The government should insist the OCR be deeply negative for now

It really is quite remarkable that the government is willing to shred our civil liberties, abandon Parliament, ban funerals –  to my mind, the most egregiously inhumane, almost evil, specific of the entire Ardern partial lockdown –  and accentuate, for now, the temporary implosion of the economy, and yet the same government is unwilling to act to bring about lower interest rates.

They have a recalcitrant public agency that simply refuses to (has formally promised not to) act, in face of a huge slump in activity and employment, a period when time has no economic value.  And yet they just sit politely by, as if this was some minor difference of emphasis over 25 basis points or so.  They have all the powers they need to act, but simply refuse to do so.  Having chosen not to act, interest rates are current levels are now the direct responsibility of the Prime Minister, the Minister of Finance, and the rest of the Cabinet collectively.

Consider a thought experiment.  Suppose that for the last 18 years instead of an inflation target of 1-3 per cent, centred on 2 per cent, we’d actually had a target of 9-11 per cent, centred on 10 per cent. (Note, I do not think this would have been an appropriate or necessary policy, but just humour me for a moment).  And pretty much everything else –  good and bad – about the economy to the end of 2019 unfolded as it did.  Assume that coming out of the Great Recession a decade ago, central banks would still have struggled to (or been as reluctant to) do what it takes to keep inflation at target, but they had more or less got there by 2019.  Perhaps core inflation was about 9.7 per cent, perhaps inflation expectations (a mix of survey and market measures) were somewhere between 9 and 10 per cent.    And, consistent with that, assume the OCR had been 9 per cent at the end of last year (a full percentage point below the target midpoint just as it was in real life.)

(And, yes, I know all about the interaction between the tax system and inflation which mean these things aren’t exact by any means, but for now this is just a very simple story.)

And then the coronavirus hits, and all that followed around fighting the virus  – policy measures here and abroad, personal choices to distance etc here and abroad – happened just as in real life.

Oh, and the economy?  Well, serious people would still be talking about the unemployment rate going to perhaps 25 per cent, a really major export industry had simply closed down, investment demand (national accounts sense) was heading for zero, and so on.

Does anyone imagine, for the slightest moment, that in such an alternative world –  but a path we and other countries’ could have chosen –  that the OCR would have been cut by only 75 basis points?

Of course not.    Not only do typical New Zealand (or US) recession see around 500 basis points of cuts, but even in crisis-type events in the past (precautionary responses to 9/11 and the 2011 earthquake) the Reserve Bank has cut by a bit more than that  –  and the Christchurch earthquakes, after the very brief initial hiatus, represented one of the largest positive, unforecast, demand shocks to the New Zealand economy ever experienced.

Who knows how low the OCR would have been cut in that alternative world where the OCR had started at 9 per cent.  But we know that in the 2009/09 recession – when GDP fell by about 3 per cent –  the Bank cut by 575 basis points. In the US, where the Fed cut by about 500 points in 2008/09, versions of the Taylor rule later suggested that the Fed funds rate could more appropriately have been cut by another 500 basis points on top of that.

So why (didn’t and) don’t adjustment of this magnitude happen?    Because central bankers abroad –  but specifically here, where the MPC has set an explicit floor at 0.25 per cent –  have becom almost terrified of the possibility of seriously negative nominal interest rates, and have spent a decade doing nothing much about making such outcomes work effectively.  Far too much of the focus of central bankers this last decade was on looking to the next tightening, and the idea of “normalisation”, not preparing for the next serious downturn –  now upon us in unusual and particularly savage form.

But they would have had few qualms in lowering a nominal OCR of 9 per cent –  in the presence of a 10 per cent inflation target –  to, say, 1 per cent.    It makes no sense.  It is bad money illusion in reverse, without any good justification.

Now, of course, everyone knows and accepts that monetary policy isn’t going to stop GDP collapsing over the next month (at least) –  perhaps on a scale just without precedent ever (if we ever had the data).  But it wasn’t really that much different in the fourth quarter of 2008.  Really substantial cuts in official interest rates happened, and rightly so, but in a climate an extreme loss of confidence, fear etc, that wasn’t going to stop GDP falling right then.  At the best of times, the lags are longer than that.

But markedly lower interest rates, when massive excess capacity is opening up and the neutral interest rate is falling, still do a number of useful things:

  •  they signal to markets (and the wider public) that the central bank is thoroughly serious about doing its job, and keeping inflation expectations up very close to target  (the risks around this not happening are much greater in our real world than in the alternative, higher inflation target, world I mentioned above),
  • they get relative prices positioned as soon as possible in way that puts the economy in as less-bad position as possible for the eventual recovery (not just the bounce back to a, say, 15 per cent loss of GDP if the lockdown itself is eased/lifted),
  • and the greatly ease debt servicing burdens, reallocating income from (close to) variable rate depositors to (close to) variable rate borrowers, consistent with the new stylised facts in which time for now has no economic value.   As it is, short-term term depositors are still being taken at positive real interest rates – even as the economy is shutdown –  while variable rate borrowers, even with rock-solid collateral, are still paying substantially positive real interest rates.  All this at a time when the government appears keen to encourage firms to borrow more….

Given the significant margins between the OCR and retail interest rates (lending and borrowing) we really need, and should have, a substantially negative OCR –  deeply negative in real terms, and not that inflation expectations have been falling.

You might be wondering if (materially) negative official interest rates is just some hobbyhorse of mine.  Even if that we the case, it is still the arguments that should be examined, not the advocates.  But it isn’t the case.  Over the last decade or more, people like former Bank of England Monetary Policy Committee member Willem Buiter, or US academic Miles Kimball (who was the guest of the RB or Treasury just a few years ago) have been among those pushing the case for ensuring that official interest rates could be taken a lot lower in the next crisis.

As a refresher, the twin obstacles are that (a) central banks now have a monopoly on the issuance of physical currency, and (b) as monopolies do, did not innovate over time so still operate with much the same rules and technology as 100 years ago.  If the OCR were to be taken deeply negative, on those rules, it would at some point become attractive for wholesale investors, in particular, to switch from holding securities and bank deposits, to holding physical cash.   If so, you can cut the OCR all you like and it won’t make much useful difference to anything, except stocks of zero-interest cash.  It doesn’t happen easily: storage and insurance costs are real, AML restrictions are annoying, and it isn’t worth doing if you think the OCR will only be very low for a month or two  We don’t know quite where the limits are, but the current consensus has been that no one is really willing to try  –  on current rules – below about -0.7 per cent.

But those rules and practices can be changed.  Ideally, doing so would have been properly consulted on and socialised over a long period by governments and central banks. But in a crisis –  perhaps especially a crisis where surfaces, including bank notes, can carry the virus –  things can be done very quickly.  They should be in this case.    Suspend the issuance of net new bills in excess of $50, cap the total currency issuance (for now) at, say, 20 per cent above the current level, and if revealed demand for currency is higher than that, ration by price (run a weekly auction at which banks offer a premium over face value to buy physical currency, which they can pass through to all customers or just those taking a large amount of cash, at their discretion).

Of course, having led to believe for the last couple of years that a modestly negative OCR was an option they were open too, the Governor now tells us that the Reserve Bank simply never got round to ensuring that all banks’ systems would be able to cope with negative interest rates.  That’s a pretty stunning indictment, that he/they should be held to account for one day (perhaps the Simon Bridges-chaired select committee could summon him?)

As I’ve noted before, mostly even if what the Governor says is true, it is more likely an excuse for inaction (action they don’t want to take) rather than a real and valid justification.  As I’ve noted previously, many wholesale interest rates abroad have been modestly negative for years now.  An bank operating internationally has to have been able to cope (even in New Zealand some of our inflation indexed bond yields had gone negative).   And even setting all that aside, if the OCR were set to say -2 per cent, that would still only be consistent with term deposit rates near zero and lending rates still positive (business one quite a lot positive).    There is material relief that can be given, that really should be given urgently, without the main retail rates even getting to the point of going negative.   And, frankly, it is surely time for some naming and shaming.  If better banks have systems that can operate negative rates, it will provide a competitive advantage and put pressure on those who just didn’t get ready to fix things quickly (even if initially in an improvised way).  In the current climate, an OCR of -5 per cent might be something good to aim for.

A couple of my old colleagues have offered brief dissenting views in comments on earlier posts. I appreciate them taking the time to do so.    I dealt with the first comments, from Geof Mortlock, in a post late last week

A former colleague, from mostly a banking supervision background, left a comment yesterday disagreeing with my call for negative rates.

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….

What to make of Geof’s specific arguments?

First, I don’t accept that it would be destabilising to the financial system at all –  if anything, at the margin it would assist financial stability by shifting the burden from borowers (increasingly indebted in most cases) to depositors (time is offering no real return right now).

I also don’t belief that there would be anything like the sort of flight to Australia Geof suggests.  After all, exchange rates –  even NZD/AUD are volatile enough and transactions costs high enough – to swamp any possible small interest gains.   Perhaps more to the point, in a floating exchange rate system, unless there is a run to physical cash – and recall that under my model cash would be more expensive to purchase/withdraw –  the total deposits in the banking system do not shrink because someone seeks to withdraw money.    For every seller of NZD there has to be a buyer.  And, frankly, the more people wanted to sell NZD at present, the better –  a materially lower exchange rate is one more helpful part of the stabilisation package.

Finally, Geof also notes that lower interest rates won’t do much to boost spending right now.  That is, of course, true and a point I’ve been making throughout.   The point of policy right now is not to boost spending (the time for “stimulus” will be later) but, in this case, to ease servicing burdens materially, and to help stabilise and reverse the falls in medium-term inflation expectations that risk materially complicating the recovery phase, by starting us off with higher real interest rates than those we went into the crisis with.

Ian Harrison, now of Tailrisk Economics, also weighed in

I think the negative interest rate is a diversion, with several problems and does nothing that can not be done more effectively in most cases by direct interventions in our wartime economy.

Thinking about the flow through to interest rates people are paying – banks have reduced the floating rate to 4.5 percent – a huge margin still. It appears that the fixed rates where the business gets done haven’t moved much at all.

My off the top of the head suggestion is to pretend that time doesn’t exist for one two or three months. Time bound contractual -rents interest wouldnt exist for that period. lots of fishhooks and inequities of course. and it would put the banks under pressure. If that got too much then the OBR could be activated for the entire banking system and owners’ interest effectively confiscated.

But I think this is itself something of a distraction, and (after all) my scheme actually involves some quite direct interventions.  I quite like, at a conceptual level,  the idea of pretending that time doesn’t exist for contractural purposes in the midst of the crisis, but no one believes that problems are going away in two or three months.  When, for example, do we suppose the tourism sector might be back to “normal”.  Not next year would be my guess: we need relative prices to signal resource-switching and draw forward demand as recovery begins to beome possible.

As for OBR, it is of course a bank failure/resolution tool, but for now at least the presenting problem is not potential bank failure  (that could become a risk in time, as the toxic brew of falling asset prices and collapsing incomes lasts long enough) but the sustainability of borrowers themselves.  And using OBR in a bank failure –  unlikely to ever happen –  does nothing to relieve borrowers or support existing companies holding together.

Ian followed up on Friday with another comment

The problem with relying on a reduction in the OCR is that the transmission to borrowers who actually need the relief is highly uncertain. Some thing as direct as a maximum interest on bank lending would have some of the desired effect. – say 6percent, accompanied by no reduction in lending limits.

To which my response is that yes the transmission is a bit uncertain in the abstract.   In concrete terms though, what Ian suggests could be achieved by making it a condition of participation in the governments’s business loan guarantee scheme that any OCR cuts are fully, or almost fully passed through.  If necessary –  it is an emergency – legislation could be used directly.   And we don’t need 6 per cent interest rates for reasonable credit business borrowers at present, but something more like zero or negative (still a significant risk margin over, say, an OCR of – 5 per cent),

And finally, Geof put in another comment

Your continued advocacy for zero or negative interest rates ignores the commercial reality that, in periods of stress, such as this, the risk premium in interest rates will rise. This as true (maybe even more so) in a period of prospective deflation. Lenders will price in the risk of lending such that, even in periods where the zero default rate might be zero or negative, bank lending rates will be positive. Equally, bank funding rates are unlikely to go to zero or negative given that depositors, especially at the wholesale level, are factoring in the increased (but still low) risk of bank default. As credit markets globally tighten further, that risk premium is likely to rise. I therefore view your stance on negative interest rates as commercially unrealistic and inconsistent with how a well functioning market could be expected to operate.

As for Ian’s suggestion of regulatory caps on interest rates, I think that would be daft. Such regulatory responses rarely produce desired outcomes. They distort risk pricing in both funding and lending rates and impede efficient credit allocation.

The smartest way to address borrower stress is to provide targeted income support for a defined period, together with debt servicing holidays. If the lockdown is effective in markedly lowering infection rates to a low level, then we should be able to progressively normalise things after 4 to 8 weeks. Border controls will need to continue for months to come, but if the quick result (15 minute) tests, which are apparently under development, can be deployed as a prerequisite for boarding a plane or ship bound for NZ, or at leadt on arrival here, then maybe the economic damage can be reduced to a significant degree.

What is needed now are the indicators (eg infection rates etc) that will be applied for a progressive easing of restrictions after this 4 week period.

On his first point, as I’ve noted since the OCR in this climate should be deeply negative, retail interest rates that would be zero or slightly negative –  not that 6 per cent advertised rates ordinary SMEs face at present –  leaves plenty of margin for risk premia.

On his second point, if depositors are so confident about alternative investment options –  whether other countries or other assets – as to reluctant to accept negative deposit rates, that is (all else equal) a good thing, monetary policy at work.  Either they are spending (ie demand rising), trying to shift abroad (lowering the exchange rate, welcome), or supporting otherwise cheap asset prices (again one way monetary policy works.

On regulatory caps, of course in general they aren’t a good thing. They might not even be needed with a deeply negative OCR, but even if they are sometimes exceptional times call for exceptional measures.  We’ve seen a few in the last few weeks….

For the rest, I’m not debating what might or might not be possible on testing etc, but no one supposes that even if the current lockdown is lifted in a month or two, that we will quickly snap back to even a recession of the relative shallowness (by these standards) of 2008/09.  We still need, and should want, deeply supportive monetary policy, including because whatever fiscal policy might be able to do as time goes on, it is almost inevitable that there will be pushback before that long about the bills being run up for the future.  Monetary policy is designed to be the principal stabilisation and countercyclical tool.      If it is allowed to work and used decisively again, it can play that role again once the worst of the virus is behind us.

I’m happy to engage with, or respond to, any other sceptics with specific points.  But on the face of it –  and thinking much more deeply and practically – we are overdue some vigorous easing in monetary conditions.  The MPC could and should do it.  But if they refuse, the government should –  in these extreme circumstances –  simply override them and compel them to act.

(In the meantime, of course, the bigger issue is that of extreme uncertainty and downside risk around business and household incomes.  The government has done quite a bit to support households, although quite time limited.  On the business side, there isn’t much other than encouraging firms to take more debt, when for most it simply won’t be worth doing so.  And there are disconcerting hints of the government helping big firms, but not the vast mass of companies that make up most of the economy. My “ACC for the whole economy”,firms and households, remains the best option to provide some insurance, some certainty, to buy time, all without attempting to lock in firms that really may now have no readily conceivable future.)

 

 

Effective treatment

That is the title of a paper issued on Thursday by the New Zealand Initiative think-tank (mainly written by their chief economist Eric Crampton).  The subtitle is “Public policy prescription for a pandemic” and they range pretty broadly (although not really on public health itself) in the suggestions they offer and issues they raise.  It is well worth a read for anyone seriously interested in thinking about what policy responses the current situation demands, as well as the sorts of issues that will need to be faced when, some considerable way down the track most likely, we are in a position to think seriously about a recovery.

(By contrast, if it is political spin you want re the eventual recovery, you could try the front page of this morning’s Dominion-Post reporting and channelling comments from the Minister of Finance suggesting some sort of Bill Sutch-like pulling back from the world longer-term, insulationism, and massive public works projects.  The election campaign is clearly getting underway, and the PM and Minister of Finance have claimed to be inspired by Michael Joseph Savage, and whatever good things his government did it led us into the rocks of financial crisis and an insulationism that took decades to undo.)

There is a lot of material in the NZI paper and I don’t want to write a super long post, so what I’m going to do is to take the Executive Summary section by section and offer a few comments on each, and then pick up a few of the interesting or puzzling other ideas that didn’t quite make it up to the front of the document.

Unless effective treatment for the novel coronavirus Covid-19 emerges quickly, the world faces not only misery but economic depression. New Zealand will be immune to neither. The normal economic uncertainties of a downturn will be compounded by the uncertainties of a pandemic.

Perhaps a matter of terminology here –  and I know the first draft of the document was written a while ago – but what we already have is much more than a “downturn”.  More like a “dramatic slump”, partly a result of New Zealand government choices re the virus, but much just unavoidable whatever our government had chosen to do.  The scale of the actual quarterly fall in GDP in the June quarter is likely to be utterly unprecedented –  even if by some miracle the current partial lockdown ends 3.5 weeks from now.

The New Zealand Government’s policy needs to directly boost capabilities in the health sector while providing the kind of appropriate economic support necessary when we’re all taking a lengthy staycation and some industries are put on ice.

Uncertainty about the duration of this crisis makes deciding on the most suitable policy difficult.

Certainly agree about the uncertainty, but in a way the uncertainty is even greater, and much more constraining, for the typical business (and many households).  And that facts does point in some policy directions rather than others, given that the Crown is better placed to bear much of that risk that individual private sector operators (firms or households).

(Incidentally, I’m guessing that the huge number of people losing their jobs altogether each day aren’t thinking of this as a “staycation” but as an utterly disorienting disaster (even if, as for most of us, we know no one with the virus itself yet).

What they say on health itself seems sensible to me

The first priority must be with health.

Increasing the capacity of the health sector to deal with peaks in numbers of Covid cases is important to reduce mortality and morbidity rates. But nobody quite seems to know just where the binding constraints in the health sector are. While credible newspaper articles warn about substantial shortages in equipment and incredible pressure on staff, official statements have been far more sanguine.

If there really will be shortages of critical equipment in four to six weeks, potential suppliers should know that today. Quietly shoulder-tapping likely suppliers may partially solve the problem but won’t provide the necessary scale of response. Suppliers can come from unlikely places. For instance, Italian hospitals are reportedly trialling ventilators reconfigured from scuba diving equipment. Simply announcing a willingness to purchase equipment – and the prices the Government is willing to pay – would allow potential suppliers to identify themselves. Serious companies aren’t likely to re-tool without the certainty of a contract. But they do need to know the demand exists and that they can get essential service status to do the job.

Rapid identification of equipment and skills necessary to boost capability in the medical system, combined with a wide call for assistance, would enable people and businesses to find ways to help. If the health system is not already doing so, it should be offloading less-significant tasks to helpers with limited training, to ease the burden on key medical staff. For instance, thousands of air cabin crew have been trained in first aid and will have plenty of time on their hands. With some rapid training, they may be able to ease some of the burden.

Additionally, the Government has asked retired health workers and health workers furloughed by the current lockdown to assist in Covid-response. It should also consider those foreign-trained medical professionals already in the country who have not yet been able to secure New Zealand medical registration.

To which one could add that a commitment to utter honesty and transparency about what the government does and doesn’t know, has and hasn’t etc would help build stronger confidence.

Part of the cure for a pandemic is a sharp reduction in economic activities in areas not related either to pandemic response or critical areas like food supply. That’s why support for workers and firms is important. But the Government’s chosen wage subsidy scheme is not working well. Even if it can be extended to larger employers, it provides too little support to keep companies from laying off staff en masse.

The Initiative urges the Government to consider a version of Germany’s Short-Time Work support policy. That scheme allows firms to shift workers to a fraction of their normal hours along with an income top-up from the Government. That way, instead of laying off 80% of staff, a company could keep staff on 20% of their normal hours with little reduction in worker earnings.

This kind of scheme is better than either relying on benefits or starting up the sometimes-promoted universal basic income (UBI). A speedy reboot of the economy when this is over matters. That is much harder to do when companies must rebuild hard-earned experience and skills from scratch. The Short-Time Work support policy maintains both workers’ incomes and their links to employers. It targets support to those workers whose hours are cut, rather than spreading support broadly to those far less affected. Simply put, it works better.

I’m increasingly attracted to the Short-Time Work option.  In Germany, for example, in the last recession real GDP fell by more than in New Zealand, and yet the rise in the unemployment rate was much less in Germany than in New Zealand.  Whether or not it makes sense for a country like New Zealand in the longer-term is an open question –  I’m not yet persuaded – but….had it been in place a month ago here it would have looked quite well-suited, albeit perhaps too generous, for the situation we now face.  My unease with as proposed in the NZI paper, and given the time that has already passed, is that if we tried to adopt it as the main initiative now, it might still not do much to keep firms intact –  so severe are the losses of revenue and the extreme uncertainty about whether and when that revenue might again pick- up markedly.   And I entirely agree with the NZI that a UBI is simply not fit for purpose at present –  it does nothing to sustain firms and labour market attachments, and it provides bonus income to the large chunk of the workforce (especially in the public and agricultural sectors) that aren’t likely to be very adversely affected anyway.

Some tax provisions can also be eased. Individuals and firms should be allowed to combine the 2020/21 tax years and temporarily suspend their PAYE collection and Kiwisaver contributions. This would immediately provide more cash in hand everyone. Companies staring down provisional tax assessments based on last year’s earnings could instead defer everything to next year.

This one puzzles me a bit.  It is hard to see that it would do much harm, but it isn’t clear what good it does either.  For those still in a job, they don’t have need of huge amounts of cash right now (what is there to spend it on?). For those out of a job, they aren’t paying PAYE and Kiwisaver anyway. I guess the focus is people on reduced hours, and I don’t have much sense of how large a proportion of the labour force they might be.

Simultaneously, the Government could help reduce business’ fixed costs that otherwise might have compelled them to shut down. It could also cover Council rates bills for firms in financial distress, averting a major hit to the local government purse as well. And access to credit can be improved, especially over the longer term as wage support to employers may need to ease.

I’m a bit puzzled about the rates focus.  I don’t have the figures at my fingertips, but I would assume the business fixed costs that were typically much more substantial were rent, lease costs, and other finance costs (ie interest) –  business interest rates having hardly fallen at all.   There has been some discussion in Australia of the possibility of the government taking over not just wage liabilities but rent.   It is radical, but not out of line with the spirit of my own scheme, guaranteeeing for a year all firms and households 80 per cent of the most recent year’s taxable income.

Finally, a modified version of the New Zealand Student Loan programme should be made available to non-students to help bridge any remaining income gaps. It has the advantage of having already set provisions for income-contingent repayment when the crisis passes.

This is an idea I really quite like.  I asked Eric the other day why they weren’t including here an option to withdraw Kiwisaver funds – again done in Australia –  and he suggested that this borrowing scheme might be preferable, and avoid the risk of encouraging people to cash out of Kiwisaver at the bottom of a share price slump.   Personally, I think people should make their own judgements about that –  US share prices don’t look very low to me – but the secure access to credit (amounts capped at a moderate level) seems quite a good idea.

But financial support is not the only way the Government can and should help.

Regulations that were no real barrier to getting things done in normal times can be insurmountable in a pandemic. For example, some airline pilots require time in simulators to maintain certification, but the necessary simulators are in Australia. In normal times, this just doesn’t much matter – pilots can roster onto an Australia route when and as necessary. This doesn’t work now. But the Government can’t be expected to identify every barrier proactively. It needs to rely on business to highlight the obstacles as they come up using lines of rapid communication with regulators who can suspend or modify them during this crisis.

Sounds sensible to me.

And this is no time for policy or regulatory changes which are not related to the pandemic. The Reserve Bank and Commerce Commission have already postponed theirs. But Parliament’s Select Committees are still asking for submissions on non-urgent legislation. Doesn’t the Health Select Committee have better things to do than consider the regulatory framework for vaping? Some legislation may be urgent enough to require submissions during the Level 4 alert, but everything else should be quarantined.

Totally agree (and I could not quite believe on Thursday when someone asked me for some input on an aspect of a submission on a not-very-important-at-all bill that had submissions closing that afternoon).

Obviously, the Government should borrow the funds it needs to do all this. But this will require maintaining a disciplined approach to any spending lines unrelated to the pandemic. Entrenching new ongoing commitments would complicate a return to prudent debt levels after the crisis and make it harder to borrow the funds necessary for responding to the pandemic.

Hopefully the four weeks of Level 4 lockdown gives the Government enough time both to knock back the pandemic and adjust policy to help us through the coming economic turmoil. We need to adopt more effective treatment.

It is likely to be easy enough to borrow whatever it takes through the crisis.  Not only is the balance sheet strong, but we have a central bank, able to effectively lend into a shock that is, for the time being, powerfully deflationary.  Whatever monetary policy can do, directly or indirectly, the better.

What else struck me in the rest of the document.  Simply in the order the paper comes:

If a treatment does not emerge quickly, economic turmoil could easily last well over a year and the 2008 recession could look mild by comparison.

At this point, this is rivalling the Prime Minister for understatement. For New Zealand, what we see now is already far worse than the 2008/09 recession.

Firms that were viable during normal times and would be viable again after the crisis may nevertheless have substantial difficulty in securing credit to see them through.

The government’s small and medium business loan guarantee scheme –  details yet unknown – may well tackle this particular issue. But it is unlikely to be the main issue.  A far bigger issue is that many firms’ owners will not be willing to borrow, faced with the huge revenue loss and huge uncertainty.  If time could simply be stopped as at the end of February and resumed again 12-18 months hence, it might be one thing.  But there are real and often big costs for many firms, even if the government were to cover many of the wage costs –  and recall that at present even the government wage subsidy is only on offer for a few months, and there is no possibility of many of the adversely affected industries coming back strongly in that time.  We know that.  More importantly, owners in those sectors either know it already or will be realising it very fast.  My one year income guarantee is aimed to buy time before firms simply decide to exit.  But more will simply be exiting with each week that passes, without government action.

(Incidentally, I was a bit surprised not to see any caution in the NZI paper on one rule for the big and well-connected firms and another for the mass of companies.  Sadly, that is the way the government seems to be talking at present, and Air New Zealand already sets something of a precedent.   Quite possibly, policy will not be generous enough anyway, but it would hardly command ongoing public support if just the big-end of town is able to collect from the government.)

A post-crisis recovery period might include longer school and university hours to allow students to catch up on missed work and the temporary extension of working hours for the employed.

Quite what is going to happen, especially around school, if the situation drags on for long is hard to tell.  The current on-line model might work fine for well-motivated senior students, but I’m sceptical it can work for long.  I was a bit more troubled by the final better of the sentence: people may well want to work longer hours, and should be free to do so, but there is a tone to that sentence that almost suggests the state might direct longer hours.  And I’d be distinctly uneasy about anything of the sort.   In thinking about coming through the other side of this, it is wise to keep the overall economic losses in context.  Suppose GDP fell by 50 per cent for a year: that total loss is equivalent to 1 per cent of the total income the country and its people will generate in the next fifty years.  Even if we end this with government debt at 70 or 80 per cent of GDP – which need not happen with sensible balanced, but generous policies, in a growing economy with a balanced budget debt ratios drop away steadily without undue longer-term dislocation (as a historical reminder, the highest level of government debt on record in New Zealand was about 230 per cent of GDP).

Reckless trading provisions of the Companies Act makes directors liable for taking on more credit while insolvent. Policy may require making credit available to companies made insolvent by the crisis.
Banks may be unable to lend as needed during the current crisis if hampered by responsible lending criteria requiring assessment of future income. Relaxing these criteria will help.
Record-keeping and witnessing requirements of AML/CFT regulations currently require face-to-face processes; this may be impossible during lockdowns. Alternative compliance arrangements must be implemented.

I wasn’t quite sure of how much there was to the second point –  although would welcome any comments to elaborate-  but generally the issues raised seem sensible.

Encouraging more people to work from home may require helping individuals and firms with any unexpected costs. The Government’s decision to allow full depreciation of minor business investment will help. It may wish to go further in supporting firms providing employees with the necessary equipment if people are working from home over longer periods. Office-based workers, in the short term, can make do with a laptop but may eventually require monitors, printers and other similar equipment at home. Small condition-free grants to small business calculated by employee headcount

This one seemed like a level of specific support too far, and again would be better dealt with through my overarching income guarantee approach, which enables firms and individuals to make their own choices.

As I say, there is a lot in the paper worth thinking about and debating.  From my perspective it is mostly rather micro-focused, but in that sense much of what is good about the paper meshes quite nicely with my programme for macroeconomic stabilisation, which might usefully be read together with the NZI piece.   The proposed one-year income guarantee –  ACC for the national income, the payout of an (implicit) national pandemic insurance policy –  is at the centrepiece of that, but so too is further really major cuts in retail interest rates.  It is truly remarkable that the government can shred civil liberties, scrap Parliament in the midst of a grave crisis, close down much of the economy and almost all of society, ban funerals and so on….and yet the government, while essentially unfettered power at present, for good and ill, will do nothing to insist on such a basic aspect of responding to any large scale economic slump: much lower interest rates, and servicing costs, in a period when time simply justifies no return.

More on that issue on Monday.

 

Hopeless and complacent

I guess debate will rage for a long time about how well prepared and aggressive, or otherwise, governments around the world were when it became clear that the new and quite contagious coronavirus was becoming a large scale issue.  When all this is over there must a Royal Commission to investigate all aspects of the response (and lack of it).

But quite a lot about the New Zealand story (which may be little better or worse than most other advanced countries) is already clear to anyone who has kept their eyes and ears open as the situation has engulfed us.

On 23 January, the People’s Republic of China authorities locked down Wuhan, a huge city.  On 24 January our Ministry of Health issued a rather anodyne press release.  In that release, the Ministry claimed to be taking the outbreak “very seriously” (there appears to have been another statement two days earlier, but the link didn’t seem to be working this afternoon).   There was a further press release on the 27th where the words were upgraded to “extremely seriously”, but the fateful routinely-repeated line that

the likelihood of a sustained outbreak in New Zealand remains low. 

was first given to the public.   I wonder if they now regret that line, still being repeated more or less as late as last week, as the entire country is in lockdown, civil liberties shredded and economic activity slashed further.  I wonder at what point they really concluded that the risk was no longer “low”.  Just last weekend perhaps?  Or when?

It still isn’t clear quite what ‘extremely seriously’ actually meant in practice in late January. After all, there was no sign of them urging ministers to dramatically scale up either stocks of relevant equipment (in some cases, not even count how much equipment they had), add ICU beds, and their public tone remained emollient almost to the end.  Why is it that news reports only today tell us the Ministry is still trying to get its line and numbers straight?  It was, after all, just three weeks ago that the official Ministry of Health Twitter account was repeating a line that the world had more to fear from rumours, stigma etc than from the virus itself.  How anyone could have uttered, and repeated such lines, and still hold high public office, having uttered not a word of contrition, is really beyond me.  I presume that in some narrow technical sense they must have taken it seriously, perhaps even “extremely seriously”, but to what end?

Because whatever the Ministry of Health did, it clearly wasn’t adequate.   And more importantly, as the channellers of expert professional expertise on the health issues, there is no sign at all that they ever convinced either the Prime Minister and Cabinet or the heads of other major government departments to take the threat as one of utmost seriousness and urgency.  Is there on file somewhere, well hidden from the public, what I’ve described elsewhere as a “Whoop, whoop, pull up” memorandum, whether to Cabinet or other key departments heads, dated late January?  I’m pretty confident there isn’t, because nothing about the subsequent words or actions of ministers, the Prime Minister, or key government agencies suggested any such sense of urgency, a recognition of this as a major imminent threat to New Zealand, which demanded urgent action and urgent contingency plans then and there.      Were 100 of the ablest senior policy and operational people from across the public sector immediately dedicated to fulltime substantive contingency planning?  I’m pretty confident that they weren’t.

I’ve noted previously the sense of complacency, and China focus, in the transcripts of the Prime Minister’s press conferences since the start of the year (the first just after those Ministry of Health “extremely seriously” comments, and her comments don’t appear to have been out of line with those of the Minister of Health or the Director General.   And that same complacency, and China focus, was on public display in the way the economic package, announced early last week, came together.  For several weeks it appeared to be all about the specific industries hit by the China’s responses to the coronavirus, with a sense that it might take a few months or even quarters for those markets to get back to normal.  By the time they finally announced the package, reality was beginning to break over them, but even then in a barely serious way.   Faced with extreme and imminent threat, whether directly in New Zealand or, as some still hoped, in the rest of the world seriously affecting New Zealand’s economy, they used much of their bulked-up package not for temporary crisis responses but for permanently worsening the underlying fiscal position, on things that had nothing to do with the coronavirus situation (whether permanent benefit increases, or permanent business tax cuts) just as the biggest shock in at least 90 years was about to break over us.  It was breathtakingly complacent, politicised, and just did not address most of the main issues.  And that was barely 10 days ago (my contemporary comments here).

All of that could be clear up with a programme of radical transparency, pro-actively all major relevant papers from all government agencies. But I guess the government would prefer to keep us guessing; in fact going by their continuing communications approach they’d prefer to treat us, and hope we acted, as children.

But, as it happens, we already have some specifics about one particular agency that, for all its faults, puts more material in the public domain than most.  The Reserve Bank.

We first heard from them, almost in passing, on 29 January.  The Ministry of Health was, so they told us, already taking the coronavirus “extremely seriously”.  One of the Bank’s deputy chief executives gave a speech on the 29th observing –  probably added at the last minute

In recent months, coronavirus is a human tragedy that has emerged that we will need to monitor, through all three channels.  The SARS virus in the 2000s provides some potential parallels, particularly through the effects on travel and confidence.

Now I don’t really hold Christian Hawkesby to blame for not then being more concerned.  And The Treasury was making similar comments at the same time.  Neither outfits are experts in infectious diseases.  But the early comments of neither organisation betrayed any sense that the Ministry of Health was alerting any one that mattered –  public and private – to the nature of the threat, the real risk of wider spread, and the sheer scale of the disruption China was putting itself through to try to get control (although that latter point might have been something the economists would have noticed, and worried about).

There was a couple of weeks until we again heard from the Reserve Bank, in the Monetary Policy Statement on 12 February.  I won’t go through it all in detail again, but here was our central bank –  Governor and statutory Monetary Policy Committee –  in distinctly upbeat mood.  Sure, there was a small negative GDP effect immediately on account of the China closures and the New Zealand travel ban, but it would all soon be behind us. The Bank actually moved on this occasion to a more optimistic medium-term stance, actually adopting a tightening bias for the next OCR move.   Do note that the Secretary to the Treasury is a non-voting participant in the deliberations of the Monetary Policy Committee, and there is no sign in the minutes that she –  or any of the rest of them –  had been alerted to the imminent huge threat and already had in mind serious contingency planning .  It was really all backward-looking (just waiting for the China effects to pass).  If The Treasury displayed no sense of urgency, the Prime Minister displayed no sense of urgency, the Minister of Health displayed no sense of urgency or serious imminent threat, I think we can conclude none of them just missed the message.  That message was never sent.

Another two weeks on –  by now 25 February, really only a month ago, and  by then already serious epidemiologist types abroad were talking of that virus as something that would potentially affect 50 per cent of the world’s population – we heard from the Reserve Bank again.  This one was unusual, and frankly a bit puzzling.   I wrote about it here.   You see, the Bank had never really used Twitter for monetary policy messaging, and (as I noted at the time) it wasn’t really appropriate to be dropping random comments into the ether with no notice (not how serious central banks do things).  But this was the core of their tweet that day.

One of our jobs at the Bank is to forecast where we think the economy is heading. While there is still things that could trip up our prediction, we expect activity will pick up later this year, meaning more investment, more jobs & higher wages.

I saw it on my way into a meeting and expostulated along the lines of “what planet are they on?”, but later in the day offered a possible more charitable interpretation

My guess is that the tweet wasn’t really intended as monetary policy and related economic commentary at all.  My guess is the MPC wasn’t aware of it, and quite possibly the Governor was not either.   Perhaps someone down the organisation running the Twitter account just thought it would be a good idea to tell us a bit more about the Bank (“we do forecasts”).    But official communications need to be managed better than that –  an excellent central bank, best in the world, would certainly do so.

Sadly, what I’m very slowly learning is that when you think of a charitable and moderate interpretation of the Bank it is usually wrong.   I lodged an Official Information Act request asking for all material relevant to this tweet, including any reaction to it.  And the response arrived yesterday afternoon (you might think handling OIA requests is a bit of a distraction at present, but I had already indicated to them that in the circumstances I wouldn’t be bothered by any reasonable delays in replying).   They haven’t yet put the response on their website, and their response was not very complete (probably in breach of the law), but it makes clear that the absurd tweet, talking of the expected upswing in economic activity this year, was not only authorised by the Bank’s Chief Economist (a statutory appointee to the Monetary Policy Committee) personally, but that it was intended as part of a multi-week Twittter campaign advancing monetary policy messages.  It was planned that by mid-March this would be their message

We are picking the economy will get better in coming years, creating
more work and wealth for New Zealanders. But low interest rates will be
needed to support that growth for a little while yet.

Now, I need to be clear that the decision to authorise these tweets was made on 19 February, but there is no sign at all –  or else they would have to have released it –  of any rethink or revision before it went out on 25 February.

There was simply no sign of one of our major economic institutions –  these days often very well aligned with the government’s messaging –  displaying any urgency or awareness of the gathering threat whatsover.  It was just like everything we saw from the rest of government –  complacent and backward (China) focused.

And so it went on.  There was that strange speech (and questions and answers) of the Governor’s just over two weeks ago now.   We were assured we were nowhere near the need for any special monetary policy action.  That was followed quickly by further highly complacent interviews with other Bank senior managers – best characterised, as I did at the time, as almost unbelievable.   They finally buckled last Monday and cut the OCR, but still there was no hint in their statement even then, or the minutes (and recall the Secretary to the Treasury was part of that), of any serious awareness of what was about to break, of any serious pre-emptive policy, or of any serious practical contingency planning.

Perhaps by then the Reserve Bank was even worse than some parts of government.  Perhaps people near the top of the Ministry of Health, or the Minister of Finance/Prime Minister, implored Orr and his colleagues to open their eyes and get real.  But there is little or no sign of it.  After all, at the time Health was still spouting pretty upbeat lines about the risks here.

Orr went on that week to record an interview in which he described himself as really not overly worried, dismissing any possible comparisons to the depth of the Great Depression or the associated policy challenges.  That was barely 10 days ago.

And so it has still gone on.  Not just the Bank but the wider government has failed to adequately address the huge challenges facing the economy right now.  It is clear that there was no detailed planning undertaken in advance – if there had been, not only would we have seen more serious policy, actually addressing core issues, but even what has been announced –  mortgage holidays, business loan guarantees, and associated bank capital implications –  would actually have some details, not still be little more than statements of good intentions, even as they seem overwhelmed by what has hit them.

There are people around who want to believe in the notion of detailed and extensive advance planning.  People (very young ones) apparently believe in the tooth fairy too.  But all the evidence is to the contrary: they were backward looking, playing things down, perhaps simply unable to comprehend that something like this could hit – even with a full two months notice from Wuhan.  Whatever the explanation it is no excuse.   Would it have been hard to do something well?  Quite possibly, but this is the sort of stuff we really count on governments for –  they have the resources, the people, the intelligence networks etc etc, in a way that no one else does.  They could have done much more –  it is not as if no one out in the wider world was alerting us to the risks and threatss.  It would never have been enough, and wouldn’t have been perfectly fitted to the situation.  Instead, almost none of them even seemed to try.   They did nothing to front the situation with the public, indeed actively played down public concerns and presentations, and since I really don’t believe any of them consciously lied to the New Zealand public one can then only conclude that they didn’t believe it themselves, from the Prime Minister on down.    The Reserve Bank’s complacency –  nearer to the theme of this blog, and perhaps just a little better documented –  only became more egregious as time went on.

It is a simply huge failing.  Much of the stuff governments and their agencies do really doesn’t matter that much in the scheme of things.  The crisis that currently sweeps over us, sweeping away civil liberties, even Parliament, casting hundreds of thousands onto the welfare rolls and probably slashing GDP by a third or more, destroying countless businesses really does.  Our government – and probably most of their overseas peers – failed us badly, simply wasting very scarce time, whistling as they kept their spirits high, even as the boat was about to go under.  Could they have stopped it?   Who really knows now?  But they –  all of them –  Health, Treasury, Reserve Bank, ministers, and countless other agencies could, and should, have been a great deal better prepared and ready to act firmly.  They owed that to New Zealanders.  They let us down.

 

Coronavirus economics and policy: 25 March

Typing the date I notice that in the Christian calendar today is the Feast of the Annunciation –  the announcement of a coming Saviour and Redeemer – and that today it is nine months until Christmas.  One can only wonder how things will be, here and abroad, on Christmas Day 2020.

But what about current policy and related issues?  First, to get out of the way a couple of important, but less central or immediate issues.

The first is around accountability.  Personally, I’m uneasy that Parliament is simply closing down for the time being, in the middle of one of the most severe crises in our history, with an unprecedented usurpation of power by the executive.  But whatever the shorter-term questions, challenges etc (that the planned Select Committee is unlikely to do much about) there will be a need for a serious reckoning with how the authorities, political and official, handle all stages of this pandemic –  those past and those, perhaps over many many months –  still to come.  After the 1918 pandemic, the New Zealand government set up a Royal Commission, which reported back within about six months.  The report is here.   It seems like a good model for a variety of purposes: accountability, documenting issues and experiences, and learning from what worked well (and what do not) for future pandemics.     It would be a welcome commitment to openness and accountability if the Prime Minister would now commit that once the pandemic is passed such an independent and powerful Royal Commission will be established (in case there is a change of government before then, ideally that would be endorsed –  or done jointly with – the Leader of the Opposition.

In the meantime, a serious commitment to accountability and openness –  around contentious and highly uncertain re effect policies (and even choices not to act) –  would be enhanced if the current government would commit to the pro-active release of all Covid-related papers going to Cabinet, to Ministers, and to government agencies and officials who have either independent policymaking power or delegated authority to set operational policy on these matters,  (There might perhaps be a few  – very few exceptions – around national security, but openness builds trust –  or exposes weaknesses, which in turn is a basis for correcting and improving things.)

The second is around economic data.  New Zealand’s official data are pretty mediocre at the best of times –  one of only two OECD countries with only a quarterly CPI, badly lagging GDP numbers, no monthly read on the unemployment rate, and so on.   It is hard not to imagine that the official data will only get much worse this year, with long delays even if adequate numbers are finally able to be patched together.  It would be helpful for analysts if Statistics were to give an early outline of their plans and contingency plans.

But in the meantime, it would also be highly desirable if the authorities (whether SNZ or economic agencies like MBIE, the Reserve Bank or the Treasury) and getting together a timely public dashboard of high-frequency administrative data.  Things it might cover could include, for example:

  • daily or weekly new welfare benefit applications,
  • weekly bank credit data
  •  weekly data on electronic payments
  • daily or weekly arrivals data

These –  and no doubt others –  would be valuable not just now as we tumble into the abyss, but through all the inevitable ups and downs –  perhaps quite volatile ones –  in the coming months.   If/when we eventually get official data it will be good for the economic historians (and the Royal Commission) but for now we need a range of timely high frequency data (no doubt all stuff that could be compiled by people working from home).

What I really wanted to focus on today is the announcement by the government and the banks (and the Reserve Bank) yesterday afternoon.   There were very few details in the announcement, but what we know is this:

The package will include a six month principal and interest payment holiday for mortgage holders and SME customers whose incomes have been affected by the economic disruption from COVID-19.

The Government and the banks will implement a $6.25 billion Business Finance Guarantee Scheme for small and medium-sized businesses

The scheme will include a limit of $500,000 per loan and will apply to firms with a turnover of between $250,000 and $80 million per annum. The loans will be for a maximum of three years and expected to be provided by the banks at competitive, transparent rates. The Government will carry 80% of the credit risk, with the other 20% to be carried by the banks.

The Reserve Bank has agreed to help banks put this in place with appropriate capital rules. In addition, it has decided to reduce banks ‘core funding ratios’ from 75 percent to 50 percent, further helping banks to make credit available.

Take the “payment holiday” first.  I guess it was always likely for customers that were only fairly modestly indebted and had a fair amount of collateral to offer –  indeed, in those circumstances the willingness to offer such an extension is obviously sensible and mutually beneficial.

But do note that this offer by the banks  –  how much was it a genuine offer, and how much were they coerced into it –  includes (or seems to) all existing residential mortgage and SME borrowers.  Just on the mortgage side, that includes those who will have taken on loans in the last year or two with LVRs well in excess of 80 per cent.  It seems highly likely that market-clearing house prices will be falling at present, perhaps really rather a lot, even if the market is highly illiquid and there won’t be any open homes for the time being.   And although people don’t have to stump up with the cash for the next few months, interest is still accruing.  Floating first mortgage rates are still around 4.5 per cent, and on a $500000 mortgage a household will  run up perhaps another $12000 of debt in the coming six months.    An 80 per cent LVR last month could easily be a 100 per cent LVR next month, and worse than that if the security had to be realised in the near future.   Typical business lending interest rates are higher than those for residential mortgages.

I am not, of course, suggesting that banks should waive the interest.  But these continued high interest rates just reinforce the absurdity of the Reserve Bank Monetary Policy Committee simply refusing to cut the OCR any further, having cut it by only 75 basis points in the biggest economic slump of our lifetimes.  Setting monetary policy in a way that delivered, say, zero per cent low-risk retail lending rates would deliver real sustained relief to borrowers, and treat depositors as is appropriate at present (time having no value, or even negative value).

And what of the business loan guarantee scheme?  It looks relatively attractive to the banks, especially as (at present) there is no sign of any guarantee fee, however modest, and will enhance/underpin to some extent and for some classes of customers their willingness to lend a bit more.  Since banks know their own customers they still need to make decisions about which firms are likely to survive, with enough prospect or security that the bank is likely to get its money back.

But I doubt it will be that attractive to many businesses at all, and they may be something of an adverse selection problem in those who actually seek to use it.    And those interest rates –  the official statement says “competitive transparent rates”, while RNZ this morning referred to them as “normal commercial rates”.  Time has little or no economic value at present, at least across the economy as a whole.  Risk-free rates should be negative in a deflationary slump like this, and normal commercial rates –  which always carry a risk margin – probably should be pretty much zero.  That is hundreds of basis points less than firms are, and will, actually pay.  Fixing that would provide real relief, and perhaps a bit more willingness to take on a bit more debt, but the Minister and the Governor simply refuse to do anything about it.

But if debt service relief –  real relief, not just delays –  would be of considerable help, the real issue remains the dramatic slump in revenue many firms have already seen and that many more are just now beginning to experience.   And there is extreme uncertainty about (a) how much worse things might get (bounded at zero revenue I guess, but often with fixed outgoings), and (b) when, and how strongly even then, things might improve.  No one knows, and certainly your typical owner of a modest-sized business doesn’t.  Many of them won’t have much collateral, and they will have low profit margins at the best of times (Martien Lubberink at Victoria yesterday highlighted that The Warehouse group seems to fit that bill), and for many it won’t be obvoius why it is worthwhile to borrow, rather than to simply close down now and perhaps get lucky enough to be among the earlier people to realise any remaining assets.  Even if there is a robust business there five years hence, it won’t be so for the current owners if they take on lots of new debt in the interim.

It may get a bit tiresome to keep reading it, but the government’s approach still does not seem to recognise –  or if it recognises the point, be willing to do anything serious about it –  that the biggest issues around the survival of firms is dramatic income loss and extreme income certainty.  While they avoid confronting that more and more businesses will close by the day.

Which, of course, brings me back to my income guarantee proposal, guaranteeing households and firms (to the extent they maintain paid employees) 80 per cent of last year’s net income for the coming year.    It is the sort of national economic pandemic insurance policy we might well have signed up to if we’d thought seriously enough about the issue 20 years ago (experts have always advised that a really severe pandemic would be along one day).   We can’t –  or shouldn’t –  go offering that level of comfort indefinitely, but given the position successive governments have kept net public debt to (zero per cent on the best OECD measure), we can –  and should –  certainly do it for a year.  It buys both firms and households (borrowers) and banks a reasonable amount of time.  If, perchance, economic life looks like returning to normal in six to nine months, it would have served its purpose, and avoiding many liquidations and insolvencies.  If there is still huge uncertainty, or worse, by then, everyone can start adjusting further.  It isn’t a policy that will or should save every firm, or perhaps even every household, but it would offer a valuable affordable buffer –  one that we’ve either paid the premium for in the last 25 years (getting/keeping that low debt) or could do so over the 25 years after the crisis in over.

And we should back it up with a 20 per cent (legislated) temporary cut in wages (and probably rents).  There are plenty of households that are going to do just fine economically this year, even as the economy’s capacity to generate returns has slumped dramatically.  It is about fairness, shared sacrifice, (and perceptions thereof) and about actually easing the burden on some of those firms (whose “profits” are now deeply negative) everyone wants to hold together if we can.  Complement it with a windfall profits tax if you like for the few firms that might do exceptionally well through all this.

I really hope it doesn’t take much longer before the government is finally willing to confront that “income loss and extreme uncertainty” nexus, and be prepared to take steps that meaningfully address it, in ways that help stabilise for now (and to the extent possible) firms, households, and (thus) underpinning the ability of banks to lend.

Oh, and what stops them just getting on and doing the little it would take to dramatically cut interest rates?

Coronavirus policy and economics: 24 March

And so the die is cast and the motley crew (of, I’m sure, well-intentioned people) that make up our government have decided on a lockdown  Liberties are shredded, but I guess people will still be free to shop at The Warehouse.  It seems a curious business.

We must hope the strategy “works”, but the problem seems to be that (a) it isn’t clear there is a strategy (just another tactical choice), and (b) it isn’t really clear what “works” means here.    The Prime Minister yesterday referred to those standard worst-case types of death numbers, that have been around pandemic planning for years.     And she talked in terms of how the lockdown should probably dampen the local outbreak.  But there was no sense of how we get from a four-week lockdown to the end, when the virus is no longer a threat (whether the hope of a vaccine is realised, or because a less-lethal version just becomes part of the normal mild perils of winter).  In particular, there is no sense of how many lives any particular set of policy responses are credibly likely to save, in a world population with no underlying immunity.   I guess the only honest answer is that no one knows, but it would be good to have sense from the government of the central estimates they are working with, and the confidence bands around those estimates.  Without anything like that it is all but impossible for citizens to reach a view on the merits of any planned set of interventions, or a strategy.

There are various efforts around to attempt at least sketch outlines of a cost-benefit analysis (though typically of “policy intervention” defined very generally).  Some people simply object to such exercises as somehow immoral in the face of the threat.  I disagree.  I think they can help frame some of the discussions society has to be having.  Even if, say, you or I might give everything (if necessary our very lives) to save our children, that simply isn’t the way public health policy (or any other area of public policy for that matter) actually works.   We make choices about costs and tradeoffs, whether it is about speed limits, food safety or (closer to this blog) bank capital.

A few weeks ago, I tried to tease out, in a back of the envelope sense, some of how one might like to think about the issues (towards the end ofthis post).   A couple of extracts

According to the Treasury’s CBAx spreadsheet, the value of a statistical life (price community would pay to avoid premature death) this year is just on $5m.   25000 people at $5m each is $125 billion.  However, the evidence so far – including the Chinese data –  is that the deaths are very concentrated among older people.   On the Chinese data –  which may have its weaknesses –  the median age of those dying looks to have been as high as the late 70s, whereas the median age for all New Zealanders last year was 37.3. Remaining life expectancy at 80 seems to be about a quarter of that at 37, so we can chop down that maximum possible saving (from avoiding premature deaths) to no more than, say, $31 billion.

But, of course, even that is too high, since the implicit assumption is that all those lives could be saved with appropriate policy responses.  And from everything I read that seems incredibly unlikely.  Often people seem to talk about using policy measures and costly private actions (distancing etc) to spread out peaks and reduce the intense, perhaps overwhelming, peak pressures on the health system, and thereby (a) reduce the number of deaths and (b) make the whole experience less intolerable for those who would die anyway and those who, while sick, live.   Obviously I have no idea how many lives might be saved in total, but no one seems to seriously suppose it is anything like all of them.  If it was half, it would –  all else equal – be worth spending $15 billion or so to avoid those premature deaths.

Of course, there are other potential benefits to be added, including any sustained impairment of health (eg lung functioning) for some of those who recover.

Probably three weeks ago $15 billion seemed a really big number.  Sadly, now it is chicken-feed relative to the output losses New Zealand will suffer this year.  The loss in the June quarter alone could end up getting on for doubling that, if the lockdown gets extended much.

But in any such discussions, it is also worth bearing in mind that we need to think about marginal effects on both sides of the “equation”.   How many lives will be saved over the next couple of years by the planned set of interventions vs the additional economic cost from the New Zealand’s government’s interventions.  Both what the rest of the world’s governments do, and what the wider public (here and abroad) do anyway isn’t, in principle, relevant to the calculation.    And a great deal of the economic losses we are now facing, and about to undergo, are already baked-in.   There would be no tourists anyway, as just one example.  There would be massive investment uncertainty.  There would be increased physical distancing and postponement of events, and so on.

It is hard to put numbers on any of these items, but the discipline of writing the assumptions down, expressing realistic confidence intervals, articulating the basis for your judgements on each line item, and then disclosing that material to the public should be a part of what is going on now  It is also at least partly about accountability, for some staggeringly big choices governments are making now, and look set to continue to make in some form or another for some time to come.    I don’t have a strong view myself –  interesting question to ask is whether, if there was a referendum today you would support the lockdown – but confidence in judgements being made is only likely to be enhanced if there is good, robust analysis underpinning those judgements.

(And here we should make only little allowance for the mad rush; they’ve had two months to learn from Wuhan and prepare and yet in all too many fields of government it is increasingly clear how little that time was used for serious bad-case planning and preparation.  That seems particularly evident –  perhaps just because it is my focus – in the economic policy area.)

Of course, the more immediate issues now are around economic policy.   The interviews on the morning shows this morning suggest an announcement from the Minister of Finance later today around credit.   Unfortunately, there is still no hint in any comments from the Governor or the Prime Minister that they are yet willing to do what is really needed.   Simply being willing to extend credit to firms might be helpful, but it isn’t really the issue, because for many firms it simply won’t be worthwhile to borrow, taking on more debt against the totally unknown horizon at which something like normality might resume (hint, it isn’t after four weeks).     We need a comprehensive system of income guarantees (80 per cent of last year’s net) for individuals and for firms that stay fully staffed and capable, for the year ahead.   Just possibly, the guarantees would not prove to be needed for that long, but that is really beside the point now: what matters now is uncertainty and expectations, and not just for the next few weeks (still what the wage subsidy is doing).  (My macro-stabilisation package here.)

This sort of guarantee is the sort of policy (“ACC for the whole economy” as someone put it to me) that will help buy a reasonable amount of time, and give firms some confidence in a willingness to take on debt (while still leaving each firms’ owners to make their decision about likely future viability).  Is such a scheme likely to be expensive?  Sure, but in a sense we paid the premium already, in that low public debt over the last few decades.  We should expect the (unwritten, implicit) policy to be honoured, not obviously as some matter of law, but of charity and good economic sense.

The other thing where there is no progress evident at all is on securing a substantial easing in monetary conditions, and substantial relief of servicing costs (not so much the cash outlay as the legal liability) of borrowers.  On RNZ this morning the Governor was talking up all his tools, but it all really amounts to almost nothing.  He can do large scale asset swaps, and in doing so ease some pressures in specific markets.  But monetary conditions are tightening and they need to be loosening a lot.  He talks of the further tools he has at his disposal, but apart from easing specific stresses, they simply don’t amount to much, nothing like the scale of the need (and one of his own MPC, his chief economist) told us that just before the crisis really intensified).

Interest rates need to come a lot further down.  Business and household borrowing costs at present probably should be no higher than zero.   Even getting towards that would require the OCR to be set significantly negative.  That can quite readily be implemented.  It really needs to be done, and the indifference – and bluster, bordering on outright misrepresentations –  from central bankers, including our own, on the failure to adjust interest rates is frankly quite incredible, ie almost literally unbelievable.  OCRs don’t stop being effective at zero, it is just that too many central bankers stopping trying (while doing lots of handwaving).

A former colleague, from mostly a banking supervision background, left a comment yesterday disagreeing with my call for negative rates.

geof m

I’m sure (well, know) he isn’t the only sceptic, here and abroad, but that isn’t going to stop me championing an idea whose time is long overdue (after all, the near-zero bound only exists because of government regulatory restrictions and monopolies –  it isn’t a given of nature).

What to make of Geof’s specific arguments?

First, I don’t accept that it would be destabilising to the financial system at all –  if anything, at the margin it would assist financial stability by shifting the burden from borowers (increasingly indebted in most cases) to depositors (time is offering no real return right now).

I also don’t belief that there would be anything like the sort of flight to Australia Geof suggests.  After all, exchange rates –  even NZD/AUD are volatile enough and transactions costs high enough – to swamp any possible small interest gains.   Perhaps more to the point, in a floating exchange rate system, unless there is a run to physical cash – and recall that under my model cash would be more expensive to purchase/withdraw –  the total deposits in the banking system do not shrink because someone seeks to withdraw money.    For every seller of NZD there has to be a buyer.  And, frankly, the more people wanted to sell NZD at present, the better –  a materially lower exchange rate is one more helpful part of the stabilisation package.

Finally, Geof also notes that lower interest rates won’t do much to boost spending right now.  That is, of course, true and a point I’ve been making throughout.   The point of policy right now is not to boost spending (the time for “stimulus” will be later) but, in this case, to ease servicing burdens materially, and to help stabilise and reverse the falls in medium-term inflation expectations that risk materially complicating the recovery phase, by starting us off with higher real interest rates than those we went into the crisis with,

There is always resistance to paradigm shifts, and too many central bankers and the like are operating within a paradigm that simply isn’t open to negative interest rates –  even though in New Zealand we went for years with substantially negative real rates a few decades ago.  That really now needs to change, and fast.  Our Reserve Bank could show the way.  Our economic policy position, our stabilisation options, would be improved if they did.

UPDATE: I remembered that I meant to mention an idea a reader passed on this morning.  Since many many businesses will fail anyway, and in many cases that may involve personal bankruptcies, in respect of personal guarantees of business borrowings, in this exceptional climate is there a case for considering cutting in half the period in which someone who goes bankrupt is unable to be involved in running a business.  Like everything in this crisis, there are risks, but it might be an option worth some officials thinking about.

Self-imposed constraints (the latest from the RB)

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

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

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

nz depression

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

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

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

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

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

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

yuong ha

Really just “a little”.

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

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

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

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

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

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

A sobering chart

It astounds me that I have not seen this chart once in the New Zealand media (or from any of our political and bureuacratic officeholders –  I hesitate to call them “leaders”).

aus cases 2

Australia confirmed their first “community outbreak” case on 3 March, when there were 33 cases in total (just fewer than we had yesterday).

It is much the same locally-exponential pattern we’ve seen in so many other countries.  If current rates of increase continue then by the end of tomorrow Australia will have per capita numbers akin to those in the US or UK yesterday.  That is the sort of impact exponential growth has.

There was routinely a lot of trans-Tasman travel.  There is, apparently, still a lot of travel this way as people try to get home.  And while in the last few days self-isolation was supposed to be practiced, there are numerous stories of it simply not being following consistently.  My worst one was a story someone told me the other day: they’d gone to the hairdresser, who was young and pregnant. The hairdresser passed on the story of a customer who’d come in the previous day and commented that while she was in self-isolation she really needed to get her hair done.  The hairdresser, perhaps unsurprisingly burst into tears.

All this means that one can think of New Zealand and Australia as having been essentially a Common Virus Area –  what is mine is yours, and what is yours is mine.  Since we haven’t been doing the sort of aggressive mass testing that some have called for –  although the pace has stepped up in the last few days –  it seems simply irresponsible for the government to be running policy on the presumption that we do not have community out break here.  No one can be certain, but the question has to be what is the safer assumption to make decisions on right now.  Given the rest of the world, given Australia, given the lags (when you confirm community outbreak you should wish you’d acted a couple of weeks earlier), the only sensible approach now is to assume presence, and act accordingly.  But apparently in an interview on Newshub this morning, the government’s chief official on health matters said they were still assuming the opposite, staking a great deal on their view being right.

I see the Prime Minister is to speak at midday.  We’ll see what she says.

For me, I’m less interested in specific announcements or new rules, but on whether there is evidence that (a) they are going to break with the past and actually take the public into their confidence and engage on the issues, options, costs and risks, (b) whether they finally are willing to front with the public on the severity of what is to come, health or economics, (c) whether there is any sign of a developed stable framework for thinking about policy responses through time (d) whether they any sense of an exit strategy for whatever approaches they adopt, (e) whether there is any sign they have identified what things they belief to be more important than public health in this specific situation, and (f) whether they have thought through seriously how sustainable, economically or socially, whatever strategy they adopt is, or whether they are still just attempting to buy “a bit more time” and risking lurching again before long.

These are difficult issues, and few leaders here or abroad seem to be handling them at all well, but no one made any of them take office.

I had been planning to write a post today prompted by the economic and other policy choices and trade-offs implied by the very useful Imperial College paper published earlier in the week, but I might now come back to that –  and particularly questions about whether suppression strategies are worth the costs to the economy and society and its freedoms and values, if anything like what the Imperial College authors suggest it implies were to be an accurate representation of the issue.

UPDATE: Unfortunately, the PM’s statement did not seriously or adequately address any of the sorts of issues raised in the paragraph a couple above.