purchase programmes do?  They transform the liabilities of the Crown from quite long-dated to increasingly quite short-dated, exposing the Crown (us as taxpayers) to really substantial interest rate risk.      Perhaps at the end of all this the Reserve Bank will have $50 billion of government bonds, with a representative range of maturities.  On the other side of its balance sheet, it will have a lot of very short-dated (repricing) liabilities –  all that settlement cash (see above).   Whether the Bank eventually sells the bonds back into the market –  which hasn’t happened a lot in other countries –  or holds them to maturity, the interest rate risk doesn’t go away.     It isn’t obvious what public interest is being served by skewing the Crown’s (net) debt so short term.  Perhaps interest rates will never rise again……but that won’t be the view many people will be taking,

And then, of course, there is the small matter of how much interest rates have fallen at all.

We know that floating first mortgage interest rates came down by 75 basis points back in March when the Reserve Bank belatedly cut the OCR.  That isn’t much consolation as surveyed inflation expectations –  medium-term measures –  are down by about 70 basis points.

Some people don’t like me constantly focusing on floating rates (which I do for several reasons, including (a) a long time series, (b) the more-direct link to the OCR, and (c) the fact that even if most new borrowers initially take a fixed rate, much of the stock of debt ends up on floating rate terms.

But I try to be at least a little open-minded, and the Reserve Bank does publish data on fixed rate offerings.  I had a look at their table of new special residential mortgage rates for various initial fixed terms, and updated it to now from the tables  on   Unfortunately, since the end of last year the typical offerings –  fixed rate specials –  has only fallen by about 25 basis points.  At best, the one year rate is down by about 35 basis points.  And did I mention that inflation expectations are down about 70 basis points.

What about term deposit rates?  Again, I mainly focus on the six month rate because there is a very long-term time series. But the Reserve Bank does now publish data for a wider range of maturities.  Again, I updated the numbers to today.  Very short-term rates (1-3 months) seem to have come down perhaps 50 basis points since the end of last year, but for any longer terms the fall is only around 30 basis points.  Perhaps I’ve mentioned that inflation expectations have fallen about 70 basis points?

We don’t have anything like that transparency around business lending rates but I suspect we are pretty safe in concluding that those real interest rates won’t have fallen either.

And all this amid the biggest economic slump on record…..and with all that (alleged) support from the bond purchase programme.

As it happens, of course, we can get a direct read on real interest rates from the inflation-indexed government bond market.  There are the yields for the four bonds on issue, with maturity dates from 2025 (now about five years) to 2040.

IIBs longterm

You can see the huge spike in yields in March, at the time of the global asset liquidation. But once one looks through that what one notices is that current real interest rates are not as low now as they got in August/September last year and barely different that they were in December.  The Reserve Bank’s bond-buying programme is not at present buying inflation-indexed bonds, but those yields will have been affected anyway.

In isolation perhaps that wouldn’t be so interesting –  after all, perhaps the market was just banking on a really quick rebound in economic activity.  But this chart is much the same one but for the United States.


In the US, even the longest-term indexed bond yield is a lot lower now (50-60 basis points on a 30 year bond) than it was in the second half of last year.  And recall that the US government debt is a lot higher –  share of GDP –  than ours is, or is likely to become.

What explains the difference?  Well, one factor –  probably not the only one –  is that the US Federal Reserve has cut short-term interest rates this year a lot more –  150 basis points – than most other countries, including New Zealand.    Lower short-term rates often influence long-term rates.  When our Reserve Bank refuses to cut the OCR more – in fact not at all in real terms –  perhaps it isn’t that surprising our real longer-term yields haven’t come down.

Incidentally, there was some excitement last year when, for a time, New Zealand nominal government bond yields fell below those in the United States.    But do note that end-point levels on those two charts: New Zealand real 20 year bond rates are just over 50 basis points, while comparable US rates –  as a much more heavily indebted borrower –  are about -25 basis points.   We can even compare implied market rates for the second 10 years of a 20 year indexed bond: in the US -10 basis points, and in New Zealand around +90 basis points.

So for those who are keen on the really low interest rate narrative and the suggestion that governments should be borrowing-up large, just recall (a) interest rates are low for a reason, (b) New Zealand long-term interest rates remain well over those in the United States (itself a relatively high interest rate advanced country soveriegn borrower, and (c) for what its worth, our long-term productivity performance has been lousy (productivity is relevant here because a country with really rapid productivity growth on a sustained basis might tend to support sustainably higher real yields).

For now, we all await the Monetary Policy Statement tomorrow. If there was jusr one question I’d like to see journalists ask the Governor (or MPs if FEC is having a hearing) is “quite what is there to lose from doing what it takes to drive the OCR deeply negative, as former IMF chief economist Ken Rogoff advocates?”    Is the recession not deep enough, unemployment not high enough, or are perhaps upside inflation risks troubling you?  We deserve to know.  On the face of it, the MPC simply isn’t doing its job.

In the meantime, if anyone is interested in tuning in I’m appeared at the Epidemic Response Committee at about 11 tomorrow, to talk about economic policy responses to the impact of the coronavirus –  both what’s been done to date and what might need doing (the Committee proceedings are livestreamed and are also on Parliament TV).  Appearing straight after me is Ian Harrison of Tailrisk Economics whose work I’ve linked to here on various occasions.  From talking to Ian, his session should be particularly stimulating.


The macro outlook

I noticed last evening that the Bank of England had released its Monetary Policy Report with some rough and ready GDP estimates/forecasts.  They reckon UK GDP probably fell by about 3 per cent in the March quarter (which would be a smaller fall than in quite a few other big European countries) and then by about a further 25 per cent in the June quarter.   In previous comments both the Bank of England and the Office for Budget Responsibility had estimated that during the lockdown itself GDP would be perhaps 35 per cent less than normal.

The Bank of England described their numbers as rough and ready.  I pulled out an old envelope and sketched out on the back of it some week by week stylised “rough and ready”) numbers for New Zealand.   In part I was curious to see what it would take to produce a similar June quarter fall in New Zealand, and to benchmark that against some of the numbers in my post yesterday.   Bear in mind that even though our restrictions have been eased somewhat, on the widely-used Government Response Stringency Index our restrictions have been tighter than those in the UK and remain so today, although it is possible that over the next few weeks our easings will go further than those in the UK.

We don’t have a good read on the March quarter, and given the difficulties SNZ has reported with some of its collections late in the quarter there may well be quite a bit of uncertainty for a long time, perhaps always.  I’ve assumed that the economy was running as normal during January (growing slightly) so that the notional level of GDP at the end of January would represent normal.   I then allowed for a 1 per cent drop from there to about 10 March, another then a 0.5 per cent the following week, and a 1 per cent drop the week after that (recall that tourism was dropping away sharply and distancing and uncertainty were mounting locally).  The last six days of March were at the so-called “Level 4”.  Treasury assumes GDP was 40 per cent smaller than usual during that period (as discussed yesterday, the Reserve Bank guess is a bit smaller, mine a bit larger).  Apply that for the final six days and one ends up with GDP down by 2.7 per cent for the quarter.  Realistically, I suspect the truth could be anything perhaps two percentage points either side of that (although my bias is probably something on the weaker side).

What about the June quarter?  Here are two scenarios

june gdp scenarios

Assume –  with Treasury –  that GDP was 40 per cent below normal in the “Level 4” period (one day short of four weeks of April).   Then I’ve assumed a lift to operating at 70 per cent of normal in “Level 3” (consistent with comments in yesterday’s post) and that that period only lasts two weeks.  Then I assume we move up to 80 per cent of normal in “Level 2”.  You’ll recall that the Reserve Bank numbers looked more optimistic than that, but as I noted yesterday their estimates seem to be closer to the legal practical capacity of the economy, not the level of actual utilisation of that capacity.  I remain pretty comfortable with an 80 per cent –  and perhaps the more so after reading about and listening to reactions to the practical constraints that “Level 2” regime would pose.

But perhaps I’m too pessimistic, so my alternative scenario has the economy adding another full percentage of normal each week for the rest of the quarter so that by the last week of June –  still “Level 2” by assumption –  the economy is at 86 per cent of normal.  In previous posts I have suggested that while the border remains largely closed then direct and indirect effects (uncertainty, weak world etc) –  and lack of much monetary policy support –  could easily see the economy running 10-15 per cent below normal.

On my central scenario, GDP in the June quarter is 25.7 per cent lower than in the March quarter.  But even on the less pessimistic scenario –  since the further recovery comes late in the quarter – June quarter GDP is still 24 per cent lower than in the March quarter.

Those losses are quite a lot larger than I gather the bank economists are forecasting.   On the other hand they are pretty similar to “around 25%” fall Treasury had in its Scenario 1 (which, in terms of restrictiveness, seems closest to what we are likely to see).  Since the fall also happens to be fairly similar to those Bank of England numbers –  and we’ve had until now tighter restrictions (especially on economic activity) than them – they have the feel of being in the right ballpark to me.   You could add five percentage points to each of my less-pessimistic scenario numbers (so starting “only” 35 per cent below normal in Level 4, as the Reserve Bank thinks), and you still get a June quarter fall of  about 19 per cent.

(Of course, if things go more or less to plan, all of these scenarios would have significant positive growth rates for September.)

For anyone tempted by still more positive views, I found the indicator shown here – suggesting China may still be running 20 per cent below normal even now –  salutary.

The other reason I went to the effort was that the Reserve Bank yesterday released the results of the latest Survey of Expectations.  Normally no one pays much attention to most of the questions (inflation expectations aside –  and I’ll come back to them), but this time there is so much uncertainty and so little hard data that it was always going to be interesting to see what this group of semi-experts (a large number of economists are on the panel) thought on average.   The survey forms were completed in the week ending 24 April.

Three months earlier, respondents on average expected GDP growth in each of the next two years to be around 2.2 per cent.   Now they expect (on average) a fall of 4.9 per cent in the year to March 2021 and a rise of 3.2 per cent the following year.  Note that the survey asks about growth from the March quarter of 2020 to the March quarter of 2021; they are – in the jargon –  point to point estimates, not annual averages.

That fall to March 2021 might not sound too bad.  But bear in mind that almost everyone probably expects the worst quarter to be the current quarter and much of those losses will have been reversed over the following few quarters.  Unfortunately, the survey no longer asks about expectations for the most recent quarter, but (see above) most likely GDP had already fallen in the March quarter.

If I take my estimates for the March and June quarters, and then apply the March year expectations from the Bank’s survey, one could see a path for real GDP a bit like this (blue line).

stylised GDP

That still leaves real GDP in the March 2022 4.5 per cent below the level it was in December last year.   Respondents aren’t asked about potential GDP, but if it grew by even 1 per cent per annum over the next two years (some mix of a bit of population growth and a bit of productivity growth) it would still leave GDP 6.6 per cent below potential.    If so, then even in two years’ time these respondents views might be consistent with a negative output gap then which was still quite a bit larger than the Reserve Bank estimates the output gap to have been at the worst in 2009.

This is all very stylised and little more than illustrative, but there is nothing at all encouraging about those GDP growth expectations.    Consistent with that, respondents expect the unemployment rate to still be above 7 per cent in March 2022 (rather more pessimistic than the Treasury’s extra-stimulus scenarios, although more optimistic than my response to the survey.)

What else was in the survey?  There was the record low wage inflation expectations (the survey has been running since 1987), although I suppose even in the first year the expectations are still just positive.

wage inflation

For the coming year, house price inflation expectations also went negative (but those questions haven’t been asked for long, so it is hard to benchmark the answers).

Then there were the questions about monetary conditions.  Respondents are asked to indicate how tight or loose they think “monetary conditions” are on (as I recall) a seven point scale.  “Monetary conditions” is in the eye of the beholder –  not specifically defined – but although interest rates are part of the story, they’ve never been the whole story.  That is particularly clear this time.

Respondents are asked about three dates: right now, at the end of the next quarter (September in this case) and in a year or so’s time (March 2021).  On both the first two questions the mean responses were that “monetary conditions” are tighter now than respondents thought they were in late January (previous survey) or in October 2019 (after the MPC’s unexpected 50 basis point cut).    Since nominal interest rates across the board are lower and the exchange rate is also a bit lower than in January, I presume respondents have in mind some mix of share prices and credit conditions.  I don’t want to make too much of the responses, but they should be a bit sobering for the MPC as they prepare their Monetary Policy Statement  –  after all, management keep telling us how much they’ve done to ease conditions.

And then, of course, there are inflation expectations.  The Reserve Bank used to put considerable emphasis on the two year-ahead expectation (the one year ahead one is thrown around by tax changes, sudden oil price changes etc).    Sometimes it has looked as though it was quite influenced by recent inflation outcomes.  That clearly isn’t so this time.

2 yr expecs may 20

Thirty years of inflation targeting, 12 years in which the target was lower than it is now, and never have these medium-term inflation expectations been lower than they are now (1.24 per cent).    The median response is a bit higher than the mean, but both about  70 basis points lower than they were in January.  You’ll recall that the OCR has been cut by 75 basis points since then. In real terms, the OCR has barely changed, in the face of the biggest economic slump in a very long time.

You might perhaps look at that chart and take some very slight consolation from the fact that expectations are still above the bottom of the 1-3 per cent target range.  Even on its own, that shouldn’t be reassuring given (a) the self-imposed limits on the OCR, and (b) that the Remit requires MPC to focus on the 2 per cent midpoint.

But it may also be worth remembering that for the last decade, as medium-term expectations have clung close to 2 per cent, the Bank’s preferred measure of actual core inflation has consistently undershot.

expecs and actuals

Also a little concerning to the MPC should be the expectations of inflation five years hence. It is a relatively new question and until now responses have clung very close to 2 per cent.  This time, the average response is 1.8 per cent –  for a period five years hence.

And, of course, there are the breakeven inflation rates from the government bond market.  For some reason, the Reserve Bank seems to disdain these indicators and hardly ever refers to them, but not only have the implied expectations fallen this year, they’ve edged a bit lower again since those Reserve Bank Survey of Expectations forms were completed.

breakevens may 2020

It isn’t just New Zealand – less liquid markets and all that. The fall in the implied expectations in the United States has been very similar to that in New Zealand.

This stuff really should be worrying the MPC.

(It should be worrying the bank economists too, but for some reason they all seem to think no further effective monetary policy easing is required –  except perhaps for the Bank to buy some more bonds, which might hold bond yields low, but will have little more useful impact on the New Zealand macro/inflation outlook than what has been announced already.   In fact, since the notion that MPC would materially increase the bond purchase programme has been around for weeks, any benefits there might –  or that respondents might think there might be –  should already largely be incorporated in these gloomy expectations above.)

The MPC hasn’t been doing its job at all well (as well as being exceedingly non-transparent and noon-accountable).  Next Wednesday is an opportunity to redeem themselves.  If they won’t –  as they won’t –  the Minister of Finance should insist, if he is at all serious about fast return to something like full employment.



Looking towards the MPS

It must be a busy busy time in the upper ranks of the bureaucracy and their political masters as they rush to complete the Budget –  due on the 14th –  and whatever schemes, plans, and campaign promises the governing parties have in store for us.  Between the three parties that make up the current governing majority, it is sadly hard to think of a single policy proposal in the last couple of months that might actually improve New Zealand’s woeful longer-term economic performance.  Indeed, the risk seems to be that the three parties between them have in mind something more akin to a Great Leap Backwards.

But it is policy deliberation time at the Reserve Bank too.  Their next Monetary Policy Statement is due on the 13th.  In many respects, it should not be very interesting.   After all, only little more than six weeks ago the Monetary Policy Committee firmly pledged to not change the OCR at all –  no matter how bad things got – for the coming year.   Quite possibly, the MPC will decide to increase its bond purchase programme, but if you think that will make much difference in macroeconomic terms, I’m sure vendors could interest you in all sort of dodgy deals (bond purchases aren’t dodgy per se, but just don’t achieve much useful and are mostly political theatre here in the current context).

What the Monetary Policy Committee should be doing is quite another matter.  When they made that rash commitment not to cut the OCR any further, no matter what, for at least a year, the Governor was still in some sort of alternative reality: at the press conference after the announcement he was refusing to concede that New Zealand would necessarily experience a recession, and seemed to have no conception of what was already breaking over the world and what was about to break over New Zealand.  He wasn’t alone –  this was, after all, still in the days of mass gatherings that even the PM was keen on –  but he and his Committee are the ones charged with the conduct of monetary policy (I was going to say “responsible for monetary policy”, but the Act is quite clear that the Minister of Finance shares that responsibility).

The economic situation has got a whole lot worse since then.   And that is so even if you are optimistic that New Zealand might soon emerge to the government’s “Level 2” –  whatever that will specifically mean by the time we get there.  Apart from anything else, the rest of the world –  including China –  is in the midst of a very severe economic downturn.  Recall 2008: there wasn’t too much initially wrong here, but a very sharp global downturn still had big adverse ramifications for us and our economy, that took years to recover from.

And with the deterioration in the economic situation, confidence that the Bank will deliver on the inflation target the government has set for it has also drained further away.   That was a risk that greatly concerned the Governor only six or eight months ago when the MPC acted boldly last year.  It should concern him/them much more now when are actually in the midst of a savagely deflationary shock (globally).

Westpac’s economics team had an interesting note out earlier in the week  in which they noted –  correctly in my view – that

In our assessment, the RBNZ is going to have to deliver much more monetary stimulus.

They still seem to be believers in the bond purchase programme but argue that even after an increase in that programme

 In our assessment even more monetary stimulus will eventually be required.

They now expect that the Reserve Bank will move to a modestly negative OCR,  in November.

As they note, there are two possible obstacles.  The first is this claim the Bank keeps making that “not all banks’ systems can cope with negative interest rates”.   Westpac –  being a bank I guess-  seems to think this is some sort of adequate excuse.  I certainly don’t.  Even allowing for the Governor’s utter negligence in not having ensured all systems were in place  –  the Bank having been aware of the possibility of negative rates for years – it is simply inconceivable that any significant financial institution can be unable to cope with the sorts of modestly-negative OCR levels Westpac is talking about (-0.5 per cent).  Perhaps they and the Reserve Bank really have been remiss and some banks’ retail systems or documentation aren’t really positioned for negative retail rates, but with term deposit rates above 2 per cent and lending rates a lot higher than that, negative retail rates simply aren’t a material issue at present if the OCR is only going to go to -0.5 per cent.   We need the additional monetary policy support now, not months from now when the Bank and the banks might finally have sorted things out.   Institutions that might not be able to cope should simply be left exposed.

And Westpac again

The second impediment is that lowering the OCR this year would break the RBNZ’s commitment to keep the OCR at 0.25% until March 2021. The RBNZ could probably hold its head high by pointing out that the Level 4 lockdown was a truly extraordinary event, and we doubt they would come in for much criticism. However, any move to break an earlier commitment would have to be carefully explained and justified.

I don’t think any of that makes much sense.  If the Bank on 16 March didn’t realise the risks ahead of them –  lockdowns weren’t exactly unknown globally by then, and a sharp downturn was on its way anyway –  the MPC members simply aren’t fit to do their job.  Of course, they could shamefacedly say “Oops, sorry, looks like we made a pretty bad misjudgement, and we now need to change course”, but actually acknowledging error isn’t the official style, let alone Orr’s.  And as for “carefully explained and justified”, well maybe, but Orr’s style so far has been nothing like that  –  we’ve just seen one lurch after another (recall the 50 basis point cut last year, not foreshadowed at all) where they mostly make up the rationalisations after the event.

We get to a similar bottom line I guess….and I suppose Westpac has to be more respectful of the Bank or else senior officials might (a) stop talking to them, and/or (b) complain to the chief executive.

Westpac expects that Bank will walk away from the “no cuts for a year” line in August, preparing the way for an actual cut in November –  six months from now.

A journalist asked me yesterday if I thought they would abandon the pledge in May. My response then was a quick no –  it seemed too close to when the pledge was first made, and to walk away at the first opportunity would deeply degrade the value of any future forward guidance commitments the MPC might offer.   But on further reflection I wonder if there isn’t more chance than I initially thought that they will simply walk back much of the “no cuts” commitment this month.  After all, their messaging and policy haven’t been consistent and discplined through time in the MPC’s first year, so why suppose it would start now?   And, realistically, against this economic backdrop it just looks silly to continue to pledge not to cut the OCR come what may.   After all, some journalist might actually ask hard and persistent questions challenging the Governor to justify that bizarre pledge (not likely, but you never know), and that might be a challenge even for our loquacious Governor.   Then again, maybe we would simply get handwaving and more claims about all the good the bond purchase programmes have done –  bluster over analysis

And there seems to have been something of a change in market sentiment too.  The 90 day bank bill rate has fallen by 17 basis points since mid-April and is now at a level consistent with markets pricing a reasonable probability of an OCR cut at some point in the next three months.  Longer-term rates are falling too –  the 10 year nominal government bond yield this morning was a mere 0.69 per cent.

But long-term bond yields don’t really matter much in New Zealand –  to anyone other the government,  It isn’t as if there are lots of long-term fixed rate mortgages repricing off the 10 or 15 year bond rates.

And if wholesale interest rates have been falling this week, the exchange rate hasn’t been.  In fact, yesterday’s reading of the TWI was less than 5 per cent below the December average –  and in those far flungs days people were getting upbeat about economic prospects here and abroad this year.    Back on 16 March, the Governor claimed the exchange rate was doing its “buffering” job…….but not really very much at all, relative to the scale of the shock.

And what about inflation expectations?  If there was a modicum of relief in the specific inflation expectations questions in the ANZ Business Outlook survey yesterday, there was none in the “pricing intentions” results (or, for that matter, in the volatile ANZ consumer expectations measures out today).    And what of the wholesale markets?   This is the chart of inflation breakevens –  the gap between nominal and indexed 10 year bond yields.

breakevens may 20

These implied expectations had already fallen away quite a lot over the last few years –  a 1 per cent average of 10 years is just not even close to the 2 per cent target –  but have dropped away quite a bit further since then (five year breakevens are even lower).  And recall that these are the same upbeat global markets that now have equity markets showing strength that puzzles most economic analysts: it is hardly as if an excess of gloom is currently driving markets.

It also isn’t just some New Zealand idiosynrasy –  thin markets and all that.    The drop in the implied US breakevens is of similar magnitude to that in New Zealand (and I happened to watch a webinar yesterday run by Princeton economics department and in an online poll of their viewers, the breakeven numbers weren’t regarded as out of line with reality).

In other words, real retail interest rates have not come down much at all, the exchange rate has not come down much at all, and inflation expectations have been (a) falling and (b) always well below the target midpoint.  Add in the unemployment we are seeing, rising by the day, it is a standard prescription which in normal times a central bank would see as a pretty compelling basis for a much looser monetary policy.

With an economy that has been shrinking fast, and seems set to remain well below normal for quite some time, it remains pretty extraordinary that both term deposit rates and low-risk retail lending rates (conventional variable mortgage rates) are still materially positive in real terms.    Run your eye down the term deposit offerings listed on and the big banks are typically still offering 2.3 per cent for six months, and their standard variable rate mortgage seems to be priced between 4.4 and 4.6 per cent.

Cross-country comparisons of retail rates are hard –  product features differ etc, and our sort of variable rate mortgages are largely unknown in the US –  and so I rarely do them.  But I thought some Australian comparisons might be relevant –  after all the RBA’s policy rate is also 0.25 per cent.  But the gap between the policy rate and retail rates is larger here than in Australia.

Thus, whereas ANZ in New Zealand is offering 2.3 per cent for NZD six month deposits, ANZ Australia isoffering 0.9 per cent for AUD six month deposits.    Westpac NZ is also offering 2.3 per cent, while in Australia they are also offering 0.9 per cent.

For a variable rate mortgage, ANZ locally is offering 4.44 per cent.  In Australia, ANZ will lend Australian dollars on a variable rate mortgage at as low as 2.72 per cent (although there is myriad of product offerings).  The best Westpac offering I could see (in Australia) was a bit higher, but still a long way below Westpac’s New Zealand variable rate of 4.59 per cent.    This issue here is not about bank margins (between borrowing and lending rates) but about monetary policy, which influences the overall level of rates.

And if Australian nominal retail interest rates are lower than New Zealand’s, recall that the RBA’s inflation target is centred higher than New Zealand’s –  centred on 2.5 per cent inflation –  so that in real, inflation-adjusted, terms the gap in favour of Australian’s retail customers is even greater.   Now, to be sure, Australian real retail rates are usually lower than New Zealand’s –  all New Zealand’s real interest rates generally usually are  – but when we have a larger adverse shock than Australia, that shouldn’t be the case right now.  And when the Governor tries to tell us –  as he tried to tell Parliament –  that New Zealand interest rates are as low as they can go, he is simply wrong.  Real retail interest rates are far too high for this economic climate and need to come down.

Getting them down further remains technically easy.   Simply lower the OCR to -0.5 or -0.75 per cent and there will be no large-scale transfer to physical cash.  And as I’ve argued before dealing with the large-scale cash conversion risk is also relatively trivial as a technical matter.  The Reserve Bank simply refuses to do it, and the Minister of Finance apparently refuses to insist on it.  In this climate –  and given the margins between the OCR and retail rates in New Zealand –  an OCR of -5 per cent would be more appropriate, and if it were implemented decisively –  lowering the exchange rate, boosting inflation expectations, easing servicing pressures (why all the focus on rents, and almost none on interest rates?) and signalling a climate supporting a quick return to full employment – the extremely low rates might not even be needed for long.  But stick around current levels and the growing risk is that it takes many years to get off the lows, and inflation expectations keep drifting down, reinforced by repeated weak actual inflation outcomes.

The MPC on 13 May should:

  • abandon the “no change for a year pledge”,
  • cut the OCR to zero,
  • announce that the OCR will most likely be cut further in June (which would get many of the benefits immediately, but give a little time if there are some real system issues re a negative OCR), and
  • commit to have in place by June robust mechanisms that for the time being removed, or greatly eased, the current effective lower bound on short-term wholesale interest rates.

An apology would be good too, and some long-overdue openness from the invisible –  but supposedly accountable – external members.  But I won’t push my luck.  If they got the substance of policy right now, the past failures could be largely set to one side.

(Oh, and if they wanted to they could offer to buy some more government bonds, but get the basics right and the theatre won’t be necessary.)

Social Credit – too timid by far this time

Social Credit ideas have a long history in New Zealand.  The originator, Major Douglas, even visited New Zealand in 1934 and testified to a parliamentary committee.  The ideas influenced Labour in particular in the 1930s, and some who later played very prominent roles in National.  We got our very own political party – the Social Credit Political League – in 1954 and from time to time Social Credit did very well in the polls (and under FPP even managed four MPs at the different times from the 1960s to the 1980s).  I recall a time –  perhaps 1980 –  when Social Credit briefly polled ahead of Labour.  There had been an entire Royal Commission in the 1950s, mostly intended to debunk them, but  they weren’t deterred –  as a young economist at the Reserve Bank, a fair amount of my time was spent responding to letters, to us or the Minister, from Social Credit monetary reformers.  Some of were admirably dogged, and typically very polite, although one particular frequent letter writer once lamented that his letters were getting nowhere with us and felt as if he might just as well jump off a cliff.  Our then chief economist suggested that perhaps writing a book might help, and a year or two later we got the book in the mail.

It is a fascinating history but today I’m not going to wallow further in it.  The key policy plank always used to be cheap Reserve Bank credit as the macroeconomic answer.

It still appears to be so.   Social Credit still exists in New Zealand.   Democrats for Social Credit got 806 party votes at the last election.  And on Saturday I opened both papers – Dominion-Post and Herald – to find full page adverts from the NZ Social Credit Association.

social credit apr 2020

Several economists and various other commentators have extracts of their work presented as supporting the Social Credit vision/platform (to be fair, the advert makes clear that none of the people concerned have any association with Social Credit or with the advert).  It isn’t hard to find such quotes –  as my wife notes, I should probably count myself lucky that none from me appeared (after all, that quote from Shamubeel Eaqub is very much in line with my post the other day noting that there was no real macro difference between the Reserve Bank, at its discretion, choosing to buy bonds on the secondary market and choosing to buy them direct from the government).

Anyway, Social, Credit is trying to gather signatures for a petition (although not, it appears, a real parliamentary one) as follows:

We are calling on the New Zealand government to use the Reserve Bank (which the government owns) to fund the Covid-19 economic rescue package.

It is, they claim

The world’s first fully-funded plan to reclaim our environmental and social well-being

And here is underlying graphic

socred 2

The thing that seems to unite most monetary reformers is that they believe monetary policy and things around “the money supply” are much more powerful, much more important, than most monetary economists and central bankers do.

Before addressing what the Social Creditors are proposing, I should say that I am not one of those who thinks governments can do little or nothing useful in severe economic downturns  (there are a few such people, at least in principle, although few are visible/audible right now).  I’ve been championing here a more aggressive use of fiscal policy in the short-term (the 80 per cent net income guarantee for 2020/21), and for a much more aggressive use of conventional monetary policy.  Macro policy can help get the economy back to work as promptly as possible, but borrowing from the Reserve Bank –  whether at 1 per cent as Social Credit used to call for, or 0 per cent as they may now belief –  is largely irrelevant to the solution.

Note –  and here perhaps I depart from some of my friends on the right –  I did not say reckless and highly inflationary (as, for example, Social Credit prescriptions in the 1950s would have been).     There is far too much jumping at inflationary shadows still –  as there was 10 years ago in some circles (in the US in particular), and (so I was reminded rereading Eichengreen over the weekend) in the depths of the Great Depression –  at a time when the predominant macro risk (reflected in market prices themselves) is deflation.  Just largely irrelevant for now.

There is much talk of the government simply borrowing from “its own bank”, the Reserve Bank.  But the Social Creditors don’t seem to realise that there is really no such thing –  in any substantive sense.  After all, to most intents and purposes the Reserve Bank is just another division of the government –  the bit the banks bank with.

Take a really really oversimplified example.  The government wants to spend $20 billion in the depths of the recession and gets the Reserve Bank Governor to agree to lend it $20 billion (the government’s account at the Reserve Bank goes up by $20 billion and the Bank’s holdings of government bonds go up by $20 billion).  For most macro purposes, the interest rates charged/paid on either leg doesn’t really matter.

Now, assume the government goes and spends the money, perhaps distributing it in something like the wage subsidy programme.  The government’s operating account at the Reserve Bank will drop by $20 billion, and the accounts the banks hold at the Reserve Bank will rise by $20 billion (as recipients of the wage subsidy payouts bank the proceeds).

For the government sector as a whole, the net effect of this set of transactions in that the government sector has borrowed $20 billion from the banks.

Which is just what Social Credit thought they were avoiding.    They weren’t.  And the other relevant detail here is that the Reserve Bank pays interest on those deposits banks hold with them: at present 0.25 per cent per annum on the entire stock.

Banks, of course, have their own liabilities on the other side of their balance sheets, on which they too pay interest.    Some of them might be “wealthy foreigners”.  Others will be Grandma.

And what determines (or is supposed to determine) the rate the Reserve Bank pays on the deposits banks hold with it –  the OCR?  Why, that would be the inflation outlook, since they are required to aim to keep inflation at or near the target the Minister of Finance sets for them.

Perhaps advocates of Social Credit will be saying “ah, but 0.25 per cent is still cheaper than the interest rates the government might pay if it issued the bonds directly on market” (at present, long-term bond yields are a bit below 1 per cent, but would be higher than that if the Reserve Bank were not in the secondary market).   And that is true, but a 10 or 15 year bond yield is capturing, among other things, implicit expectations as to what monetary policy will be doing –  where the OCR will be set –  for the next 10 or 15 years.  Perhaps rightly, perhaps wrongly, at present the consensus view is that on average over that period the OCR will be higher than it is now, once the economy gets back to something more like full employment.

If that is right then, all else equal, even if the government has locked in zero interest funding itself from the Reserve Bank at zero per cent interest, the Reserve Bank would find itself having to pay higher interest rates over time to holders of settlement cash balances (or it might auction off some of its bonds to reduce settlement cash balances, but the macro effect would be much the same).    Reserve Bank interest expenses are a net cost to the Crown just as surely as if the Crown issued the debt directly on market.

And if the Reserve Bank did not make those adjustments –  higher OCR if and when inflation pressures eventually recovered – the result would be higher inflation.  And high inflation would be just as surely a “tax” –  transferring real resources from the public to the Crown –  as the taxes Social Credit claims they offer a path to avoid.

Perhaps the bigger problem still is that the Social Credit proposals are probably inadequate to the needs of the hour.

As I’ve noted in various posts in the last week or so, the Reserve Bank has added a huge amount to banks’ settlement account balances in total (balances last week were more than $20 billion higher than usual).  The “money supply” –  particular aggregate measures the Bank publishes – will also have increased to some extent (we’ll be waiting for weeks to see the end-April numbers).   But the higher settlement cash balances simply don’t mean very much.  For banks, it is just another asset –  a rock-solid one (which must be welcome) paying a reasonable interest rate for now, 0.25 per cent.    It isn’t as if there is much real effective credit demand at present, and the nervousness of many households and firms is probably reflected in quite a strong desire to save.

And whichever mechanism the Reserve Bank uses to buy bonds isn’t itself affecting how much the government is spending.  You might think (I suspect Social Credit do) that the government should be spending more.  That’s fine, but it won’t have any problem raising those funds –  whether it does so by issuing bonds on market, or issuing them to the Reserve Bank.  And it isn’t as if a shortage of settlement cash is constraining bank lending at present –  instead it is primarily weak demand from demonstrably creditworthy borrowers and perhaps an absence of attractive projects to fund (two sides of the much the same coin).

If the Social Creditors wanted a monetary policy that made a real difference in the current climate they’d give up their small ambitions and focus instead on where the big gains might really be on offer.

Perhaps a 1 per cent interest rate sounded really low to Major Douglas back in the 1920s, or to Social Creditors in most of the decades since.     These days it would be a very high interest rate, quite out of line with the needs of the economy.   Same goes for that 0.25 per cent the Reserve Bank is paying on the tens of billions of settlement cash balances.   Same really goes for zero, when so much of the government debt of major advanced economies has been earning a negative yield for some time.  Not surprisingly then, on the one hand our exchange rate is staying quite strong –  really unusual for a serious New Zealand recession –  and expectations about future inflation are falling (in turn raising the real interest rate –  a simply insane outcome in the midst of a deep recession with a highly creditworthy sovereign borrower).  But it isn’t wealthy investors or evil foreign banks who are determining that our interest rates are still so high: instead, it is Adrian Orr (and his Monetary Policy Committee, several of whom share the Governor’s left-wing credentials) and Grant Robertson, he who is always talking about the significance of full employment, but yet who does nothing to bring about the much lower (short-term) interest rates the current situation calls for.   Even in the last US recession, highly orthodox researchers within the Federal Reserve system concluded that a Fed funds rate of more like -5 per cent would have been helpful.  Our starting point this time, is worse than the US’s in 2008 (the Fed funds rate then started at 5.25 per cent).

In this environment, Social Credit is a distraction, but then so is the Governor’s bond-buying programme itself.    As in the Great Depression it was breaking free of the “golden fetters” that eventually allowed robust recovery, so this time it is the self-imposed “paper chains” – the refusal to do anything about seriously negative interest rates, that will impede prospects for any sort of robust recovery (and, not incidentially, worsen the worthy outcomes in the Social Credit graphic above).  Bond-buying programmes at yields well above the current natural rate of interest are just flashy-sounding asset swaps with little macro significance.

(And in case people are worrying about threats to central bank independence, recall that (a) the Bank’s current bond-buying programme, and any purchases it might in future make directly from the Crown, are a discretionary choice for Bank, and subject to the inflation target, and (b) central bank independence is not an absolute, or even always helpful –  the Fed, for example, was independent in the early 1930s and consistently resistant to doing very much of what needed to be done to get the US economy going (statutory powers for the Minister to (a) set the Bank’s target, and (b) override the Bank in some circumstances, but openly, exist for a reason).

And two final historical points:

  • one of the quotes Social Credit use is from Bernard Hickey about the 1930s.  Not only was the macro environment rather different –  fixed exchange rate and all that –  but the experiment did not end well (being used when the economy was already back near full employment) leading to a crisis in which a sovereign default would have been the outcome but for the looming war, and the imposition of tough exchange controls that took decades to get rid off
  • Canterbury economics academic Paul Walker has links here to a couple of pieces on Social Credit from the 1950s, including extracts from the Royal Commission report.


Reserve Bank answers to questions from MPs

I haven’t changed my view that suspending Parliament for the duration of the greatest economic disruption, social dislocation, impairment of civil liberties, and assertion of executive power in a very long time (probably ever on at least some of those counts) was a (telling) mistake.  Nonetheless, the Epidemic Response Committee –  which is no real substitute for Parliament (including that it could not pass all the retrospective legislation the government is now promising) –  has done some useful work.

My interest, of course, has been mainly on the economic side of things.  Last Thursday they called the Governor of the Reserve Bank (and offsiders) to appear.  I sketched out here some of the sorts of questions the Bank needs to be asked, whether now or in a subsequent inquiry.  And I wrote about the questionable nature of many of the more important responses the Bank gave to the Committee when they appeared, some of which could only fairly be characterised as some mix of pure spin and just making things up.  That was particularly so around the alleged extent of the easing in monetary conditions, and the promise by the MPC not to cut the OCR further, no matter what.

Anyway, I assumed that was all over and done with, so it was a pleasant surprise when a reader sent me a link to some additional written questions the Committee had lodged and the Bank’s responses, which were quietly released onto Parliament’s website yesterday (the Bank certainly wasn’t drawing attention to this material).   There were a few odd questions at the start, but then the questions got quite meaty and serious, and appeared to draw on some of the lines I’d suggested last week.

Here were the questions that caught my eye:

  1. What steps had the Reserve Bank put in place prior to the Covid-19 outbreak to ensure it could practically implement negative interest rates?
  2. What work did the Reserve Bank undertake, and when, to explore ways in which it could reduce any practical constraints to negative interest rates?
  3. If there was any work or research undertaken to remove any practical constraints to negative interest rates, could any papers or advice be released?
  4. What modelling or research was undertaken, if any, to prepare for the possibility of a significant economic downturn while the OCR was at such low rates?
  5. In the Governor’s speech on March 10th 2020 negative interest rates were discussed as an option for unconventional monetary policy – what changed between that speech and the OCR cut on March 16th 2020 that stated “that an OCR of 0.25 percent was currently the lower limit, given the operational readiness of the financial system for very low or negative interest rates”?
  6. When did the Reserve Bank first become aware that not all Banks were operationally ready for low or negative interest rates?
  7. How many banks are not operationally ready for low or negative interest rates and what share of the banking market do they account for?
  8. What are the operational barriers to negative interest rates (for example, are the barriers at the wholesale or retail levels)?
  9. What steps is the Reserve Bank taking to remove barriers to negative interest rates?
  10. When does the Reserve Bank expect any operational barriers to negative interest rates to be removed?
  11. What evidence does the Reserve Bank have that the large scale asset purchasing programme has been an effective substitute for lowering the OCR?
  12. What is the Reserve Bank doing to address falling inflation expectations considering the Reserve Bank’s pledge not to reduce the OCR further?
  13. By how much have retail interest rates fallen this year and how does that compare to every previous New Zealand recession?
  14. Will the Reserve Bank immediately release all relevant papers relevant to Monetary Policy decision-making this year?

For most of the questions they avoided giving straight answers, or even answering at all (which seems unusual, since my impression had been that when, for example, the Finance and Expenditure Committee asks the Bank supplementary questions in normal times they actually get answers).

Of the questions, there is a clear and specific answer to number 14.  That’s a no.  The Bank has no interest in any greater degree of transparency than the (very limited) amount there normally is, and that despite the huge uncertainty, unconventional policy and manifest unpreparedness.

There are no answers at all to questions 2 and 3, suggesting the Bank had done no work at all on these issues (eg limiting the potential for conversion to physical cash to hamstring the transmission mechanism), despite the extensive literature over the years on issues and options.

For question 4 they supplied this answer

The Reserve Bank has been updating internal forecasts for the probability of the Official Cash Rate (OCR) needing to reach negative territory on a regular basis since August 2019, and had been monitoring this probability less frequently before this. The possibility of a significant economic downturn in 2019 prompted the Reserve Bank to begin a closer examination of its alternative monetary policy options, and resulted in the Reserve Bank developing a range of alternative monetary policy options to respond to the COVID-19 event, meaning it would not have to rely on using only the OCR to conduct monetary policy.

Which isn’t very specific, but perhaps they regard as good enough for Parliament. There is simply no indication that they ever engaged with the fact that in typical past recessions 500 basis points of OCR easings had occurred, and by late last year the OCR was only 1 per cent.  And if they’d got to this point –  explicitly updating forecasts for the probability of needing a negative OCR –  by August last year, you’d suppose they’d have checked that there were no remaining technical obstacles, and if they’d found any made it a matter of urgency for them to be resolved.

That is what might have happened in a well-functioning agency –  bearing in mind, that this wasn’t even the first time they’d turned their mind to the issue (having published a Bulletin article in 2018, had an internal working party in 2012 recommend these issues be investigated and resolved, let alone the precedent of several other advanced country central banks for several years.

But as their answers to questions 1 and 6 make clear, that wasn’t the approach of our central bank –  recall, this was the central bank whose Governor keeps talking up his ambition for the Bank to be “the Best Central Bank”.

The Bank provided a page or so of summary response to the questions about negative interest rates.  Here are some extracts (emphasis added).

The Reserve Bank has been undertaking a programme of work on unconventional monetary policy tools, including negative interest rates, for some time. Since late 2019, this work included ensuring that the Reserve Bank’s systems can operate with negative interest rates, and understanding the banking system’s operational preparedness for negative interest rates. The Reserve Bank has the operational and legal ability to implement negative interest rates.

I guess that is good to know, although as I recall it the working paper I chaired in 2012 was told then that the Bank’s own internal systems could handle negative rates.

But what about the wider financial system and banks?  First there was this

Over the second half of 2019, the Reserve Bank engaged with registered banks regarding their ability to operate negative interest rates. This first involved engaging with the Reserve Bank’s counterparties in its open market operations in financial markets.

Okay, but this must have been a pretty minor issue.  After all, plenty of overseas wholesale instruments had been trading with negative yields for years, and according to the tables on the Bank’s website, indexed bond yields here first went negative in August last year, and presumably all those trades were conducted and settled just fine.

The real issue was always going to be banks and other deposit-taking institutions.  Here we learn

More broadly, bank supervisors raised the issue of preparedness for negative interest rates at banking sector workshops in December 2019.

This sounds pretty low-level, non-specific, and not at all urgent.  And this was the end of the pre-Covid era (the timing posed in question 1).

But then, very belatedly, they seem to finally started to get the grips with the potential for problems.

In late January 2020, the Reserve Bank’s Head of Supervision sent a letter to banks’ chief executives formally requesting they report on the status of their systems and capability.

By this point, of course, Wuhan was already in the daily headlines.  All those years, all that talk, and not til late January did they even start to do anything serious.  What did they find?

The responses raised a number of material constraints and concerns regarding operationalising negative interest rates. These included:
 – technical system issues (including front, middle and back office IT systems);
 – required changes to loan documentation;
 – tax and accounting considerations; and
 – market conventions for settling negative interest rate transactions.
Some of the issues affected the entire banking system, while others were limited to particular banks. The majority of banks reported further testing was required, and advised it was being undertaken.

Which is interesting, I guess, but does not answer some of the specific questions.  Thus, if the issues relate primarily to retail systems and retail rates (question 8), most retail rates are still well over zero now, and that is not a constraint to taking the OCR itself negative (and the Bank more or less tells us the wholesale instruments can’t have been the problem –  see the note above about the OMO counterparties).

They also don’t say when they got these responses (question 6) –  although I have an OIA request in that may eventually shed some light on that.

It all seems astonishingly negligent on the Reserve Bank’s part, put on notice of the issue years ago, claiming to be actively looking at it last year (recall the Governor’s major interview talking up his preference for the negative rates option).  This from an institution that has boasted since the last crisis how well positioned it was because it was both the monetary policy agency and the banking regulator (and operator of the wholesale securities settlements system) so that all the synergies should be realised and little or nothing should have fallen through the cracks.  This one –  a big one –  most clearly did.

(Of course, none of this reflects particularly well on the banks either, although quite how many are at fault, and how large those ones are, is still unknown –  the Bank won’t tell us.  They must have heard the Bank talk about negative rates, they must have looked abroad, in some cases their economists even wrote useful pieces on unconventional options….and yet.)

Then note that final sentence in which it is stated that “the majority of banks reported further testing was required, and advised it was being undertaken”.   But there is no sense of time frame there, or any urgency whatever (and recall that the Bank’s previous answers –  and even this one – suggest that “testing” wasn’t the only issue/constraint).   The Bank’s answer goes on

The Reserve Bank is engaging with the banks and expects them to be taking steps to be operationally prepared for negative interest rates.

But there is nothing hands-on or specific about that (and thus there is no answer at all to question 10).

Elsewhere in the answers they include this observation, attempting to justify their relaxed attitude.

As discussed in Preparations and readiness for negative interest rates [the one pager], many of the commercial banks still needed to undertake work to be able to operate with negative interest rates. This would have been disruptive for these banks at a time when they were also adding other new programmes, working remotely, and having to greatly increase customer service capacity.

But even this is playing distraction, and seems more about not inconveniencing the banks, and perhaps a Governor who no longer believed that lower interest rates were even desirable/appropriate.   After all, people weren’t working remotely in late January, in late February (after the  MPS), by 10 March when the Governor gave his speech still listing negative interest rates an option (and talking up the possibility of easing the effective lower bound itself) or even on 16 March when the MPC made its public commitment not to cut the OCR further no matter what happens, and we started to be run the “technical obstacles for banks, wouldn’t want to bother them, sorts of lines” from Bank management.  Instead, it is pretty clear that the Reserve Bank badly dropped the ball, and is now playing distraction to cover for its past and ongoing failures.  The Governor and Deputy Governor (the latter responsible for bank supervision) must bear particular responsibility.

What of the other questions?    There was one (qn12) about falling inflation expectations –  this was a big theme of the Governor and his monetary policy deputy for a time last year.  But this time round, amid actual market price and survey evidence of inflation expectations falling away and, all else up, driving up real interest rate?  Well, we (well, Parliament actually) simply got boilerplate bureau-speak

The Reserve Bank and Monetary Policy Committee are committed to the Remit’s dual economic objectives of achieving price stability and maximum sustainable employment, and will continue to evaluate the use and extension of its monetary policy tools, and enhanced coordination between monetary policy and fiscal policy.

An utter refusal to even engage on one of the core issues of monetary policy.

But my bigger concern, as when I wrote about the appearance at the Committee itself, is how the Bank is attempting to spin its large-scale asset purchase programme.    You can read the detail there, but this extract captures the point

I think there is little doubt that the Reserve Bank’s large-scale asset purchase programme –  which, mostly, I support –  has acted to bring government bond yields back down again (and with them some other interest rates).  In that sense, there is probably quite a large effect in those markets.  But what that has done is to reverse a tightening in monetary conditions that got underway as assets were being liquidated globally; it is not any sort of easing relative to where conditions stood three months or so ago.

In its latest answers, the Bank attempts more of the same sort of spin and distraction.   Thus, in question 11 they were asked about their claim that the LSAP programme had been an effective substitute for a lower OCR.   Mostly they avoid the question, falling back on the questionable claim that the LSAP is equivalent to 150 bps of OCR easing, but acknowledging that there is “considerable uncertainty” about these estimates.  Then there is this bit of the answer:

The LSAP has been successful in offsetting the rise in government bond yields that was observed in the lead-up to the decision to implement it. In addition, LSAPs have stabilised financial markets by providing liquidity and surety at a time when it was needed. These effects would not have been achieved with a negative OCR

Both of which strands are true, but not really relevant, since the MPC made the pledge not to cut the OCR further at a time when bond yields were still falling sharply.   As I noted in the earlier piece, the LSAP successfully reversed the later panicky rise in bond yields, but has done nothing to actually ease conditions relative to where they were on 16 March.   It is also true that the OCR and LSAP are not straight substitutes  –  as the Bank notes in the final sentence –  but in a sense it was them who were claiming otherwise.  Stabilising the government bond market might have been helpful –  although its role in the monetary transmission mechanism is much less important than in, say, the US – but it isn’t a substitute for actually easing monetary policy.

In fact, the Bank more or less gives the game away in their answer to question 13.

Retail interest rates have fallen by considerably less this year than during previous recessions. This in part reflects the OCR falling by less, and dislocations in global and domestic financial markets have also hampered the full transmission of monetary policy. Marginal market funding costs for New Zealand banks have increased due to stress in financial markets, and this has limited falls in mortgage rates. Benchmark short-term interest rates have fallen by around 0.8 percentage points this year, compared to falls of almost 6 percentage points during the Global Financial Crisis (GFC). Deposit rates and 1-3 year fixed mortgage rates have fallen on average by 0.25 percentage points since the beginning of the year, and floating mortgage rates have declined by 0.75 percentage points. By contrast, fixed mortgage rates fell by an additional 2 percentage points on average during the GFC.

I could also help with this extract from my previous post

In December, before anyone in New Zealand had even heard of the new coronavirus, those interest rates were 2.63 and 5.26 per cent respectively.  As of this morning, using the data on current rates on, the big banks are offering between 2.3 and 2.45 per cent for six month terms deposits (shall we call it 2.38 per cent), and offering between 4.44 and 4.59 per cent for floating rate mortgage (call it 4.5 per cent).   In nominal terms these deposit rates have come down by 0.25 percentage points and 0.75 percentage points.  It is harder to replicate the Bank’s “SME new overdraft rate”, but by March it had come down by 0.59 percentage points.

Here, by way of comparison, is how much those three series fell from December 2007 to April 2009:

Six month term deposit rate:     -4.6 percentage points

Floating first mortgage rate:      -4.1 percentage points

SME new overdraft rate:             -2.4 percentage points

Oh, and inflation expectations have come down, so actually real retail interest rates –  the ones that mostly matter –  have hardly fallen at all in face of the biggest economic slump in a very long time.

They simply have not been doing their job.   Recall that the Remit that guides the MPC, set for them only last year by the Minister of Finance requires them to

a) For the purpose of this remit the MPC’s operational objectives shall be to:

i. keep future annual inflation between 1 and 3 percent over the medium term, with a focus on keeping future inflation near the 2 percent mid-point. This target will be defined in terms of the All Groups Consumers Price Index, as published by Statistics New Zealand; and

ii. support maximum sustainable employment.

When core inflation started below the target midpoint, inflation expectations are falling away, demand is slumping and unemployment is surging, it is time for much more of an effective monetary policy response than modest falls in nominal retail interest rates –  little changed in real terms –  and a small fall in the exchange rate.  Focusing instead on stabilising government bond yields, worthy as it might be, is really a bit of a distraction (whether they realise it or not).

In a way this is the bizarre thing about the flurry of excitement caused by the suggestion from the Governor and the Minister that it might make sense at some point for the Bank simply to buy more new-issue government bonds directly from the market.    For any given stance of fiscal policy –  and realistically, fiscal policy has remained pretty cautious (too much so in my few) since this crisis launched –  however the Bank buys the bonds it is going to hold is really neither here nor there when the  prevailing interest rates are still well above where they should be and when the exchange rate has not fallen much at all.     There is little or no significant risk of a surge in inflation in the next couple of years –  any more than such surges happened in the countries that engaged in large scale bond purchases after the last recession –  and the big presenting risk is on the deflationary side at present.      Lower financial market prices (retail interest rates and the exchange rate) won’t make a huge difference to economic outcomes right now –  heavily constrained by regulation anyway –  but are about (a) relieving debt service burdens, (b) sending the right signals as people think about spending and borrowing for the next few years, and (c) supporting inflation expectations, avoiding rising real interest rates, by giving people confidence that central banks will do what it takes –  and what will make a difference – to get inflation back towards target and keep it there.

There has been much talk about negative oil prices in the last few days.  They really are an unsustainable anomaly –  about storage capacity – and the marginal extraction costs set a floor on sustainable prices.  There is nothing natural or inevitable about positive interest rates.  Interest simply serve to balance savings preferences and desired investment plans: if investment intentions collapse and private savings preferences rise significantly, it is quite plausible for the market-clearing price –  the interest rate – to be negative.  The only thing that stops nominal interest rates being materially negative at present is central bank conservatism, and reluctance on the part of central bankers to simply do their job.

In Orr’s case, playing distraction and pandering to all his other interests is clearly easier and more to taste.  See this account of his speech this week –  a speech for which there is no transcript and no public record of the Q&A session –  for Orr the politician, Orr the philosopher, Orr’s judgement on the public’s desire to consume, Orr on the (alleged) failings of democracy, but little or nothing on Orr charged with getting inflation to 2 per cent and supporting employment in the face of a huge deflationary shock and slump.

It is too bad the Epidemic Committee can’t call the Governor back and insist on some straight answers.  Better still might be if the Minister of Finance and the chair of the Bank’s Board did their job and insisted that the Governor does his.





Central bank watch

Our Reserve Bank has been all over the place on monetary policy going back to last year.

There was the totally out-of-the-blue 50 basis point OCR cut last year.  It may or may not have been substantively justified, but they never had a compelling rationale at the time and were reduced to dreaming up (quite reasonable) stories after the event.    The concern about minimising the risk of falling expectations was one of those stories –  good, but clearly an ex post rationalisation (since all the contemporary statements made little or no mention of the issue).

In the wake of that cut, the Governor gave quite a few interviews.  One of the most substantial was with Newsroom’s Bernard Hickey (there is a full transcript at the link).   In that interview – barely eight months ago –  we learned that the Governor had no particular qualms about a negative OCR and in fact preferred that options to large-scale asset purchases (“QE”)

The effectiveness of interest rate changes, even into negative territory, made it preferable to other types of policies such as quantitative easing, which is where central banks invent money to buy Government bonds to force down longer term interest rates.


Probably the most effective and simplest one is having negative interest rates – so, bizarre as that seems, it still operates the same difference around the shape of the yield curve, and it makes people either bring spending forward or delay spending: it’s just zero – around negative sides. It also makes people think much harder about alternative investments: so, it makes them think about putting their capital to work outside of just a bank deposit. And that is, again, another positive reason for monetary policy.

We also heard from the Governor about the importance of keeping inflation expectations up (ex post rationale for the 50 basis point cut).

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

It was a really substantive interview –  much more so than any speech or other interview the Governor has given on monetary policy in his time in office.   Much of it was explicitly focused on options if conventional monetary policy reached its limits.  So you might reasonably have supposed that this sort of thinking would still have been the sort of framework the Governor had in mind when a really severe crisis began to unwind only a few months down the track.  And, specifically –  given the gung ho comments on a negative OCR –  you’d have taken for granted that the Governor had assurred himself that all relevant systems were ready to cope with a negative OCR.

More fool you (or me) then.

But on negative interest rates, it wasn’t just a one-off comment.     When this crisis was already well upon us –  on 10 March in fact –  the Governor gave a speech outlining the Bank’s monetary policy options.   As I wrote at the time, he was astonishingly complacent that day, but set that to one side for the moment.  In his discussion of options there was no hint at all that a negative OCR was about to ruled out of consideration, let alone of the argument he was shortly to fall back on that it couldn’t be done because (some) banks “weren’t ready”.   In fact when I saw this item in the table in the speech, I nodded approvingly (especially, in fact, about that second sentence).

Negative OCR

Reduction of the OCR to the effective lower bound (the point at which further OCR cuts become ineffective), which may be below zero. The Reserve Bank could consider changes to the cash system to mitigate cash hoarding if lower deposit rates led to significant hoarding.

In that speech incidentally, the Governor promised that the Bank would be releasing a series of technical working papers on the options over the following weeks.  As yet, we’ve seen nothing; not a shred of supporting analysis for the choices the MPC has ended up making.   Consistent with the balance in the speech, on 13 March the Bank’s chief economist was quoted in the Herald stating that asset purchases etc weren’t that much of a substitute for interest rates, but just give “give you a little more headroom”.

But by 16 March the MPC finally, quite belatedly, cut the OCR, but it was a mystifying “one and done” strategy.  A 75 point cut was all well and good, but suddenly  we had a floor being put in place on the OCR: not at the sort of negative levels several other central banks had gone to, not even at zero, but at 0.25 per cent.

And, the Monetary Policy Committee agreed to provide further support with the OCR now at 0.25 percent. The Committee agreed unanimously to keep the OCR at this level for at least 12 months.

And not a shred of substantive analysis for this position has been published.  All we get from the Bank is the bland assertion that (not all) banks were ready for negative interest rates (not even clear whether the problem is the wholesale rate –  the OCR –  or retail rates which are typically still well above zero)…..and (not having put any pressure on banks to be ready in the preceding years) they now don’t want to trouble the banks.  I’m sure there are myriad businesses across the country that today wish they hadn’t been troubled by regulatory interventions (let alone viruses).  But the Reserve Bank has suddenly become solicitous of the banks, in utter disregard of their statutory mandate, which focuses not on the convenience of banks but on price stability and employment.  In the face of the unfolding huge slump in economic activity and demand.

Within days, the MPC had lurched into a very large announced programme of buying conventional government bonds, supplemented further this week (more questionably) by huge purchases –  relative to the size of the market –  of local authority debt.

I’m not suggesting that the bond purchase programme was inappropriate given the MPC’s refusal to cut the OCR.  It is the sort of climate in which, all else equal, one might expect an upward-sloping yield curve to steepened.   But had they been willing to cut the OCR aggressively, including signalling action on the notes constraint, there would have been much less need to announce a bond-buying programme.  And, more importantly, real and substantial relief would have been provided to floating rate borrowers, redistributing income from floating rate depositors/funders (ie the way monetary policy usually works).  All else, the exchange rate would also have fallen….again, a typical part of how monetary policy works.   As it is, the announced bond-buying programme has, more or less successfully, capped the rise in government bond yields.  That is a gain worth having, been it falls a long way short of lowering interest rates across the board –  in the face of a simply unprecedented economic slump.  I’m pretty sure that no other central bank in history, with a floating exchange rate, has ever pledged not to cut interest rates into a deepening slump, no matter how bad things get.  But that’s the Orr Reserve Bank for you, accommodated by the Minister of Finance and his appointeee as chair of the Bank’s Board.

There has been a fair bit of commentary from the Reserve Bank over the last few weeks, some of it just weird (the Governor on Stuff last Sunday), others fairly routine.  What is worth noting is that not once, not in a single communication from any of the Monetary Policy Committee (whether the four internals who speak, or the three internals who stay silent and seem to avoid all scrutiny from the media). has there been any mention of falling inflation expectations, as a risk that needs to weigh highly with any central bank faced with a deflationary shock and a reluctance to cut interest rates further.  To the extent that expectations fall –  and they have been, on both market and survey measures – real interest rates start rising.  And that is the exact opposite of what the situation demands.  But, of course, the MPC has offered no analysis or commentary on why they are now so unconcerned about something that, when simply hypothetical, the Governor seemed very concerned about just a few months ago.

But I wanted to jump forward to a succession of comments this week from the second tier internal MPC members, Assistant Governor Hawkesby (Orr’s chief deputy on matters macro and markets) and Chief Economist Ha.

On Monday, Ha told Bloomberg (written responses to written questions)

“The OCR can technically be taken lower, but as outlined in the Unconventional Monetary Policy principles and tools document, we would assess the effectiveness, efficiency and an impact on financial system soundness of doing so,” he said. “That would also take into account the operational readiness of the banks’ systems to implement a lower OCR.”

Asked if the OCR could be lowered in increments of less than 25 basis points, he said adjustments have to strike a balance between making changes meaningful — “will it translate into changes in rates faced by New Zealanders” — and avoiding excessive fine tuning from smaller moves.

“We also have to avoid unnecessary volatility in interest rates and exchange rates in setting monetary policy,” Ha said. “International practice has largely settled on 25 basis point increments as a minimum.”

A lot of that made no sense at all –  especially the bit about avoiding volatility – but sadly the Bloomberg journalist doesn’t seem to have asked (a) why the Bank never ensured banks were ready, (b) the exact nature, and scale, of the technical constraints (is this one small bank or ten; is it wholesale or retail?) and seemed content just to report the Bank’s lackadaisical approch – never mind the economy, don’t bother the banks.

Then Bloomberg get a real interview with Hawkesby. Here were his comments on this issue

Asked about cutting the official cash rate further below its current level of 0.25%, Hawkesby said banks weren’t operationally ready for negative rates and the RBNZ had given them an assurance that was off the table for the time being. However, the central bank was “open minded” about a negative OCR, he said.

“There could well be point down the track, where time passes, that we do have a negative official cash rate somewhere, sometime in the future.”

“Where time passes”, “sometime in the future”……even as economic activity is collapsing around them now, and deflationary risks are rising. It is just an extraordinary approach, still not supported by any serious analysis, just this line about “keeping their word” to the banks.   Who are the stakeholders here?  Surely, the public –  the wider economy –  of New Zealand, with a statutory mandate about keeping inflation up near target and leaning against losses of output/employment?  Again, though, the questioning seemed pretty tame, but since the Bank only tends to grant interviews when the questioning is likely to be tame, I guess the journalist did what he thought he had to do.

Then Ha reappeared.  I’m going to take his latest two comments out of order.  This morning on RNZ I heard Ha talking up the success of the Bank’s asset-buying programmes, claiming that they had got lots of interest rates well down.    As noted above, no doubt that is true from the peaks, but it is to deliberately skate around the real issue.  Given the MPC’s refusal to cut the OCR further, very few interest rates have fallen far at all relative to where they were just a couple of months ago –  and nothing like what a slump of this magnitude would typically see.  All the big banks, for example, are offering well over 2 per cent for a six month term deposit, a more 20-30 basis points lower than they were offering in February.  In the midst of the biggest economic slump in history, real deposit rates are flat or rising.      That is simply a choice – an extraordinary one –  by the MPC, and one that their members never own up to or justify (and which, sadly, media never seem to challenge them on).

Ha’s other comments were in an interview yesterday with   There was quite a bit there I could unpick, including some comments –  similar to Hawkesby’s –  about the (strange to me) decision to buy local authority debt, perhaps even Housing New Zealand bonds (both of which sets of issuers are non-market entities) but not corporate bonds.    But I wanted to keep the focus on interest rates. From Ha we got this

While the RBNZ on March 16 cut the OCR by 75 basis points to 0.25%, and committed to keeping it there for at least 12 months, Ha said cutting it further is “probably something that comes back on the table at some point”.

He said the RBNZ had been mindful of giving banks some “breathing space” before going into negative interest rate territory.

Same complacency –  “at some point” (well after the worst is over?) –  same consideration for the banks, at the expense of the economy.   And still no serious rationale, no detail as to the nature of the issue, simply a bunch of officials –  ministerial appointees all –  who simply see no urgency about actually getting interest costs lower, even as though urge that more debt be taken on (as Ha did in his interview this morning, urging banks –  already facing higher risk and lower credit ratings –  to “step up”).

But in a way what really took the cake, and prompted this post, was the final bit of the report of the Ha interview

Pressed on why the RBNZ hasn’t released technical papers or more information explaining the rationale behind the unprecedented moves it’s making due to COVID-19, Ha said it was trying to be transparent.

He noted the speed at which things have been moving and how quickly data necessary for decision-making was becoming outdated.

He said the RBNZ was trying to be innovative, sourcing more real time data like credit card transactions, bank balance sheet data, information from the Inland Revenue and Ministry of Social Development and internet traffic.

Economists have been critical of the RBNZ, Treasury, Statistics New Zealand and government agencies more generally for not releasing more real time information ahead of regular releases.

I totally share the concern in the final paragraph (isn’t it extraordinary that we don’t yet routinely have weekly data on new unemployment benefit applicants, or a commitment from SNZ to publish indicative HLFS data monthly for the duration, and so on.  And it is good to hear that the Bank is looking at more real-time data but……..that claim that the Bank itself “was trying to be transparent” is simply belied, day in day out, by their actions and choices.  It is either an outright lie, or (more probably) just a typical manifestation of a longstanding approach: to them transparency means telling us what they think is good for us to know, and only that.

Of course, things are moving quickly. Of course data are quickly outdated.  Most probably some of the analysis presented to the MPC has been overtaken by events.  But that doesn’t justify the secretive approach the MPC continues to take, as they’ve embarked on huge monetary experiments (in this case,  for example, lets not cut the OCR despite the biggest most sudden economic slump in many half-centuries) or as they’ve lurched from one “model” to another with no explanation whatever.  It simply isn’t good enough.

I reckon their stance of policy is utterly indefensible, and have urged the Minister of Finance to use his long-established statutory powers to override the MPC’s choices (crisis times justify use of extreme, but well-established, statutory provisions).  Presumably the MPC members –  each of them, internal and external –  disagree.  Presumably they have a story to tell about:

  • why inflation expectations no longer seem to matter when they were a big concern a mere matter of months ago (exactly the same MPC members),
  • why doing something serious about negative rates was a realistic option on 10 March but by 16 March it had been absolutely ruled out for at least a year,
  • why real interest rates that are little or no lower than they two or three months ago remain appropriate in the face of the huge economic slump and deflationary shock,
  • why the MPC had done nothing to ensure banks were operationally ready for negative interest rates (retail or wholesale)

and so on.  But they’ve given us precisely nothing.

If Yuong Ha is remotely serious about his claim that the Bank/MPC is trying to be transparent, there is an easy remedy: simply release all the staff papers that have gone to the MPC this year to date (extraordinary times, extraordinary departures from usual practice).  It is, after all, official information, generated with taxpayers’ money for public policy purposes.

But of course they aren’t serious.  They were asleep at the wheel in getting prepared, complacent as the economic risks began to mount, and now seem out of their depth,  lurching from story line to story line, and oblivious or indifferent to the scale of the economic fallout and the way monetary policy should be responding.  Capping a rise in government bond yields is all very well and good, but it is a long way from actually fulfilling the mandate Parliament and the Minister of Finance have given them.

We deserve better, from the Bank/Governor/MPC, but also from those who have the power to do something about it: the chair of the Bank’s Board and, most notably, the Minister of Finance.  But seems the latter himself seems to have no vision or overarching framework for thinking about the economic dimensions of this crisis, and is ever loathe to go against conventional wisdom –  whatever it is at the particular hour – we can expect nothing from him.

(And, of course, talking of transparency, isn’t it remarkable that not a single Cabinet paper or substantive officials’ papers – whether or the health or economic dimensions –  has yet been released, even as one of the biggest crises for a century breaks over us, extraordinary powers are taken, rights shredded etc etc.  It was a government that once claimed it would be the most open and transparent ever. You have to wonder what the government and the Bank have to be afraid of. It isn’t that the enemy is listening –  it is a virus remember – but perhaps the fear is that we might see just how threadbare much of what has been done has been based on.  I suspect the Ombudsman is going to be kept busy for the next few years adjudicating on the determination of agencies and ministers –  including the Bank – to simply not be transparent at all.)

Self-imposed constraints (the latest from the RB)

The Governor of the Reserve Bank had an op-ed in the Sunday Star Times yesterday, and I’d intended to use it as the basis for post today.   The column is quite as complacent, relative to the fast-unfolding reality, as anything we’ve had from Orr since first we heard from him on the coronavirus topic at the mid-February Monetary Policy Statement.  Even last week he was telling Mike Hosking that his level of concern wasn’t really that high (“six out of ten” was his line, and none of it sounded like simply an attempt not to spark a panic, and he told RNZ’s Kathryn Ryan that it was ridiculous to compare what was unfolding with the Great Depression (of course the specific causes are differerent, but when people make those comparisons they are typically highlighting the scale and severity of the drop in output and/or the  –  largely self-imposed –  limitations of monetary policy).  Everything Orr has said on the subject has sounded as if it might have been reasonable 10 days earlier, but not when he actually said or wrote things.   Complacency has been the best description, in a climate in which it is the last thing we can afford from our powerful, but barely accountable, head central banker.

But I’m not going to waste time unpicking the latest column, which it isn’t even clear why he wrote.

Before moving on, this is the standard real GDP estimates for New Zealand for the Great Depression (there are no official numbers that far back, although there were a lot of partial indicators).

nz depression

Real GDP in New Zealand is estimated to have fallen by about 15 per cent, peak to trough, over three years ( as a reminder it had fully regained those losses, though not got back to the previous trend, before Labour’s icon Michael Savage took office in December 1935).

Any bets on how deep the fall will be in New Zealand’s GDP over even just the first half of this year?   It depends a bit on how intense any lockdown is, but if someone forced me to put a number on the likely fall (June quarter GDP relative to last December quarter’s) it would probably be 25-30 per cent (similarly numbers are bruited about by serious people in the US, with the risks skewed to something worse.

And, reverting to the Great Depression, what got things going again then?  Well, the UK –  our major market, and less hard-hit than many countries – went off the Gold Standard in September 1931 allowing a substantial easing in monetary conditions.  And we, without yet having a proper currency of our own, further devalued against sterling in January 1933  (the US threw in some monetary policy easing later in 1933 as well).  In other words, letting off the previous self-imposed shackles of monetary policy made a great deal of difference for the better.

This is a quite different, but for now much more severe, sort of shock.    It seems unlikely that we can envisage even beginning much of any economic recovery until the virus situation is more or less sustainably under control, not just here and abroad.  Neither monetary nor fiscal policy will stop the deep drop in GDP going on right now, and probably shouldn’t even think to try right now (we are deliberately closing things down as part of fighting the virus).

But that doesn’t mean significant monetary policy easing would not still be helpful.  There are those worrying falls in inflation expectations, and more immediately there are the still-high servicing costs of a rising stock of private debt.  Public and private debt overhangs were a big issues, including in New Zealand, in the Great Depression, exacerbated then by the sharp fall in the price level.    It is pretty unconscionable that in this climate, where time has no value, floating rate business borrrowers are still paying 5 , 6 or more per cent interest rates.  That is almost solely because the Governor and the Bank refuse to do anything about significant negative interest rates possible –  it is this generation’s Gold Standard (there was a real aversion to moving away from it, and yet doing so finally made a huge difference for the better).

The Governor likes to claim that the Bank still has lots of monetary policy leeway within his own refusal to take the OCR negative (even though his chief economist told the public two weeks ago that it really wasn’t so)

yuong ha

Really just “a little”.

And I think it is safe to say that we have had fairly confirmation of Ha’s (generally not very controversial point) this morning.  The Bank and MPC issued a statement in which they committed to buying $30 billion of government bonds over the coming year.

It was a pretty feeble programme, even if the headline number was big.  A year is a very long time at present.  And whereas the RBA the other day announced an asset purchase programme centred around targeting government bond yields of three years to maturity at 0.25 per cent, it isn’t really clear what the goal of our MPC actually.  Settlement cash balances –  which is what banks get when market participants sell bonds to the Reserve Bank –  aren’t the binding constraint on anything.

And what did this large asset purchase programme announcement do?   The yield on a 10 year government bond fell by 50 basis points.  That is a big move for a single day, but……that still leaves the 10 year bond rate materially above the lows reached after the MPC’s cut in the OCR last Monday.  Quite possibly, without this action bond yields and corporate credit spreads would have spiked still higher.  So I’m not opposed to the action, but all it has done is to stop monetary and financial conditions tightening further, when what the circumstances demand is a really substantial easing of monetary conditions.    It isn’t as if there was a great deal (much at all, it seems) of an easing in the exchange rate either.   And this was the MPC’s preferred unconventional tool……as I said last week, if they are going to refuse to go negative it really is game over for monetary policy, at just the time when adjustment is most needed.  Recall the 400+ basis point cuts in retail rates we typically see in a New Zealand downturn, all of which will have been less dramatic than what we are now experiencing.  Central banks huff and puff and wave their hands to suggest lots of action, and they have done useful stuff on liquidity (again to stop conditions tightening) but the Reserve Bank of New Zealand is not alone it seems in playing distraction, to divert attention from what little monetary policy is doing given the self-imposed (wholly self-imposed) constraints.

(All of which said, even relative to the RBA, our MPC is not doing as much as they could.  As noted above, they could explicitly target and securely anchor government bond yields.  They could also still cut the OCR, even without going negative: the headline rates in both countries are 0.25 per cent, but in New Zealand that is the rate we pay banks on deposits at the Reserve Bank, while in Australia the deposit rate is lower again.   These are small differences, of course, but there is no sound analytical or systems reasons for not using all the leeway even their self-imposed constraints allow them.

Of course, the much more immediate huge issue is what the government is going to do to underpin the credit system and support a willingness of banks to lend and firms to borrow.  The only secure foundation for that remains some mix of grants and income guarantees (which will become grants).  I can only repeat that the most useful way of thinking about these thing is as the national pandemic economic policy we would have adopted twenty years ago if we’d thought hard enough, been serious enough, about what could happen: undertake to underpin all net incomes at 80 per cent of last year’s for the first year (reducing after that if the issue is still with us).    The fiscal costs are easily manageable for New Zealand: if guaranteeing 80 per cent of incomes than even if full year GDP fell 40 per cent, it would still only be a fiscal commitment of 20 per cent of GDP, and we are starting with net government debt (properly defined) of zero per cent.   It isn’t the exact dollars that really matter at this point, let alone trying to distinguish good and bad firms, but the certainty such a guarantee –  ex post insurance policy –  would provide in capping the extreme downside risks, individually and collectively for the first year.  It wouldn’t stop all exits –  some have already happened, some firms are likely to think it not viable to come back even with a grant/guarantee –  but it is the best option to help stabilise the economic damage, and to ensure that banks are able and willing to play a strongly facilitative part.

On Q&A yesterday the Minister of Finance suggested more announcements very shortly. I hope so but what worries is that once again whatever they do will be inadequate and not really get ahead of the issue. There is an opportunity now, but time is running down fast.

Reserve Bank still behind the game

There was a new announcement from the Reserve Bank this morning.  The two key elements, as summarised by Westpac are

       A Term Auction Facility. The RBNZ will lend to banks for up to 12 months, taking Government bonds, residential mortgage-backed securities, and other bonds as collateral. This basically ensures banks will be well-funded for the foreseeable future. This will prevent an increase in the cost of bank funding, which in turn will help ensure that short-term interest rates for businesses and households remain low.

–       FX swap market funding. Banks sometimes borrow money from offshore and swap the debt back to New Zealand dollars. In recent days the cost of performing this swap has exploded. Left unchecked, this could have caused an increase in the cost of funding New Zealand banks, which in turn could have led to higher interest rates in New Zealand. The RBNZ has essentially offered to facilitate some of those swap arrangements, which will keep the cost of overseas funding contained.

Both initiatives seem sensible, as (for that matter) does the rest of the statement (although the new Fed USD swap line is surely of symbolic significance only, recognition that we are a real advanced economy, since New Zealand banks tend not to have an underlying need for USD.

I’m guess the fx swap market activity will make a useful difference. But I wonder how much difference the Term Auction Facility will make though.  I recall conversation with bankers at the height of the 2008/09 crisis who observed that their boards simply would not look at Reserve Bank funding –  however reasonable the term –  as a particular secure foundation on which to maintain, let alone expand (as it hoped for this time), their credit.  Time will tell, but the Reserve Bank of Australia announced a much more aggressive package yesterday afternoon, including provisions explicitly allowing banks to borrow more –  at very low fixed rates –  to the extent they increase business credit this year.

There were also indications in the statement that the Bank has been dabbling in the government bond market

Supporting liquidity in the New Zealand government bond market

The Reserve Bank has been providing liquidity to the New Zealand government bond market to support market functioning.

But, as Westpac notes,

However, the amount of liquidity provided seems tiny so far, and has had little effect on longer-term Government bond rates.

Funding rates through the fx swaps market aren’t transparent to you and me.  But bank bill yields are readily observable.  As I noted in yesterday’s post they had moved much further above the OCR than one we normally expect (especially when the Bank has committed not to change the OCR itself).    On this morning’s data, that gap is still 42 basis points (a more normal level might be around 20 basis points.   When the goal is supposed to be abundant liquidity and interest rates as low as possible (consistent with MPC’s self-imposed floor on the OCR), there is simply no need or excuse for these pressures.  Surely they aren’t worried about some spontaneous outbreak of inflation?

Similarly, here is the chart for the 10 year bond


In other words, barely below the levels at the start of the year, before any of us had heard of the novel coronavirus, let alone had our economies shredded by it.   The 10 year rate appears to have dropped a little further this afternoon, but it is still well above where it probably should be.

The Reserve Bank of Australia yesterday announced a significant bond purchase programme designed to cap three year government bond yields at 25 basis points (with flow through effects on the rest of the curve.  Our Reserve Bank has still done nothing of substance on that front –  and our shorter-term government bonds yields are well above 25 basis points.  Why not?  Well, there is no obvious reason for the lethargy –  inflation isn’t about to be a problem –  other perhaps than that Orr and Hawkesby went so strongly out on a limb with their complacency about the situation, as recently as last week and this, and Orr has never been one to be willing to concede he might have got things wrong (despite being in a game where such errors are, from time to time, inevitable).

Ah, but perhaps inflation and inflation expectations are just where we want them.  But no.  These are the New Zealand inflation breakevens (difference between nominal and indexed 10 year government bonds.

breakevens mar 20

Recall that the target is 2 per cent, and these are 10 year average implied expectations.  Things were not that great anyway –  not averaging much above 1 per cent in the last couple of years –  but now we are down to 0.65 per cent.  (It isn’t quite as precipitate as the fall seen in the US, but hardly comforting even if the data are harder to interpret than usual.)   This risk –  inflation expectations falling away, raising real interest rates all else equal –  used to worry the Governor.  Nothing has been heard of the line from him or his offsiders since it became a real and immediate threat.

There isn’t really much excuse for the MPC’s sluggishness and inaction.    After all, they talked about bond purchases being next cab off the rank, and then markets went haywire, their peers in Australia acted, and they did nothing.  Of course, it doesn’t help that it seems the Reserve Bank was seriously unprepared.  You’ll recall that as recently as Tuesday last week, we had 19 pages of high level stuff on alternative instruments from the Governor, with the clear message he thought we were well away from needing them.  We were promised a series of technical working papers “in the next few weeks” but despite the crisis breaking upon them almost two weeks later we’ve seen nothing.  All those years they had to prepare, and it seems all too little serious preparation was actually done (as we now know –  because they told us so –  despite all the talk of negative interest rates as an option, it now turns out they’d taken now steps to ensure banks’ system could cope).

But none of that need stop the Reserve Bank launching a large scale bond purchase offer (or auction programme).  It isn’t operationally complex.  The Bank transacts these securities in the normal course of its business, and each year buys back bonds approaching maturity.    There won’t be any systems implications.

I wonder if one other reason they are reluctant to act is a sense that then people would see how little the alternative instruments they favour actually offer.  While they don’t act, there is a pretence that there is a big bazooka.   But only while they don’t act.

As I’ve noted previously, I think there is fair consensus on the last decade’s unconventional policies in other countries: at times there were some real and significant benefits in case of specific market dysfunctions, but beyond that the beneficial effects were relatively limited.  Asset purchases, with a policy-set OCR floor, have no mechanisms that would lower interest rates to bank customers.  They’ll cap government bond rates, probably with some benefit to interest rate swaps rate, but the biggest effect will simply be to flood bank settlement accounts with a lot more settlement cash.  And since that is a rock-solid asset (now) fully remunerated at the OCR itself, it won’t prompt material behavioural changes.

You needn’t just take my word for it.  Last Friday in the Herald  the Bank’s chief economist (and MPC member) Yuong Ha (who had spent some years monitoring financial markets in his previous role), was talking about alternative instruments (bond purchases, intervention in the interest rate swaps market and so on).   He was quoted this way

yuong ha

These tools “give you a little more headroom, a little more time and space”.  In some circumstances “a little” might be all the situation demands.  In these circumstances it is grossly inadequate and simply no substitute for failing to act on interest rates.

That is part of why I think they should get on now and do the large scale bond buying, or even buying foreign exchange assets.  With an interest rate (OCR) floor in place it just won’t make much macro difference, the emperor’s new clothes will be exposed for what they are(n’t), and perhaps we might finally get some focus on the crying need to get retail interest rates lower.

Recall the Bank’s claim that bank systems aren’t ready.  For a start, this should be challenged, and some naming and shaming should go on.  Apparently some banks aren’t ready, but others are.  Name them.  Second, at least for wholesale products all the big banks must be finel –  lots of financial products abroad have had negative interest rates for several years, and our own inflation-indexed bonds were trading at negative yields at times in recent months.   Perhaps as importantly, actual retail rates –  and it is probably the retail components of some banks’ system that are the issue –  are still well above zero, both term deposit rates and retail lending rates.  If the OCR –  a wholesale rate – could be set to, say, -2.0 per cent (without triggering conversions to physical cash on a large scale), term deposits might still be only around zero, and retail lending rates higher again.  There is a lot of space the Bank could use to drive retail rates down without even having to envisage negative rates for the main retail products.  In times like the present every little helps. (As an example of the issue, the Australian banks today announced a scheme to freeze debt repayments for SME borrowers for six months, which is fine, but those borrowers are still paying an interest rate of perhaps 6 per cent, in a climate where time –  which is what an interest rate is mostly compensating for –  currently has no, or perhaps negative, value.)

Perhaps the Bank, The Treasury and the Minister of Finance are now cooking up some decisive intervention to support the credit system as a whole  rather than just extending government loans to the iconic and politically connected Air New Zealand.  Such an intervention is sorely needed, and once again the government is behind the game.  The credit system is probably the most pressing point right now, but it is no excuse for the MPC, an independent operator, to be not doing its  job.  The times demand a large easing in monetary conditions, including in real interest rates.  The Bank is delivering almost nothing, all while playing smoke and mirrors with the suggestion that its next instrument offers much more potential than is really there.

Once more our key decisionmakers fall short.

There would be nothing to lose now by bold and decisive action.  Nothing.

Retail interest rates fall substantially in recessions…

I’m out of town today, so just something short.

I’ve noted in various posts recently that in past recessions in New Zealand since we liberalised in the 1980s the OCR (or prior to 1999, the 90-day bank bill rate) had fallen by around 500 basis points in a typical (median) recession.   Small sample and all that, but it was a reasonable stylised fact (and happened to around the same size adjustment as you see in the longer run of US data).

But, of course, the OCR isn’t a rate paid by anyone –  technically in fact it is the rate the Reserve Bank pays banks on their settlement account balances.   In thinking about the experience of firms and households one has to look at retail interest rate and how they changed.  In the 2008/09 recession, for example, there was quite a widening in the margin between the OCR and retail deposit and loan rates.

One can identify five reasonably material downturns in the interest rate data on the Reserve Bank’s website.  Here are the changes in floating first mortgage interest rates in each of them.

Floating first mortgage new customer housing rate Six-month term deposit rate
percentage point chg in downturn
post 87 crash -4.3 -4.3
1991 -6.2 -4.9
1998 -3.1 -3
2001 -1.8 -1.9
2008/09 -4.6 -4.6
Median -4.3 -4.3
Now -0.8 -0.1

Not all of those events were particularly significant for the New Zealand economy, and the 2001 interest rate falls combined the effects of the northern hemisphere economic slowdown that year and the precautionary cuts the Reserve Bank implemented after 9/11.

But across this sample, the median reduction in both deposit and residential mortgage rates was 4.3 percentage points.  For the two deeper recessions, 1991 and 2008/09 the changes were larger still.

I’ve also shown the adjustments we’ve seen this year to date.   The main banks all lowered their floating mortgage rates on Tuesday by the full 75 basis points of the Reserve Bank’s OCR adjustment.  But retail deposit rates have only just begun to fall.

And in even The Treasury’s view, this recession “could” be bigger than the 2008/09 one (more realistic would be to view 2008/09 as tiddler by comparison, even if one allowed for nothing more than the elimination of our international tourism industry).

And then there are two problems to ponder:

  • first, the MPC has pledged not to change –  raise or lower –  the OCR for at least a year.  So if one believes they will keep their word, what you see now is all you get.  Retail lending rates aren’t going any lower, and retail deposit rates will take a while to catch up but probably won’t fall more than 75 points either.  75 basis points is a great deal less than 430 points, and
  • second, while it was probably good PR for the banks to cut point for point on Tuesday, actually it looks as though they’ve ended up with squeezed margins.  Here is a chart showing the 90 day bank bill rate less than floating first mortgage rate, up to yesterday

bill rate

The 90 day bank bill rate is usually a bit above the OCR, and fluctuates mainly with shifts in sentiment re future OCR adjustments.  When the OCR is expected to be cut imminently the 90 day rate drops below the OCR.  That had happened recently. But note what happened after Tuesday’s cut: the margin between the bill rate and the OCR is now higher than at any time in the last two years.  That would usually only occur if the OCR was expected to be raised, but that clearly isn’t the story as the MPC just pledged not to change the OCR for at least a year.  In fact, it points to liquidity pressures in the local market (details not known to me).    The Reserve Bank’s liquidity operations would usually be able to ease such pressures, and it is a bit surprising they haven’t already done so.

But the key point remains: there is no prospect of further retail interest rate reductions in the middle of the most severe adverse shock of our lifetimes.  75 points is it.     It is a ridiculously small adjustment.  But that is what you get when (a) the Reserve Bank fails to do anything about removing/easing the effective lower bound, (b) fails to ensure banks’ systems were ready for negative interest rates, and (c) pledges not to cut the OCR any further anyway. It really is Alice-in-Wonderland stuff.

Even in circumstances like the present where we aren’t –  or shouldn’t be for now – trying to stimulate aggregate demand, low interest rates play an important role in managing economic downturns.  First, they help lower debt service costs, including for existing flexible rate borrowers (and most New Zealand debt reprices fairly frequently), and do so by transferring some prospective income from depositors to borrowers, consistent with the idea that time is temporarily less valuable.  Second, at a wholesale level they help to weaken the exchange rate, which also typically plays a significant part in buffering adverse shocks.  And third, the flexibility to adjust rate, actually exercised, helps to support and stabilise medium-term inflation expectations.

Did I mention the exchange rate?  In the 1991 recession, the TWI fell by about 10 per cent. In the 1998 recession, the TWI fell by 17 per cent, and in the 2008/09 episode the fall was in excess of 20 per cent.

And this time?  Well, the TWI yesterday morning was only 5 per cent lower than it had been at the end of December, despite the adverse shock being much greater than in any of those earlier events.    This week, we have had the extraordinary sight of the New Zealand dollar approaching parity with the Australian dollar.  I’m sure a variety of factors help explain that, but an unexpected commitment from the MPC not to lower the OCR further can’t have helped.  The TWI appears to have fallen overnight and perhaps before long panic and flights to cash/flights to home will mean the TWI will fall a long way, but monetary policy so far has been an obstacle in the road.

The economy is already in deep strife, and the problems are going to get a lot worse.  We shouldn’t settle for the complacency of central bankers talking up their adjustments, their alternative instruments etc, and all the while retail rates have barely moved, relative to the scale of change seen in most past (smaller) downturns.

The Minister of Finance should simply insist that the Bank sort it out, including getting bank systems fixed post-haste.  There is no conceivable way in which on OCR with a positive sign in front of it makes any sense in today’s New Zealand economy.  Retail deposit rates really should be negative, and retail lending rates probably should be too.

Game’s up

I may well have more to write about the Reserve Bank announcement this morning after the Governor’s press conference at 11am – which I hope begins with a formal apology from him and Hawkesby for their appalling complacency and minimisation of the issues as recently as a few days ago –  but these are some initial reactions.

I guess I have three key points:

First, a 50 basis point was warranted at the time of the last  MPS (and doing so would have been entirely in line with past practice of reacting to out-of-the-blue shocks) so 75 basis points now is seriously inadequate.   Everything has got a great deal worse since then including –  though not mentioned in the statement –  medium-term inflation expectations.

Second –  and this was the mindblowing bit to me –  was this extract from the minutes

Staff also advised that an OCR of 0.25 percent was currently the lower limit, given the operational readiness of the financial system for very low or negative interest rates.

This is simply inexcusable if true (which it may not be).  As just one small point, I lead a working group at the Bank in 2012 –  height of the euro crisis – which identified then the need to ensure, as a matter of urgency, that banks and the RB itself were able to operate with modestly negative interest rates.   And for years we have seen various other countries operating with negative policy rates, so if the Bank has not been taking action to ensure the system could operate, when needed with negative rates it is simply an inexcusable failure. For which, frankly, heads should roll.   Neither when they put out their Bulletin article two years ago nor in the Governor’s speech last week was there any suggestion that negative rates could not be used now.  Best surmise, they simply weren’t taking things sufficiently seriously until the last few days.

And, third, they have basically conceded that it is game over and that monetary policy has reached current limit  (which is so wholly because of their failures –  on this narrow point and, like most of their peers, dealing more decisively with the near-zero lower bound.

Note that as part of their statement they formally rule out any further changes –  including cuts –  for at least the next 12 months.  In other words, tbey rule out taking urgent action now to remedy their past failures.  Simply extraordinary.   I guess climate change and the like were taking priority for the Governor and his staff?

But the point I also wanted to focus on was this bit of the resolution.

Agree that Large Scale Asset Purchases of New Zealand government bonds would be the best additional tool to provide further monetary stimulus in the current situation – if needed.

I never got round to writing about the substance of the Governor’s seriously inadequate speech last week, but had I done so one of the points I would have made was that outside immediate financial crisis conditions –  not NZ now –  these asset purchase routes simply did not offer much.    It isn’t as if bond yields are now at the still-high levels they were in most countries in 2009 even after the OCR had been cut (even if they have been rising in the last few days as the global rush to cash has taken hold).

You might doubt my interpretation –  but you really shouldn’t as it is pretty widely shared, even if often in muted language –  but, as it happens, we have the word of one of the MPC members for it.  Again, I’d been meaning to use this in a fuller post this week.  I hadn’t seen this quote elsewhere, but in his column in Friday’s Herald Brian Fallow reported the RB Chief Economist Yuong Ha as saying, of the unconventional options,

“they give you a little more headroom, a little more more and space”

Precisely.  And “just a little more” is not what the occasion demands.

In effect, in this announcement it is a case of “one and done” –  not in sense of “we”ll be bold and not need to move again” –  sort of their justification for the 50 point cut last year –  but “we’ll move now, and then……well, we have to retire from the field and stare into the macro/monetary abyss….because we spent years just not doing our job, distracted by all sorts of pet things, always looking for rates to rise (as recently as the last MPS).

It really is inexcusable.   Personally I think there is a strong case for dismissing the Governor, and probably most of the MPC too –  including those externals we’ve never heard a word from to explain or justify their collective inaction and failure of preparedness.   I don’t suppose it will happen, but it is what often does –  and should –  happen after battlefield disasters and revealed gross failures of preparedness.   Then again, to act would be for the Minister of Finance to concede some of his responsibility –  he appointed them, he is supposed to hold their feet to the fire, hold them to account.  And only a few months ago in a letter to me he indicated how satisfied he was with the Governor’s stewardship.

I plan to have a fuller post this afternoon on some ideas for macro management now and in the months ahead.  As I’ve said in posts last week and on Twitter, now isn’t the time for stimulus per se –  new spending by the public isn’t the goal as the economies of the world deliberately de-power. The immediate focus has to be income support, the health system, and then some assurance about the framework to see us through the period –  perhaps protracted – until genuine stimulus becomes the appropriate focus.