A run on the bank (well, building society)

Being a bit early for an appointment yesterday, I ducked into a secondhand bookshop and emerged with a history of Countrywide Bank (by Tony Farrington, published in 1997), to add to my pile of histories of New Zealand financial institutions and major corporates.   For younger readers, perhaps unfamiliar with the name, Countrywide grew up from the building society movement, became a bank in the late 1980s after deregulation, and was taken over by the National Bank (itself later taken over by ANZ) in the late 1990s.

As I idly flicked through the book, I came across the account of one of those little episodes in financial history that (as far as I know) are not that well documented: the run on the building society, in April 1985.  Literal physical retail bank runs –  people queuing in bank branches and out onto the street – just aren’t that common.   When there was a run on Northern Rock in the UK at the start of what become the widespread financial crisis of 2008/09, the story was told that it was the first retail run in the UK for 140 years.  I am not sure if that is strictly true, but (fortunately) such runs are rare.   Deposit insurance supposedly contributes to that, but so do well-managed banks.

In April 1985, it was still the very early days of the comprehensive new wave of financial liberalisation that had begun when the Labour Party had taken office the previous July.  And it was only six weeks since the exchange rate had been floated, and five weeks or so since the extreme pressure on liquidity had seen overnight interest rates trade up towards 1000 per cent.  One-month bank bill rates peaked at about 70 per cent, and three-month rates peaked at around 35 per cent before the Reserve Bank intervened to stabilise the situation.  The overall level of interest rates had risen enormously (even post liquidity stabilisation) and anyone left sitting on (say) long-term government bonds faced very substantial mark-to-market losses.   There was a great deal of uncertainty about who might flourish, and who not, in the new environment.  And the newly-floated exchange rate was not exactly stable.

According to the Countrywide history’s account, in early April there had been rumours circulating for several days about the viability of Countrywide, which crystallised on Wednesday 10 April when an Auckland radio station ran a comment from one of their journalists that “there is no truth in the rumour that Countrywide is in financial difficulty”, which seems to have made the rumour much more widely known than it had been.

Countrywide protested to the radio station (perhaps reasonably so, but inevitably it was futile –  what was done was done), and they prepared a media release supposed to highlight their strength, but it took several days to get this in daily newspapers.  Reading the release now, with 34 years hindsight, I’m not sure that as a nervous depositor I’d have been reassured by it –  indeed when financial institutions boast about how rapidly they had been growing (in a climate of big changes in relative prices, and a great deal of uncertainty) it is probably reason for increased unease.

By this time, deposit withdrawals were already increasing significantly, and management was at pains to ensure that no branch was in danger of running out of cash even briefly.    And by this time, management had tracked down how the rumours seem to have started –  in the failure of a totally unrelated trucking company Countrywide Transport Systems Limited.  By then, the knowledge wasn’t much use to them.  They’d planned a press release explaining where the rumour had come from, but before it could run they had to deal with a development completely from left field: a Social Credit (monetary reformers) MP had issued a press statement referring to “widespread rumours about the impending collapse of a major building society” (by this time there were only two majors).

Countrywide called in the Reserve Bank and the then Governor, Spencer Russell, managed to get hold of the MP concerned –  at Wellington airport –  within 45 minutes of the statement being issued.  Morrison retracted the statement, but it was too late. As the history records “hundreds of depositors demanded their money”.

The run seems to have been focused in Wellington (and Hamilton), with queues outside several branches – 50 metres down the street outside the main Lambton Quay branch.   By the end of the day, customers had pulled out $10 million of deposits (Countrywide’s total assets then were about $445 million).  The next day, Thursday, they lost another $9 milliom in deposits (not just “mums and dads”, with withdrawals by solicitors being particularly evident.

The powers that be engaged in a significant (and successful) effort to staunch the run, with statements from the Associate Minister of Finance, the Governor of the Reserve Bank and the chief executive of the National Bank all reassured the public that Countrywide was sound.  By the Friday, it was estimated only $1 million of panic withdrawals occurred.

(These numbers don’t fully add up but) the history records that total deposit losses over the period of the run were around $30 million –  a far from insignificant share of total deposits.  Countrywide estimated that the run had involved a  direct P&L hit of around $1m, arising from the need to liquidate assets (government stock) in a rush, and additional staff, advertising, and communications costs.

And then the money flooded back –  it is recorded at times there were long queues to deposit the funds that had been withdrawn just a few days previously.   And the history mentions –  without comment –  that people were often depositing the same cheque they had taken from Countrywide only a few days previously.  I don’t really remember the run –  I was a junior Reserve Bank economist doing monetary policy stuff, and yet there is no mention of the run in my diary at all –  but that factoid was grist to the mill in debates about financial stability for years to come.  If you were so concerned about the health of your bank (building society) as to run on the bank, spend an hour in a queue, forfeit your place in the queue for mortgage eligibility (this was a thing still in 1985), why would you (a) take a cheque from the very bank you were concerned about (the danger of mugged on Lambton Quay had to be small, for example), and (b) why would you then not bank it straight away and pay for expedited clearing?  I still don’t claim to fully understand the answer to either question.

Eligibility for mortgage lending was still an issue in early-mid 1985.  Banks and building societies had been liability-constrained, and thus the practice grew up of having to have a suitable “savings record” with a specific lender to get a (first) mortgage (at least if you didn’t work for a bank, an insurance company, or the Reserve Bank).  The lender was doing you a favour not (as now to a great extent) the other way around.   Pulling your money out of the financial institution you might want to borrow from really was a big issue. Of course, better to lose your place in the mortgage queue than to lose your deposit (had it come to that), but it was a hurdle many depositors faced then that they would not face now.

As it happened, times were a changing, and the history records that Countrywide eventually “relented” (their words) and restored to their place in the mortgage queue those who had pulled their money out in the run.  Before very long, those depositors would have found other lenders competing to lend to them.

There are quite a number of unanswered questions in the Countrywide history (unsurprisingly –  geeky monetary economists weren’t the target market for the book), and I had a look at various other books on my shelves to see if I could find any other angles.  There was nothing in Roger Douglas’s book or in the biography of (then Deputy Governor) Roderick Deane, but there was a brief mention in the history of the Reserve Bank published in 2006.   Here is the relevant text.

countrywide.png

But, of course, that passage only raises further questions, including ones about how the Governor (or the Associate Minister) could be confident in their assertions about the soundness of Countrywide.  Whatever the substantive health of the institutions, were their statements well-founded in verified and verifiable data, or were the statements to some extent a confidence-trick: well-motivated, but actually based on little or no more information than the public had?    (There are readers of this blog who would pose similar questions about the style of bank supervision adopted by the Reserve Bank to this day.)   The Bank’s files may offer some answers (or maybe not).  And was the statement of support from the National Bank chief executive supported by offers on unsecured liquidity assistance (that would be a clear signal of confidence that might have encouraged the Reserve Bank).

Perhaps  the authorities made a relatively safe call –  after all, resurgent inflation meant that the value of Countrywide’s loan collateral was rising. On the other hand, like all regulated entities in those days, Countrywide had had to hold significant amounts of government securities, and government security interest rates had risen sharply.    Many institutions –  notably the trustee savings banks –  had taken big mark to market losses, and there was a strong sense that the viability of some of them would have been in jeopardy, especially if there had been timely and clear mark-to-market reporting.  Add in the high and very variable wholesale funding costs (probably only a small proportion of Countrywide’s funding) and one is left wondering how robust an analysis lay behind the official statements of support.  There was another building society run –  on competitor United –  a few years later, and the Reserve Bank history records that that time United took the view that official statements of support (Governor and Prime Minister) were tardy.    What sort of rethinking went on internally after the Countrywide episode?

I’m not playing any sort of gotcha here.  If anything, it is more a plaintive appeal for some economic and financial historian to undertake a systematic treatment of the New Zealand banking and financial sector through the liberalisation period.    There were all manner of small crises and near-crises during this period (PSIS, the devaluation “crisis”, Countrywide, United, RSL, the DFC, NZI Bank, the BNZ (twice) and probably others that don’t spring immediately to mind.  There are serious scholarly treatments of the experience in the Nordic countries with liberalisation at about the same time, but surprisingly little about New Zealand.

Not, I suppose, that historians will be able to help answer the question of why panicking depositors took their money in a cheque and then, it appears, in many cases didn’t even rush to get the cheque cleared, or to bank it at all.

I’m sure there are readers who were involved to some extent in these matters, whether at the Reserve Bank or elsewhere. I’d welcome any perspectives or insights in comments.

Economic failure: the reluctance to recognise the implications of extreme remoteness

As regular readers know, I tend not to be particular upbeat about the New Zealand economic story.  For anyone new, there should be a hint in the very title of the blog.  If, by chance, you are still attracted to an upbeat take, only last week in a post here I critiqued a recent book chapter taking that sort of view.

And so I was a bit surprised when, more than a year ago now, I was asked to write a chapter for a forthcoming book on aspects of policymaking, and associated outcomes, in a small state (this one).  In principle, the book sounded potentially interesting, and they were approaching a bunch of pretty serious and senior people to contribute.  But it wasn’t clear there was much in it for me, and since the plan was for the introduction or foreword to have been written by the head of the Department of Prime Minister and Cabinet, it seemed likely that the thrust the organisers were looking for was a positive take on the New Zealand story.   So as not to mess people about, I declined the invitation, only to have my arm twisted, with assurances that there was no such agenda.  In the end I agreed to write something, and although the organisers/editors still seem keen on a more positive spin, by the time I discovered that I was committed.

The latest draft of my chapter, attempting to be positive where I can, is here.

An underperforming economy; the insufficiently recognised implications of distance (draft chapter)

I’ve had useful comments from various people on an earlier draft (none of them bear any responsibility for the current version though), but if any readers have comments you’d like to add to the mix, you can earlier leave them as comments to this post or email me directly (address in the “About Michael Reddell’s blog” tab).

The potential market for the book, as I understand it, is people like students of public policy, perhaps in parts of Asia.  Many of these potential readers, I’m given to understand, see New Zealand as a sucesss story.   Within the (severe) limitations of length, I’ve set out to provide a more balanced take on the economic story.  In a way, I guess, New Zealand is a sort of success story.  200 years ago on these islands there was not much more than a subsistence economy, and only recently had overseas trade resumed after the inhabitants had been isolated for several hundred years.  From that to one of the richest countries in the world in a hundred years was remarkable.  And even now, after a century of relative decline,  there is only a handful of countries in east Asia and the southwest Pacific with material living standards matching or exceeding our own (Australia, Japan, Singapore, Taiwan, with South Korea coming close).   And from a macroeconomic policy perspective, we’ve now had low and stable inflation again for 25 years, have had low and stable public debt, and a considerable measure of financial stability.  That isn’t nothing by any means.

But it doesn’t exactly mark us out.  What does mark us out is that century of relative decline: of course, we are much richer than we were 100 years or so ago, but then we were among the top three countries in the world (GDP per capita), and now we languish a long way down the advanced country rankings (especially on productivity measures).    With productivity levels not quite 60 per cent of those in the leading bunch of advanced economies, we are getting closer to the point where New Zealand could really only be described as an upper middle income country.

My story, as a regular readers know, is that our physical remoteness –  in an era where, internet notwithstanding, distance appears to be not much less of a constraint than ever in many respects – is the key issue in our underperformance.  It isn’t that –  as some models and sets of estimated equations suggest –  distant countries are inevitably poorer, but that distant countries seem to thrive (to the extent they do) mostly on natural resources, and industries building directly on those resources.  And with a limited stock of natural resources, there are limits to the number of people that such places can support top tier incomes for (a very different proposition than for economies –  eg those of northwest Europe – where most of the most productive economies are found) where natural resources are simply no longer that important, and where the advantages of proximity can be realised more readily.    The story is much the same for Australia as for New Zealand –  and Australia has also been in (less severe) relative decline over the last 100 years – with the difference that Australia found itself able to utilise whole new sets of natural resources, either unknown or uneconomic previously.  New Zealand has had nothing – that material – similar, and no big asymmetric technology shocks in our favour for a long time either.   Against that backdrop, using policy to drive population growth (rapid by advanced country standards) simply did not make sense –  putting more people in a fairly unpropitious location, albeit one with some reasonable economic institutions (rule of law etc).  It didn’t make sense decades ago –  before people fully appreciated the nature of New Zealand’s relative economic decline –  and it doesn’t now.   There was a valuable signal, that policymakers and their advisers simply chose to ignore, when New Zealanders –  who know New Zealand best –  starting leaving in numbers that (while cyclical variable) are really large by international or historical standards (absent a civil war or the like).

Perhaps the new bit to my story in this draft chapter – which was prompted by the way the initial specification was framed –  was to think about why the stark economic underperformance has been allowed to go on, not just by our politicians and political parties, but with no compelling remedies offered by our major economic policy advisory institutions (The Treasury in particular) or by international agencies that offer advice (notably the OECD).  I suggest a story in which it is simply difficult to identify that right comparator countries when thinking about economywide productivity and economic performance issues.  For many areas of policy –  monetary policy is an example, but it is probably true of health and education and welfare –  pretty much any advanced market economies can offer useful benchmarking, but if remoteness really does matter (not just to, say, defence, but) to the viable options and business opportunities available here, then the experiences of –  say –  Belgium or Denmark just aren’t likely to be that useful, even if Denmark has a similar population and was once the major competitor for UK dairy markets.

We may be able to learn something from reflecting on the differences, but it is typically much more compelling if one can point to another similar country (or 2 or 10 of them) and learn from them.   And thus I note an important difference between New Zealand and many of the (now fast) emerging advanced economies of central and eastern Europe.  Not only are they physically proximate to various highly productive economies (easy and cheap to meet fellow policymakers and analysts regularly, including in EU fora), but have a lot of similarities across each other (similar location, similar communist past, and so on).     I don’t claim to know Hungary, Slovenia, the Czech Republic or Slovakia in great detail, but if I were a policymaker in any of them, I’d be (almost obsessively) benchmarking my economic policies against those of the others, and of nearby rich and productive countries (eg Austria and Switzerland).  There are never exact parallels, but in New Zealand’s case it is hard to find good parallels at all. I suggest that Israel might be in some respects the best for New Zealand –  but it is little studied here (and its productivity performance is about as bad as ours –  partly, I’ve suggested, for similar reasons).

The lack of easy examples to benchmark ourselves against isn’t really an acceptable excuse, but I suspect it is part of the explanation.  It is long been a problem for the OECD in their advice to New Zealand: they’ve repeatedly brought a northern European mindset to a remote corner of the world, after early on investing quite a lot in the idea that the New Zealand reforms were exemplary, and almost sure to reverse our underperformance.  Places like the OECD work a lot on illustrating cross-country comparisons, but they simply never found the right ones for New Zealand (on these economywide issues) and have not shown much sign of trying.  It is particularly problematic because the OECD are full-on committed to high immigration, regardless of the experience of an individual country (see my post about the then OECD Chief Economist extraordinary performance when she launched their 2017 New Zealand report – there is a new report due out in a few weeks, and I’m not holding my breath).

Of course, New Zealand politicians no longer seem to have any appetite for trying to reverse the staggering decline in New Zealand’s relative performance.    But just possibly they might if their advisers were offering a compelling diagnosis and set of prescriptions.  As it, The Treasury seems to have no more idea than the OECD, and seems to have abandoned much interest in the productivity issue, in favour of the feel-goodism and smorgasbord of random indicators that makes up the Living Standards Framework, supporting the “wellbeing Budget”.  I was exchanging notes the other day with someone about the mystery as to who the next Secretary to the Treasury will be (there is a vacancy a month from now, and applications closed three months ago).  It is hard to be optimistic that it will make much difference who gets the job –  given the hoops they will have to have jumped through to get it –  but sadly it is a story of a low-level equilibrium: no political demand for answers and options to reverse our decades of relative decline. and no bureaucratic supply of such answers or the supporting analysis either.

Anyway, for anyone interested here are the concluding paragraphs.

Conclusion

After the bold reforming period of the 1980s and early 1990s, official and political economic policymaking in New Zealand appears to have been at sea, without a tiller or compass, for at least a couple of decades.   Much that was positive was done during the reform era, and various good institutional reforms were put in place.  Much needed to be done, and in some respects it was to the credit of a small country that so much – initially attracting considerable international admiration –  could have been put in place so quickly.    Seared by the experience of the quasi-crisis of 1984, and rapid escalation of official debt in the previous decade, New Zealand has since enjoyed an enviable degree of macroeconomic stability: low and stable public debt, low and stable inflation, and domestic financial stability (even amid severe policy-induced upward pressures on house prices and household debt).  Unemployment rates that are fairly low on average are another successful element.   In those areas of policy, meaningful international benchmarks have provided a routine check of policy, and the external advice sometimes provided has typically been drawn from countries (small floating exchange rate countries), where the comparisons are apt and insightful.

But if stability has been successfully regained and maintained, on the wider counts of economic performance only a “fail” mark could possibly be assigned.  Among the failures, policymakers managed to preside over reforms that have created artificial scarcity of urban land and sky-high housing prices, in common with many of their Anglo peers.  But the productivity failure is more stark, because it is more specific to New Zealand.   Despite numerous (de)regulatory steps taken to open the economy to international competition –  and a considerable increase in the real volume of exports and imports –  foreign trade as a share of GDP has shrunk and with it the relative size of the tradables sector.  The export sector itself remains heavily dominated by industries reliant on domestic natural resources (a fixed asset) – services exports have been shrinking as a share of GDP – and, despite rapid population growth, business investment has been modest at best.

To an outsider, perhaps the surprising feature of such an underperforming advanced economy is that population growth has nonetheless been quite rapid. Birth rates have been below long-term replacement rates for several decades now. But defying the revealed preferences of New Zealanders, who have left the country in huge (but cyclically variable) numbers over the last 50 years for 25 years now policy has been set to bring in one of the largest migrant flows (per capita) of any advanced country.   Regularly presented as a skills-focused approach, it has remained difficult to attract many really talented people to a small remote country with lagging incomes and productivity[1] and there have been few (apparent or realised) outward-oriented economic opportunities in New Zealand for either natives or migrants.

Advocates and defenders of New Zealand immigration policy often attempt to invoke arguments and indicative evidence from other countries.  Even then, the value of insights appears more limited than the champions believe: not one of the high immigration advanced economies (Canada, Australia, New Zealand, Israel – or the United States) has been at the forefront of productivity growth over the last 50 years, and only the US is now near the frontier in levels terms.  But even if those arguments might have some validity in some other countries, there has been too little serious engagement with the specifics of the New Zealand situation: remoteness, lack of newly-exploitable natural resources,  and the actual experience (lack of demonstrable gains for New Zealanders) following 25 years with a high level of (notionally) skills-based immigration.    As by far the most remote of any advanced country, it is perhaps the last place one might naturally expect to see policy actively working (encouraged by local officials and international agencies) to support rapid population growth.

Looking ahead, if New Zealanders are once again to enjoy incomes and material living standards matching the best in the OECD, policy and academic analysts will have to focus afresh on the implications, and limitations, of New Zealand’s extreme remoteness and how best policy should be shaped in light the unchangeable nature of that constraint (at least on current technologies)   Past experience –  1890s, 1930s, and 1980s – shows that policies can change quickly and markedly in New Zealand.  But with no reason to expect any sort of dramatic crisis – macro-economic conditions are stable, unlike the situation in the early 1980s –  it is difficult to see what might now break policy out of the 21st century torpor or, indeed, whether the economics institutions would have the capacity to respond effectively if there was to be renewed political appetite for change.

[1] OECD (2016) adult skills data suggest that although the gap between skills of natives and migrants is small, migrants to New Zealand are, on average, less skilled than natives.

There won’t be any posts for a few days as we are heading off this morning to attend the funeral for my wife’s (extremely aged) grandmother.  Back blogging on Tuesday.

(Un)successful public policy

Yesterday afternoon I saw this in my Twitter feed

My first thought was along the lines of “well, I guess there is nothing about New Zealand economic policy”, (a) so poor has our long-term performance been, and (b) because surely outcomes matter?.   But I’m a policy geek sort of person, ANZSOG is chaired by our very own State Services Commissioner, and ANU is the top-ranked university in Australasia, so I clicked the link to see what examples of successful policymaking in New Zealand they’d found. To my surprise I found this

New Zealand’s economic turnaround: How public policy innovation catalysed economic growth (PDF, 0.2MB)Michael Mintrom and Madeline Thomas

(Downloads of all the individual chapters appear to be free, and there are pieces on ACC, early childhood education, Kiwisaver, nuclear-free New Zealand, and so on, some of which may interest some readers.)

But I was a bit flummoxed even by the title of this economic chapter.  I recognised the “public policy innovation” –  thirty years on I still support most of it –  but the idea of an “economic turnaround” or “catalysed economic growth” seemed, to say the least, at odds with the data.

Mintrom is a public policy academic, now at Monash University in Melbourne. He worked for The Treasury for a few years in the late 1980s before heading off to do his PhD.  But, from the look of his publications, he seems to know a lot about public policy processes, but not necessarily a great deal about economic growth or overall economic performance.  Thomas is his research assistant, with a psychology degree and some experience working on social policy with local governments.

When I got into the chapter itself it turned out the authors were focusing on a handful of specific initiatives undertaken in the late 1980s and early 1990s:

  • reduction of market interventions (controls, subsidies, import restrictions etc),
  • creation of SOEs and subsequent privatisations,
  • simplification of the tax system and introduction of GST, and
  • passing responsibility for monetary policy to an independent Reserve Bank.

And they lay out early on how they define success.  Their first criterion is endurance, and thus they argue that “these policy innovations have now remained in place for decades. Thus, judged by endurance, they have been highly successful.”

There, it would appear, speaks someone more interested in processes than outcomes.  After all, the broad range of policies the 1980s and 90s reforms replaced –  exchange controls, heavy import protection, monetary policy set by ministers – also lasted for decades, and were generally not accounted a success.   The Soviet Union managed 70 years.

But the authors offer three other perspectives from which to view the success of the policy programme.  There was something called the “programmatic perspective”, which seems to be encapsulated in these two sentences:

A highly coherent theory of change guided the development of these policy innovations.  After a relatively short time, it was clear the changes were producing beneficial outcomes.

Then there is the “process perspective”, where they claim (and I mostly wouldn’t disagree) that “the policy innovations were well designed and generally well managed”.

And, thirdly, there is the political perspective, which they describe as “more complicated”.  That, presumably, does duty not only for the deep divisions that opened up in the Labour Party, Jim Anderton’s breakaway, and the divisions that opened up in National, culminating in the founding of New Zealand First, to all of which one could add the public sense that politicians hadn’t been straight with them (many readers will be too young to recall that in 1987 Labour published its manifesto the week after the election) and the replacement of FPP by MMP (you may think that change good, but it simply wouldn’t have happened without the ructions of the previous few years).

Remarkably, in a chapter focused on economic policy and –  at least according to the title –  economic growth, the authors take as their “starting point” several very positive assessments of the reforms written from 1994 to 1996.    Some of those articles are valuable, but each was written with the benefit of almost no distance or perspective, and were written a quarter of a century ago.  I found it remarkable that in a chapter about New Zealand’s economic growth, there were no references at all to the literature over at least the last decade about New Zealand’s disappointing productivity performance (sometimes, but quite wrongly, characterised as the New Zealand “productivity paradox”).    Those concerns, from extremely orthodox sources, have been around much longer than that: I happened to be dipping into the OECD’s 2000 report on New Zealand yesterday and found explicit concerns there about the failure of the New Zealand economy to converge, highlighting in particular the disappointing productivity growth.

The first part of the chapter is devoted to rehearsing some of the political and economic context for the reforms –  with which I mostly have only relatively minor quibbles – before they move on to focus on the four areas of reform (listed above).  Again, as pure description, it isn’t too bad –  with the odd annoying mistake (eg the exchange rate was not pegged to the US dollar in 1984, the price freeze had been lifted before the 1984 election), but whenever there is any sort of evaluative tone it is almost always very upbeat.  And perhaps only a young Treasury official from those days could describe, with a straight face, the Treasury’s approach to other departments as “Treasury analysts showed a great desire to….seek insight from colleagues in other departments”.

There is a variety of odd claims.  Thus,

The move to a more independent Reserve Bank came after several years of a floating New Zealand dollar, which was also viewed as a key element of market liberalisation; it was therefore uncontroversial.

Where did they get that from?  The Reserve Bank Act was intensely controversial at the time, with considerable opposition (wrongheadly in my view, but it was there nonetheless) from most prominent academic economists in New Zealand and some vocal business lobby groups.  The authors talk up the legislation passing Parliament unanimously (perhaps so if Jim Anderton was away that day), but if they’d done even the slightest refreshing of memories, they’d have been aware that the legislation divided both major party caucuses.  National – in Opposition – voted for the legislation, but Ruth Richardson’s former economic adviser recorded later that the vote in favour at caucus secured a majority of only one: Sir Robert Muldoon (opposed) was away seriously ill, and Winston Peters (opposed) for some reason skipped the meeting.   And I’ve perhaps mentioned before that in every subsequent election –  down to and including 2017 – one or other political party was campaigning on a platform of changing the Policy Targets Agreement or the Reserve Bank Act.

There are other odd claims.   The authors are mildly circumspect about aspects of the privatisation programme (“some sales were poorly managed”), but then cite as evidence of the “policy success” of the Labour government’s privatisation programme, that the succeeding National government did more privatisations.

The authors begin their Analysis and Conclusions section suggesting that in the early 80s New Zealand was heading towards “economic collapse”, but that is simply overblown political rhetoric for a process of stagnation, fairly high and variable inflation, and rising debt.  The broad direction of policy was still towards liberalisation, but it was a halting, half-hearted, and inconsistent process.  A crisis it wasn’t –  even if forced devaluations make good headlines.  Thus, the authors note that “unemployment grew” and yet the historical backdating of the HLFS suggests that the unemployment rate in June 1984 was 4.4 per cent, almost identical to the current rate.

What else struck me?  There was the claim –  about the 80s period –  that “through listening and working with others – even those who might have strong objections to a proposals –  it is possible for advocates of change to improve policy design and build a strong colation to support change”.  No doubt that is true generally, but it bears very resemblance to anyone else’s impressions of 1980s/90s reform period –  it was. after all, Roger Douglas, who championed the approach of “crash through or crash”.

Our authors carry this lesson forward:

“subsequent New Zealand governments have achieved important reforms while moving more slowly and working to ensure implementation is well managed. For example, the National Party-led coalition of 2009-17 [wasn’t a coalition, and it was 2008-17, but I guess those are details] established a new program of privatisation of government assets. Important work was done that drew on lessons from hre past and met considerable success.”

You might –  as I did –  have supported those more recent partial privatisations, but lets remember how small they were.  One of the companies involved was already market-listed (Air New Zealand) and all are still majority state-owned.    And the list of “important reforms” undertaken by that more recent government was limited, to say the very least.

The very final (short) paragraph begins this way.

In sum,we judge New Zealand’s economic turnaround to have been a major public policy success. Innovative public policy changes catalysed economic growth.

And yet, remarkably, in the entire chapter there is not a single number or chart or even a discussion of the specifics of economic growth. Not one.  And despite (rightly) lauding the removal of protection and subsidies, no mention of the fact that foreign trade as a share of GDP is no higher now than it was in 1984.   Absent evidence of this “catalysed economic growth”, perhaps we are just supposed to imagine it, and somehow feel better for the thought?   But I hope this isn’t how ANZSOG helps train our public servants.

My own take on the reform and stabilisation effort of the 1980s/90s is roughly as follows:

  • stabilisation was a major success.  We have low and stable inflation, low and fairly stable government debt.  We also have a considerable measure of financial stability.  For all that, we should be truly grateful.  But we should also recognise that (a) low and stable became a pretty global phenomenon (especially in the advanced world) around that time, and (b) that various other well-managed countries (eg Australia, Canada, Sweden, Switzerland) have much the same sort of fiscal record we do.  That leaves me sceptical of stories which put too much emphasis on specific New Zealand events, circumstances, law, individuals, or policy processes.    Moreover –  and I don’t think this appears in the chapter at all – we have greatly benefited from a big increase in the terms of trade (reversing the couple of decade decline that policymakers from the late 60s to mid 80s had to cope with),
  • many of the specific reforms (including those Mintrom and Thomas deal with) served us well.   Lower import protection, a well-designed GST, injecting much greater efficiency into state trading operations and a bunch of others benefited most New Zealanders.
  • but that isn’t true of all the reforms.  One might focus in on the RMA and associated provisions which have given us among the most unaffordable house and urban land prices in the developed world, or one might look at the tax treatment of savings.  And then there are the immigration policy reforms.
  • and, as honest observers have known for 20 years, there has simply not been the productivity turnaround that champions of the reforms hoped for at the time (and there is also no reason to suppose that problem is just that we didn’t engage in radical enough reform.)

Here is a table I was working on the other day, comparing average productivity in New Zealand with that of a leading bunch of OECD countries.

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The book was an ANZSOG project.  Here is labour productivity for New Zealand relative to Australia, indexed to when the New Zealand domestic data start in 1989.

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I reckon there is a plausible argument that the whole reform programme taken together slowed the rate of decline in New Zealand’s relative fortunes (although even that isn’t clear-cut: the rate of decline slowed, but I’ve not seen any careful attempt to assess how much of that was policy and how much about, say, improvements in the terms of trade).

But that isn’t the case Mintrom and Thomas attempt to make.  Judged by economic growth outcomes –  the sort of criterion their title asks us to use –  the programme just cannot be judged a great success. Perhaps the processes were good in some respects, and there was certainly a lot of intellectual rigour behind some of the reforms. It remains a fascinating case study in concentrated far-reaching reform.  But the productivity results really suggest that the episode belongs in another book, about the disappointing results despite the very best of intentions.  Those are salutary lessons policy advisers need to be trained in too.

How we –  certainly anyone who supported, voted for, worked on the reforms –  wish the outcomes had been different –  much better.   But they weren’t.  That is a failure –   uncomfortable as it is, there is no other word for it –  politicians and policy advisers have to grapple with honestly.

 

 

 

 

 

An expert weighed in on Reserve Bank reform

I was exchanging notes last week with someone who is doing research on New Zealand economic policy, and the development of economic institutions, in the 1980s and 1990s.  In the course of that conversation he sent me a copy of interesting short paper –  presumably obtained from the national archives –  from the period when the thinking and debates that led to the Reserve Bank of New Zealand Act 1989 were underway.

Reform of the Reserve Bank had been in the wind for some time.  Loosely, the Reserve Bank tended to be keen on an independent central bank, and recognised that some accountability procedures would be part of the price of that.  On the other side of the street, the Treasury was keen on an accountable and efficient central bank.  Neither institution –  nor the key ministers at the time –  wanted the Minister of Finance to be determining day-to-day monetary policy. (Ministers determining policy adjustment had been the standard practice, by law, for decades – and it was the practice at the time in most western countries, the exceptions being Switzerland and West Germany and (more or less) the United States.)   Everyone involved wanted a much lower average inflation rate than New Zealand had had in the 1970s and 1980s.

The Treasury was heavily involved in work on reshaping the institutional form of much of what central government did.   Of particular relevance was the new state-owned enterprises (SOE) model, adopted for many/most government trading enterprises (NZ Post, for example, is still with us today).    The Reserve Bank, then as now, was a somewhat anomalous organisation and part of the – at times – acrimonious debate between the Reserve Bank and the Treasury over several years reflected the idiosyncratic nature of the institution, and differing views over what parallels or comparators were relevant.    For example, were banknotes or the retail government banking operations, or the sale of government bonds really just commercial activities really just commercial activities.  And might the (apparent) policy goals be achieved better in an organisation given more commercial incentives.

At one end of the spectrum was a proposal out of The Treasury in late 1986 to turn the Reserve Bank into an SOE (it was never quite a final Treasury proposal, but was written by a senior Treasury adviser and taken seriously as the highest levels of The Treasury.  For anyone interested, you can read more about it in Innovation and Independence, the 2006 history of the Bank (bearing in mind that that history was very much written from a Reserve Bank perspective, one of the authors not only having been an active protagonist in the late 1980s debates but at the time of writing serving as chair of the board of the Reserve Bank).

The proposals were stimulating, far-reaching (including allowing for the Reserve Bank to be declared bankrupt and statutory managers appointed) and –  in the views of probably all Reserve Bankers involved at the time (and in my view now) –  quite unrealistic, and failing to really grapple with the reasons for having a central bank at all.  I am one of those who believes that the economy and financial system could function adequately without a central bank –  although on balance I think a central bank can improve our ability to cope with severe shocks –  and in many respects the logic of the Treasury position might have been better developed into a proposal to explore whether we could do without a central bank altogether.  But they didn’t.  (Had the Bank been abolished, my position –  then and now –  is that New Zealand would fairly quickly have become a de facto part of the Australian dollar area, with monetary conditions influenced by the RBA with Australian perspectives in mind.  That is probably clearer now than it was then –  in 1986/87 only Westpac and ANZ of the larger banks were Australian owned.)

But the point of this post isn’t to rehearse all the old debates. I was overseas on secondment at the time, and only got involved in the debates (which lingered in various forms for several years, even after the Reserve Bank Act was passed) a bit later. But I was intrigued by this one particular paper I was sent last week.

The Reserve Bank has received the “Reserve Bank as SOE” proposal in November 1986.  At the time, the Reserve Bank Board was the decisionmaking body for the Bank itself (although not on monetary policy, which was in law set by the Minister).   The Board asked management to obtain independent expert analysis and advice on the Treasury ideas and for their March 1987 meeting the Board had in front of it a six page commentary from Professor Charles Goodhart.

Goodhart is one of the more significant figures in the last 50 years or so in thinking and writing about central banking.   At the time, he was Professor of Money and Banking at the London School of Economics and had previously served as Adviser to the Governor of the Bank of England.  He had relatively recently published an influential book The Evolution of Central Banks: A Natural Development? (and had been the star guest, and guest lecturer, at the Reserve Bank’s somewhat-extravagant 50th anniversary celebrations in 1984).  Goodhart was very smart and thoughtful, but well-disposed to a traditional (British) view of central banks.

A decade later, Goodhart served as one of the first members of the UK Monetary Policy Committee, after the newly-elected Labour government in 1997 gave the Bank of England operational independence in the conduct of monetary policy.  But in 1987, the Bank of England was, to a considerable extent, the executing agent for the policy choices of the Chancellor of the Exchequer –  the Chancellor being advised by both the Bank and the Treasury, and typically being closer to The Treasury (in the UK ministers have their offices in the department for which they are responsible, not something akin to the Beehive).  It is worth noting that by 1987 the UK had successfully lowered its inflation rate very substantially (the UK inflation record in the 1970s had been, if anything, worse than New Zealand’s).

It is perhaps also worth noting that when the Reserve Bank of New Zealand Bill was finally brought to Parliament in 1989, Goodhart played an important role in providing public support (including FEC testimony) for the chosen model.  Part of that involved providing an academic counterweight to the New Zealand academic (macro)economics community, most of which, at very least, sceptical of the legislation.

But that was 2.5 years later, long after the notes for the Reserve Bank Board had been written.  In those notes, Goodhart’s stance –  while useful to the Bank in countering Treasury – was very different to the legislation he later provided public endorsement to.

The first half of the paper (history and theory) is interesting, but not particularly controversial for these purposes. But the second half is about “policy conclusions”, drawing from an analysis that was generally in favour of (a) discretionary monetary policy, and (b) a central bank not influenced by profit-maximising considerations.

Here is his view on who should do what

goodhart 1

Get the Minister of Finance further away from the conduct of monetary policy and let the Reserve Bank itself decide what rate of inflation to target.  (This was more than year before “inflation targeting” itself became a thing, and was presumably just about setting a broad direction for policy –  in New Zealand at the time there was, for example, beginning to be talk about “low single figure inflation”).

I don’t suppose that idea went down overly well with his Treasury readers (including the Secretary to the Treasury who was then a member of the Board).

One of the later mythologies that developed around the Reserve Bank Act (over the years we spent a lot of time rebutting it) was that the Governor’s salary was tied to the inflation target.  It never was.    But until reading this paper I hadn’t realised where the possibility of making such a link had come from.  Here is Goodhart, talking about accountability.

goodhart 2.png

Wow.  At this stage, there was still no sense of making the Governor the single decision maker, but a leading academic writer on central banking was seriously proposing not just that the Reserve Bank should be able to set a target rate of inflation for itself, but that a range of key executives should be partly paid in the form of options that would pay off if the target was met.    He doesn’t seem to notice, for example, the distinction between a private business (operating in a market it can’t control) and a public agency able to do whatever it takes, at whatever short-run cost, to achieve a target rate of inflation.

At the time, there was still a presumption that decisionmaking at a reformed Reserve Bank would be made (ultimately) by the Board –  as, of course, responsibility in SOEs and many other Crown agencies rested with the respective boards.  The Board was largely non-executive (Governor, Deputy Governor, Secretary to the Treasury plus other members appointed by the Minister) and Goodhart moves on to discuss the issue of whether non-executives could be involved in monetary policy decisions.

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Reasonable points in some respects (how to manage potential and actual conflicts has been an issue even in the recent appointment of members of the new MPC), although note that in Australia the Reserve Bank of Australia Board –  which sets monetary policy –  is very similar in composition to the way the RBNZ Board was in the 1980s.

Perhaps more interesting is about the qualms Goodhart has –  in early 1987 –  about the case for an independent Reserve Bank, in particular around the case for a more active coordination (at least in some circumstances) of fiscal and monetary policy.

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Goodhart’s paper ends with this paragraph.

good8If you were generous, you could interpret the final Reserve Bank of New Zealand model as looking something like that paragraph.  Unlike the Bundesbank, the Reserve Bank of New Zealand never had the power to set any specific policy objective for itself, and there was explicit override provisions built into the legislation allowing the government to (temporarily) override the agreed (Governor and Minister) policy targets.  But this paragraph sounds a lot more like the Bank of England in the 1980s, than the case made in public for the Reserve Bank of New Zealand Act 1989 (much of which was about having as few residual powers for  Minister as was consistent with getting the legislation through the Labour Party caucus).

In fairness, the Bank asked for these comments from Professor Goodhart at relatively short notice. On the other hand, he was at the time a leading academic writer in the area, and a former senior practitioner.  And so I am still struck by the conflicting strands of thought that one finds in this short paper –  on the one hand, the idea of options to reward senior central bank staff for meeting a target they might specify themselves, and on the other a real concern about the potential disadvantages in separating fiscal policy too far from monetary policy, and thus some ambivalence about too much operational autonomy for the Reserve Bank at all.

Having said all that, in a way what struck me most about the Goodhart paper is what wasn’t there.    The UK’s disinflation experience in the 1980s had a wrenching one.  Economic historians will still debate the contribution of monetary policy to the peak of three million people unemployed, but no one seriously doubts it played a part.  At the time, there hadn’t been many economywide costs to the degree of disinflation New Zealand had so far managed –  the credit boom and stock market excesses were still in full swing-  and for a time that was to induce a degree of complacency among New Zealand advisers (I recall a meeting I was in perhaps a year or so later at which the then Deputy Secretary to the Treasury was telling the IMF about how modest he expected the costs of disinflation to be –  the head of the IMF mission politely begged to differ).

But in this paper there is no mention of output costs at all  – either those associated with getting inflation down to a much lower average level, or the short-term deviations of output from potential that would come to play such a large role in central bank thinking in subsequent decades.  Just none.  It is quite extraordinary  (and thus when Goodhart talked about tying staff pay to the inflation target, no sense of the political impossibility of giving central bankers financial bonuses for actions that would, at least temporarily, raise unemployment –  even if one could accurately and formally specify a binding target for the life of the options he proposed).

What of Reserve Bank staff ourselves?  From mid-1987 I was Manager of the Monetary Policy (analysis and advice) section at the Bank, and thus quite heavily involved in clarifying what it was we were going to target, how and when.   If memory serves, I think many of us were probably too complacent, perhaps a little blind, around the short-run issues, and tended to work on an over-simplified mental model in which once inflation was lowered to target all we really had to worry about were things like oil price shocks or GST adjustments (we didn’t explicitly – and probably not implicitly –  think much about significant positive or negative output gaps developing).

On the costs of disinflation itself, we were (on the whole) more realistic, but to some extent that depending on the individuals.  There were “battles” between what might loosely be called “the wets” and “the dries”, the former tending to emphasise the transitional costs and the latter the medium-term goal.   Some of the wets (I was mostly of the other persuasion) probably doubted that the 0 to 2 per cent inflation target, adopted in 1988, was really worth pursuing.  Perhaps what united us was a belief that a lot of other reform –  greater fiscal adjustment and more micro reform –  would reduce the costs of getting inflation sustainably down.

Some 20 years ago now I wrote a Bulletin article on the origins and early development of the inflation targeting regime.  In that article, I tried to capture some of competing models that influenced the legislative framework (a funny mix of independence –  not trusting politicians –  and accountability –  not trusting officials and having ministers hold them to account). I also reported some extracts from some of the papers we wrote (I often holding the pen) as the target came together.    From one early and somewhat ambivalent paper (and I can’t recall why shipping got so much attention that month)

Moreover, the Bank noted that “the potential improvements in living standards to be derived from more rapid and complete removal of import protection, and the deregulation of such grossly inefficient sectors as the waterfront (already under
way) and coastal shipping, far outweigh the real economic benefits of slightly faster [emphasis added] reductions in inflation”. In an early echo of what later became a dominant theme in subsequent years, the Bank argued that if price stability was to be pursued over a relatively short time horizon, everything possible needed to be done at least to try to influence expectations and wage and price-setting behaviour.

This post isn’t about having a go at Charles Goodhart, The Treasury, the Bank, or me and my colleagues who were working on some of this stuff at the time.   Mostly, it is just about history, and the sober perspective that history often provides –  things that seemed clear at the time seem less clear with the perspective of time, and some things –  that one later realises are really quite important –  that hardly get attention at all.  If it is an argument for anything, it is probably for more open and deliberative government and policy development processes, perhaps even for incremental and piecemeal (in Popper’s words) reform.   That probably never appeals to reformers –  perhaps especially not young ones  –  and perhaps there are occasions when it can’t be (practically) the chosen path, but blindspots are all too real.

As for the Reserve Bank Act 1989, if there were mistakes and weaknesses in its design (most especially the single decisionmaker model), it did probably serve New Zealand fairly well for several decades.  It was, almost certainly, superior to the Atkinson/Treasury scheme.   And yet one can also overstate the difference legislation really makes –  Australia having made a similar transition to low and stable inflation under legislation still much as it was first passed in 1959.

 

 

 

1984 and all that

Eric Crampton of the New Zealand Initiative yesterday sent out a couple of tweets drawn from some pages a reader had sent him from Wellington’s evening newspaper of 18 July 1984.    The general election had taken place on the 14th and the foreign exchange market had been officially closed for a couple of days as everyone awaited resolution of the political disputes around who would take responsibility for the by-now-inevitable devaluation.  The outgoing (but still caretaker) Prime Minister finally buckled and a 20 per cent devaluation was announced on the 18th.   It marked the beginning of almost ten years of pretty thoroughgoing economic reforms, the legacy of which (good and ill) is still with us today.

Anyway, here were Eric’s tweets

(Click on the right-hand side of the first page and you can read a “fake news” story from 1984, how the Evening Post fell for a Michael Cullen hoax press release.)

Eric’s tweets sent me down to the garage and my box of old newspapers from (in)auspicious days.  I didn’t have that particular one, but I did find one from a couple of days earlier.  In that paper there was an advert for a competition offering as a prize a microwave with a retail value of $1495 –  $4800 in today’s money.   Whether you run with Eric’s microwave advert or mine, there is no doubt some things are dramatically cheaper (in real terms) than they were then.  Of course, for many technology items that will be true everywhere; it isn’t primarily a New Zealand story. Actually, flicking through that old paper it was the car prices that surprised me more: a two-year old Ford Cortina advertised for $18995 ($61000 in today’s money).   The New Zealand car assembly industry then really was very heavily protected.

Eric notes “we forget too quickly what a mess the place was in”, which reads a little oddly when he did not, I gather, come to New Zealand for another 20 years.  But setting that quibble to one side, and taking on board my own youthful enthusiasm for most or all of the reforms being done at the time (most of which still seem right and/or necessary), I think that with the benefit of hindsight the picture is rather more mixed than perhaps Eric suggests.

On the macro side, the problems were all-too-evident.  Fiscal imbalances were large and the balance of payments current account deficit was large.  If debt levels (government and external) weren’t that high by the standards which too much of the advanced world has since become used to, they were a huge departure from New Zealand’s post-war experience.  Inflation was partially suppressed by a series of freezes –  although Muldoon had lifted the price freeze a few months earlier –  supported by a series of interest rate controls, which were undoing the partial financial liberalisation of the 1970s.   Outside the control of any government, the terms of trade had been trending down for 20 years, and New Zealand material living standards and productivity had been falling behind those nearer the upper ranks of the OECD group.   We were still in the construction phase of that disastrous set of wealth-destroying government sponsored energy projects known as “Think Big”.  And if protective barriers were slowly being removed –  for example, CER was inaugurated the previous year –  it was a slow and halting journey at best. High protective barriers not only made many goods unnecessarily expensive to New Zealand consumers, but acted as a heavy tax on actual and potential New Zealand exporters.  Much about the tax system was in a mess.

And yet, and yet.

The unemployment rate in June 1984 (from Simon Chapple’s work backdating the HLFS) is estimated to have been 4.4 per cent.  Right now it is 4.3 per cent –   and 4.3 per cent is well below the average for the last 20 years, while the 1984 was well above the comparable average.

Or house prices.  I started looking to buy a first house a few months later, in early 1985.   Single 22 year olds could do that sort of thing in those days.  Yes, concessional Reserve Bank staff mortgages would have helped, but I recall looking at various houses in Island Bay and Newtown for about $80000.  That’s less than $250000 in today’s money.   The same houses now look to be perhaps $750000.    That mess was created by some of the post-1984 reforms.

Or productivity.  In that old newspaper I dug out of the garage I found a post-election op-ed written by Len Bayliss, then a leading New Zealand economist.  Among the five major economic challenges he identified for the new government was this

Fifth –  extremely poor productivity growth, and more recently GDP growth, have been the subject of a series of economic reports since 1962.  As a consequence of this poor performance, other countries’ living standards have risen more than New Zealand’s.

The worst single period for productivity growth in New Zealand history was in late 1970s, but even 35 years ago people knew that the problems were much more deep-seated.   Unfortunately, of course, the productivity gaps are now larger than they were in 1984. On OECD estimates of real GDP per hour worked, in 1984 we were close to the levels in Iceland, Ireland, and Finland.  These days, we are far behind each of them.   We were only about 10 per cent behind the UK in those days, and now they are about 30 per cent ahead of us.    Things might not be in such a “mess” nowadays –  disorderly macro imbalances and weird interventions –  but the economic bottom line still makes sorry reading.   No champion of change in 1984, told all the policies that would be adopted and the huge measure of macro stability achieved, would have predicted that we’d have drifted further behind by 2019.

Perhaps especially if they’d been given the additional information of what would happen to New Zealand’s terms of trade over the subsequent decades – the turnaround (outside any government’s control) starting just a couple of years after the reform period got underway.

TOT annual

The devaluation in July 1984 was a huge part of the economic narrative at the time.  There was a strongly-held consensus, among local officials, local commentators (it is explicit in that Len Bayliss article) and international agencies, that the New Zealand real exchange rate had become persistently out of line with fundamentals, and that a substantial and sustained depreciation would have to be a significant part of putting the economy on a better-footing.   It was, among other things, a repeated and urgent theme of the numerous meetings I attended, as a junior note-taking official, in late 1984.

And here are the two OECD measures of New Zealand’s real exchange rate.

RER 84

I’ve marked the 1984 devaluation.  In real terms, it proved very temporary indeed.    It would be great if really strong and sustained productivity growth had supported a structural increase in the real exchange rate.  But that, of course, hasn’t been the story.  Once we got through the disinflation period –  when it was reasonable to expect some temporary periods with a high real exchange rate –  it seems to reflect the same sort of domestic demand pressures that have given us persistently among the very highest real interest rates in the advanced world.

And then there is foreign trade.  A narrative at the time was the heavy protection had resulted in New Zealand’s foreign trade shares of GDP falling, or failing to grow.  The overvalued exchange rate (see above) further impeded the prospects of potential export industries, probably only partly offset by the various (highly questionable) export incentives and subsidies.

And yet

trade shares feb 19

I’ve circled the data for the years to March 1984 (latest actuals when the devaluation happened) and for the year to March 1985.  There was, as you would expect, a short-term boost to the nominal trade shares on account of the devaluation, but of course that didn’t last.  But if we take the subsequent 33 years together, there is just no sign of foreign trade having become more important to the New Zealand economy  (as it happens, exports as share of GDP in the year to March 2018 were almost identical to those in the year to March 1984).  Only one other OECD country has not seen the export share of GDP increase over that time.

I don’t want to kick off a futile debate about whether the reforms should have been done.  I’m still squarely in the camp that most should have been.  But, equally, nothing is gained by pretending to a degree of economic success we haven’t achieved.   We’ve shared –  with every market economy (and probably the non-market ones too) –  the rapid declines in the cost of various technology goods and services.  All of our own doing, we’ve managed to bring about, and sustain, an impressive level of macroeconomic stability.   But, equally all of our own doing, we’ve managed to rig the housing market against the current (and next) young generation, and despite reducing or removing all manner of protective barriers (and even getting other countries to do something similar for stuff New Zealand firms exports), foreign trade shares are no higher now than they were on that momentous day in 1984.  And, as for productivity, poor –  and rightly alarming –  as it was then, all indications are that it is worse now, and there are no signs of  those gaps beginning to close.

The New Zealand economy isn’t in some disorderly mess at present.  But if it is perhaps more orderly, it is failing nonetheless.

Looking back to the deposit guarantee

12 October 2008 was a frantic day.  It was a Sunday, and I never work Sundays (well, two financial crises, one in Zambia, one in New Zealand, in 30+ years).  There was a call in the middle of our church service summoning all hands to the pump, to put in place a retail deposit guarantee scheme that day.   We did it.  My diary later that night records that we’d “delivered a brand spanking new not very good deposit guarantee scheme”, announced a few hours earlier.   It was a joint effort of the Reserve Bank and The Treasury.

I had recently taken up a secondment at The Treasury.  I’d been becoming increasingly uneasy about the New Zealand financial situation for some months (flicking through my copy of Alan Bollard’s book on the crisis I found wedged inside a copy of an email exchange he and I had had a month or so earlier about Lender of Last Resort options for sound finance companies, potentially caught up in contagious runs) but I hadn’t had any material involvement in the unfolding sequence of finance company failures.   But it was the escalating international financial crisis – this was four weeks after Lehmans, 3.5 weeks after the AIG bailout, two weeks after the US House of Representatives initially voted down TARP, and two weeks after the Irish government surprised everyone by announcing comprehensive deposit guarantees –  that really accelerated interest in the question of what, if anything, New Zealand should do, or might eventually be more or less compelled to do.    The initiative for some more pro-active planning came from The Treasury, but with some parallel impetus  –  including around guarantees – from the then Minister of Finance, Michael Cullen (who, a few days out from Labour’s campaign launch, was also looking for pre-election fiscal stimulus measures).

On Tuesday 7 October, there was a long meeting at the Reserve Bank, attended by both the Secretary to the Treasury, John Whitehead, and the Governor of the Reserve Bank.  My memory – and my contemporary diary impression – is that the Governor was considerably more focused on the managing the Minister’s political concerns than on any sort of first-best response.    But the outcome of that meeting was agreement to quickly work up a joint paper for the Minister which would not, at that stage, recommend introducing a deposit guarantee scheme, but which would outline the relevant issues and operational parameters, giving us something to work from if the situation worsened.

Which it quickly did, both on international markets, and with the political pressure, with the Prime Minister signalling that she wanted to be able to announce something about guarantees in her campaign launch that coming Sunday afternoon.

I and a handful of others on both sides of The Terrace scurried round for the next few days.  I see that in my diary I wondered what the best approach was: do nothing, allow some risk of the crisis engulfing us, and then pick up the pieces afterwards, or be more pro-active and take the guarantee route.  My conclusion –  and even today I wince at the parallel (but this was a late-at-night comment) – “I suspect that if the pressures really come on, the Irish approach is best”.   As relevant context, although much of the finance company sector was in solvency trouble (many had already failed) there were no serious concerns about the solvency of the banking system.   (Liquidity was, potentially, another issue.)

At Treasury we had recognised the importance of the Australian connection –  most of our banks being Australian-owned.     I’m not sure of the date, but we had taken the initiative –  at Deputy Secretary level –  of approaching the Australian Treasury to see if they were interested in doing some joint contigency planning around deposit guarantees, and had been told that the Treasurer had no interest in such guarantees and so our suggestion/offer was declined.

But even Australian authorities could look out the window and see that the global situation was deteriorating rapidly, and by late in the week that recognition was being passed back to authorities on this side of the Tasman.  Alan Bollard always kept in close contact with his RBA counterpart Glenn Stevens, and on the Friday my diary records (presumably told by some RBNZ person I was working with) “apparently Glenn S[tevens[ told Alan this afternoon that the RBA/authorities might fairly soon have to consider a blanket guarantee”.     In the flurry and uncertainty, one other senior RBNZ person –  still holding a senior position there –  told me that in his view nothing should be done here unless there were queues outside New Zealand banks.

Between a handful of people on the two sides of the street, we got a paper on deposit guarantee scheme possibilities out to the Minister of Finance on the Friday afternoon.  It was a mad rush, with some uneasy negotiated compromises (and everyone’s particular hobbyhorse concern got its own mention). I was probably too close to it to tell, and noted I wasn’t that comfortable with it, but when I got Alan Bollard’s signature he indicated he was happy with it.  I noted “lots of small details to sort out next week –  we hope only that, not implementation”.     To this point, we were focused mostly  on retail deposits, but I see in my diary that in The Australian on the Saturday there was talk from bank CEOs of a possible need for a wholesale guarantee scheme.

The full, unredacted, paper we wrote is available on The Treasury’s website.   The thrust of the advice was that (a) action was not necessary immediately, but (b) that should conditions worsen a scheme could be put in place at quite short notice.  The rest of the paper outlined the relevant issues, and the recommended features of any such scheme, and we advised against announcing a scheme until the remaining operational details had been sorted out, something we suggested could be done in the folllowing week.

These were the key features we suggested, largely accepted by the Minister.

dgs 1

One thing that puzzles me looking back now is why we were focused on guarantee options, rather than lender of last resort options.  The latter would have involved lending on acceptable collateral to institutions that we judged to be solvent, perhaps at a penal rate.  It was the classic response to the idea of a contagious run –  troubles elsewhere in the financial system spark concerns about other institutions, and people “run” –  cashing in deposits, retail or wholesale –  just in case.  A sound institution could, in principle, be brought down very quickly by such a run (empirically there are few such examples –  most actual runs end up being on institutions that prove to be at-best borderline solvent).

In the paper we sent to the Minister on 10 October we don’t seem to address that option at all.  I presume the reason we didn’t was twofold.  First, guarantees were beginning to proliferate globally.  And second, there probably is a pretty strong argument that if (a) you are convinced your banking system is sound, and (b) there are nonetheless doubts in the wider environment (in this case, a full scale global crisis, and a domestic recession), a guarantee is likely to be considerably more effective in underpinning confidence.  Not so much depositor confidence, as the confidence of bankers (and their boards).    Even if lender of last resort funding, on decent collateral, had been available without question, few bankers would have been happy to rely on that, and many would have been very keen to cut exposures, pull in loans, and reduce their dependence on the good nature of the Reserve Bank Governor.   A guarantee –  where the Crown’s money is at stake –  is a much stronger signal than a loan secured on the institution’s very best assets.   On the other hand, as the paper does note, once given a guarantee may not leave one with much leverage over the guaranteed institution.

Almost all of the subsequent controversy around the deposit guarantee scheme related in one form or another to one key choice.

All the systemically significant financial institutions in New Zealand were banks (not that all banks were systemically significant).  But they were not, by any means, the only deposit-taking institutions, and we were in the midst at the time of a finance company in which many companies were proving to be insolvent and failing.  Other finance companies appeared –  not just to the Reserve Bank, but to the market, and to ratings agencies – just fine.

Treasury and the Reserve Bank jointly recommended to the Minister that any deposit guarantee scheme include finance companies.  Why did we do that?

The simple reason was one of both fairness and efficiency.  Had we proposed to offer a guarantee only to banks (let alone only the big banks) then in a climate of uncertainty and heightened risk, there would have been an extremely high risk that such an action would have been a near-immediate death sentence for the other deposit-taking institutions, including ones with investment grade ratings, and in full compliance with their trust deeds.    We knew that finance companies (while small in aggregate) were riskier than our banks, but that was no good reason to recommend to the government a model that would have killed off apparently viable private businesses.  It still seeems, with the information we had at the time, an unimpeachable argument.  Classic lender of last resort models, for example, don’t differentiate by the size of the borrowing institution.

We weren’t naive about the risks –  including that there was still no prudential supervision of finance companies and the like –  and we explicitly recommended that risk-based fees (tied to ratings) be adopted, and the maximum coverage per depositor be much lower for unrated entities.   We included in the table an indicative fee scale, based credit default swap pricing for AA-rated banks in normal times, scaling up (quite dramatically) based on the much higher default probabilities of lower-rated entities.

We even included a indicative, totally back of the envelope, guess as to potential fiscal losses –  drawing on the experience of the US S&L crisis.  As it happens, actual losses were to be less than that number, even though the scheme as adopted by the Minister of Finance was less good than the one we recommended.  (Treasury provided some other –  but lower – loss estimates a few days after the actual announcement, but I can’t see those on the Treasury website and can’t now recall the approximate numbers.)

But all that was just warm up.   We’d been under the impression that the Prime Minister was going to announce, in her campaign launch speech, that preparatory work was underway on a deposit guarantee scheme.  That was probably her intention.  But that didn’t allow for the Rudd effect.  The Australian Prime Minister decided that he was going to announce an actual retail guarantee scheme for Australia that day –  the Sunday.  And so it was concluded that New Zealand had little choice but to follow suit.   As a matter of economics, there probably was little real choice but to follow the Australian lead.  But the timing was all about politics.  Neither economic nor financial stability would have been jeopardised if we hadn’t had a deposit guarantee scheme announced before the banks opened on Monday morning.  We’d have been much better to have taken a bit more time and hashed out some of the details with the Minister in his office in Wellington, not at campaign launches and then, as the day went on, airport lounges (at one point late that afternoon I –  who’d talked to the Minister perhaps twice in my life previously –  was deputed to ring Dr Cullen and get his approval or some detail or other of the scheme).   But I guess it might have left open a brief window in which critics might have suggested that New Zealand politicians were doing less for their citizens and their economy than their Australian counterparts.

The main, and important, area in which Dr Cullen departed from official advice was around the matter of fees.   We’d recommended that the risk-based fees would apply from the first dollar of covered deposits (as in any other sort of insurance).     The Minister’s approach was transparently political –  he was happy to charge fees to big Australian banks (who represented the lowest risks) but not to New Zealand institutions (including Kiwibank).  And so an arbitrary line was drawn that fees would be charged only on deposits in excess of $5 billion.   Apart from any other considerations, that gave up a lot of the potential revenue that would have partly offset expected losses.  The initial decision was insane, and a few days later we got him to agree to a regime where really lowly-rated (or unrated) institutions would have to pay a (too low) fee on any material increases in their deposits. A few days later again an attenuated pricing schedule was applied to deposit-growth in all covered entities.   But the seeds of the subsequent problems were sown in that initial set of decisions.

The weeks after the initial announcement were intense.  We rushed to get appropriate deed documents drawn up, dealt with endless request from institutional vehicles not covered who sought inclusion (property trust, money market funds etc), and set up a monitoring regime.  In parallel, we quickly realised that the way wholesale funding markets were freezing up suggested that a wholesale guarantee scheme was appropriate, and got something announced in a matter of weeks –  a much more tightly-designed, better priced scheme, operating only on new borrowing (but I’m biased as that scheme was mostly my baby).  As it happens, that scheme provided the leverage to actually get the big banks into the deposit guarantee scheme.  Once the government had announced the retail scheme the big banks had little incentive to get in –  they probably thought of themselves (no doubt rightly) as sound and as too big to fail –  and the scheme was an opt-in one (we couldn’t just by decree compel banks to pay large fees).   But the Minister of Finance –  probably reasonably enough –  insisted that if banks wanted a wholesale scheme (which they really did) it would be a condition that they first sign up to (and pay for) the retail scheme.  Perhaps less defensible was the Minister’s insistence that any bank signing up to the guarantee scheme indicate that it would avoid mortgagee sales of home owners in negative equity but still servicing their debt (the ability of banks to do so is a standard provision of mortgage documentation).

After the first few weeks of the retail scheme I had only relatively limited ongoing involvement, and so I’m not going to get into litigating or relitigating the South Canterbury Finance failure, and whether –  even the constraints the Minister put on –  and how that could by then have been avoided (the Auditor-General report some years ago looked at some of those issues).   The outcome was highly unfortunate, and expensive.  Nonetheless, it is worth remembering that the total cost of all the guarantee schemes – retail and wholesale – was considerably less than officials had warned was possible.  And it is simply not possible to know the counterfactual –  how things might have unfolded here had either no guarantees been offered, or if the finance companies and building societies had been excluded from day one.  Personally, I think neither would have provided politically tenable, but we’ll never know that, or how that alternative world played out.

But with the information we had at the time –  including, for example, the investment grade credit rating for SCF (which had outstanding wholesale debt issues abroad –  and actually my only meeting with SCF was about their interest, eventually not pursued, to try to use the wholesale guarantee scheme) –  the recommendation made on 10 October seem more or less right. Given the same information I’m not sure I’d advise something different now.  And once Australia had made the decision to guarantee retail deposits, there was little effective economic or political choice for New Zealand.   Had they not done so –  and there was real data, regarding increasing demand for physical cash in Australia, supporting Rudd’s action (rushed as timing was) – perhaps we could have got away with a well-designed wholesale guarantee only.   That would have been a first-best preferable world, but it wasn’t the set of facts we actually had to work with.

 

Electioneering 1954 style

A few weekends ago I was fossicking in a charity book sale when I stumbled on The National Government 1949-1954: FIve Years of Progress and Prosperity, published by the National Party.   It was, it appears, published as part of National’s 1954 election campaign: 150 pages of (often quite detailed) text and tables, complete with a detailed chronology of measures, and an index.

I’ve always been interested in that first National government.  Apart from anything else, the Prime Minister (and Minister of Finance) was my grandfather’s cousin –  they’d been close, and in our family Sid Holland was always “Uncle Sid”.  It was a government with a fairly mixed record.  Through my career at the Reserve Bank I was always quietly proud that a relative had legislated to establish the primacy of price stability in what we expected from monetary policy and to put monetary policymaking at a further remove from direct ministerial control (even if, in practice, it didn’t make much difference).

There was some genuine liberalisation –  including of those banes of New Zealand economic management for too many decades, import licensing and exchange control.  And there was the ANZUS Treaty –  which I hadn’t previously known came into effect on ANZAC Day, a nice touch –  and the interesting episode of New Zealand’s approach to the Suez crisis.  It was the time of the wildly popular first ever visit by a reigning sovereign.  And the sort of short-term austerity that led to the Auckland Harbour Bridge being built too narrow from the start, or central planning that meant that for years the Reserve Bank wasn’t allowed to start building its own building.

In the territory of serious black marks, it is hard to defend the way the 1951 waterfront strike was handled –  not so much the confrontation with the watersiders itself, but the brutal undermining of civil liberties and the freedom of the press during that period –  often using powers introduced by the previous Labour government.

Perhaps only in New Zealand  –  where good histories and biographies are few – could a government that was in power for eight years, with a leader who spent 17 years in the role, not have either a decent scholarly treatment of that government or a biography of its leader.

But what of the book?

It has a foreword by the Prime Minister which, I imagine, captures quite well the way National saw things in those years

It is a proud thing to belong to a Government which is able to say that the people have never been better off, that there is a new spirit of vigour and enterprise abroad in the land, that there was never a time when so much progress was being made in the development of the resources of the country.

Once again, New Zealanders feel that the future belongs to them…….

Freedom, which is at the heart of the National Government’s philosophy, is perhaps an intangible thing – until you have lost it.  But it yields tangible results. The Government’s recrod, which this book outlines, is the answer to those who stand to the creed of Socialism.

But having lauded freedom, the Prime Minister goes on to laud the apparently growing role of the state.

A vast programme of development works is in progress –  imaginative and progressive schemes like the new pulp and paper and timber industry in the Rotorua-Bay of Plenty area, the utilisation of geothermal steam, the huge hydro-electric project at Roxburgh.  More hospitals, more schools, more houses –  there is no neglect of everyday necessities because of the scale of the development programme.  The Government has liberalised and extended social services, more is provided for other social services, trade is booming, the needy are cared for, the workers are prosperous, savings are greater.  On all fronts New Zealand has gone ahead, as a young country should…..

I lived in Kawerau as a child, but it is only over the last decade as I’ve come to read a lot more New Zealand history that I’ve come to realise how big a deal –  in some way, the decade’s Think Big, complete with outside capital and protected markets –  the Kawera/Murupara development really was in the 1950s.  The state was at the leading edge of promoting economic development, as it saw it (in this book, the Kawerua scheme is described –  perhaps with a little exaggeration, depending on how one classifies Vogel’s interventions –  as “the greatest single enterprise ever attempted in New Zealand”.

On the one hand, in the early 1950s, New Zealand still had some of the very highest material living standards in the world.  On the other, only a few years later people started writing serious reports (eg the new Monetary and Economic Council and the new NZIER) observing that New Zealand’s productivity growth was lagging behind.  Sadly, it was to be the story every decade from then to now.

But this post isn’t really intended to be an abbreviated political or economic history of the decade.  It was more that I was fascinated by things the National Party chose to highlight, and the accounts of interventions I’d just never been aware of.

Take rest homes for example.  When I was young, almost all of them were run and provided by church groups. I had never given much thought to why –  caring for the vulnerable was one of those things the church had done since Roman times.   But this little book tells how the government skewed the playing field:

Soon after taking office the Government introduced a policy of helping charitable or religious organisation to establish homes for aged people. Generous subsidies, up to 50 per cent, are offered, together with loans finance on favourable terms in respect of housing schemes.

The next sub-section recounts the introduction of a similar subsidy for such groups to establish youth hostels.

There are reminder of times past: anti-tuberculosis campaigns get two-thirds of a page to themselves.

There were 506000 radio licences in New Zealand in 1954, and not a single television.

And in a country of two million people, there were still only 334580 telephone subscribers (and a little subsection on “Mobile telephone services” –  some 2000 people had telephones in vehicles, up from only 192 when the government had taken office five years earlier).

The forerunner to Air New Zealand –  Tasman Empire Airways Ltd –  flew 30888 people trans-Tasman in the entire year to March 1954: fewer than 100 a day.  Domestic air services, so the party (fairly) boasted, has increased substantially during its term in government, but total passenger numbers were still less than 1000 per day.

And if economists are (largely rightly) inclined to be censorious about the excess demand policies of the period (inflation nonethless kept in check) there is still something to hanker after in these numbers:

In spite of the large increases in the labour force, ample work is still available.  At 15/1053 the number of vacancies for men was 13500 and for women 6500. Unemployment in 1953 averaged only 85 persons throughout the year.

(These were people registered as unemployed.  Five-yearly census numbers were higher, but still very low by modern standards.)

These were the days when, in New Zealand almost uniquely, cars held their value, the numbers imported being rationed.  There was an exception for people with overseas funds themselves (the “no-remittance” scheme) –  which made an English OE additionally attractive.  My grandfather was not infrequently heard to jest that my father proposed to his daughter only because she had a car, (having done her OE).

What of monetary policy?

The declared policy of the Government is to divorce currency and credit from political control, to avoid the issue of credit unbalanced by goods and services, and to stabilise internal prices by establishing a proper balance between money and goods.

From an economist’s perspective, two out of three isn’t bad, but that middle phrase is disconcertingly reminiscent of the real bills doctrine.  In fairness, the same government liberalised what were then known as “capital issues controls” restricting the ability of firms to raise funds on market.

And if there were elements of liberalisation, (eg the “state monopoly of coal seams” was abolished  on 10 October 1950) there was also this

The Potato Board was established in 1950 to control the production and marketing of main crop potatoes.

Why, one has to wonder?

In the some things don’t seem to change category, there was the boast that

Maori land claims.  Removal of grievances over land claims is being vigorously pursued, Claims settled include: [and a list follows]

Perhaps in the same category, pages and pages are devoted to housing and housing finance, including this curious observation under the heading “Encouraging local authorities to buy land and develop it for housing”

A retarding influence in many cases has been the desire on the part of local bodies to avoid placing a further burden on ratepayers by raising loans for housing activities, but the loan procedure has been simplified to open the way for local authorities to engage in housing activities without recourse to long-term finance.  They can now finance these projects on bank overdraft.

I’m clearly missing something in understanding the greater appeal of a bank overdraft.

Meanwhile large scale immigration has restarted (I wrote about it here), including subsidised (“assisted”) migration.  Being a skilled building trade worker was enough to get assisted passage for married people (at the time, policy explicitly favoured single people because of the housing shortages).  But there is no hint of the politicians realising –  what economists knew even then –  that new arrivals added more to housing demand, and overall resource pressure, than any feasible increase in supply (even in the building sector specifically).

For an economic history junkie, it is a fascinating read.  There is the line from L P Hartley’s novel The Go-Between that “the past is another country, they do things differently there”, and it comes to mind strongly reading this book  And, it won’t surprise regular readers to know that the other thought that comes to mind is one along the lines of “if only” we’d done things differently then and since, and could still today boast of being one of the richest countries in the world.  How much more we could offer our people –  on market, and off.  Of course, in material terms, people are better off today than they were in 1954.  That is an important benchmark, too easily lost sight of –  only a few years prior to 1954 my mother had done her masters’ thesis on the incidence of basic home appliances in Dunedin (far from universal) –  and yet, and yet, the failures and lost opportunities since then, which mean we now languish so far down the international league tables, matter too.  Both National and Labour must take responsibility for that failure.  Not that one would know it from either party’s campaigns last year.