Just how little interest rates have fallen

There was a little flurry of media coverage over the weekend about the latest set of cuts in retail mortgage interest rates.  But it is worth keeping these changes in some perspective.

The Reserve Bank publishes monthly data for the “special” rates advertised for new borrowers (or those moving to another bank) and we can get a read of current rates from bank websites, as summarised in the tables on interest.co.nz.

So how much have residential mortgage rates fallen since the coronavirus slump began?  As it happens, rates had been pretty stable for several months up to February, so this chart compares the latest rates on offer with the average for the period November to February.

special mortgages

For most maturities, that’s not nothing.

On the hand, these are nominal interest rates.  And we know that the expected future inflation rate has fallen.   There is a variety of measures, survey-based and market.  The one the Reserve Bank has typically paid most attention to is the two-year ahead measure in its quarterly Survey of Expectations.  On that measure, inflation expectations have fallen by 0.62 percentage points since the pre-crisis period (the one year ahead measure shows a larger fall, the ANZ one year ahead measure a smaller fall).

Apply that fall in inflation expectations to those “specials” and the real –  inflation-adjusted – version of the chart now looks like this.

specials 2

I guess there is still a slight reduction in longer-term real rates, but…..not many people in New Zealand fix for four or five years.  The market is concentrated on the shorter-term fixed rates (at present, it appears, the 18 month term) and there has been no reduction in real interest rates there at all.

Term deposit rates have come down a bit more too.  But here is how the chart of those rates looks if we compare current rates with those around the turn of the year.  I’ve shown the nominal rates and real rates (using the same drop in inflationn expectations as above) on the same chart.

TD may 20

Pretty much across the board, real term deposit rates have risen slightly since the crisis began (including at what appears to be the most competitive part of the market, for terms of 6-12 months).  It is an odd response to a really serious economic slump.

Don’t blame the banks, or depositors for that matter; this is about choices made by the Reserve Bank Monetary Policy Committee – the prominent ones (Orr especially) and those faceless unaccountable external ones (Buckle, Harris, Saunders), all appointed by the current Minister of Finance.

The Governor keeps talking about getting interest rates as low as possible.  But they clearly aren’t – term deposits are mostly still a bit above 2 per cent (and far higher than in Australia) –  and yet the MPC has pledged, and repeatedly reiterated its dogmatic commitment based on no published analysis, to not cut rates any further until at least next March, still 10 months away.

And yet this is a really serious downturn.   Everyone seems to agree on that.  All the unemployment predictions –  even with the temporary cover (keeping people out of the official statistics) of the wage subsidy scheme –  involve higher peaks than we saw in the 2008/09 recession.  Even with big fiscal commitments, nominal GDP is expected to be way lower than previously expected, and the Bank expects to undershoot the bottom of its inflation target for a couple of years (for which there was nothing comparable in 2008/09).

How, then, did retail rates (real and nominal) behave over 2008/09?  Recall that that was an event that had its foundation in financial system problems, and even if the credit concerns weren’t specific to New Zealand the problems affected our banks’ access to funds, pricing etc.

The data are bit thinner for that period.   The Reserve Bank was only publishing “standard” mortgage rates, and single (six month) term deposit rate.  Oh, and it is a bit less clear when to date comparisons from.  Retail rates had gone on rising into 2008 (with the Bank’s acquiescence) as offshore funding costs were rising, and at the other end, shorter-term rates kept dropping further into 2009 than longer-term fixed rates did.    Inflation expectations also fell during that recession, on the Bank’s two-year ahead measure perhaps by about half a per cent.

But this is what happened from the end of 2007 to April 2009. (Changing start or end dates changes some of the numbers –  either way – by up to perhaps 50 basis points, mostly small on the scale of this chart.)

0809 retail

In other words, falls in retail rates (at the horizons where most of the business was written) of hundreds of basis points.   And that, in the Bank’s view (correctly as it turned out) was consistent with keeping inflation in the target range, even if not quite as high as they would have liked).

The Governor keeps claiming that his Large Scale Asset Purchase programme –  buying huge amounts of government bonds now yielding less than 1 per cent, in exchange for issuing huge amount of Reserve Bank deposits currently yielding 0.25 per cent –  is hugely effective and a fully adequate substitute for choosing not to do more with the OCR.    One can get down in the weeds of detailed arguments about what the LSAP may or may not be doing at the margin to bond rates or swaps rates, but whatever those effects may be –  and I reckon we are pretty safe in concluding that they are mostly small –  the rates that firms and households are actually receiving/paying is the bottom line.

In real terms, the household rates shown above have hardly moved at all, and there is little or nothing to suggest that picture facing businesses will be materially better (eg headline SME rates have fallen no further, and many larger businesses have facilities on which they pay a fixed margin over bank bill rates.  Bank bill rates have fallen by about 1 per cent since the start of the year, so in real terms a fall of perhaps 0.4 percentage points.  The contrast to 08/09 remains striking.

Of course, there is also the exchange rate.  The Governor claims to be successfully influencing it as well.   It is always difficult to know where to date comparisons for exchange rates, but here I’ve shown the fall in the exchange rate in the last two recessions:

  • for 08/09 the average in April 2009 relative to the average for the second half of 2007, and
  • for the current event, yesterday’s TWI relative to the average for the second half of 2019

TWi recessions

Monetary policy just is not doing its bit, even once all the fiscal support is factored into the projections.  That is a pure choice by the MPC.

We don’t know why they’ve just chosen not to do their job –  aiming for 2 per cent inflation and, as much as they can consistent with that, supporting a speedy return to full employment.  Last year, MPC seemed to embrace their mandate with some gusto. Now they appear like stunned animals caught in the headlights, uninterested in doing what they are paid for –  all while their spokesman keeps claiming to be doing a lot.

It is pretty reprehensible, and I find it quite remarkable that the MPC –  all of them, not just the Governor –  have not been asked harder questions about their failures.  Instead, much of the media seem to treat their acknowledged failure to ensure that banks’ operational systems etc were ready for negative rates as just “one of those things”, as if it could happen to anyone –  never for example drawing the contrast with Y2K, when the Bank proactively ensured it and the banks were ready, with contingency plans as well.   And notwithstanding that all of the data in this post are readily available, none has been yet heard to ask the Governor –  and his MPC –  why they are content with such trivial changes in real interest rates even when, with all their avowed enthusiasm for it, in combination fiscal policy and monetary policy in combination still have the Bank quite openly acknowledging that inflation will undershoot, and apparently not very bothered about the unemployed either.

Of course, the Minister of Finance bears responsibility for all this, and for all the individuals involved. Perhaps an Opposition that wanted to ask hard questions about the government’s stewardship at present –  even perhaps flag a different more pro-active approach –  might ask him just why he thinks it is appropriate for real interest rates to have hardly changed at all (and the real exchange rate not much more), even as he is willing to lend to the weakest business credits are far lower rates than his central bank’s monetary policy would support more generally.

Financing the government

In normal circumstances governments finance themselves primarily with visible legislated taxes, with a bit of additional debt on the side.

In New Zealand, over the last complete 10 years, core Crown revenue was $715 billion (mostly taxes) and debt contributed between $10 and $40 billion –  depending which gross or net measure you prefer.    That borrowing was almost all from the private sector, again as one would expect.  The Reserve Bank’s holdings of government bonds. for example, hardly changed at all (nor did bank settlement cash balances at the Reserve Bank).   And the government mostly had credit balances in its account at the Reserve Bank.

In the last couple of months, everything has been thrown up in the air.   On the Budget numbers I mentioned in Friday’s post, almost a quarter of government spending over the five years (including 2019/20) is expected to be financed by increased debt.   And on the Reserve Bank’s own numbers we could easily see at least half of that increase in debt take the form of Reserve Bank lending to the Crown (the forecast rise in net debt is $134 billion, and the Governor has talked of the possibility of raising further the current $60 billion limit on the LSAP programme).

That the Bank is buying those bonds on the secondary market, rather than getting some or all direct from the government (as some advanced country secondary banks are now doing to an extent), is a second or third order issue, making little or no macroeconomic difference.   The important point at present is that (a) the Bank is buying the bonds, and (b) the Bank is sterilising the liquidity effect on those purchases by paying an at-or-above market rate on the resulting settlement cash balances.

Oh, and the most important points of all were that the decision to buy bonds at all is (a) wholly a decision for the Monetary Policy Committee, and (b) working with an unchanged (from pre-crisis) mandate: delivering inflation near 2 per cent and, as much as it can consistent with that, supporting employment.  The government has given the Bank an indemnity, which makes the Bank feel more comfortable taking the associated interest rate risk, but if the government had not done so, it need not have stopped the Bank making the purchases if the MPC felt that was what the monetary policy mandate required.

I wrote about all this a month ago when there was first a flurry of concern about reported comments suggesting that at some point the Bank might buy bonds direct from the Crown, in a post intended to be basically supportive of the Bank.

Now, as you know, I don’t think the LSAP is making much difference at all now to anything that matters much to macroecononomic outcomes.  It is slightly perverse in that it involves shifting the duration of the Crown’s effective debt portfolio much shorter –  swapping long-dated government bonds for on-demand instantly repriceable settlement cash liabilities –  but if you believe interest rates are going to be low for quite some time, you might even downplay that.  Other than that, it probably does little harm –  and adds to our database of monetary experiments for future analysis – if little good.

But in the last couple of weeks there have been a number of comments from the Governor that suggest that something much more troubling is afoot.

The first hint I heard of it was when the Bank turned up to Parliament’s Finance and Expenditure Committee on the day after the Monetary Policy Statement.  This is an extract from the post I wrote then.

Goldsmith asked the Governor about those comments a few weeks ago that the Bank could consider buying government bonds directly from the Crown, rather than (as at present) in the secondary market.  He seemed to just be wanting to close off the issue, but the Governor opened it up all over again, in a way that seems to have attracted no attention.

The expected answer would probably have been along the lines that there were no plans at present, the secondary market was working well, but if there ever were dysfunction there was really no macro difference in the Bank buying direct, so long as the decision rested with the Bank, consistent with the inflation target.   In backing the Governor on this point previously, that is what I have said.

Instead, the Governor launched into a discussion noting that while the Bank did not rule out lending direct to the Crown, that was really fiscal policy not monetary policy, that the central bank can always lend as much as fiscal policy requires, but that that would be a matter for the government to decide, not the Bank.

Goldsmith then challenged him on that, asking whether he was really saying that the Minister could decide whether the Bank would lend direct.  Orr reiterated the possibility of market dysfunction, while noting that at present markets were functioning well, but then repeated that what he called “pure monetary financing” would be a matter for the Minister of Finance to decide.

At this point, the Governor invited the Deputy Governor Geoff Bascand –  usually the safe pair of hands in that senior management cohort –  to comment.  He indicated that it would be a matter of ministerial direction, but which would involve a substantial process including looking at whether what the minister might be directing would still be consistent with the existing price stability etc target.  And then he tried to close things down by suggesting that this was all just an “esoteric discussion”.

Reasonably enough ACT’s David Seymour reacted to that, suggesting that if the Bank was seriously saying the Minister of Finance could direct them to lend to the government, in any amount he chose, it was “anything but esoteric”.

I went on to articulate the (possibly) relevant provisions of the Act as I saw them, concluding

But……there is no hint in this provision [section 12 override powers], or anywhere else in the Act, suggesting that the Minister of Finance can direct the Bank to lend to the government.  Perhaps the Bank and its lawyers think/worry that “lend to the government at zero interest up to $…billion” is an alternative “economic objective” within the meaning of section 12 of the Act.   But, at very least, it would be a stretch –  it isn’t an “economic objective”, but an instrument,  and favouring one specific party in the economy.    And note that if a government did attempt to impose such an “economic objective” there would still be nothing to stop the Bank setting interest rates for the rest of the economy at a sufficiently high level to counter the inflationary effects of this coerced lending.

I’m at a loss to know what the Governor and Deputy Governor mean.   I’m tempted to lodge an OIA request, but am not sure I’ll bother, as they would find myriad ways to refuse to release anything.  But journalists could directly ask the Bank what the Governor/Deputy Governor were on about?   MPs could use parliamentary questions to ask the Minister of Finance whether (a) he has received any advice as regard his direction powers over the Reserve Bank, and (b) whether he or Treasury believe he has the statutory power to compel the Bank to lend to the Crown.  Most everyone I’m aware of has always assumed they can’t –  and took great reassurance in that –  so if the powers that be now believe differently we deserve to know?    (Of course, if the government just wants more inflation, it can always raise the inflation target, but that is a rather different issue).

And there I left it, a bit puzzled, none the wiser, and even wondering whether Orr had perhaps confused some details and there really wasn’t anything to worry about.

At least until over this last weekend.  Then I happened to listen to a post-MPS presentation Orr had given to clients of Jardens (on 15 May), in which he touched on the issue and noted that (paraphrasing from my notes) “if we were to take a direction from the government to finance it directly – as distinct from what monetary policy needs might imply – we would have to have different legislation”

I then read an interesting interest.co.nz article reporting comments the Governor had given to their journalist Jenee Tibshraeny late last week in which this topic was addressed at some length.

Orr said it was up to government to decide if it wanted to go further and give the RBNZ the mandate to buy bonds for fiscal policy purposes, rather than monetary policy purposes – IE buy bonds to help pay for government spending initiatives rather than to keep inflation and employment in check.

“There’s no right or wrong,” Orr said.

“It’s just that it is different and you would need legislative and/or institutional instructions, because when I last looked at my job description, I’m not allowed to go off and buy whatever I feel like because I’ve got the ATM…

“That would take some significant transparency as well as operational structures to ensure everyone knew who was doing what, why, how, where, when.”

Asked whether he would be hesitant to go down this path if Robertson asked him to, Orr responded: “Yes, I mean, it really depends to what purpose… and under what conditions is this managed.

“Because you could take it to the extreme immediately and you’ve gone back in time 30, 40 years and the central bank is being used as the ATM for a government and it’s unclear whether we can control inflation anymore, and it’s back in the hands of the elected officials…

“It’s not for me to choose the policy. I would implement the policy, but I would be extremely cautious about making sure the risks are understood, managed and mitigated wherever they could be.

“And I imagine I would be surrounded by many many people with free and often unsolicited advice around whether it did or didn’t work… which is good…

“People are very passionate about the structures that have been built and you don’t muck around with them lightly.

“These things are achievable; they’re just different.”

On the one hand, it is good to know that the Governor seems to think that under current law he can’t just go and buy anything he likes (he probably can, but it has to be consistent with the Bank’s statutory functions, including the monetary policy Remit the Minister has given him, which in turn is subordinate to the Act).   But then note those Bascand comments earlier suggesting the Bank thinks it could be directed under existing legislation, even if that might involve overriding or changing the Remit.

The Bank has clearly been giving such radical options quite a bit of thought, not just as extreme contingency plans (Parliament, being sovereign, can empower almost anything) but as something they are quite openly talking about.    That suggests something that they are either keen on themselves, or which the Minister and/or Treasury has raised fairly seriously as a possibility.

Given the Governor’s longstanding belief in a bigger government and a more aggresssive use of fiscal policy, it wouldn’t be entirely surprising if this were something he was championing (indeed, it would be the best explanation for why (a) he is the only one talking about it, and (b) doing so in a non-negative sort of way).

Going down such a path would, however, be a seriously retrograde step. Perhaps it might lift inflation expectations a bit –  governments acting to direct the central bank to lend to them will create some concern – but in a quite undesirable sort of way (even if Social Credit and the more rabid MMT enthusiasts might be salivating at the prospect).

For a start, there is no obvious need for such a mandate.  The New Zealand government is a highly creditworthy borrower which, on current government plans, will remain one of the least-indebted of all the advanced countries.   One can never rule out a new extreme global crisis that might seize up markets for a few days, but the prospects of the New Zealand government not being able to issue on market the quantity of debt believes it requires is slim indeed.   And the Crown already has an overdraft facility at the Reserve Bank that it can draw on to smooths ups and downs.

More disconcertingly, although technically the Reserve Bank could be required to lend to the government –  beyond anything consistent with the Remit –  and that wouldn’t immediately tip us into serious inflationary problems, it would be a highly distortionary policy.  In principle, the Bank could lend lots of money to the Crown at zero interest, and the government then further increases its spending beyond what would normally be consistent with the inflation target. If that happened, you would expect the MPC to start raising the OCR, to keep overall demand in check.  And then we’d be in the bizarre throwback world in which the government was borrowing for zero and the rest of the economy faced really quite high interest rates, squeezing out private sector activity to favour the government.

I’m not going to allow myself to be drawn into an inconsistency here.  At present, if anything, the presenting issue is that the Reserve Bank is not doing its core monetary policy job sufficiently well that either the market, survey respondents, or the Bank itself believe that inflation will be consistent with the target set for them.  If they persist in that stance, amid a really savage recession, I believe the Minister of Finance should act, using existing powers either to replace the key individuals (to ensure the current Remit is being followed) or to explicitly direct the Bank to adopt an easier monetary policy (consistent with the current Remit over the medium term).  Those powers are in the Act for a reason, to protect citizens.   There is no such power to direct the Bank to lend to the government and there has long been an international consensus that it would be quite unwise to provide for such a power.  It would be to step away from any sense that monetary policy operates in a neutral way, not setting out to favour or disadvantage any particular party or sector (private or public), and into a world where governments could regard control of the “printing press” as an acceptable way for them to finance their spending (or reluctance to tax) preferences.  With reasonable people, it isn’t some immediate path to hyperinflation, but it would be undesirable on numerous counts and further increase the politicisation of the Reserve Bank.

One can make an argument against central bank operational autonomy –  I sometimes come and go and whether there are real advantages that justify the costs and lack of accountability (part of the reason why I keep on about enhancing real central bank transparency) – but giving the government reason to think control of the printing press is a legitimate tool has nothing going for it at all.

We need some answers as to just what is going on.   When I tweeted about this on Saturday, Tibshraeny responded

That is encouraging, and I will look forward to her story.  But if Robertson –  who always seem conservative and risk averse (sometimes beyond what is warranted) – is not interested, then what cause is Orr championing, to what end, and why?

If he thinks more macroeconomic stimulus is required, try conventional monetary policy (would have helped, of course, if he’d sorted out those alleged “operational issues” some banks are claimed to have, but even those obstacles exist they can be overcome).  If the governments thinks it needs to spend more, the conventional options are still open to them –  higher taxes (probably not a great idea at present) or tapping the global market for public debt.  Maintaining that borrowing capability was, as you’ll recall, one of the main reasons why successive governments kept net debt low and stable.  (Of course. it also has a $40 billion fund –  which it insists on putting more money into, even as its new borrowings are large, to speculate on world markets –  much of which could be quite readily liquidated.)



Losing $128 billion

I don’t usually pay much attention to forecasts of nominal GDP.  Not many people in New Zealand really seem to.  But The Treasury takes nominal GDP forecasts more seriously than most, since nominal GDP (in aggregate) is, more or less, the tax base.

Out of little more than idle curiosity I dug out the numbers from last December’s HYEFU forecasts –  the last before the coronavirus –  and compared them to the numbers published in last week’s BEFU, accompanying the Budget.  And this was what I found.

Nominal GDP ($bn)
HYEFU BEFU Difference
2019/20 319.8 294.2 -25.6
2020/21 336.4 294.2 -42.2
2021/22 354.1 328.3 -25.8
2022/23 371.5 352.3 -19.2
2023/24 389.2 374.3 -14.9
Total 1771 1643.3 -127.7

Over the full five years, New Zealand’s nominal GDP is projected to be $128 billion less than The Treasury thought only a few months ago.

Recall that changes in nominal GDP can be broken down into three broad components:

  • the change in real GDP  (the volume of stuff produced here),
  • the change in the general price level (inflation), and
  • the terms of trade

On this occasion, changes in the terms of trade make only a tiny difference over the five years taken together.

General (CPI) inflation is expected to be lower than previously thought.    On average over the five years, the price level in the BEFU forecasts is about 1.8 per cent lower than in the HYEFU forecasts.  That accounts for about $33 billion in lost nominal GDP.

The balance –  the overwhelming bulk of the loss –  is real GDP.

I haven’t written anything much about The Treasury’s forecasts, which were done quite a while ago, and could not fully incorporate the final fiscal decisions the government made.  But for what it is worth, I reckon Treasury’s numbers were on the optimistic side –  quite possibly on all three components of nominal GDP.  On inflation, for example, they are more optimistic than the Reserve Bank (which finished its forecasts later), even as they assume tighter monetary conditions than the Bank does.

But the point I really wanted to make was that these forecast GDP losses will never be made back (in the sense that some future year will be higher to compensate –  resources not used this year mostly represents a permanent loss of wealth).  And that these losses occur despite all the fiscal support (and rather limited monetary support).   And fiscal here includes both the effects of the automatic stabilisers (mainly lower tax revenue as the economy shrinks) and the discretionary policy initiatives (temporary and permanent).

How large are those fiscal numbers?  Well, here is core Crown revenue (more than 90 per cent of which is tax)

Core Crown revenue ($bn)
HYEFU BEFU Difference
2019/20 95.8 89.5 -6.3
2020/21 101.6 87 -14.6
2021/22 106.5 94.6 -11.9
2022/23 112.7 104 -8.7
2023/24 117.7 109.9 -7.8
534.3 485 -49.3

Almost $50 billion the Crown was expecting but which it won’t now receive.  Some of that will be the result of discretionary initiatives –  the corporate tax clawback scheme, much of which will result in permanent losses, and the business tax changes announced in the 17 March package –  but the bulk of the loss will be the automatic stabilisers at work.

And on the expenditure side?

Core Crown expenses ($bn)
HYEFU BEFU Difference
2019/20 93.8 114 20.2
2020/21 98.8 113.5 14.7
2021/22 102 119.8 17.8
2022/23 106.3 118.6 12.3
2023/24 109.2 113 3.8
Total 510.1 578.9 68.8

Almost $70 billion of current spending the Crown didn’t expect to make only a few months ago.  A small amount of this will be the automatic stabilisers at work (the unemployment benefit), but The Treasury is pretty optimistic about unemployment.  Most of the change is discretionary policy initiatives (announced or provided for).

And here is the change in net debt

Net core Crown debt (incl NZSF) as at year end  ($bn)
2018/19 14.1 14.1
2019/20 14.6 47.6
2020/21 17.6 82.8
2021/22 17.1 111.7
2022/23 12.3 131.7
2023/24 3.9 138.2 134.3

That will be almost $135 billion higher than expected.

As I’ve noted in earlier posts, I don’t have too much problem with the extent of overall fiscal support (although I would have structured it differently and made it more frontloaded –  consistent with the “pandemic insurance” model).

But even on this scale, fiscal policy is nowhere near enough to stop the losses.  Some of those losses are now unavoidable.  It is only five weeks until the end of 2019/2020, so we can treat $26 billion of nominal GDP losses (see first table) as water under the bridge now.   As it happens, fiscal policy looks to have more than fully “replaced” the income loss in aggregate (whether $27 billion from operating revenue and expenses in combination, or the $33 billion increase in net debt) –  not as windfall, but as borrowing (narrowing future choices).   (UPDATE: Even in quote marks “replaced” isn’t really quite right there, as without the fiscal initiatives it is near-certain that actual nominal GDP would have been at least a bit lower than The Treasury now forecasts, even for 19/20.)

But there is a great deal of lost income/output ahead of us, even on these (relatively optimistic) Treasury numbers.

Which is really where monetary policy should be coming in.   The Treasury assumes that monetary policy does almost nothing: there is no further fall in the 90 day rate (the variable they forecast), and as they will recognise as well as anyone inflation expectations have fallen, so real rates are little changed from where they were at the start of the year.  And although the exchange rate is lower throughout than they assumed in the HYEFU, the difference is less than 5 per cent –  better than nothing of course, but tiny by comparison with exchange rate adjustments that have been part of previous recoveries.  It isn’t entirely clear how The Treasury has allowed for the LSAP bond purchase programme, but whatever effect they are assuming…….there is still a great deal of lost output.

The Governor has often been heard calling for banks –  private businesses – to be “courageous”.  It is never quite clear what he means, but he apparently wants to risk other peoples’ money.  But the central bank is ours –  a public institution.   A courageous central bank, that had really grasped the likely severity of this slump, could have begun to make a real difference.  If they’d cut the OCR back in February, and taken steps to ensure that large amounts of deposits couldn’t be converted to physical cash, and then cut the OCR to deeply negative levels (perhaps – 5 per cent) as the full horror dawned, we’d be in a much better position now looking ahead.     Wholesale lending and deposit rates would be substantially negative at the short end, and even real rates on longer-term assets might be as low as they now, without much need for bond purchases.   Retail rates might also in many case be modestly negative –  perhaps for small depositors achieved through fees.   And, almost certainly, the exchange rate would have fallen a long way, assisting in the stabilisation and recovery goal.  There are winners and losers from such steps –  as there are from any interventions, or from choices just to sit to the sidelines –  but it is really just conventional macroeconomics: in a time of serious excess capacity and falling inflation expectations, act to seek to bring domestic demand forward, and net demand towards New Zealand producers.    Working hand in hand with the substantial fiscal support (see above), we’d be hugely better positioned to minimise those large future nominal GDP losses –  losses that at present, we risk never making back.

But neither the Governor nor, apparently, the Minister of Finance seem bothered.

Finally, if nominal GDP appears to be a slightly abstract thing, it is worth recalling that almost all debt is nominal and it is nominal incomes that support outstanding debt.  There is about $500 billion of (intermediated) Private Sector Credit at present (and some other private credit on top of that).  Most likely that stock won’t grow much over the next few years. But government debt will –  on Treasury’s numbers net debt rises by $134 billion.   Against those stocks, a cumulative loss of nominal GDP of $128 billion over five years is no small loss.  As noted earlier, amid all the uncertainties, the precise numbers are only illustrative, but the broad magnitude of the likely losses (on current policies) are what –  and that magnitude is large, if anything perhaps understated on The Treasury’s numbers.


A practical suggestion for the Governor

A commenter on a recent post left the reasonable question

if the RBNZ is flooding banks with deposits/reserves to pay for its QE, why are the banks still paying 2.5% to raise term deposits from the public ? Surely the banks have more cash than they know what to do with ?

Well might she ask.  And her question prompted me to think a bit harder about useful steps that could be taken in response to what looks like quite a glaring anomaly.    At present, the Reserve Bank pays 0.25 per cent on settlement balances banks hold at the Reserve Bank, banks are paying much the same rate on (wholesale) 90 day bank bills, but when I checked this morning the average retail rate on offer for a six month term from our five largest banks was about 2.15 per cent.

It wasn’t always so.  Here is a chart showing the 90 day bank bill rate and the 6 month term deposit rate (the one the Reserve Bank provides a long time series for) back almost 30 years.

retail and wholesale

Short-term wholesale rates used to be a bit higher than comparable maturity retail rates.  That made sense.   The marketing and admin costs associated with one $20 million bank bill are going to be a lot lower than those associated with 400 retail deposits of $50000 each.  The margin ebbed and flowed a bit, but it was rare for retail rates to be below wholesale.  All that changed at the time of the 2008/09 recession and financial crisis, and the old relationships have never resumed.

In this chart I’ve taken a shorter period –  since the start of 2007 –  and have also shown the rate on a 1 year interest rate swap (for which the Bank has only published data since mid 2010).

retail and wholesale 2

The maturities differ a bit, but despite that you can see how similar the two wholesale rates have mostly been and how different they’ve been to retail rates.    And here, for the same period, are the margins between the 6 month retail rate and the 1 year swap rate respectively and the 90 day bank bill rate (itself usually moving very similarly to the OCR).

retail and wholesale margins

The gaps that sometimes open up for a while between the swap and bill rate just reflect the maturity differences – eg in 2013 and 2014 the Bank was strongly expected to raise the OCR so swaps yields rose in anticipation.  Over time, the differences have been small and non-persistent.    By contrast, the margin between retail and wholesale rates has typically been large and somewhat variable.

What accounts for this weird situation in which Michael Reddell private saver can get, pretty consistently, 150 basis points more for my smaller deposit than Michael Reddell trustee of the Reserve Bank staff pension scheme can get for the much larger amounts of money he (and other trustees) formally own (on behalf of the members)?

(Totally parenthetically, hasn’t policy been pushing people into collective savings vehicles –  where they can only get the lower rates – ever since Kiwisaver was set up?)

It has a great deal to do with the 2008/09 crisis conditions, and perceptions and regulatory responses thereto.    In New Zealand in the run-up to 2008/09 banks had had a very large share of their funding in the form of very short-term foreign wholesale instruments.  That funding was cheap and easy to raise –  times were good, money was easy, the mood was exuberant – and banks simply did not believe those markets could ever seize up  (I’ve told the story previously of one very senior risk manager of one of the big banks who when we were doing pandemic planning in about 2006 asserted that very strongly).  They did.  More generally, wholesale runs were the catalyst for the failure of various major institutions abroad.

And so, perhaps understandably, there was a quite a reaction, by banks themselves (scares change behaviour, for a time at least), rating agencies, investors in bank debt, and regulators.  In this post I will be focusing on the New Zealand regulatory intervention, but I don’t want to be read as suggesting it was the whole story (in fact, some readers may have memories long enough to recall my arguing 10 years ago that the regulatory effect then was probably small, relative to the private market response in those early post-crisis days).

Prior to 2008/09, the Reserve Bank had never had minimum liquidity requirements for banks.  It was talked about from time to time –  we used to worry, some more than others, about the macro risks associated with very high levels of short-term foreign debt –  but in a small organisation it had never been a top priority, and there was Basle II to implement.

The Reserve Bank, The Treasury, and the banks got a fright in late 2008.  It generally wasn’t totally impossible for our banks to borrow abroad but for a time it was very difficult to borrow (including on terms that didn’t send an atrocious signal) for much longer than overnight.  Even with their prior fondness for fairly short-term debt, that was troubling for banks.  (None of this, of course, was about the health of our banks or their parents; it was all about global markets seizing up.)

There were immediate policy responses to get through that episode –  Reserve Bank liquidity provision, Crown guarantees for new wholesale borrowing – but also a fairly quick Reserve Bank policy response to try to reduce or substantiallly eliminate the risk of finding ourselves in that situation again.   For a bank with a sound asset base, it is almost a given that a central bank will eventually lend if necessary, but the idea was to put buffers in place that meant we weren’t the port of first resort if things got tough, and (since banks’ board never like relying on central bank funding) to reduce the extent of pro-cyclical shocks to credit availability.

There are a number of strands to Reserve Bank liquidity policy but the bit I want to focus on is the one-year Core Funding Ratio (CFR) requirement: now that “core funding” must equal at least 75 per cent of each bank’s total loans and advances.  In practice, as banks do with capital buffers, they typically hold a considerable margin above the regulatory minimum.     Here are systemwide numbers since 2013, when the minimum ratio was raised to 75 per cent.

CFR data

And what counts as “core funding”?

Well, here is the summary from the policy document

CFR defn

Simplifying a bit, core (Tier 1) capital counts, as does all funding with a residual maturity in excess of one year, half of any long-term securities in the period between six months and one year to maturity, and (per the table) “short-term non-market funding”.

There is quite a lot of other detail defining “market funding”, but suffice to say that long-term wholesale (market) funding is attractive for these purposes (sell a 7 year bond, and the bank can count it as core funding fully for six year, and half for six months), but so is money from the little person –  you and me.  Anything we hold, so long as it less in total than $5 million per bank, counts at 90 per cent as term funding, even if the relevant account is fully liquid and the deposit are withdrawable on demand without question.  It isn’t just individuals; corporate cash holdings are treated the same (not on an instrument by instrument basis but based on the total holdings of that firms and all its related parties).  And other financial institutions – even small and passive ones (like the Reserve Bank superannuation one) – are explicitly excluded.

It is just great if you are an individual depositor.  But it is really rather anomalous, and not based on any terribly-robust analysis.

Now the missing bit in all this is the cost of that long-term wholesale funding, which is more or less as valuable as a retail term deposit for CFR purposes.  It is hard for outsiders to get a reliable fix over time on those costs, but from time to time the Reserve Bank includes a chart like this in the MPS, as it did last week.


Quite how they put it together isn’t that clear (and the underlying data aren’t disclosed), but the line to focus on is really the grey one –  the estimated all-in cost of long-term foreign funding (issuing the debt in foreign currency and hedging it back into NZD for the term of the loan).  The margin between the grey line and the OCR is both large and variable.  Much of that typically has to do with the hedging costs –  again not something easy for outsiders to track routinely, but which have typically been more adverse, and more variable, over the last decade or so than was typically the case in the years prior to 2007.     If the hedging costs were consistently low, the grey line would be a lot closer to the OCR and the cost of domestic wholesale short-term funding, which in turn would mean banks would price term deposits much closer to the OCR/bank bill or to those domestic interest rate swaps.

Perhaps the other relevant consideration here is that the New Zealand economy as a whole is still quite heavily dependent on foreign capital, and in particular on foreign debt intermediated through the banking system.    If our net international investment position was different, there would be a larger stock of domestic retail/corporate deposits, and the relevance of the offshore funding costs (including hedging) might be a lot less.

But as it is, the banks are compelled to have –  in total – a lot of funding from retail and long-term wholesale sources.  A rational bank will price term deposits so that the cost of that form of core funding is typically and roughly equivalent to the cost of equivalently-useful long-term wholesale funding (the latter mostly from abroad).

When the CFR was put in place there was a recognition that core funding would be a bit more expensive that other funding, and that was a price judged worth paying. By the time of the increase in the minimum ratio to 75 per cent, this huge margin between the cost of “core funding” and the cost of other liabilities seems –  from the relevant RIS –  to have come to be accepted as some sort of new-normal, perhaps even desirable.  At the time, the Bank even toyed with the idea of the CFR as a so-called macroprudential tool (it appears in the MOU on such things agreed in 2013), and there was a view afoot that a higher CFR might enable us to tighten overall conditions without pushing up the exchange rate.

But, frankly, it all looks a bit daft at present.    The policy is premised on the notion not only that Michael Reddell as personal depositor is less likely to run on his bank than Michael Reddell the super fund trustee and that – even if granted that that was true –  that stickiness (possibly not even rational, since I might just be slacker about my finances than about my fiduciary responsibilities) was so valuable from a financial stability perspective to be worth driving such a massive wedge between the rates available on two products with absolutely the same credit risk.    More generally, if you were around in 2007/08 you may recall (a) the retail runs on domestic finance companies,  and (b) Northern Rock and the queues down the streets in the UK.     There probably is some value in encouraging banks to have a reasonable volume of longer-term funding, that can’t be encashed on demand by the holder, but there is little obvious basis for distinguishing deposits of the same maturity held by individuals, by companies, by other small financial institutions and so on.    A cost-benefit analysis simply could not support the sorts of –  inefficient –  wedges we have come to see.   I emphasis the “inefficient” because (a) the Governor likes now to refer to efficiency, and (b) more importantly, because the provisions of the Reserve Bank Act governing the exercise of prudential powers still do, as an important constraint on what the Bank does.

From a macroeconomic perspective, none of this much mattered when the Bank was freely able and willing to adjust the OCR as required, to more or less keep inflation towards target.  If term deposit rates were going to be a little high, the OCR would be lowered, and although there would still be much the same wedge between retail and wholesale rates, the level of retail lending and borrowing rates could be more or less managed to what the Bank regarded as consistent with the inflation target.

These days, however, the Bank seems to regard itself as bound to an exceptionally rash commitment it made in a hurry on 16 March, not to reduce the OCR further.  And the Governor and Deputy Governor are reduced to asking really really nicely (or not so) for the banks to lower lending rates, even as they say they can ‘rationalise’ –  in terms of those funding costs –  why they don’t.  To me the answer is straightforward: if as a central bank you think retail rates need to be lower, consistent with your inflation target, then cut the OCR until retail rates get there.  Simple as that.

But if the Governor really does regard himself as honour-bound –  like some teenager’s promise to a dying parent that he’d never ever partake of the demon drink – there are still options, and ones that might make a real difference where it matters to depositors/borrowers.   Specifically, the CFR.

For example, the Governor –  and this is his decision, not the MPC’s –  could lower the minimum CFR to, say, 65 per cent (and commit to keep it no higher than that for, say, the next five years).  Do that and the pressure would come off term deposit rates very quickly and the relevance of those marginal foreign term funding costs would abate.  He could do more complicated things as well – options we looked at a decade ago –  of imposing a minimum requirement only on the share of foreign funding that is long-term (recognising that we don’t have largely repo-funded investment banks as they had in the US). I wouldn’t recommend the more complex changes in the short-term –  action is what is called for, and not things that take lots of careful drafting and consultation.

You might  –  perhaps especially if you were a bank supervisor –  think it strange to propose such a relaxation in the middle of a very troubled period.     But bear in mind several points:

  • we aren’t in the exuberant phase of the cycle (unlike, say, 2005 to 2007), where banks are just pursuing whatever is cheapest regardless of rollover risk,
  • we’ve already got to the point where the Bank is happy to provide almost limitless funding to the banks.  They are running term loan liquidity auctions, and for now getting no takers.  And although the wholesale deposits that arise through the bond purchase are technically pretty short-term, I heard the Governor on the radio yesterday stating that he thought the Bank would be holding the bonds to maturity (in which case the funding will also be there for years).  None of this funding counts as ‘core funding” for CFR purposes,
  • there was no robust cost-benefit analysis of just what was being gained from the CFR, let alone the specific parameter settings (nothing even to match what was done for capital last year). In other words, the current 75 per cent is no less or more ad hoc than a 65 per cent ratio for a few years would be.
  • the Bank has already wound back its capital requirements (delayed the start of the increase in required capital), so there would be no particular inconsistency in doing the same for liquidity, given the anomalous pricing the Bank’s rules are producing.

The Reserve Bank was a fairly early adopter of a core funding requirement after the last recession.  Many other countries now have something called a net stable funding requirement as part of their bank supervision arrangements.   The rules are a bit different, and no doubt each country has its own specific calibrations (and I’m not that familiar with the details of any of them).  This post is not an argument for getting rid of a funding requirement rule –  although in the end it is the quality of bank assets that matters mostly –  but for recognising how large a wedge our specific rules have driven, and the way that now (with the self-imposed OCR floor) contributes to holding our retail lending rates up.

I’ve noted in a couple of posts, including yesterday’s, that even though the New Zealand and Australian policy rates are essentially the same, retail term deposit rates in Australia are much lower than those –  offered by the same banking groups –  in New Zealand (and by much more than any slight differences in credit quality might explain).  As I noted earlier, it isn’t just regulatory provisions that explain the wedge between core and non-core funding of the same term and credit, but it seems likely that the specification of the NZ rules explains the bulk of the difference between New Zealand and Australian term deposit rates.

If the Governor is determined to stick to his crazy OCR promise for now, action on the CFR offers the fastest surest mechanism to materially lower domestic retail interest rates.  The Governor says that is a priority for him.  This decision is entirely his.

It is fair here to point out that the Governor’s prudential regulatory powers have to be used for prudential regulatory purposes –  soundness and efficiency of the financial system –  and can’t just be used as a monetary policy tool (any more than LVRs could).    But on this occasion that should not act as a constraint: after all, that large wedge between returns on instruments of the same maturity and credit, dependent solely on who holds the instrument, doesn’t look good on any sort of efficiency test, and I’m sure I’ve heard in recent weeks the Governor suggest –  quite credibly –  that lower retail lending rates were likely to be, at the margin, a positive contribution to financial stability.   When efficiency and soundness ends are both served it really should be an easy call.  There is a Bank Financial Stability Report due next week, which would be a good opportunity to announce such a change –  or for MPs and journalists to grill the Governor on why he would continue to oversee a policy that drives such a wedge into the interest rate structure.

UPDATE:   Shows how many initiatives there have been that one can lose track of.  A reader draws my attention to the fact that the Reserve Bank had already cut the CFR in late March.   I must have read that at the time and then forgotten it.  Will have to reflect further then on why term deposit rates are still so high relative to wholesale rates.  One possibility might be uncertainty about how long the relief will last.


Monetary policy again

One way of looking at developments in New Zealand’s monetary policy is to compare what has been done, and how that has affected market prices, in the country that is in many respects most similar to New Zealand, Australia.

There are no perfect comparators –  and in many ways everyone is flying a bit blind at present – but the two economies do have many of the same banks, similar institutions (variable or short-term fixed mortgages) and a fairly similar experience of the virus.   Sceptic that I am of the Reserve Bank of New Zealand, I am not starting from a view that the Reserve Bank of Australia’s monetary management is some sort of standard to which we should aspire.  Coming into this crisis, for example, both central banks have presided over core inflation undershooting the midpoint of their respective inflation targets, the RBA by more than the RBNZ.      And for reasons that are not very clear (at least to me), the Reserve Bank of Australia is more resolved not to adopt a negative policy rate than our own central bank.

What was the starting point at the end of last year (a time when no one in either country had the coronavirus in focus)?  Recall that Australia’s inflation target (centred on 2.5 per cent) is a bit higher than ours (centred on 2 per cent).  Here are the interest rates I could find, all from the respective central bank websites, except the Australian interest rate swaps yields.

31 dec 2019 int rates

Every single one of the New Zealand rates was higher than the comparable Australian rates –  the smallest gap of all being in the two policy rates, and by far the largest being in term deposit rates.   Note that at the end of last year, markets were looking to the prospect of a cut in the RBA cash rate later this year, while in New Zealand attention was beginning to turn to the possibility of an OCR increase at some point.

So what has happened since then?

  • the RBA cuts its cash rate by 50 basis points to 0.25 per cent, while the RBA cuts its OCR by 75 basis points to 0.25 per cent,
  • both central banks have massively increased the volume of settlement cash in the respective systems.  At the RBNZ, all those balances (currently around $28bn) are remunerated at 0.25 per cent, while at the RBA balances are remunerated at 0.10 per cent (both central banks changed their rules for remunerating large balances),
  • the RBNZ announced its large-scale asset purchase programme, concentrated on government bonds, currently with a limit of $60 billion,
  • the RBA announced a target rate of 0.25 per cent for the yield on three year government bonds, indicating that they would operate in the market (primarily that for government securities) to maintain market rates at or near that target.

And here is how much those rates have changed to now (latest available data)

int rate changes

Tracking down old mortgage rates for Australia is beyond me, but note that both variable and fixed mortgage rates in New Zealand are well above those in Australia.    But so are term deposit rates: averaging across the big four banks, in Australia for AUD six month term deposits the banks are paying about 0.8 per cent, and in New Zealand for NZD six month term deposits the banks are paying about 2.2 per cent.

As you can see from the table, wholesale rates (bills, bonds, swaps) have fallen by more in New Zealand than in Australia.  That is not inconsistent with the fact that the Reserve Bank of New Zealand cut its effective policy rate by more than the RBA cut its effective rate.  Here are the current wholesale rates (Australia in the second column)

wholesale 3

It is notable that longer-term rates are now lower in New Zealand than in Australia –  quite a contrast to the situation at the end of last year.

Consistent with all that, incidentially, the NZD/AUD exchange rate fell by about 4 per cent over this period.

What might explain these developments?

On the one hand, quite possibly people trading the markets in the two countries may reckon the New Zealand recession will be more severe and/or longer-lasting than Australia’s.    It is certainly true that forecasts of the decline in June quarter GDP are much steeper for New Zealand than for Australia, although beyond that –  looking ahead a year or two –  it isn’t obvious at this stage why things might be so very different at the sort of horizon more relevant to longer-term rates.  So for now I’ll just note that possibility and pass on.

What about central bank words and choices?

The Reserve Bank of Australia has apparently been pretty clear that it will not lower than cash rate from here.   The market seems to more or less believe them (the OIS rates on the RBA website are consistent with the current effective cash rate).  By contrast, the Reserve Bank of New Zealand has opened the door to the possibility of a negative OCR next year. I don’t have access to New Zealand OIS data, but I did notice this chart in a Westpac market report, dated yesterday, that someone sent me.


Markets here are pricing a negative OCR throughout next year.  In other words, our longer-term interest rates price in even more conventional monetary policy easing.  Consistent with that, a reasonable chunk of the fall in the exchange rate has occurred since the Reserve Bank’s MPS last week.

All of which then leaves the question of quite what difference the Reserve Bank’s vaunted long-term asset purchase (LSAP) programme is making.  The Reserve Bank repeatedly tries to suggest the answer is “a lot”.  But there is reason to be more than a little sceptical that it is making much difference where it matters.

As I noted above, both central banks launched novel asset purchase programmes.  The RBA’s approach involved purchasing whatever it took to keep the three year government bond rate around 0.25 per cent.   In the early days –  amid the global bond market liquidation –  achieving that goal took a lot of purchases.  But here are the RBA’s total bond purchases

Total 51348
March 27000
1st half Apr 17500
2nd half Apr 5748
May 1100

You’ll recall that the Australian economy is quite a lot bigger than New Zealand’s.  A$51 billion in bond purchases there might be akin to perhaps NZ$7-8 billion purchases here.

But note what has happened: after heavy purchases in late March and early April, the RBA’s bond purchases have almost completely dried up.  Despite the heavy expected federal government bond issuance, expectations about short-term rates are now sufficiently subdued that the three year government bond rate is holding at the target rate with no material bond purchases at all.  And the purchases the RBA has been doing have been heavily concentrated in relatively short-dated government bonds, consistent with reinforcing monetary policy signalling and with the fact that, as in New Zealand, most private sector borrowing tends to be on variable or short-term fixed terms.

What about the Reserve Bank of New Zealand?    Here is the same table for them (government bonds only –  there is a small amount of LGFA purchases also).

Total 11,228
March (from 26th) 950
1st half April 3,833
2nd half April 2,845
May 3,600

Relative to the size of the economy, total purchases here have been somewhat larger, but the real difference is that the Bank is buying just as heavily as ever.  And as I noted in my post on Monday more than two-thirds of all their purchases have been for maturity dates from 2027 and beyond –  and virtually no one I’m aware of, other than the government itself, takes funding exposed to rates that long.

In other words, it seems plausible that the LSAP programme might be knocking 20-30 basis points off long-term government bond yields and swaps rates, while making almost no difference at the short-end (where the RBA would seem now to provide a reasonable benchmark).  And yet it is the short-end that influences borrowing costs for most households and corporates.  At the long end……well, there is the government.    It all looks quite a lot like a programme designed to do two things:

  • by waving around very big numbers to suggest that monetary policy is doing a lot when it actually isn’t really doing that much at all, and
  • to lower the marginal borrowing costs of the Crown, at a time when the Crown has a very big borrowing programme.  At very least, that is a questionable use of monetary policy – not at all consistent with the MPC’s Remit (since fiscal policy will be what it will be whether or not bond yields are 20 points higher or lower) –  and all while exposing the Crown to a really high degree of unnecessary degree of interest rate risk (if the authorities really believe interest rates are extraordinarily low they should be markedly lengthening the duration of the Crown’s debt to the private sector, not skewing it dramatically shorter by buying in government bonds and issuing variable rate settlement cash in exchange).

And, on the other hand, if the Bank were really serious about getting retail interest rates down –  rather than anguishing in public and suggesting that commercial banks aren’t doing their job –  it would just get on and cut the OCR quite a lot further.  As it is, go back briefly to the changes table (the second one from top): nominal rates have fallen to a moderate extent this year, but survey and market measures of inflation expectations suggest that expectations of future inflation have fallen by probably 0.7 percentage points.  Real rates generally haven’t fallen much at all, while retail deposit rates –  held up by the combination of the Bank’s core funding requirement regulation (their choice) and the continuing relatively high cost of offshore terms finance (illustrated in the MPS last week) –  have actually risen in real terms.

Quite a claim to fame that: to be the central bank, in a country with a highly safe banking system (as the Governor now repeatedly avers), that presided over a rise in real deposit rates in the face of the biggest economic slump in decades.  Extraordinary.

Meanwhile, in the last 24 hours we’ve had the Deputy Governor offering interviews to both Stuff and the Herald reaffirming the MPC’s commitment to stick to its bizarre promise on 16 March not to cut the OCR further before next March, come what may.   Apart from anything else, it has the objective effect of tightening monetary conditions relative to where they were –  in effect, urging markets to price out those early negative OIS prices and, all else equal, push up the exchange rate.

There is, of course, something to be said for sticking to one’s word.  But rash promises generally should not be followed through on.  I suppose we should be thankful that the MPC in February –  recall, they were upbeat about the rest of the year then –  had not offered “forward guidance” committing not to cut the OCR this year, come what may.  Perhaps they’d have felt obliged to stick to that rash pledge as well?  As it is, this was a pledge made on 16 March, at a time when the Governor was reluctant to even concede that a recession was happening, at a time when the Secretary to the Treasury (observer on the MPC) was telling the PM that things might be not much worse than the 2008/09 recession.   Perhaps (or not) those were pardonable calls at the time, but they were clearly mistakes, and not small ones.   Sticking to a rash pledge made in some highly uncertain and fast-moving circumstances is almost akin to the suicidal person talked down from the edge, but still averring that “I promised I’d jump, I even left a note, I need to stick to my word”.  Among the sick, such misperceptions might be pardonable.  From highly-paid public figures charged with conducting a nation’s monetary policy, it is simply stubborn, verging on the crazy –  the more so if the MPC thinks that sticking to that pledge in any way enhances the sort of credility that matters.  After all, it was the MPC last week that published projections showing inflation below the bottom of the target range for two years, and unemployment unacceptably high.  Those were supposed to be the considerations people judged the Bank on.

Finally, I see that Stuff’s Thomas Coughlan in his column this morning has picked up my call that if the MPC won’t move –  won’t do the job that is really needed, to provide a lot more stimulus, to get us on the path back to full employment and price stability –  that the Minister of Finance should use the override powers Parliament has long provided him with.  They aren’t powers that should be exercised lightly, but these are exceptional times, and the Bank seems to be content to do little of substance, while pretending otherwise.  Of course, the Act was initially written primarily to protect us from inflation-happy politicians, but also has to protect us from central bankers just not doing their job –  in this case, on either the employment or inflation dimensions.  If he fails to act –  as surely, risk averse as he is, the Minister of Finance will fully share responsibility for the unncessarily slow recovery that he and his MPC seem set to risk.   To what end?

LSAP scepticism

The Governor of the Reserve Bank is always keen to tell us what an important contribution the Reserve Bank is making through its large-scale asset purchase programme (LSAP).  Recall that the Bank cut the OCR by 75 basis points and then gave up on using conventional monetary policy –  promising (in one of the weirdest pledges in the history of modern monetary policy) to do no more for 12 months, come what may – in favour of buying lots of (mostly) government bonds.  At present, the MPC has authorised the Bank to buy up to $60 billion of bonds, and there is speculation from some banks that that total may even be raised further at the next  Monetary Policy Statement in August.   The Bank claims –  as it did in the MPS last week and at its appearance at FEC the next day –  to be making a big difference, but it is mostly a smoke and mirrors show.  There are big numbers involved, but the differences being made to things that might matter economically are really rather small.

Sadly, it seems to suit our very conservative and risk-averse Minister of Finance to believe –  or acts as if he believes –  the Bank’s story, even if by doing so he aids and abets an insuffficient macro policy response to the savage recession that is upon us.  The macro consequences of his indifference probably won’t show up before the election, but even beyond that horizon in his entire term in office he has been remarkably deferential towards the Bank. It is if he is scared of doing what the economy needs.

It is fair to say that there has been an active debate over quite what these asset purchase programmes have achieved ever since they were launched.   While I was still at the Reserve Bank I recall a couple of visits from Dan Thornton, then a senior researcher from the St Louis Fed, who presented versions of papers arguing that the Fed’s various asset purchase programmes really hadn’t made much sustained difference to anything.    I was never fully convinced but if you’d asked me a year ago I’d have said that my summary impression was that earliest Fed programme –  in the midst of the financial crisis –  probably added some value, but that the later ones didn’t achieve much at all, perhaps beyond some announcement signalling.  (The issues in Europe were a bit different, since breakup risk was in play).  Long-term interest rates in the US, for example, hadn’t seemed to have fallen more, relative to the change in the policy rate, than we’d seen in New Zealand or Australia (which, to then, had not resorted to asset purchase programmes).

In truth that didn’t seem very different to the approach being taken by the Reserve Bank’s chief economist only two months ago.  This was reported in the Herald on 13 March

yuong ha

That sounded –  sounds in fact –  about right to me.   It isn’t, of course, the line that either Ha or his boss are running now.  Instead, we get repeated suggestions – never quite pinned down with hard estimates or illustrations –  that what the Bank is doing with the LSAP is some sort of fully adequate substitute for the sort of scale of OCR adjustment we’ve had in past serious recession (recessions which, it might be added, it has often taken years for the unenemployment rate to drop back acceptably).

Strangely, the Governor has found some supporters among the local bank economists.  I presume they really believe what they are saying, but I still don’t find it very persuasive at all.

Much has been made of the claimed impact of the bond purchase programme on wholesale interest rates.  But even there, the story isn’t particularly persuasive.

Typically, the biggest influence on longer-term interest rates is the expected future path of short-term interest rates.  Why?   Because, in principle at least, someone holding a 10 year bond has as an alternative investing in a series of 40 day 90 day bills.  If the market thinks the short-term rates wil rise or fall materially over the life of the bond, that will influence bond yields themselves.

Sometimes, there is a serious recession, involving significant cuts in the OCR, but where the effect is expected to be quite shortlived; before long it is expected that the Reserve Bank will be raising the OCR again.   If so, bond yields might not fall much, and in particular the implied forward interest rates (eg the second five years of a 10 year bond, backed out using yields for five and ten year maturities).   That was more or less exactly how markets reacted in 2008/09.

5 yr forward rate

It took a couple of years for markets to really begin to appreciate that future policy rates were likely to be low for some considerable time.  This New Zealand experience wasn’t that unusual.  In fact, it took a while for the Reserve Bank to learn –  they’d actually started tightening in mid 2010.

But what about this recession?  I’ve not seen a single serious commentator here or abroad –  I’ll set aside the columnists who reckon we are now on an inexorable path towards Venezuela –  who think there is any material chance of policy rates being raised any time in the foreseeable future (several years at least).  By contrast, just a few months ago people were beginning about the possibility of OCR increases perhaps later this year or next year.

And yet even with all that Reserve Bank bond buying –  actual and promised –  the implied five year forward government bond rate hasn’t really fallen that much at all.  It is down 80-90 since the middle of last year and 60 points since January.  It just isn’t very much –  look at the size of some of the past movements even just in the period of this chart –  and all this against a backdrop of a 70-80 basis point fall in medium-term inflation expectations (whether one uses survey measures or market prices).  Unfortunately, long-term historical swaps data isn’t readily available, but for the more recent period the picture is much the same: implied forward rates haven’t fallen very much relative to history, relative to the scale of the economic shock, or relative to the fall in inflation expectations.  And yet it was this fall in swaps rates on which the Bank seems to pin its claims.

Ah, but what about the counterfactual?  What would have happened if the Reserve Bank had not launched and then expanded the Large Scale Asset Purchase programme?    The only fully honest answer of course is that we do not know.

The Bank likes to run the charts showing how bond yields surged upwards in late March, and then fell after it intervened with the LSAP.

10 yr yield may 2020

The global rush to cash and liquidation panic was well-recognised.  Quite probably, central bank interventions helped to stabilise things.  But that is a different proposition from a claim –  which is the one the Bank and its supporters are making –  that the current level of yields, six weeks on, is being very materially influenced by central bank purchases.  One could mount a counterargument that where yields are now isn’t much different than where they might have been anyway given (a) the OCR being stuck at 0.25 per cent for now, and (b) the economic situation having got a whole lot worse than it was, say, on 16 March, and (c) medium-term inflation expectations having fallen quite a bit further.

One might say the same looking at this chart of the swaps yield curve on various dates.

swaps curves

The grey line was the peak in rates amid that flight to cash that most severely affected te bond market.  But again, compare the 16 March line (the day the Bank cut the OCR) with the latest observation last Thursday.  It has the feel of the sort of fall –  concentrated over the front five years –  you might have expected if you’d been told that in the interim the economic situation had got so much worse and inflation expectations had fallen materially.

But, again, the counter-argument will come: what about all those fiscal deficit and the big volume of debt issuance coming down the track?  To a first approximation, my response is “what of it?”.

First, recall what else is going on.  Investment demand has slumped and is likely to remain lower than it was for several years.  And private savings preferences also appear to have risen. So if we are thinking about what might be expected to happen to interest rates  – even if the Reserve Bank were buying nothing –  we have to think not just about what the government is doing but about the private sector.  Money is, after all, fungible.  Absorption, frankly, seems unlikely to have been an issue, in a very lightly-indebted sovereign –  even if the Reserve Bank had not done any LSAP.

Gross public debt as a share of GDP is now projected to rise by 30 percentage points between last year and 2023/24.  But it isn’t as if big increases in public debt have never been seen before.  In fact, the last time was only a decade or so ago, when gross public debt as a share of GDP rose by 20 percentage points between 2008 and 2012.   There was no asset purchase programme then and –  as illustrated above –  once markets became convinced that the OCR would have to stay down for a while, it wasn’t enough to stop implied forward rates falling a long way.

And how much would we expect changes in government debt to affect interest rates, absent central bank intervention?   Views will differ on that, but the Governor did write about exactly that issue in his relative youth, publishing empirical estimates drawing on work he’d previously been part of at the OECD.  Perhaps the Governor has changed his view since 2002, but then he estimated that 30 percentage points on net debt might have been worth perhaps 15 basis points on bond yields, all else equal (which it decidedly isn’t right now, with very high levels of excess capacity).

Another point worth bearing in mind is that even the Reserve Bank will, I think, concede, that very long-term interest rates just don’t make that much difference to many people in New Zealand, other than just lowering the government’s own financing costs.  The marginal activity in the residential mortgage market, for example, is typically around one and two year fixed rates.  And yet the data on the Bank’s LSAP shows that more than two-thirds of all the Bank’s government bond purchases have been for maturities of 2027 and later.   So even if those purchases are having a material impact on those very long-term rates, so what?  To what end?  As it is, we know that shorter-term fixed rates have hardly fallen at all in real terms –  what one might have expected with a small, badly lagging, OCR response, not with all the power the Bank asserts its balance sheet purchases can have.

Perhaps also the Bank is right that there has been some helpful exchange rate effect, and we do not know the counterfactual. But we do know how much the TWI has often fallen in past serious recessions, and it is much more than anything we’ve seen to date this time.  The LSAP might be a little better than nothing, but it is no substitute for the OCR the Bank is now so reluctant to use.

Are there other possible channels where there might have been an impact?    A commenter last week noted that perhaps equity markets were higher as a result?  Perhaps, although the effect must surely be small, but equity markets have always been seen as much less important a part of the transmission process here than in, notably, the US.  The Bank and its supporters have also been talking up portfolio balance effects –  in other words, the people selling bonds to the Bank have to do something with the money that is freed up.  Again, perhaps there is some small effect, but it is difficult to see where such material tangible effects might be.    For example, I’ve seen this chart a couple of times in ANZ publications

corp bonds

It is a useful chart (altho perhaps with a line missing?), with data on corporate bond yields that those of without a Bloomberg terminal can’t otherwise easily track.  The Reserve Bank doesn’t buy the corporate bonds, but purchasing government bonds may displace some holders into corporate debt.  But, again, count me fairly sceptical that the ongoing LSAP programme is explaining much about the current level of these yields, given (a) weakening OCR expectations, and (b) the weakening economic environment.  It is hard to be sure, but it is hard to believe that any effect is very large.

We don’t have real-time inflation data, but we do have near real-time proxies for inflation expectations –  and especially changes in them –  from the inflation-indexed government debt market.   When implied inflation expectations for the next five years on average have fallen by about 80 basis points (measured imprecisely, so call it anything from 70 to 90 points) in just a couple of months

IIBs mAY 20

it is not a sign of a central bank that is doing its job well, of a central bank whose instrument is doing what needs to be done, even allowing for all the fiscal support as well.   If we had a Minister of Finance who really cared about macroeconomic stabilisation he’d insist on change.

A deeply negative OCR, generating retail rates near-zero (consistent with what the governments is lending to SMEs at) is more like the sort of monetary policy stance we need, one that might make a real and sustantive difference to inflation, inflation expectations, output and (un)employment.    What we have at present is theatre –  arguably doing little harm and perhaps a modicum of good, but successfully (it appears) from the Bank’s perspective distracting from where the real gains might be had.



RB at the Finance and Expenditure Committee

After each Monetary Policy Statement (and Financial Stability Report – there is another of those along very shortly), Parliament’s Finance and Expenditure Committee invites the Governor and his colleagues along.   They tend not to be particularly searching appearances – when times are more or less okay, MPs seem more interested in securing soundbites for media coverage than in serious scrutiny.  In principle, the Committee takes the process seriously –  they even hire a local economist as a part-time adviser to brief them and suggest questions –  but any real scrutiny is pretty rare.  I haven’t been along to one of the hearings in the time I’ve been writing this blog, and although I had become vaguely aware that the hearings were being livestreamed, I hadn’t even bothered to track down those.

But some members of the Epidemic Response Committee had been willing to ask the Bank some fairly specific questions a few weeks ago (my write-up on the Bank’s responses is here).  And many of the issues around the Bank’s handling of the current situation haven’t gone away, so I found the link to the footage of the Bank’s appearance on Thursday morning,  As far as I could see, there was almost no subsequent coverage (the Budget and all that), which was a shame as some significant issues surfaced.

In this post, I want to focus on the questions/comments by three MPs, and the responses of Bank officials to them.

The first was a question from Labour MP Duncan Webb, who took a longer-term perspective and asked the Bank about the exit strategy from the Large Scale Asset Purchase programme.  It was a good question, because it is easy to get into these things, and not always easy to get out again.  The Governor’s response was also straight, and really the only one he could give.  He noted that he would love to be in the position, a few years hence, where the economy was running strongly, inflation pressures beginning to build, when the Bank could sell its bond holdings gradually back into the market (“tapering”).  That is clearly a first-best situation from here.  On the other hand, the Governor noted that in other countries it has more usually been the case that the bulk of bonds purchased have been held by the central bank until maturity (the longest current New Zealand government bond matures in 2040).  There is a variety of reasons for that observed behaviour, some defensible, others not.  My point here is not to disagree with either the Governor or Mr Webb, but to welcome the fact that an MP raised the longer-term issues, and to hope that the Committee and the Bank continue to engage on the issue.  It would not be ideal if the Bank ends up holding half of all the government bonds on issue for the next decade, and to support that has to maintain unusual liquidity management arrangements on the other side of its balance sheet.

The most serious questions about the immediate situation were asked by National’s Finance spokesman Paul Goldsmith.  He seems, reasonably enough, to have become a little troubled at (a) the lack of much sign of an easing in monetary conditions as they affect real people, and (b) the apparently rather relaxed approach the Bank has taken, and appear to continue to take, to the option of a negative OCR.

This time he succeeded in getting a slightly more specific response from the Bank.  You’ll recall that Orr has claimed that some banks are ‘not ready’, without ever being specific as to which banks, what the specific issues are, or even why some banks allegedly not “being ready” should hold back the entire economy.  (On this note, I happen to have had credible reports of two bank chairs this week each stating that they don’t understand the issue either, and that of course their banks are quite ready.)

As I’ve noted in previous posts,  this “not ready” claim has always been a bit fishy.  We never heard it a decade ago in other countries that dipped their toes into negative policy rate territory.  And most of the banks operating here are part of overseas banking groups, at least parts of which will be operating in countries with negative policy rates.  And if the issue was really about retail rates and retail systems, most of our retail rates are still so positive that any “readiness” issues wouldn’t arise even for OCR levels much lower than those at present.

Anyway, Orr finally clarified his claim, which is now that “some banks” (“some” presumably being less than “most” or “a large number”) still had systems problems that meant they could not cope with “a negative OCR or negative wholesale rates”.   He went on to add that banks were quite busy at present, but that only last week the Reserve Bank had written to banks, indicating that banks needed to show that they would be “ready to go” should negative rates prove to be needed, by “towards the end of the year”.

It still somewhat defies belief.   When much of the government bond markets in the rest of the world have been trading with negative yields for some time, when our first (indexed) bond yields went negative last year, surely every bank with any sort of wholesale operation must be capable of coping with negative wholesale rates –  be it small (here) Chinese banks or big (here) Australian banks, or Citi, HSBC, JP Morgan or whatever.   Is all this somehow about SBS and Heartland Bank (or even tinier NBDTs)?  If so, isn’t that their problem, not something appropriate macro stimulus should be held back for?

Anyway, I have now lodged a request for a copy of the letter sent to banks last week, and for the letter the Bank sent out in late January and responses (without names, or tabulated again anonymously) to it.  In the meantime, here is the list of NZ-registered banks: perhaps some enterprising journalist could ring them each and ask if they have any systems obstacles to a negative OCR and if they do, what those obstacles are?

Goldsmith also asked the Bank about the rather limited extent of the fall in retail interest rates (especially lending rates, whether for business and households), asking why the Bank had chosen to emphasise the large-scale asset purchase programme (LSAP) as its tool.  In response, in addition to the alleged “operational problems” Orr ran through a litany of considerations: they looked, he claimed, at what would be most efficient, most effective. most easily operated, and with fewest distortions to markets and the LSAP had won ‘hands down’.    He claimed –  as he had on Wednesday at the release of the MPS –  to be very pleased with the effectiveness of the LSAP so far.

I went through some of the problems with that argument in my post on Thursday.  But Goldsmith himself also persisted.  The gist of his response was to say ‘well, yes, it is all very well to say you’ve lowered government bond rates –  no one disputes that –  but retail rates haven’t come down much at all have they?”.

And at this point the Bank started floundering. The Governor turned for an answer to his chief economist Yuong Ha – who had been quoted in the Herald as recently as the 13 March observing that programmes like these don’t really achieve that much, buying just a little space, a little time etc.  The gist of Ha’s response was “well, that isn’t really our issue is it?  We don’t control the margins over wholesale rates banks set.”  He went on to accept that wholesale rates had come down around 100 basis points – presumably here he meant the swaps yields I illustrated on Thursday –  but that retail (deposit?) rates had only fallen by 20-30 points.  He noted that the Bank “understood” the lack of passthrough so far”, but they would expect to see a lot more “as the economy recovers”.  That didn’t seem to be much consolation, in an economy that needs monetary policy support now not in six or twelve months time?  And, of course, Ha made no mention of the fact that –  whether it is surveys or market prices one looks at –  inflation expectations have come down a long way so that even real wholesale rates haven’t changed that much at all.

Then Orr weighed in again suggesting that he was “very pleased” with the wholesale rate impact, but “less pleased” about the retail rate response.  He too ran the line about ‘we can rationalise why that is”  –  as they did in the MPS, noting that effective marginal funding costs remain high.  But neither he nor Ha seemed willing to entertain the otherwise-obvious conclusion that if wholesale rates had fallen but retail rates hadn’t much, and you can understand why that is, the usual – wholly conventional –  response is some more easing in wholesale rates.  That is exactly what happened in the 2008/09 recession, when funding costs also remained under heightened pressure.  But not now: instead, there is just handwringing and hope.

Goldsmith also challenged the Governor on his call to the banks to be “courageous”, suggesting that “courageous” lending might easily be rather risky or dangerous lending.  The Governor had not much more than bluster in response, but it isn’t my focus.

Then Goldsmith asked the Governor about those comments a few weeks ago that the Bank could consider buying government bonds directly from the Crown, rather than (as at present) in the secondary market.  He seemed to just be wanting to close off the issue, but the Governor opened it up all over again, in a way that seems to have attracted no attention.

The expected answer would probably have been along the lines that there were no plans at present, the secondary market was working well, but if there ever were dysfunction there was really no macro difference in the Bank buying direct, so long as the decision rested with the Bank, consistent with the inflation target.   In backing the Governor on this point previously, that is what I have said.

Instead, the Governor launched into a discussion noting that while the Bank did not rule out lending direct to the Crown, that was really fiscal policy not monetary policy, that the central bank can always lend as much as fiscal policy requires, but that that would be a matter for the government to decide, not the Bank.

Goldsmith then challenged him on that, asking whether he was really saying that the Minister could decide whether the Bank would lend direct.  Orr reiterated the possibility of market dysfunction, while noting that at present markets were functioning well, but then repeated that what he called “pure monetary financing” would be a matter for the Minister of Finance to decide.

At this point, the Governor invited the Deputy Governor Geoff Bascand –  usually the safe pair of hands in that senior management cohort –  to comment.  He indicated that it would be a matter of ministerial direction, but which would involve a substantial process including looking at whether what the minister might be directing would still be consistent with the existing price stability etc target.  And then he tried to close things down by suggesting that this was all just an “esoteric discussion”.

Reasonably enough ACT’s David Seymour reacted to that, suggesting that if the Bank was seriously saying the Minister of Finance could direct them to lend to the government, in any amount he chose, it was “anything but esoteric”.

The thing is, I am not at all sure what the Bank is talking about.  As I’ve noted here previously, in the 1989 Reserve Bank Act there were no prohibitions on the Bank lending to the government, directly or indirectly, but it was entirely a matter for the Governor to agree, or not.  His constraint was the inflation target he was required to pursue, and he had the ability to adjust other instruments to offset any inflationary impact of lending to the government.   Such lending has happened at the past, including through a priced overdraft facility at the Bank (although the Crown tends to prefer now to operate with credit balances).  But there was no explicit power for the Minister of Finance to direct the Bank to lend to the Crown.  I’m less familiar with the fine details of the 2018 amendments, but I cannot see any change to that position in the current legislation either.  It is as it should be.  I’m pretty sure that no modern advanced country central bank’s enabling legislation empowers the Minister of Finance to direct the central bank to lend to the government.  The government can of course choose to spend (run deficits) as much as it likes, and as a technical matter the Bank can finance any amount, but if the initiative for fiscal deficits rest wholly with the government, the ability of the Bank to say no to funding those deficits is pretty foundational to modern central banking.

There are two sets of directive powers in the (monetary policy bits of the ) Reserve Bank Act, one or other of which are I presume what the Governor and his Deputy were talking about.  The Minister can direct the Bank to deal in the foreign exchange market and can even direct them to set a fixed exchange rate (sections 17 and 18) and if the MPC considers that giving effect to such directions would be inconsistent with the existing mandate (the Remit), it can (sec 19) require the Minister to either issue a new mandate consistent with the direction, or it does not give effect to the foreign exchange market directive.    That sounds quite a lot like what the Deputy Governor was talking about –  and every so often Bank officials refresh their understanding of these provisions (I recall writing at least one such paper myself) but………a direction under these sections of the Act has nothing at all to do with compelling the Bank to lend to the government.

The other, better-known, directive/override power is section 12 of the Act.    Under that provision –  a directly parallel provision was in the 1989 Act as well –  the Minister of Finance can, for up to 12 months at a time (and transparently), override and replace the existing Remit (the 1-3 per cent inflation target and requirement to support maximum sustainable employment) with one or more other “economic objectives” and the MPC is then required to conduct policy in accord with that new mandate.   I’ve long held that this power could be used to directly compel the MPC to, say

  • target short-term interest rates of -0.5 per cent (or even -5 per cent), or
  • to target the nominal exchange rate at, say, 20 per cent below current levels, or
  • to use monetary policy with the goal of getting the unemployment rate below, say, 5 per cent in two years’ time,

or a variety of other alternatives.

The Bank, the Governor and the MPC have no choice in the matter.  They are required to run monetary policy consistent with devoting their best efforts to achieving the target the Minister has set.  If they tried to avoid taking the new target sufficiently seriously, it would be clear grounds for the Governor and Deputy Govenor to be dismissed, and other members of the MPC to be removed from those statutory offices.

But……there is no hint in this provision, or anywhere else in the Act, suggesting that the Minister of Finance can direct the Bank to lend to the government.  Perhaps the Bank and its lawyers think/worry that “lend to the government at zero interest up to $…billion” is an alternative “economic objective” within the meaning of section 12 of the Act.   But, at very least, it would be a stretch –  it isn’t an “economic objective”, but an instrument,  and favouring one specific party in the economy.    And note that if a government did attempt to impose such an “economic objective” there would still be nothing to stop the Bank setting interest rates for the rest of the economy at a sufficiently high level to counter the inflationary effects of this coerced lending.

I’m at a loss to know what the Governor and Deputy Governor mean.   I’m tempted to lodge an OIA request, but am not sure I’ll bother, as they would find myriad ways to refuse to release anything.  But journalists could directly ask the Bank what the Governor/Deputy Governor were on about?   MPs could use parliamentary questions to ask the Minister of Finance whether (a) he has received any advice as regard his direction powers over the Reserve Bank, and (b) whether he or Treasury believe he has the statutory power to compel the Bank to lend to the Crown.  Most everyone I’m aware of has always assumed they can’t –  and took great reassurance in that –  so if the powers that be now believe differently we deserve to know?    (Of course, if the government just wants more inflation, it can always raise the inflation target, but that is a rather different issue).

This post has gone on quite long enough, so I won’t devote the space I was going to to David Seymour’s extraordinary attempt to out-New Zealand First in defending old people.  Weirdly, Seymour –  who is usually quite wary of loose use of fiscal policy –  declared himself all in favour of bigger government, aggressive use of fiscal policy –  while expressing great concern about the way savers were being “penalised” by interest rate cuts, and currency being debased, all while accusing the Bank of deviating from its mandate. I thought the Governor showed commendable –  admirable –  restraint in his response, stepping through how monetary policy works (“one interest rate for all” etc) and even came close to (but couldn’t quite do so explicitly) pointing out to Seymour that real deposit rates are now HIGHER than they were a few months ago.   That’s perverse, of course….but then the Governor and MPC could do something about that –  this tool called the OCR.

And there was the extraordinary claim late in the session from the Deputy Governor (with responsibility for bank regulation and financial stability) that there was “no reason for banks to tighten up credit” amid a really deep recession and huge uncertainty about the future, whether for individual sectors, firms or individuals, or for the economy as a whole.    But perhaps I’ll come back to that breathtaking claim another day.  Perhaps the banks could reply to Bascand with that old maxim Keynes invoked; “when the facts change, sir, I change my mind.  What do you do?”.

To repeat, if the Bank/Governor/MPC will not do their job, and act aggressively in ways that credibly keep forecast inflation, and expectations of future inflation, on target, the Minister’s extraordinary (but clearly specified, there for a purpose) powers should be used.  But there should be no question of compelling the Bank to lend to the Crown.

Still falling short

Your main focus today, as mine, may well be this afternoon’s Budget, but I’m not letting the Monetary Policy Committee’s statement yesterday go by without comment.

Back in February, the Committee was really rather upbeat.  There was this temporary disruption to some exports to China, but it really wasn’t much to worry about.  Once we got beyond that things were looking good this year.  In fact, a couple of weeks later they were still singing from that upbeat songbook, tweeting out their upbeat message.  It wasn’t just management, but also the silenced ciphers who sit as external members of the Committee, collecting generous fees –  no word of any 20 per cent cuts there? – while never being available for questioning or any serious accountability.

Since then, of course, they’ve been mugged by events, but always with the sense that they were never quite taking things seriously enough, never willing to do what might make a real and material difference.  So they cut interest rates once, and then firmly pledged not even to think about doing any more of that for another year.  They claim to have (very belatedly, given that they had 10 years notice) discovered that some banks weren’t “technically ready” for a negative OCR –  a very fishy story, given we heard it nowhere else in the world in the last decade –  but even having “discovered” that there appears to be not the slightest urgency to resolving the matter.  The government can get in place wage subsidy schemes or company tax clawback schemes paying out within days, but the Reserve Bank is still just asking nicely that could the banks please, please, think about having systems ready by the end of the year –  still the best part of eight months away.

I saw one funds manager quoted in the media suggesting that the Bank really wanted to cut the OCR yesterday but just couldn’t.  With respect –  and I like and generally respect the person concerned – that has to be nonsense.   Even if there really really are technical obstacles in one or two banks –  and why do no journalists go round and ask them individually? –  nothing stopped the Bank cutting the OCR to zero.  Nothing would have stopped them letting it be known they’d insisted that any technical obstacles be resolved before the end of June.  But there was nothing of the sort.

Instead, there was the repeated pretence that a gigantic asset swap –  buying government bonds and issuing government deposits instead (which is what Reserve Bank settlement cash is) –  was somehow a fully effective substitute.   This little clip is from the cartoon version the Bank does for the general reader (never clear how many of them there are).


So, yesterday’s substantive policy announcement was an 80 per cent increase in the (maximum) amount of government and local body bonds the Bank may buy over the year.

This was my initial reaction

Now as it happens, the exchange rate appears to have fallen by about 1 per cent on yesterday’s statement, and interest rates are down as well.  But much of that appears to be not because of the bond purchase programme – which was widely expected –  but because of the explicit references to the possibilities of a negative OCR next year.  It wasn’t really new, but apparently some must have focused on it afresh, and as a contrast perhaps to the outlook in the US and Australia.  Apparently, the OIS market is now pricing negative rates for much of next year.  The Governor may get his reported wish and retail interest rates may fall a little.

The bond purchase programme itself, however, remains largely theatre.  What isn’t clear is whether the Governor knows it and doesn’t care, or is a true believer.  There are hints in the text of the document that the staff know there is less to the programme than the Governor likes to make out.

As I noted in that tweet, there would be a credible case that big bond purchase programmes would make a real macroeconomic difference –  what we look for from monetary policy, as a key countercyclical actor – if:

  • insufficient settlement cash were an important constraint on banks’ activities, willingness to lend etc.  There is no evidence of that at all (and the Bank does not emphasise this channel either),
  • a lot of New Zealand borrowing was taking place at long-term fixed interest rates, and the interest rates on those products were significantly linked to interest rates on long-term government bonds.

But that isn’t so either.  Most New Zealand borrowing is done either at variable rates –  where the OCR is a key influence – or short-term fixed rates (lots of action in the mortgage market tends to centre on 1 or 2 year fixed rates).  Even when corporates go out and issue long-term bonds, they typically enter into swaps to shift back to floating rate terms (but with secure long-term funding).    The key entity that borrows long-term and is directly exposed to long-term rates is…..the ultimate non-market actor, the government.  In fact, it was telling that the MPS specifically claims one of the benefits of the asset purchase programme as being lowering the borrowing costs of the Crown –  but monetary policy is generally supposed in a neutral way across all sort of savers/borrowers.

There were a couple of interesting graphs in the MPS which seemed make my point.

bond mkts

In late March, there was a huge sell-off in all sort of asset markets, including global government bond markets.  The Bank has another chart nicely illustrating the blow-out in bid-ask spreads (which flowed through to investors more generally).  The bond market was not functioning very well, and you can see in the top chart how far long-term government bond rates rose relative to rates on interest rate swaps.  But it is the swaps that matter for general credit pricing in the economy, not the bonds themselves.  In the second chart, from a few days ago, government bond yields had come right back down again relative to swaps, but the swaps curve itself was only down about 20 basis points.

To repeat, I am not opposed to the Reserve Bank doing a bond purchase programme –  although I think they would be more sensible to follow the RBA and focus on targeting a short-term bond rate (say, the three year rate, as per the RBA).   Their activities helped stabilise markets –  which would probably have settled down eventually anyway –  and have lowered bond yields, but the scale of the effect on rates that really matter to the wider economy is small –  and not really consistent with the scale of the Bank’s claims.

Did I mention real interest rates?  Curiously, as far as I could tell in the entire document yesterday there was not a single mention (and certainly not in the upfront material the MPC itself more clearly owned).  Here is the interest rate swaps curve for 31 Dec last year and the close of business on Tuesday (with the market then fully expecting a big expansion in the bond purchase programme).

NZ swaps

The whole curve is down about 100 basis point since the end of last year.  Unfortunately, inflation expectations have fallen about 70 basis points, so that even real wholesale rates have not fallen very much at all. In face of the biggest sharpest slump on record.

As even the Bank acknowledges –  a point I’ve made here repeatedly –  there has not been that much action on retail rates, and in particular retail deposit rates have not fallen much at all.  In fact –  the Bank doesn’t point this out –  they’ve risen in real terms.  The Bank is reduced to plaintive appeals to banks to lower retail lending rates, even as they acknowledge that wholesale term funding costs also remain relatively expensive, in turn influencing what banks are willing to pay for term deposits.

The Bank’s final argument is to claim that the large scale asset purchase programme (LSAP) has reduced the exchange rate.  The Governor made that bold claim, while the staff are (rightly) more nuanced.

In addition to lowering interest rates, LSAPs put downward pressure on the New Zealand dollar exchange rate. The New Zealand dollar has depreciated in response to the COVID-19 outbreak (see chapter 4). It is difficult to disentangle the precise impacts of the Reserve Bank’s actions from a range of other factors that influence the exchange rate, in particular the volatile swings in risk sentiment over recent months and the actions of overseas central banks.

In principle, if the Reserve Bank has bought $10 billion of so of bonds, some of the sellers will have been foreign holders.  Some of them will have been unhedged holders of NZD, and they may now have closed out those positions.   But when the Governor and Bank were making these claims, the TWI was about 5 per cent below where it had been late last year, in total, from all influences.  Perhaps the LSAP had an effect at the margin, but if so it must have been relatively small, since the overall movement in the TWI was small relative to past, less severe recessions, and our overall yield curve is still not extremely low by international standards.

To repeat, I’m not suggesting the LSAP has had no effect, just that relative to the scale of the challenge –  the collapse in economic activity, employment and prospects for inflation – what has been done is just not remotely comparable to the scale of monetary easing that a serious central bank would normally have done previously.

And, actually, once you dig just a little into their numbers, even they tell you as much.  I reckon the Bank’s baseline scenario is rather too optimistic about the extent of the economic recovery, on current policies, over the next few years.  Their view on the unemployment rate in particular seems almost incomprehensibly optimistic on announced policy as at yesterday (which is what they said they were basing things on)  But even if one takes them at their word, this is their inflation outlook.

baseline inflation

Under the Remit given to them, the MPC is required to focus on the 2 per cent midpoint of the target range.  The bottom of the target range is 1 per cent.   They now expect annual inflation to be below 1 per cent for the next two years, on current policy.  At the end of 2022, on these projections inflation is still only 1.3 per cent, about as low –  core inflation terms –  as it ever got in the last 10 years.  I’m almost certain that the Bank has never published inflation projections that have annual inflation outside the target range for so long.  And it is not as if somehow there is overfull employment during this forecast horizon –  even on the (optimistic) Reserve Bank numbers, the unemployment rate is still 5.5 per cent three years from now.

It is really pretty inexcusable.  The MPC is keen to shift responsibility onto the government, claiming that fiscal policy has to carry the load.  But MPC has been given a task by Parliament and the Minister and are just abdicating responsibility for it.

The related thing I find troubling is that while the MPC acknowledges that the risks are to the downside, there is no sustained discussion of inflation expectations at all.  Neither the word nor the notion appear in the minutes of the committee’s deliberations.  I was talking to someone yesterday who told me he’d searched the document and the word “deflation” didn’t appear at all, and there is no hint of the Committee being alert to the risks, or even highlighting the powerfully deflationary nature of this shock.  If inflation expectations have already fallen so much, and yet the Committee is now content to deliver inflation below target for several years, isn’t it likely that expectations will fall even further?  Given the self-imposed limits on nominal interest rates, doesn’t that create a risk of further retarding the recovery, by driving up real interest rates?  Whether it does or not, you’d expect a serious MPC to at least engage with these sorts of issues and risks?

The unseriousness of it all was perhaps highlighted by this new chart, showing some sense of where the OCR might go if there were no (self-imposed) constraints.

unconstrained OCR

Something like -2 per cent would certainly be a great better than we have now (0.25 per cent, with a bit of help from the LSAP), but that would still amount to only 300 basis points of monetary policy easing –  small compared to 2008/09 or to 1990/91, even though the adverse shock this time is almost certainly much larger.  As I’ve noted before there were standard Taylor rule estimates for the US in 2008/09 suggesting that even then -5 per cent interest rates would have been helpful (although clearly not critical as the economy eventually recovered without them).  And I noticed yesterday one of investment banks estimating that for Australia –  with a less severe economic shock than New Zealand –  something like -5 per cent might be a Taylor rule recommendation now.   As it is, we have a tiny –  quite inadequate –  easing in real monetary conditions.

The MPC and the Governor are simply not taking things anything like sufficiently seriously.  They’ve deferred to fiscal policy, claiming (not very credibly) no inside knowledge of today’s Budget, but (a) it is four months from an election and who knows what fiscal policy will actually be delivered over time, and (b) as noted above, even with all that support, inflation still materially undershoots the target they have been formally given.

Finally, of course, there is no suggestion that the MPC is interested in doing anything at all to ease the rules –  imposed the Bank –  that create something like an effective lower bound (modestly negative) on nominal interest rates.  That is just irresponsible.   If the MPC won’t act, the Board should insist.  If they can’t make any headway –  or, more likely, won’t even try – the Minister needs to act.  At present, the MPC appears to be frustrating the clear intentions of Parliament and the Minister –  price stability with monetary policy doing all it can to support maximum sustainable employment.  Laws are written to provide remedies for these exceptional circumstances.  If the Minister refuses to use them, he shares the blame.

For his Zoom press conference yesterday, the Governor was flanked –  excuse the grainy photo – by his billboard boasting of/aspiring to being “Best Central Bank”

orr photo

You be the judge.    But however well the people down the organisations are doing, the statutory appointees –  those we are supposed to be able to hold to account –  are again/still falling well short, led by the Governor.

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 interest.co.nz.   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.