Funding for lending and other myths

There is a huge number of stories around at present on various aspects of monetary policy and the (successive) governments-made housing market disaster (the two being, in fundamentals, quite unrelated). Were I in fine full health and energy I’d no doubt be writing about many of them. Instead, I’m going to focus here just on the controversy around the Reserve Bank’s so-called Funding for Lending programme, the details of which were announced last week.

It isn’t always inviting to defend the Reserve Bank, since they are often (as here) their own worst enemy, but on the essence of the FLP programme I’m mostly going to. That doesn’t mean I think it is a particularly good scheme – there is a perfectly straightforward way to lower interest rates (the OCR), which influences the exchange rate as well, that they simply refuse to use. And they have named the scheme in a way that actively misleads and invites misunderstanding from those who haven’t thought hard about monetary systems.

All the FLP programme really is is a scheme to lower interest rates a bit more without changing the OCR. That isn’t just my take; that is the official Reserve Bank view. Here is the graphic from the MPS last week as to how they think the thing works

FLP 2

Even that is a bit inaccurate since – as the Governor explicitly noted in his press conference the other day – the expectation that the Bank will be willing to offer funds (not a dollar has yet been transacted) has already done the job. Retail deposit interest rates have fallen relative to the OCR.

But you will note that nothing in that graphic talks about a channel in which additional funds are now available in ways that enable banks to lend in ways, at rates ($m), they couldn’t otherwise.

There are at least two good reasons for that.

The first is that banks are simply not funding constrained. In fact, they are awash with central bank provided funding/liquidity: total settlement cash balances that were about $7bn pre-Covid are now about $24bn. If lending is not occurring at present to the sort of borrowers that some politicians or commentators might prefer – and you have to wonder what such private transactions have to do with them – it isn’t because banks are facing some sort of funding constraint (actual or prospective – there is no uncertainty that adequate funding will be available, including because the Reserve Bank’s core funding requirements – on precise types of funding – have been markedly relaxed for the duration). The Governor made basically that point in his press conference the other day: if not much new business lending is happening at present that is most likely because there is considerable (much larger than usual) economic uncertainty – not anyone’s fault, not anything that can quickly be allayed. That uncertainty affects both prospective lenders and prospective borrowers. Market reports – and the RB credit conditions survey – indicate that banks have tightened their effective credit standards, which is surely what one would expect – probably even hope for, from prudent bankers – in such a climate. There will always be chancers, keen to borrow, but in such a climate banks should probably be particularly cautious about potential business borrowers without strong collateral who are particularly keen to borrow.

So at a system level (and we have no reason to suppose it is different at an individual bank level), settlement cash – which is what the Bank is willing to supply – simply isn’t a constraint on lending. (It wasn’t really even in the 2008/09 recession here, although then New Zealand banks and their parents had reasonable concerns about ongoing access to specific classes of desirable funding.)

As importantly, at an aggregate level any Funding for Lending programme lending does not replace other funding/deposits. In the normal course of bank business in a floating exchange rate economy, and for the system as a whole, deposits arise simultaneously with lending. All bank lending either results in a reduction in someone else’s loan or adds to deposits. That is true within the banking system as a whole, although not for any individual bank (if Bank A increases lending particularly aggressively most of the new deposits may end up at other banks in the system). Any Funding for Lending loans to banks add to their liabilities, but they (collectively) don’t need those liabilities to increase lending. What FFL loans will do, in direct balance sheet terms, is to increase bank borrowing from the Reserve Bank, and increase bank lending to the Reserve Bank (settlement cash balances). And that is it. All the other deposits will still be there.

Now this isn’t to suggest that the FFL scheme is futile. It is not. As the Reserve Bank notes, it is a way of lowering interest rates a bit more. And that is really all. It does that partly through signalling effects and partly (ultimately) because each individual knows it can compete a bit less aggressively in the term deposit market and still be sure (individually) of having ample funds. If all banks respond similarly, there won’t be systematic drains from any of them. And there won’t be much need for many actual FFL loans to occur at all. Time will tell whether the scheme is much used, but if it isn’t that is almost a bonus: it worked (lowering term deposit interest rates relative to the OCR) by the Bank’s willingness to provide, without needing actually to provide much at all.

From banks’ perspectives they’d probably prefer (at least in aggregate) not to use FFL much at all. After all, they borrow at the OCR and then the additional settlement cash (in aggregate) just earns them the OCR, and in the process they just blow up their balance sheets a bit more. But they probably like the option value of knowing the Bank is willing to lend at the OCR – which happens to be roughly where short-term interest rates are.

Which is a (perhaps longwinded) way of saying that the controversy over whether the Bank should have tied these loans to “productive lending” – a weird notion in itself, but that is a topic for another day – is strange and largely empty. I suppose the Bank could have insisted it would only lend under FFL to the extent banks increased their business lending, but had they done so there would have been a very real prospect that the mechanism would not have worked at all. As noted above, banks are not funding constrained and – as almost everyone seems to agree, with the possible exception of Andrew Bayly – to the extent business lending is not growing (it doesn’t usually in recessions), it has little or nothing to do with availability of funding. The scheme is designed to lower interest rates, and seems to have done that. Tying eligibility to particular types of lending – that just aren’t attractive at present, to most borrowers or lenders – would have markedly reduced the effectiveness of the tool, with no gains for the actual lending the politicians purport to champion. That, in turn, would have been a recipe for deepening and lengthening, a bit more than necessary, the recession. Some seem not to mind that, but one would have hoped that neither the government (which made employment an explicit focus for the Bank) nor a responsible Opposition would want that.

But to repeat, the Reserve Bank are supposed to be experts in this stuff, and yet they directly contributed to the problem by so egregiously mislabelling the scheme, in a way that led laypeople to think that somehow “funding” was the constraint on lending (or that up to $28 billion would be pouring into new lending, when in fact the simple availability of new settlement cash will probably no difference whatever to the stock of loans on bank balance sheets). Had they called it a supplementary short-term interest rate management tool it would have been more accurate – but I guess would have sounded less glamorous at the time.

Finally, note that unlike the LSAP programme, the FFL does not involve any material financial risk to the Crown or the Bank, so there was no need for a Crown indemnity. Any FFL loans are fully-collateralised on highly-rated securities, and the Bank’s haircut requirements are usually quite demanding, and all the loans are on floating rate terms (the OCR, as it potentially changes), matching the floating rate liability the Bank will also be assuming (the additional settlement cash balances).

Productivity and GDP

Tomorrow morning we finally get Statistic New Zealand’s first guess at June quarter GDP. If I’m being critical in that sentence, it is through the use of the “finally” – emphasising just how long (unusually long internationally) the delays are in producing national accounts data – rather than in the word “guess”. I don’t suppose SNZ will use the term itself, but I think everyone recognises just how difficult it has been for statistics agencies to get an accurate read on what went on in the second quarter this year, when so many economies were so severely affected by some mix of lockdowns and private cboices to reduce contacts/activities. There are likely to be big revisions to come, perhaps for some years to come, and most likely we will never have a hugely reliable estimate – scholars may continue to produce papers on the topic for decades to come. That is also a caveat on the inevitable comparisons that will be made tomorrow, in support of one narrative or another, about how well/badly New Zealand did relative to other advanced countries. Most/all of them – and their statistical agencies – will have had similar measurement and estimation problems.

We do, however, have some aggregate data on the second quarter, including estimates from the Household Labour Force Survey (HLFS) and the Quarterly Employment Survey ((QES) on, respectively, hours worked and hours paid. Each of these surveys – one of households, one of firms (in sectors covering most of the economy) – had their own challenges in the June quarter.

Over time, the growth in hours worked and hours paid tend to be quite similar (unsurprisingly really). From 2014 to 2019, the quarterly growth in hours worked averaged 0.74 per cent per quarter, and quarterly growth in hours paid averaged 0.65 per cent. From quarter to quarter there is quite a lot of variability, which also isn’t surprising given the way the data are compiled (as an example, my household was in the HLFS for a couple of years and I would answer for all adult members of the household: for hours, I’d give them a number for my wife’s hours that broadly reflected my impression of whether she’d had a particularly taxing time in the reference week or not, but it was impressionistic rather than precise). Partly for that reason, when I report estimates of quarterly growth in labour productivity, I use both an average of the two measures of GDP and an average of the two measures of hours.

But in the June quarter there was a huge difference between HLFS hours worked (-10.3 per cent) and QES hours paid (-3.4 per cent). Some of that will be measurement problems and natural noise. But quite a bit of it will, presumably, reflect the wage subsidy scheme. The wage subsidy scheme ensured that most people who were employed stayed employed during the June quarter – although by the end of the quarter the unemployment rate had risen quite a bit – but many of those whose incomes were supported by the wage subsidy may have been doing much reduced, or barely any at all, hours actually worked during the reference week (when they were surveyed). For some components of GDP the QES series had typically been used as one of the inputs, which would have been quite problematic for the June quarter (and, to a lesser extent) in September.

Statistics New Zealand has published a guide to the sorts of adjustments it is going to make to produce its first guesstimate of GDP tomorrow. They seem to be making a significant effort in a number of areas, and presumably this information – and direct contact with SNZ – is what has led private bank forecasters to converge on predictions that GDP will (be initially reported to) have fallen in the June quarter by something like 11-12 per cent (by contrast, in its August MPS the Reserve Bank expected a fall of 14.3 per cent, and that seemed to be a fairly uncontroversial estimate at the time).

I don’t do detailed quarterly forecasts so I do not have a view on what the initially reported estimate of the GDP fall will be, let alone what the “true” number towards which we hope successive revisions will iterate might be.

I have, however, long been uneasy – and think I wrote about this here back in April – but how, for example, SNZ were really going capture the decline in output in the public sector. Output indicators for the core public sector are a problem at the best of times, but there are plenty of stories of government departments that didn’t have sufficient laptops for all staff, or didn’t have server capacity to enable staff with laptops to all work from home simultaneously. And that is before the drag reduced effectiveness and productivity – if it were generally so productive everyone would have done it already – and the inevitable distraction/disruptions of young children at home. All these people were paid throughout, and were no doubt recorded as “working” – in an hours paid sense – but skimming through the SNZ guide I see no indication of any sort of adjustment for this sector. And in respect of public hospitals – much less busy than usual, with elective surgeries cancelled etc – there is also no sign of a planned adjustment to the measured contribution to GDP.

And this note from the guide

  • The method for school education will not be changed. Activity is assumed to be unchanged, with remote learning assumed to be a direct substitute for face-to-face learning.

didn’t strike me as entirely consistent with (a) changes to the requirements for getting NCEA passes this year (reduced number of credits students are required to achieve, (b) reports of the difficulties many students had (or the fact that the government was still trying to dish out free routers to poor households – allegedly mine – as recently as a couple of weeks ago, or (c) my observations from my kids about how relatively little many of their teachers seemed to do during the period. Some kids – including a couple of mine – have even have learned more during time at home than time at school but (a) I doubt that generalises, and (b) it certainly won’t show up in more NCEA credits, since schools actively reduced the number of credits they offered.

So those are just a few straws in the wind that leave me suspecting that whatever is published now is probably something of an overestimate of value-added in the June quarter.

I’m also a bit uneasy when I think about what sort of monthly track (implied) is required to have generated “only”, say, an 11 per cent fall in GDP during the June quarter, bearing in mind that real GDP had already fallen 1.6 per cent in the March quarter as a whole.

There was a pretty strong view back in April/May that during the so-called “Level 4” restrictions economic activity was likely to have been reduced by almost 40 per cent below normal (the Reserve Bank’s 37 per cent estimate was here, and I think The Treasury’s estimate was even weaker).

But even if one assumes that in May and June economic activity was right back up to the level prevailing on average during the March quarter (in much of which there must have been little or no Covid effect, even though by the last few days of the period the “lockdown” was in place), April (almost all of which was in lockdown) must have been no weaker than 67 per cent of the March quarter average level to generate an 11 per cent fall for the quarter as a whole.

And that just doesn’t really ring true. We know, for example, that there were no foreign tourists arriving in the June quarter, and levels 2 and 3 restrictions were in place for quite a while. We know too the firms that swore they met the legal requirements for the extended wage subsidy.

If instead, and for example, we assume that May and June were back up to 95 and 97 per cent respectively of March quarter levels of economic activity – which sounds more or less plausible – then April has to have been no weaker than 75 per cent of the March quarter to generate an 11 per cent fall for the June quarter as a whole. And that doesn’t really square with any contemporary estimates about how binding the so-called Level 4 restrictions were. Perhaps they were all wrong and things just weren’t so badly constrained at all, but count me a bit sceptical for now. We’ll see, but in and of itself tomorrow’s release may not shed much light we can count on.

And on the other hand, there is the question of the implied change in labour productivity (defined as real GDP per hour worked). Assume that the HLFS is a somewhat reasonable representation of hours actually worked during the quarter and one is working with a reduction in hours of 10.3 per cent.

Suppose then that the bank forecasters (I looked at ANZ, Westpac, and ASB) are right and GDP is reported to have fallen by 11-12 per cent. That would produce a “headline” – well, there are no headlines, because SNZ does not report this measure directly – drop in labour productivity of perhaps 1 or 1.5 per cent for the quarter.

That might, on the surface, sound plausible. All sorts of things must worked less efficiently under voluntary or regulatory restrictions around the virus. If anything across the range of sectors that normally involve extensive face-to-face contact it might sound like a reasonable stab – albeit perhaps on the small side – as a representative drop. Remember that even in places where gross output was maintained, often slightly more inputs will have been required to keep up output.

But what do we see in other countries? Finding quarterly productivity estimates for most other countries isn’t easy. The UK publishes an official whole economy series, but with a fair lag (so the Q2 estimates are not yet available, even though they publish monthly GDP). Australia does publish official estimates of real GDP per hour worked in the same release as the GDP numbers. The initial ABS estimate is that real GDP per hour worked rose quite sharply in the June quarter.

aus covid productivity

The US does not report official whole economy productivity, but labour productivity in the non-farm business sector is estimated to have risen by 10.1 per cent. In both cases, output fell, but hours worked fell even faster. Canada also reports a significant rise in average labour productivity in the June quarter even as real GDP also fell sharply.

What is going on here? It isn’t that Covid is suddenly making everyone, or even whole swathes of industry, materially more productive – the longed-for elixir of renewed productivity growth. Almost certainly what is going on is compositional change: the people who were working fewer hours (or not all) will have tended to be disproportionately in relative low wage/low labour productivity sectors/roles. One can think of bar staff, waitresses, office and motel cleaners, barbers and so on. On the other hand, a fairly large proportion of higher-paying jobs could be done, more or less effectively, with little or no face to face contact. And in Australia, for example, the hugely capital intensive resources sector will have been hardly affected at all by the Covid restrictions. Most individual sectors/roles might have maintained – more or less – their productivity, but for many lower paying ones the effective demand (and output) was just no longer there. Averaging those who were still producing/working one ends up with higher average productivity even if no individual is any more productive than ever.

Each country’s restrictions, and underlying economic structures, were/are a bit different. But on the face of it, it is a little hard to construct a story in which average labour productivity hardly changed in New Zealand when in other advanced economies it rose a lot. We were very stringent on shops and cafes/restaurants/bars. We had a large tourism sector that was very hard hit, and typically isn’t a hgh paying sector.

Now perhaps that HLFS estimates of hours worked (-10.3 per cent) is itself all wrong – although presumably other countries must have had similar issues – but if GDP comes out tomorrow with a reported fall similar to the reported fall in hours worked, it will be just another puzzle to add to the mix – and to hope for some significant revisions down the track. Of course, if (a) HLFS hours is a reasonable guide, and (b) other countries’ productivity estimates are a reasonable guide, then all else equal one might have expected a fall in GDP even less than the one those private forecasters are picking. And – even amid the great uncertainty – that really would be a surprise.

What difference did lockdowns make?

I’ve written a couple of posts over the months drawing on work by Waikato economics professor John Gibson. Back in April there was this post, and then last month I wrote about an empirical piece Gibson had done using US county-level data suggesting that government-imposed restrictions in response to Covid may have made little consistent contribution to reducing death rates (in turn consistent with evidence suggesting that much of the decline in social contact, and economic activity, was happening anyway, in advance of government restrictions).

Fascinating as I found that paper, I was never entirely convinced how far the point would generalise, It seemed implausible, for example, that government restrictions and “lockdowns” would never make much difference – even if, in practice, the particular ones used in US counties might, on average, not have. After all, at the extreme, if a population (wrongly) regarded the threat from a particular pandemic as fairly mild, and yet some megalomaniacal government nonetheless banned all cross-border movement and ordered that no one was to leave their home for six weeks it is quite likely that – gross over-reaction as the government’s reaction might be – fewer lives would be lost from the virus under extreme lockdown than with no government restrictions. Then again, if the public was right and the government was wrong, such a lockdown would not save any material number of virus deaths, but would come at an enormous cost, whether in economic terms or personal and civil liberty.

That earlier paper also used only US data, and although there is an enormous richness in US data – since restrictions were imposed at state and county level – there is the entire rest of the world, even just the advanced world, to consider. As it happens, Professor Gibson has now done another short paper looking at (much of) the OECD countries – most of the advanced world. Here is his abstract.

A popular narrative that New Zealand’s policy response to Coronavirus was ‘go hard, go early’ is misleading. While restrictions were the most stringent in the world during the Level 4 lockdown in March and April, these were imposed after the likely peak in new infections I use the time path of Covid-19 deaths for each OECD country to estimate inflection points. Allowing for the typical lag from infection to death, new infections peaked before the most stringent policy responses were applied in many countries, including New Zealand. The cross-country evidence shows that restrictions imposed after the inflection point in infections is reached are ineffective in reducing total deaths. Even restrictions imposed earlier have just a modest effect; if Sweden’s more relaxed restrictions had been used, an extra 310 Covid-19 deaths are predicted for New Zealand – far fewer than the thousands of deaths
predicted for New Zealand by some mathematical models.

Professor Gibson does not seem at all taken with the Prime Minister’s “go hard, go early” catchphrase. He argues that the New Zealand government went hard, but actually rather late. He begins the paper with this chart, comparing restrictions in New Zealand and several other advanced island countries (ISL being Iceland).

Gibson 1

And observes

Up until mid-March the New Zealand response generally lagged the other countries in Figure 1. Moreover, the initial response, from 3 February, required foreign nationals arriving from China to self-isolate for 14 days. In late February, this extended to travelers coming from Iran. Subsequent genomic sequencing of confirmed cases in New Zealand from 26 February until May 22 shows representation from nearly all the diversity in the global virus population, and cases causing ongoing local transmission were mostly from North America (Geoghagen et al. 2020). Thus, aside from self-isolation being poorly policed, restricting travelers from certain countries (for example, China, Iran) is ineffective at keeping the virus out, unless all countries in the world simultaneously impose the same restrictions. Without such coordination, the virus can spread to third countries, from whence it can enter New Zealand. It is like bolting one door on a stable with many exterior doors, with horses free to roam around inside so that a smart horse (aka ‘a tricky virus’) can escape through any of the other doors.

And goes on to note that

The evidence in Figure 1 is open to at least two criticisms. First, different comparator countries may allow alternative interpretations. Secondly, comparing with responses of other countries may not be the right metric. Sebhatu et al (2020) find a lot of mimicry; almost 80 percent of OECD countries adopted the same Covid-19 responses in a two-week period in midMarch: closing schools, closing workplaces, cancelling public events and restricting internal mobility. These homogeneous responses contrast with heterogeneity across countries in how widely Covid-19 had spread, in population density and age structure, and in healthcare system
preparedness. One interpretation of this contrast is that some governments panicked and followed the lead of others, rather than setting fit-for-purpose Covid-19 responses that reflected their local circumstances. So another approach to study policy timing is to compare policy responses with the spread of the virus in each country.

Gibson adopts an approach of working back from data on Covid deaths – imprecise as that it, it is generally regarded as better than direct estimates of case numbers, which are hugely affected by just how much testing has been done – to estimate when there must have been a turning point in infection numbers to be consistent with the observed deaths data. That involves using an estimate, informed by experience, of the lag from infections to deaths (he mentions a couple of papers estimating lags of three to four weeks). Gibson produces results for 34 OECD countries, although unfortunately (for New Zealand comparisons) not for Australia.

The results in Table 1 show that the inferred inflection date in infections ranges from February 23 to 4 June, and for the median OECD country occurred on 23 March. For New Zealand, the approach in Figure 2 suggests new infections peaked on March 16, over a week before the strictest restrictions began on 26 March. Even if a shorter lag from infections to deaths is assumed, the peak in new infections in New Zealand still will have occurred before the Level 4 lockdown began. New Zealand is amongst 17 countries whose peak policy stringency occurred after the likely turning point in infections. So based on comparing policy
timing with likely progress of the virus, the ‘go early’ claim seems untrue.

He argues that it matters

It matters that policy restrictions are applied too late. Over two-thirds of variation in Covid-19 death rates (as of August 18) across these 34 OECD countries is due to baseline characteristics: deaths are higher in more populous countries, with higher density, higher shares of elderly, immigrants and urbanites, and fewer hospital beds per capita and having land borders (Table 2). If the country-specific mean of the OxCGRT policy stringency index is included it provides no additional predictive power. However, if the time-series of policy stringency is split at the inflection point in infections for each country (based on Table 1), prepeak policy stringency is negatively associated with Covid-19 death rates while post-peak policy stringency has no statistically significant effect on death rates. A similar pattern is apparent if the (likely) dates of peak new infections are controlled for, or if the maximums of the stringency index are used rather than the means. Thus, it seems to matter more to ‘go early’ than to ‘go hard’.

Gibson goes on to deal with concerns about endogeneity, re-running tests looking at policy responses relative to those of other nearby countries. Doing that tends to confirm the thrust of the earlier results.

there is a precisely estimated negative elasticity of death rates with respect to the policy stringency that was in place prior to the peak of new infections and an insignificant effect of policy stringency after the inflection point in infections has occurred.

But even then the effects appear to be quite small

gibson 2

And what of New Zealand?

gibson 3

or, in the slightly less-loaded framing from the abstract

if Sweden’s more relaxed restrictions had been used, an extra 310 Covid-19 deaths are predicted for New Zealand – far fewer than the thousands of deaths predicted for New Zealand by some mathematical models.

Of course, all those 310 would have been people, with grieving families, but on this model, we would have had a rate of deaths per million still in the lower half of OECD countries (rates akin to many eastern European countries, and Norway) not to those of (most of) northern Europe, including Sweden.

Having read and reflected on the paper, and engaged on a couple of points with Professor Gibson, I thought there were still several points worth making in response:

  • unlike his earlier paper, this paper makes no claims about what was known, or not known, by New Zealand and other countries’ governments in mid-late March. Even if the true number of new infections had started to decline even prior to the New Zealand “lockdown” policymakers could not have used this methodology at the time (since the deaths – the foundation of the timing estimate – had not yet happened). Reviews with the benefit of hindsight are not without their considerable uses – most real-world reviews are of that sort – but it is important to be clear that that is what this paper is. Politicians, of course, use their own take on hindsight to reinforce their preferred narratives,
  • the results may depend quite a bit on the correct specification of the model, and in particular on whether the other variables included (country population, population density, elderly share of the population, foreign-born share of the population, per cent living in urban area, available hospital beds per capita, and the presence/absence of a land border) have a robust foundation. The one I was particularly sceptical about was country population, as I could not see a good reason for it to affect Covid death rates. I asked Gibson about it and he re-ran the model without that variable and in summary “the basic pattern of results in terms of the policy variables stays the same, and particularly the contrast between pre-peak and post-peak stringency”. As it happens, this variant produces a lower estimate of New Zealand deaths with Swedish-level restrictions than the models reported in the paper itself. (Gibson, however, continues to think a population variable has a sensible structural interpretation.)

If we take Gibson’s results at face value they seem pretty appealing (and, in many respects, not that surprising, since we know – from papers since released – that officials in mid-late March were not recommending a lockdown of anything like the stringency of what the government actually imposed).

That said, it isn’t clear to me what the nature (and quantification) of any tradeoffs around economic costs and loss of liberties might be. There is a reasonable argument – and it is the stance I take myself – that the extreme restrictions on economic activities and liberties should be counted as a very large cost, justifiable (if ever) only in the face of the most severe and near-certain threat. What sort of society are we when we tolerate a government banning a swim in the sea, banning funerals, banning any public celebration of Easter, banning utterly safe economic activity (a sole practitioner going to his or her place of business)? But perhaps there is a counter-argument if maintaining the sort of moderate death rate Gibson envisages also required that we kept Swedish-type restrictions in place right through the last six months? It is possible – but needs for work, more modelling – that the total economic costs might have been similar or even higher. But then should one put a higher price on the most extreme episodes not just weight all losses equally? Perhaps there is a clearer-cut argument there in respect of restrictions on liberties than on the narrower GDP effects, perhaps especially when we recognise that different people value different things, different freedoms, different obligations in different ways. And that arbitrariness and unpredictability of use of extreme controls should itself be represented as carrying, and imposing, a heavy cost.

My position all through has been that the government over-reacted in adopting the full extent of its so-called “Level 4” restrictions. But the issues in my mind then was a difference between a New Zealand “level 4” and the somewhat less severe approach adopted in Australian states. With the benefit of hindsight, a paper like that of Professor Gibson poses more questions – and the sort of the questions that need to be posed, since the virus hasn’t gone away and (for example) we see Israel being forcibly locked down again. I hope his paper gets some scrutiny from, and engagement with, some of the more thoughtful of the champions of the New Zealand government’s approach. Perhaps he is quite wrong and his conclusions just aren’t sound, but they look like results that should warrant serious engagement, perhaps even a question to the Minister of Health, the one who the other day was trying to pretend the government does not (implicitly or explicitly) put a dollar value on human life in making its spending/regulatory decisions.

LSAP, deposits, bonds, house prices etc

There has been a flurry of commentary in the last couple of weeks about the (alleged) impact of the Reserve Bank’s Large Scale Asset Purchase programme. Much of it has seemed to me really quite confused. I don’t really want to pick on individual people – none of whom, as far as I’m aware, is a macro or monetary economist – although, for recency if nothing else, Bernard Hickey’s column yesterday is as good an example as any. But the Reserve Bank itself has not helped, tending to materially oversell what the LSAP programme has actually done.

There is, for example, a complaint (there in the headline of Hickey’s article) that “printed money being parked, not invested or spent”. But this seems to completely ignore the fact – it isn’t contested – that really only Reserve Bank actions affect the stock of settlement cash. All else equal, when the Bank buys an assets from someone in the private sector, that purchase will boost aggregate settlement cash, and only some other action by the Reserve Bank will subsequently alter the level of settlement cash. When private banks lend (borrow) more (less) aggressively, that may change an individual bank’s holding of settlement cash, but it won’t change the system total. Some of my views and interpretations may be idiosyncratic or controversial, but this one isn’t. It is totally straightforward and really beyond serious question. For anyone who wants to check out the influences on the aggregate level of settlement cash balances, the Reserve Bank produces a table – only monthly and too-long delayed in publication – detailing them (table D10 on their website). I’ll come back to those numbers.

Now, of course, the transactions that give rise to changes in settlement account balances aren’t always – or even normally – primarily with banks themselves. If the Reserve Bank bought a government bond I was holding, that would increase – more or less simultaneously – (a) my balance in my account at my bank, and (b) my bank’s balance in its account at the Reserve Bank. And because the government banks with the Reserve Bank, the same goes for (say) government pension payments: all else equal, they add to the recipient’s own deposits at his/her bank, and also to that recipient’s own bank’s deposits at the Reserve Bank (in normal times, the Reserve Bank does open market operations that roughly neutralise these fiscal flows – revenue or spending).

Much of the coverage of the LSAP purchases suggests that there has been a big net transfer of cash (deposits, settlement cash) from the Reserve Bank to private sector bondholders in recent months. Thus, we get stories and narratives about what “rich people” and other bond holders are (and aren’t – often the point) doing with all the cash they are now holding. But it simply isn’t a narrative relevant to New Zealand over recent months. The Reserve Bank publishes a table showing holdings of government securities (Table D30). Again, it is only monthly and we only have data to the end of July. But over the five months from the end of February to the end of July, secondary market holdings of New Zealand government securities (ie excluding those held by the Reserve Bank and EQC) increased by around $10 billion. It simply is not the case that funds managers, pension funds and the like (private bondholders generally) are suddenly awash with extra cash. In fact, collectively they have more tied up in loans to the Crown than they had back in February.

None of which should be really very surprising. After all, the government has run a massive (cash) fiscal deficit over the last six months – a reduced tax take and programmes that put lots of extra money into the accounts of businesses and households.

We can get a sense of just how large from that Influences on Settlement Cash table (D10) I referred to earlier. In the five months March to July the government paid out $23.8 billion more than it received. There is some seasonality in government flows, but for the same period last year the equivalent net payout (“government cash influence”) was $4.5 billion (and $4.9 billion in the same period in 2018). That is a lot of money put into the accounts of firms and households – the largest chunk will have been the wage subsidy payments, but there was also the corporate tax clawback, and various other one-offs, as well as the effect of the weaker economy in reducing the regular tax-take.

Over those five months the government has also issued, on-market as primary issuance, a great deal of debt (bonds and Treasury bills) offset by maturities (and early repurchases of maturing bonds by the Reserve Bank). Over the five months, the net of all these on-market transactions was $34.4 billion – as it happens, a whole lot more than the cash deficit for that period.

Now, of course, we know that the Reserve Bank – another arm of government – has been entering the secondary market to buy lots of government bonds. For the five months, the cash value of those purchases was $27.2 billion.

Take those two debt limbs together and issuance has exceeded RB LSAP purchases by about $7.2 billion.

And those are almost all the main influences on aggregate settlement cash balances. Other Reserve Bank liquidity management transactions can at times have a significant influence, but over these five months the net effect was tiny, at around $300m.

So broadly speaking, over the five months from the end of February to the end of July, the total level of settlement cash balances increased by about $16.4 billion (to $23.8 billion at the end of July). Roughly speaking, a cash deficit (also, coincidentally) of $23.8 billion, and net debt sales by the NZDMO/RB combined of $7.2 billion. And a few rates and mice.

Another way of looking at it is that the $23.8 billion “fiscal deficit” has been financed by $7.2 billion of net debt sales to the private sector, and by the issuance of $16.4 billion in Reserve Bank demand deposits (another name for settlement cash balances).

(And thus the biggest effect of the LSAP programme itself has really just been to change the balance between those last two numbers – consistent with the line that I keep running that to a first approximation the LSAP is just a large-scale asset swap, exchanging one set of low-yielding government liabilities (that anyone can hold) for another set of low-yielding government liabilities (that only banks can hold, while banks themselves assume new liabilities to their own depositors).

But taking the private sector as a whole what has happened over the last few months is that the fiscal policy choices (spending and revenue) have put lots more money in the pockets (and bank accounts) of firms and households. And the government as a whole (NZDMO/RB) has offset the settlement cash effects of that in part by (net) selling really rather a lot (by any normal standards) of net new bonds to private sector investors/funds managers etc. They, in turn, have less cash. Firms and ordinary households have more (at least than they otherwise would).

There have been strange arguments – and the Reserve Bank Governor sometimes feeds this silly line – that banks are not “doing their bit” by lending more to businesses, even though – we are told – they have so much more settlement cash. But this is a wrongheaded argument, because systemwide availability of settlement cash has rarely, if ever, in recent times (last couple of decades) been a significant constraints on bank lending. Aggregate settlement cash balances barely changed over the previous decade and plenty of lending occurred. In a severe and quite unexpected recession, it would generally be more reasonable to suppose that lack of demand from creditworthy borrowers, some caution among banks as to quite what really is creditworthy, and sheer uncertainty about the economic environment would explain why there wasn’t much new business lending occurring. In fact, sensible bank supervisors would typically welcome that outcome. And remember my point right at the start, even if banks were doing lots of new business lending, it would not change the level of settlement cash balances in the system as a whole by one jot.

So then we get to the question of house prices. Many people – me included – expected that we would have seen house prices beginning to fall already. Severe recessions and considerable uncertainty tends to have that affect. Often, tighter bank lending standards reinforce that. So what did we miss? I can’t speak for anyone else, but for me:

  • I have not been surprised by the extent of the fall in retail interest rates.  That fall has been small in total, and modest by the standards of significant past recessions.  When people idly talk about lower lending rates driving up house prices, they seem completely oblivious to the way –  whether over 1990/91, after 1997/98, or in 2008/09 –  falling interest rates initially went hand in hand with flat or falling house prices.  Interest rates were, after all, falling for a reason in the middle of a recession.  One can argue that trend lower interest rates are raising trend house prices (I don’t think so, but that is for another day) but there isn’t really a credible story that this modest fall in interest rates –  amid a big and uncertain recession –  is raising house prices now, in and of itself,
  • we also know that people who usually hold bonds are not suddenly finding themselves at a loose end, unable to invest their cash in government bonds and having to fall back on buying a house instead.  The aggregate figures tell us instead they are holding a lot more bonds than they were (and as a trustee of super funds that do have substantial bond exposures, I know our advisers have not come and urged us to sell out and buy houses).
  • but we’ve also had a highly unusual combination of events that together probably do explain why, to now anyway, house prices are holding up in most places, perhaps even rising.  
  • we’d never previously gone into a recession with binding LVR limits in place.  The Bank removed those limits when the recession began –  sensibly enough –  for a flawed policy –  and consistent with the way they’d always talked of operating, enabling some people who regulation had forced out of the market to get back in.  Regulatory credit constraints were eased.
  • We also had the mortgage holiday scheme, which had two legs to it.  The first was that banks generally agreed to show forbearance to people who would have otherwise had trouble servicing their mortgage over this period, allowing them to defer to later payments due now.  Mostly that was probably pretty sensible, and banks might done something along those lines for most customers even with no heavy-handed government involvement.  But then the Reserve Bank engaged in questionable regulatory forbearance, telling banks that even though the credit quality of their residential loan books had deteriorated –  people unable to pay, even if perhaps just for a time, but with threats of rising unemployment –  they could pretend otherwise, at least for the purposes of the capital requirements the Reserve Bank imposes on locally-incorporated banks.
  • And, third, we’ve had an unprecedented series of fiscal support measures, putting lots (and lots) of taxpayer money into the accounts of businesses (mostly, directly) and households, to offset to a considerable extent the immediate substantial loss of market incomes and GDP.

My approach then is to reason from the counterfactual.   Suppose these actions had not been taken, what then would we have expected to have seen in house prices?

I reckon it would be a safe bet that house prices would have fallen.  Sure, retail interest rates would still have come down, but as I noted earlier that happens in almost every recession, and the falls are typically larger than those we’ve seen this year.   But even just suppose the virus had done as it did, here and abroad, and that the anti-virus choices (policy and private) were as they were.  There would have been a huge increase, almost immediately, in unemployment, and a large number of households would have been thrown onto no more than the unemployment benefit, and many of those that weren’t would have running very scared.  The cashed-up might still have been interested in buying, at low interest rates, but there would have lots of sellers –  whether forced by the bank, or people just needing to cut their debt urgently –  and that wave of desired selling would have fed doubts that would have left buyers more wary than otherwise.    But it was the fiscal policy choices that put additional money in the pockets of those who might otherwise have been rushing to sell.

The thing is, that for all the moans and laments about house prices rising a little, no one seems to have been arguing that we should not have taken a generous approach to supporting households through recent months.  Given the logic of the LVRs, probably most people think it reasonable that those restrictions were suspended.   Few people think banks should have been more hard-hearted (even if a few geeks like me might be uneasy about the capital relief the RB provided). 

And it is those that are the choices that really mattered.  (They are also why I remain sceptical that any strength in the housing market will last much longer, given that the fiscal support is rapidly coming to an end, unemployment is rising (and is expected to continue to do so), the world economy looks sick, we’ve been reminded afresh of virus uncertainty, and deferred debt has not gone away.  Time will tell.)

Now none of this is to suggest we should be at all comfortable with the level of house prices in New Zealand.  They are a disgrace, and the direct responsibility of successive governments of all stripes, and of their local authority counterparts.    But given that all of them refuse to address the real issues –  opening up land use on the fringes of our towns and cities in ways that would bring land prices dramatically down – they can’t really be surprised by where we are now.

And it is has nothing whatever to do with the LSAP programme:

  •  which has not put more money in the hands of people who buy houses,
  • has not made any material difference to wholesale or retail interest rates over the relatively short-term maturities most New Zealand borrowers borrow at (even if there is a case that the might have a material difference to long-term rates, benefiting really only the government as borrower),
  • may have actually held short-term interest rates up a little, if the Reserve Bank is being honest in its claim that it preferred using the LSAP to cutting the OCR further this year,and
  • which has not enabled, empowered, or encouraged the government to run any larger deficits than it would otherwise have chosen to run (which could readily have been financed on-market, except perhaps in the torrid week or two in late March when global bond markets were dysfunctional.   Government deficits put money in the pockets of people.  Most people –  me included –  think they were right to do so (even if we might quibble about details).

Observant readers may have noticed that the government issued much more debt over those five months than the deficits it ran.  Without the LSAP, these transactions in isolation would have tended to drain the level of settlement cash.  But that would not have happened in practice.   Either the NZDMO would have spread out its issuance a bit more, or the Reserve Bank would have done (routine for it) open market operations to stabilise the aggregate level of settlement cash balances at levels consistent with their target level of short-term interest rates.

Other observant readers might wonder how the LSAP can be so relatively unimportant (in many ways almost as unimportant as the MMT authors might suggest).  A key issue here is that the yields the (whole of) government is paying on bonds is very similar now to the yield (the OCR) it is paying on unlimited settlement cash balances.   One could imagine a different world in which things would work out differently.  It used to be common for settlement cash balances to earn either zero interest, or a materially below market rate.  So if, say, the Reserve Bank was buying bonds at yields of 10  per cent –  where they were in the early 1990s –  and paying zero interest (or even a significant margin below market) on settlement cash balances, each individual bank would be very keen to get rid of any settlement cash building up in its account.  They still couldn’t change the total level of settlement cash balances but they could, for example, bid deposit rates down aggressively, which would (among other things) be expected to materially weaken the exchange rate.  But on current policy –  only adopted in March –  the Bank pays the full OCR on all and any settlement cash balances.  25 basis points isn’t a great return, but it is probably high enough –  relative say to bank bill yields – that banks aren’t desperate to offload settlement cash.  The transmission mechanism is then muted, as a matter of policy choice.

Finally, note that –  because of the inadequacies of the Bank’s data publication (influences on settlement cash really should be daily, published daily, in times like this) – all my numbers refer only to the period to the end of July.  But note that since the end of July the level of settlement cash balances has fallen further ($19 billion as of last Friday).  I haven’t tried to unpick what specifically has gone on in any detail, but my guess is that the cash fiscal deficit has diminished, while heavy bond and bill issuance by DMO has continued.  The Reserve Bank has stepped-up its own purchases but the bottom line remains one in which (a) if anything the Bank is draining funds from banks, although in doing so not really constraining any one or any thing, while (b) it is fiscal choices –  pretty widely supported ones –  that have still been putting money in the pockets of people who might, for example, be holding houses (and owing the attendant debt).  Unsurprisingly, bank deposits have risen in recent months, exactly as one should have expected.

And there endeth the lecture,  My son (doing Scholarship economics) asked about this stuff the other day and I ran him through most of this material.  My wife suggested I’d had my best schoolmaster’s voice on at the time.  I suspect the tone of this post is somewhat similar.  I hope the substance is some help in clarifying some of the issues. 

Pandemic income insurance

Way back on 16 March, the day before the government brought down the first of its pandemic economic response packages, I ran a post here in which – among other strands of an approach to the rapidly worsening economic situation – I suggested that the government should legislate quickly to provide, for the coming year, a guarantee that no one’s income would fall below 80 per cent of what it had been in the previous year. The proposed approach was to treat individuals and companies in much the same way. The underlying idea was to provide some certainty – to individuals, firms and lenders – without offsetting all losses (society was going to be poorer) and without locking people in to employment or business relationships that may have been sensible/profitable previously, but which wouldn’t necessarily be in future. And to recognise that individual firms and people are better placed to reach those judgements – about what makes sense for the future, what makes sense (say) to borrow to support – that government ministers or officials.

I knew that any such scheme might be very expensive, and rereading the post I see that I proposed it even though I was talking about economic scenarios for potential GDP losses that were materially worse than most think we will now actually face. But part of the mindset was the parallel with ACC – our no-fault accident compensation system. Being able to treat people in a fairly generous way when a serious pandemic – that was no one’s fault – hit could be conceptualised as one of the bases for the low-debt approach successive governments had taken to fiscal policy over recent decades. And it did not require governments to pick winners – firms they thought might/should flourish – or pick favourites.

Since it was sketch outline of a scheme, dreamed up over the previous few days, I was always conscious that there were lots of operational details that would have to be worked through before an idea of this sort could be implemented, and any scheme would need to be carefully evaluated for the risks that might lie hidden just beneath the surface. But evaluated not relative to standards of perfection, but relative to realistic alternatives approaches in a rapidly unfolding crisis.

I wrote a couple of other posts (here and here) touching on aspects of the pandemic insurance idea, and as I reflected a bit further and discussed/debated the idea with a few people, I suggested some potential refinements, including greater differentiation between companies and individuals. Other people, here and abroad, also suggested ideas that had some similarities in spirit to what I was looking to achieve.

Of course, nothing like the pandemic insurance scheme was adopted. Instead, we had a flurry of schemes and of individual bailouts, the main attraction of which seemed to be a steady stream of announceables for Cabinet ministers in election year (generally a negative in terms of the public interest, in which similar cases should be treated similarly), all while offering little or no certainty to individuals, firms, or their lenders.

I’ve continued to regard something like the pandemic insurance scheme as a superior option that should have been taken, but mostly I moved onto writing about other things. But the return of community-Covid, more or less severe government restrictions on economic (and other) activity, and arguments about whether and for how long the wage subsidy should be renewed only reinforced that sense that there would have been a better way. But a few tweets aside, I hadn’t given the issue much thought for a while until a few weeks ago a TVNZ producer got in touch to say that they had found reference to the pandemic insurance idea in an OIA response they had had from The Treasury, and asking if I’d talk to them about it.

It was only late last week that I got to see the response Treasury had provided (Treasury having fallen well below their usual past standards has still not put the response – dated 12 August – on their website (or even acknowledged my request for a copy of the same material). A little of the subsequent interview with TVNZ was aired as part of their story on Saturday night, itself built around the notion that the government had rejected this (appealing sounding) idea.

OIA Response Pandemic Insurance etc

The TVNZ OIA request had actually been for material on “helicopter payments”, which was refined to mean

“one-off payments made by the Government to citizens with the purpose of stimulating the economy,

(which in some respects does not describe the pandemic insurance idea well at all).

And yet most of the material in the quite lengthy OIA response (77 pages) turned out to be about the work The Treasury had undertaken on the pandemic insurance idea over the couple of weeks from 7 April, including some advice to the Minister of Finance.

There seems to have been quite serious interest in the option, and there is paper to the Minister of Finance providing a fair and balanced outline of the scheme – merits and risks – dated 9 April

tsy pandemic

and suggesting that if the Minister was seriously interested Treasury would do more work and report later in the month. Although there is no more record of the Minister’s view, he must have been sufficiently open for more work to have been done, including drawing in perspectives from operational agencies (including IRD and MSD) on feasibility and operational issues.

My impression is that Treasury did a pretty good job in looking at the option.

tsy pandemic 2

That final paragraph was always one of the key attractions to me.

As I went through the papers, I didn’t find too many surprises. The issues and risks official raised were largely the ones I’d expected – including, for example, the risk that some people might just opt out of the labour market this year and take the 80 per cent guarantee, and issues around effective marginal tax rates for those facing market incomes less than 80 per cent. Perhaps the one issue I hadn’t given much thought to was a comment from IRD about the risk of firms being able to shift revenue and/or expenses between tax years, with the observation that existing rules were not really designed to control that to any great extent. But, and operating in a second-best world, the officials involved generally seem to have regarded few of these obstacles as insuperable, bearing in mind the pitfalls of (for example) the plethora of alternative schemes.

The work seems to have come to an end on or about 23 April with Treasury finally deciding not to recommend the pandemic insurance approach. This email is from a Principal Advisor heavily involved in the evaluation to the Secretary and key (on the Covid issues) Deputy Secretary.

tsy pandemic 3

It probably shouldn’t surprise readers that I think the wrong call was made in the end, but equally it is probably not that surprising that the decision went the way it did. One reason – not, of course, acknowledged in the Treasury papers – is how slow officials were (across government) in appreciating the seriousness of what was already clearly unfolding globally – and as a major risk to New Zealand – by the end of January. As I’ve noted before there is no indication in any of the papers that have been released, or public comments at the time, that (for example) Ministers or the heads of the key government departments had begun serious contingency planning – devoting significant resource to it – any time before mid-March. This particular work didn’t get underway until well into April, by when a great deal had already begun to be set in stone, and when rolling out bite-sized new announcements – robust or not – no doubt seemed, and was, easier than a new comprehensive approach.

As it happens, even though there was a great deal of concern back in April about the affordability of the pandemic insurance scheme, with the benefit of hindsight there is a reasonable argument that it could even have been cheaper than the approaches actually adopted (GDP losses having been less severe, on a sustained basis, than feared in April), which in turn might have left more resources for the stimulus and recovery phase (pandemic insurance – like wage subsidies – was always more about income support and managing uncertainty in the heat of the crisis than about post-crisis recovery stimulus).

From my perspective, the post was mostly about recording my pleasant surprise at how seriously the pandemic insurance idea (mine, and some other variants) was taken by officials, and by what appears to have a pretty good job in evaluating it as an option, in what will have been very trying and pressured times.

From this vantage point – with the advantage of knowing how the first six months of the virus went, and with a sense of the economic ramifications – I still reckon it would have been a better approach. And yet – and I don’t recall seeing this in Treasury’s advice (perhaps it isn’t the thing for officials to write down) I can also see political pitfalls – around very large payouts to some companies, even if they weren’t gaming the system – that might have made it impossible, and unsustainable if tried, without (at least) a very strong degree of political leadership and marketing that such a no-fault no-favour approach was a better way to have gone. As I noted in an earlier post, I’d have hated having the Crown pay out to casino companies, but I would have endured for the sake of a fair across the board scheme. But every single person, every single lobby group, would have found some potential recipient to excoriate.

The TVNZ interviewer asked me about the pandemic insurance idea still had relevance for the future. My initial response to him was that yes it did, and that we might be much better off to have the infrastructure required to make it work in place and on the shelf ready to go for when future pandemics happen. Taxes will, after all, be a bit higher than otherwise as we gradually lower debt ratios, amid repeated talk of being ready for the next major adverse event, whether earthquake, volcano or pandemic.

And yet reflecting on it again over the weekend, I’m no longer quite so confident of that answer. More detailed work, and more thought, is probably required once this pandemic is behind us to strike the right balance – individuals vs firms, generosity in a no-fault shock vs moral hazard as just some of the examples of issues to be thought through, and planned for, ideally in a way that would survive contact with a new real severe adverse shock.

Macro policy pitfalls and options

The sad sight of someone who has seemed to be a normally honourable man –  Greens co-leader James Shaw – heading off down the path of Shane Jones-ism, is perhaps a general reminder of the temptations of politics and power, but also of much that is wrong about how the government is tackling the severe economic downturn we are now in.   Fiscal discipline around scarce real resources, always pretty weak at the best of times. is flung out the window and there is a mad scamper for ministerial announceables, and thus rewards to those who successfully bend the ear of ministers in a hurry.  Connections, lobbying, and the ability to spin a good yarn seem to become foremost, with a good dose of partisanship thrown in too.   The extraordinary large grant to a private business  planning to operate a school is just the example that happens to have grabbed the headlines, but there will be more no doubt through the list (apparently not all yet announced) of “shovel-ready projects”, and we’ve seen many through the Provincial Growth Fund almost from day one of its existence.

Don’t get me wrong.  I’m not opposed to the government running deficits –  even really rather large deficits – for a year or two.   Some mix of external events and government actions have tipped the economy into a severe recession and –  against a dismal global backdrop – the outlook is not at all promising.  Tax revenue would be down anyway, and that automatic stabiliser is a desirable feature of the fiscal system.   And one can make –  I have made –  a case for a pretty generous approach across the board to those, through no direct fault of their own, are caught in the backwash of the pandemic.  I’ve argued for thinking of such assistance as if we some ACC-like pandemic insurance, for which we paid the premiums in decades past through higher tax rates/lower government spending rates –  and thus lower debt – than would otherwise have been likely.

And some aspects of the government’s economic policy response have –  whatever their other faults –  had elements of that broadbased no-fault/no-favours approach.   I guess ministers couldn’t put a press statement for each individual who benefited from the wage subsidy, or the weird business tax clawback scheme.  But beyond that, and increasingly, what is supposed to be countercyclical stabilisation policy has become a stage for ministers to choose favourites, to support one and not another, to announce particular bailouts as acts of political favour.  It is a dreadful way to run things, rewarding not just ministerial favourites but the chancers and opportunists who are particularly aggressive in pursuing handouts.  So some tourist operators get handouts and other don’t.  Some sports got handouts and others don’t.     Favoured festivals –  I see the nearby festival on the list this morning –  get handouts.  And, in general, unless you are among the favoured, businesses (the myriad of small and low profile ones) get little or nothing at all.  James Shaw’s green school gets a huge capital grant and while no one –  of any ideological stripe –  should be getting such handouts, we can be quite sure no-one of a different ideological stripe than those associated with the governing parties would be getting one.    Perhaps many people involved really have the best of intentions, but frankly it is corrupt, and predictably so.

I was reading last night an open letter on economic policy that Keynes had addressed to Franklin Roosevelt in late 1933.  It was a bit of mixed bag as a letter, and had really a rather condescending tone, but the couple of sentences that caught my eye were these

“our own experience has shown how difficult it is to improvise useful Loan-expenditures at short notice. There are many obstacles to be patiently overcome, if waste, inefficiency and corruption are to be avoided”

Quite.

Now, of course, elections have consequences, and one would expect a government of the left to be deploying public resources in directions consistent with (a) manifesto commitments, and (b) their own general sympathies.    But in this case (a) the government was elected on a promise (wise or not) of considerable fiscal restraint, and (b) whatever the broad tenor of their policy approach, we should not expect public resources to be handed to individuals or favoured groups and companies, solely on the basis of the ability of those entities to get access to, and bend the ear of, ministers.  And it is not necessary to do so to deploy very substantial fiscal resources –  whether with a focus on consumption, investment, or business etc support more generally.  Broadbased tools, that do not rely on rewarding favourites, aren’t hard to devise or deploy.

More generally, of course, monetary policy is an option that has barely been used at all.   We have a severe recession, with little or no relief in sight (including globally) and yet whereas, faced with a serious downturn, we usually see perhaps a 500 basis point fall in interest rates and a sharp fall in the exchange rate, we’ve had no more than a 100 basis point fall in interest rates and no fall at all in the exchange rate.  And not because of some alarming inflationary threat that means further monetary support can’t prudently be risked…..but because the appointed Monetary Policy Committee, faced with very weak inflation forecasts and lingering higher unemployment, choose to do nothing.  And those with responsibility for the Bank –  the Minister of Finance, and the PM and Cabinet –  seem to be quite content with this abdication.

The beauty of monetary policy, and one of the reasons it has been a preferred stabilisation tool for most of the time since countercyclical macro policy became a thing, is that even if ministers are the ones making the day to day decisions –  and they usually aren’t because we mostly have central banks with day-to-day operational autonomy –  they don’t get to pick which firm, which party favourite, gets the benefit of lower borrowing costs, who suffers from reduced interest income, or what is affected by the lower exchange rate.    It is broad-based instrument, operating without fear or favour, and doing so pervasively –  it takes one decision by the relevant decisionmaking body and relative prices across the whole economy are altered virtually immediately, not some crude process of ministers and officials poring over thousands of applications for grants and loans and deciding –  on who knows what criteria –  whether or not to grant them.  And it has the subsidiary merit, when used wisely, of working with market forces –  in times like these investment demand is weak and precautionary savings demand is high, so one would normally expect –  if no government agency were in the way – the market-clearing interest rate would fall a long way.

On the left there still seems to be a view that monetary has done a great deal, and perhaps all it could.  I saw the other day a commentary from retired academic Keith Rankin on fiscal and monetary policy.  He claims not to be a “left-wing economist” –  although I suspect most would see him as generally being on the left –  but has no hesitation in pegging me as “right-wing economist”.  Apparently “right-wing economists tend to have a philosophical preference for monetary policy over fiscal policy”.   Anyway….he was picking up on some comments I made in a recent interview on Radio New Zealand.

To a non-right-wing economist, Reddell’s position in the interview seems strange; Reddell argues that New Zealand has – so far during the Covid19 pandemic – experienced a large fiscal stimulus and an inadequate monetary stimulus. In fact, while the fiscal outlay is large compared to any previous fiscal stimulus, much of the money available may remain unspent, and the government is showing reluctance to augment that outlay despite this month’s Covid19 outbreak. And, as a particular example, the government keeps pouring salt into the running sore that is the Canterbury District Health Board’s historic deficit (see here and here and here and here); the Minister of Health showed little sign of compassion towards the people of Canterbury when questioned about this on yesterday’s Covid19 press conference.

Further, monetary policy has been very expansionary. In its recent Monetary Policy Statement (and see here), the Reserve bank has committed to ongoing expansions of the money supply through quantitative easing. Because the Reserve Bank must act as a silo, however, it has to participate in the casino (the secondary bond market) to do this; perhaps a less than ideal way to run monetary policy. Reddell has too much faith in the ability of the Reserve Bank to expand business investment spending.

Reddell is a committed supporter of negative interest rates – indeed he cites the same American economist, Kenneth Rogoff, who I cited in Keith Rankin on Deeply Negative Interest Rates (28 May 2020). This call for deeply negative rates is tantamount to a call for negative interest on bank term deposits and savings accounts; that is, negative ‘retail interest rates’. While Reddell does not address the issue in the short interview cited, Rogoff notes that an interest rate setting this low would require something close to a fully electronic monetary system to prevent people withdrawing wads of cash to stuff under the bed or bury under the house.

I struggle to see how anyone can doubt that we have had a very large fiscal stimulus this year to date.  One can debate the merits of extending (or not) the wage subsidy –  personally (despite being a “right-wing economist”) I’d have favoured the certainty my pandemic insurance scheme would have provided –  but it doesn’t change the fact a great deal has been spent.  Similarly, one can have important debates about the base level of health funding –  and I’ve run several posts here in recent years expressing surprise at how low health spending as a share of GDP has been under this government, given their expressed priorities and views –  but it isn’t really relevant to the question of the make-up of the countercyclical policies deployed this year.  With big government or small government in normal times, cyclical challenges (including serious ones like this year’s) will still arise.

And so the important difference seems to turn on how we see the contribution of monetary policy.  Here Rankin seems to run the Reserve Bank line –  perhaps even more strongly than they would –  about policy being “highly expansionary”, without pointing to any evidence, arguments, or market prices to support that.  It is as if an announced intent to swap one lot of general government low-interest liabilities (bonds) for another lot (settlement cash deposits at the Reserve Bank) was hugely macroeconomically significant.  Perhaps it is, but the evidence is lacking…whether from the Reserve Bank or from those on the left (Rankin and others, see below) or those on the right (some who fear it is terribly effective and worrying about resurgent inflation.

While on Rankin, I just wanted to make two more brief points:

    • first, Rankin suggests I “have too much faith in the ability  of the Reserve Bank to expand  business investment spending”.  That took me by surprise, as I have no confidence in the Bank’s ability to expand investment spending directly at all, and nor is it a key channel by which I would be expecting monetary policy to work in the near-term.  It really is a straw man, whether recognised as such, often cited by those opposed to more use of monetary policy.  Early in a recession –  any recession –  interest rates are never what is holding back investment spending –  that would be things like a surprise drop in demand, heightened uncertainty, and perhaps some unease among providers of either debt or equity finance.  Only rarely do people invest into downturns,  When they can, they will postpone planned investment, and wait to see what happens.  There is a whole variety of channels by which monetary policy works –  and I expect I’m largely at one with the Reserve Bank on this –  including confidence effects, wealth effects, expectations effects and (importantly in New Zealand) exchange rate effects.  Be the first country to take its policy rate deeply negative and one would expect a significant new support for our tradables sector through a much lower exchange rate.  In turn, over time, as domestic and external demand improved investment could be expected to rise, in turn supported by temporarily lower interest rates, but that is some way down the track.
    • second, as Rankin notes I have continued to champion the use of deeply negative OCR (and right now any negative OCR at all, rather than the current RB passivity).  As he notes, in the interview he cites I did not mention the need to deal with the ability to convert deposits into physical cash at par, but that has been a longstanding theme of mine.  I don’t favour abolishing physical currency, but I do favour a potentially-variable premium price on large-scale conversions to cash (as do other advocates of deeply negative policy rates).  Those mechanisms would be quite easy to put in place, if there was the will to use monetary policy.

From people on the left-  at least in the New Zealand media –  there also seems to be some angst that (a) monetary policy has done a great deal, and that (b) in doing so it has exacerbated “inequality” in a way that we should, apparently, regret.   I’ve seen this line in particular from interest.co.nz’s Jenee Tibshraeny and (including again this morning) from Stuff’s Thomas Coughlan.  On occasion, Adrian Orr seems to give some encouragement to this line of thinking, but I think he is mostly wrong to do so

Perhaps the most important point here is the otherwise obvious one.  The worst sort of economic outcome, including from an inequality perspective (short or long term) is likely to be one in which unemployment goes up a long way and stays high, and where labour market participation rates fall away.  Sustained time out of employment, involuntarily, is one of the worst things for anyone’s lifetime economic prospects, and if some of the people who end up unemployed have plenty of resources to fall back on, the burden of unemployment tends to fall hardest on the people at the bottom, people are just starting out, and in many cases people from ethnic minorities (these are often overlapping groups).  From a macroeconomic policy perspective, the overriding priority should be getting people who want to work back into work just as quickly as possible.   That doesn’t mean we do just anything –  grants to favoured private companies to build new buildings are still a bad idea  – but it should mean we don’t hold back on tools with a long track record of contributing effectively to macroeconomic stabilisation because of ill-defined concerns about other aspects of “inequality”.

Asset prices appear to worry people in this context.    I’m probably as puzzled as the next person about the strength of global equity prices –  and I don’t think low interest rates (low for a reason) are a compelling story –  but it is unlikely that anything our Reserve Bank is doing is a big contributor to the current level of the NZX indices.  Even if it were, that would not necessarily be a bad thing, since one way to encourage new real investment is as the price of existing investment assets rises relative to the cost of building new.

And if house prices have risen a little (a) it is small compared to the 25 year rise governments have imposed on us, and (b) not that surprising once the Reserve Bank eased the LVR restrictions for which there was never a compelling financial stability rationale in the first place.

More generally, I think this commentators are still overestimating (quite dramatically) what monetary policy has done.   I read commentaries talking about “money flowing into the hands of asset holders” (Coughlan today) from the LSAP programme, but that really isn’t the story at all.  Across this year to date there has been little change in private sector holdings of government bonds, and certainly no large scale liquidation by existing holders (of the sort that sometimes happened in QE-type programmes in other countries).  Most investors are holding just as many New Zealand government bonds as they were.  All that has really happened is that (a) the government has spent a great deal more money than it has received in taxes, (b) that has been initially to them by the Reserve Bank, and (c) that net fiscal spending is mirrored in a rise in banks’ settlement account deposit balances at the Reserve Bank.  It would not have made any difference to anything that matters much if the Reserve Bank had just given the government a huge overdraft facility at, say, 25 basis points interest, rather than going through the bond issuance/LSAP rigmarole.  The public sector could have sold more bonds into the market instead, in which case the private sector would be holding more bonds and less settlement cash.  But the transactions that put more money in people’s pockets –  people with mortgages, people with businesses –  are the fiscal policy programmes.   Without them we might, reasonably, have anticipated a considerably weaker housing market.  Since few on the left would have favoured less fiscal outlays this year –  and neither would I for that matter –  they can’t easily have it both ways (Well, of course, they could, but the current government of the left has been almost as bad as previous governments of the left and right in dealing with the land use restrictions that create the housing-related dimensions of inequality.

Coughlan also seems to still belief that what happens to the debt the government owes the (government-owned and controlled) Reserve Bank matters macroeconomically.  See, on this, his column in last weekend’s Sunday Star-Times.   As I outlined last week, this is simply wrong: what matter isn’t the transactions between the government and the RB, but those between the whole-of-government and the private sector.  Those arise mostly from the fiscal policy choices.  The whole-of-government now owes the non-government a great deal more than it did in February –  reflecting the fiscal deficit.  That happens to take the form primarily of much higher settlement cash balances, but it could have been much higher private bond holdings.   Either way, the asset the Reserve Bank holds is largely irrelevant: the liabilities of the Crown are what matter.  And as the economy re recovers one would expect that the government will have to pay a higher price on those liabilities.   It could avoid doing so –  simply refusing to, engaged in “financial repression” –  but doing so would not avoid the associated real resource pressures. The same real resources can’t be used for two things at once.  Finally on Coughlan’s article, it seems weird to headline a column “It’s not a question of how, but if we’ll pay back the debt” when, on the government’s own numbers and depending on your preferred measure, debt to GDP will peak at around 50 per cent.  Default is usually more of a political choice than an economic one, but I’d be surprised if any stable democracy, issuing its own currency, has ever chosen to default with such a low level of debt –  low relative to other advanced countries, and (for that matter) low relative to our own history.

Monetary policy really should have been –  and should now, belatedly –  used much more aggressively.  It gets in all the cracks, it avoids the temptations of ministerial corruption, it works (even the RB thinks so), and it has the great merit that in committing claims over real resources the people best-placed to make decisions –  individual firms and households, accountable for their choices –  are making them, not politicians on a whim.

For anyone interested, the Reserve Bank Governor Adrian Orr is talking about the Bank’s use of monetary policy this year at Victoria University at 12:30pm today.  The event is now entirely by Zoom, and the organisers invited us to share the link with anyone interested.

MMT

So-called Modern Monetary Theory (MMT) has been attracting a great deal more attention than usual this year.  I guess that isn’t overly surprising, in view of (a) the severe recession the world is now in, and (b) the passivity and inaction (and the ineffectiveness of what actions they do take) of central banks, those with day-to-day responsibility for the conduct of monetary policy.

Until about three years ago I had had only the haziest conception of what the MMTers were on about.  But then Professor Bill Mitchell, one of the leading academic (UNSW) champions of MMT ideas, visited New Zealand, and as part of that visit there was a roundtable discussion with a relatively small group in which I was able to participate.  I wrote about his presentation and the subsequent discussion in a post in July 2017.   I’d still stand by that.  (As it happens, someone sent Mitchell a link to my post and he got in touch suggesting that even though we disagreed on conclusions he thought my representation of the issues and his ideas was “very fair and reasonable”.)  But not many people click through to old posts and, of course, the actual presenting circumstances are quite a bit different now than they were in the New Zealand of 2017.  Back then, most notably, there was no dispute that the Reserve Bank had a lot more OCR leeway should events have required them to use it.

Among the various people championing MMT ideas this year, one of the most prominent is the US academic Stephanie Kelton in her new book The Deficit Myth: Modern Monetary Theory and How to Build a Better Economy (very widely available – I got my copy at Whitcoulls, a chain not known for the breadth of its economics section).   Since it is widely available –  and is very clearly written in most places – it will be my main point of reference in this post, but where appropriate I may touch on the earlier Mitchell discussion and this recent interview on interest.co.nz with another Australian academic champion of MMT ideas.

As a starting point, I reckon MMT isn’t particularly modern, is mostly about fiscal policy, and is more about political preferences than any sort of theoretical framework (certainly not really an economics-based theoretical framework).     But I guess the name is good marketing, and good marketing matters, especially in politics.

The starting proposition is a pretty elementary one that, I’d have thought, had been pretty uncontroversial for decades among central bankers and people thinking hard about monetary/fiscal interactions: a government with its own central bank cannot be forced –  by unavailability of local currency –  to default on its local currency debt.  They can always “print some more” (legislating to take direct control of the central bank if necessary).  So far so good.  But it doesn’t really take one very far, since actual defaults are typically more about politics than narrow liquidity considerations and governments may still choose to default, and the actual level of public debt (share of GDP) maintained by advanced countries with their own currencies varies enormously.

A second, and related, point is that governments in such countries don’t need to issue bonds –  or raise taxes – to spend just as much as they want, or run deficits as large as they want.  They can simply have the central bank pay for those expenses.  And again, at least if the appropriate legislation was worded in ways that allowed this (which is a domestic political choice) then, of course, that is largely true.  That means governments of such countries are in a different position than you and I –  we either need to have earned claims on real resources, or have found an arms-length lender to provide them, before we spend.    Again, it might be a fresh insight to a few politicians –  Kelton spent a couple of years, recruited by Bernie Sanders, as an adviser to (Democrat members of) the Senate Budget Committee, and has a few good stories to tell.  But to anyone who has thought much about money, it has always been one of the features –  weaknesses, and perhaps a strength on occasion – of fiat money systems.

Kelton also devotes a full chapter to the identity that any public sector surplus (deficit) must, necessarily, mean a private sector deficit (surplus).  Identities can usefully focus the mind sometimes in thinking about the economy, but I didn’t find the discussion of this one particularly enlightening.

It all sounds terribly radical, at least in potential.  One might reinforce that interpretation with Kelton’s line that “in almost all instances, fiscal deficits are good for the economy. They are necessary.”

But in some respects –  at least as a technical matter –  it is all much less radical than it is sometimes made to sound.   As a matter of technique and institutional arrangements, it is mostly akin to “use fiscal policy rather than monetary policy to keep excess capacity to a minimum consistent with maintaining low and stable inflation”.    Supplemented by the proposition that advance availability of cash –  taxes, on-market borrowing –  shouldn’t be the constraint on government spending, but rather that the inflation outlook should be.

Quoting Kelton again “it is possible for governments to spend too much. Deficits can be too big”.

What isn’t entirely clear is why, as a technical matter, the MMTers prefer fiscal policy to monetary policy as a stabilisation policy.    In the earlier discussion with Bill Mitchell, it seemed that his view was the monetary policy just wasn’t as (reliably) effective as fiscal policy.  In Kelton’s book, it seems to reflect a view that using monetary policy alone there is inescapable sustained trade-off between low inflation and full employment (a view that most conventional macroeconomists would reject), and that only fiscal policy can fill the gap, to deliver full employment.    Kelton explicitly says “evidence of a deficit that is too small is unemployment” –  it seems, any unemployment, no matter how frictional, no matter how much caused by other labour market restrictions.

I can think of two other reasons.  The first is quite specific to the current context.  Some might prefer fiscal policy because they believe monetary policy has reached its limits (some effective lower bound on the nominal policy rate).   Kelton’s book was largely finished before Covid hit –  and US rates at the start of this year weren’t super-low –  but it seems to be a factor in the current interest in MMT.     The other reason –  not really stated, but sometimes implied by Kelton – is that central bankers might have been consistently running monetary policy too tight – running with too-optimistic forecasts and in the process falling down on achieving what they can around economic stabilisation.  Since 2007 I’d have quite a bit of sympathy with that view –  although note that in New Zealand prior to 2007 inflation was consistently too high relative to the midpoint of the target ranges governments had set.  But it is, at least initially, more of an argument for getting some better central bankers, or perhaps even for governments to take back day-to-day control of monetary policy, than an argument for preferring fiscal policy over monetary policy as the prime macro-stabilisation tool.

But in general there is little reason to suppose that fiscal policy is any more reliably effective than monetary policy.  Sure, if the government goes out and buys all the (say) cabbages in stock that is likely to directly boost cabbage production.  If –  in a deep recession – it hires workers to dig ditches and fill them in again that too will directly boost activity.  But most government activity –  taxes and spending (and MMTers aren’t opposed to taxes, in fact would almost certainly have higher average tax rates than we have now) –  aren’t like that.  If it is uncertain what macro effect a cut in the OCR will have, it is also uncertain how  –  and how quickly – a change in tax rates will affect the economy, and even if governments directly put money in the pockets of households we don’t know what proportion will be saved, and how the rest of the population might react to this fiscal largesse.  In principle, there is no particular reason why fiscal policy should be better, as a technical matter, than monetary policy in stabilising economic activity and inflation.  But Kelton just seems to take for granted the superiority of fiscal policy, and never really seems to engage with the sorts of considerations that led most advanced countries –  with their own central banks, borrowing in local currencies –  to assign stabilisation functions to monetary policy, at arms-length from politicians, while leaving longer-term structural choices around spending and tax to the politicians.

These probably shouldn’t be hard and fast assignments. In particular, there are some things only  governments (fiscal policy) can do.  Thus, if an economy largely shuts down –  whether from private initiative or government fiat –  in response to a pandemic, monetary policy can’t do much to feed the hungry.  Charity and fiscal initiatives are what make a difference in this very immediate circumstances –  just as after floods or other severe natural disasters.    And we consciously build in some automatic stabilisers to our tax and spending systems.  But none of that is an argument for junking monetary policy completely, whether that monetary policy is conducted by an independent agency, or whether such agencies (central banks) just serve as technical advisers to a decisionmaking minister (as, for example, tended to be the norm in post-war decades in most advanced countries, including New Zealand).

The MMTers claim to take seriously inflation risk.  This is from the Australian academic interest.co.nz interviewed (Kelton has very similar lines, but I can cut and paste the other)

“They should always be looking at inflation risk. Because when we say that our governments can never become insolvent, what we are saying is that there is no purely financial constraint that they work under. But there is still a real constraint. So New Zealand has a limited productive capacity. Limited by the labour and skills of the people and capital equipment, technology, infrastructure and the institutional capacity of business organisations and government in New Zealand. That limits the quantities of goods and services that can be produced there is a limitation there. Also it depends on the natural resources of a country,” says Hail.

“If you spend beyond that productive capacity it can be inflationary and that can frustrate your objectives, frustrate what you’re trying to do. So it’s always inflation risks that’s important. Within that productive capacity, however, what it is technically possible to do the Government can always fund. So yes, you can fund any of those things but there’s always an inflation risk and that inflation risk is not specific to government spending. It’s specific to all spending.”

There is a tendency to be a bit slippery about this stuff.  Thus Kelton devotes quite some space to a claim that government spending/deficits can’t crowd out private sector activity.  And she is quite right that the government can just “print the money” –  so in a narrow financing sense there need not be crowing out –  but quite wrong when it comes to the real capacity of the economy.  Real resources can’t be used twice for the same thing.  When the attempt is made to do so, that is when inflation becomes a problem –  and the MMTers aver their seriousness about controlling inflation (and I take them at their word re intentions).

Partly I take them at their word because Kelton says “the economic framework I’m advocating for is asking for more fiscal responsibility from the federal government not less”.     And it certainly does, because instead of using monetary policy, the primary stabilisation role would rest with fiscal policy.  That might involve easy choices for politicians flinging more money around to favoured causes/people in bad times, but it involves exactly the opposite when times are good, resources are coming under pressure, and inflation risks are mounting.  Under this model, a government could be running a fiscal surplus and still have to take action to markedly tighten fiscal policy because –  in their own terms –  it isn’t deficits or surpluses that matter but overall pressure on real resources.  And they want fiscal policy to do all the discretionary adjustment.

Maybe, just maybe, that is a model that could be made to work in (say) a single chamber Parliament, elected under something like FPP, so that there is almost always a majority government.  Perhaps even in New Zealand’s current system, at a pinch, since to form a government the Governor-General has to be assured of supply.

But in the US, where party disciplines are weak, different parties can control the two Houses, and where the President is another force completely.     What about US governance in the last 30 years would give you any confidence in the ability to use fiscal policy to successfully fine-tune economic activity and inflation, while respecting the fundamental powers of the legislature (no taxation without representation, no expenditure without legislative appropriation)?   In a US context, I’m genuinely puzzled about that. [UPDATE:  A US commentator on Twitter objected to the use of ‘fine-tune” here, suggesting it wasn’t what the MMTers are about.  Perhaps different people read “fine-tune” differently, but as I read MMTers they are committed to maintaining near-continuous full employment, and keeping inflation in check, and even if some like rules –  rather than discretion –  it seems to me frankly no more likely that preset rules for fiscal policy would successfully accomplish that macrostabilisation than preset rules for monetary policy did.  “Successfully managed discretion” is what I have in mind when talking about “fine-tuning” in this context.]

But even in a relatively easy country/case like New Zealand using fiscal policy that way doesn’t seem at all attractive.    It takes time to legislate (at least when did properly).  It takes time to put most programmes in place, at least if done well –  and don’t come back with the wage subsidy scheme, since few events will ever be as broad-brush and liberal as that, especially if fine-tuning is what macro-management is mostly about.   And every single tax or spending programme has a particular constituency –  people who will bend the ear of ministers to advance their cause/programme and resist vociferously attempts to wind such programmes back.  And there are real economic costs to unpredictable variable tax rates.

By contrast –  and these are old arguments, but no less true for that  – monetary policy adjustments can be made and implemented instantly.  They don’t have their full effect instantly, but neither do those for most fiscal outlays –  think, at the extreme, of any serious infrastructure project.   And monetary policy works pretty pervasively –  interest rate effects, exchange rate effects, expectations effects (“getting in all the cracks”) –  which is both good in itself (if we are trying to stabilise the entire economy) and good for citizens since it doesn’t rely on connections, lobbying, election campaign considerations, and the whim of particular political parties or ministers.  And what would get cut if/when serious fiscal consolidation was required?  Causes with the weakest constituencies, the least investment in lobbying, or just causes favoured by the (at the time) political Opposition.     Perhaps I can see some attraction for some types of politicians –  one can see at the moment how the government has managed to turn fiscal stabilisation policy into a long series of announceables for campaigning ministers, rewarding connections etc rather than producing neutral stabilisation instruments –  but the better among them will recognise that it is no way to run things.  It is the sort of reason why shorter-term stabilisation was assigned to monetary policy in the first place.

Reverting to Kelton, her book is quite a mix.  Much of the first half is a clear and accessible description of how various technical aspects of the system work, and what does and doesn’t matter in extremis.   But do note the second half of the book’s title (“How to Build a Better Economy”): the second half of the book is really an agenda for a fairly far-reaching bigger government – (much) more spending, and probably more taxes.    There is material promoting lots more (government) spending on health, welfare, infrastructure, and so on –  all the sort of stuff the left of the Democratic Party in the USA is keen on.

That is the stuff of politics, but it really has nothing at all to do with the question of whether fiscal or monetary policy is better for macro-stabilisation.   I guess it may be effective political rhetoric –  at least among the already converted –  to say –  as Kelton does –  “cash needn’t be a constraint on us doing any of this stuff”.  But –  and this is where I think the book verges on the dishonest (or perhaps just a tension not fully resolved in her own mind) – the constraint, or issue, is always about real resources, which  – per the quote above –  can’t be conjured out of thin air.    Resources used for one purpose can’t be used for others, and even if some forms of government spending (or lower taxes?) might themselves be growth-enhancing in the long run, that can’t just be assumed, and almost certainly won’t be the case for many of the causes Kelton champions (or that local advocates of MMT would champion).

I can go along quite easily with much of Kelton’s description of how the technical aspects of economies and financial systems work, but the really hard issues are the political ones.   So, of course, we needn’t stop government spending for fear that a deficit will quickly lead to default and financial crisis, or because in some narrow sense we don’t have the cash available in advance.   But we still have to make choices, as a society, about where government programmes and preferences will be prioritised over private ones –  the contest for those scarce real resources, consistent with keeping inflation in check.    And we know that rigorous and honest evaluation of individual government tax, spending and regulatory programmes is difficult to achieve and maintain.  And we know that programmes committed to are hard to end,  And that government failure is at least as real a phenomenon as market failure –  and quite pervasive when it comes to many spending programmes.    And so while Kelton might argue that, for example, balanced budget rules (in normal circumstances, on average over the cycle) are some sort of legacy of different world, something appropriate and necessary for households but not a necessary constraint for governments, I’d run the alternative argument that they act as check and balance, forcing governments to think harder –  and openly account for –  choices they are making about whose real resources will be paying for the latest preferrred programme.

Kelton tries to avoid these issues in part by claiming that “outside World War Two, the US never sustained anything approximating full employment”,  and yet she knows very well that real resource constraints still bind –  inflation does pick up, and was a big problem for a time.  Hard choices need to be made –  not by the hour (government cheques can always be honoured) but over any longer horizon.

There are perfectly reasonable debates to be had about the appropriate size of government. but they really have nothing to do with the more-technical aspects of the MMT argument.  Even if, for example, one accepted the MMT claim that there was something generally beneficial about fiscal deficits, we could run deficits –  presumably still varying with the cycle –  with a government spending 25 per cent of GDP (less than New Zealand at present) or 45 per cent of GDP (I suspect nearer the Kelton preference).

This post has probably run on too long already.  Perhaps I will come back in another post to elaborate a few points.  But before finishing this post I wanted to mention one of the signature proposals of the MMTers – the job guarantee.  There is apparently some debate as to just how central such a scheme is –  that is really one for the MMTers to debate among themselves, although it seems to me logically separable from issues around the relative weight given to fiscal and monetary policy.   I covered some of the potential pitfalls in the earlier post and I’m still left unpersuaded that the scheme has anything like the economic or social benefits the MMTers claim for it, even as I abhor the too-common indifference of authorities (fiscal and monetary to entrenched unemployment.  In the current context, one could think of the wage subsidy scheme as having had some functional similarities, but it is a tool that kept people connected to (what had been) real jobs, and which works well for identifiable shocks of known short duration.  That seems very different from the sort of well-intentioned job creation schemes the MMTers talk about. From the earlier post

It all risked sounding dangerously like the New Zealand approach to unemployment in the 1930s, in which support was available for people, but only if they would take up public works jobs.  Or the PEP schemes of the late 1970s.   Mitchell responded that it couldn’t just be “digging holes and filling them in again”.  But if it is to be “meaningful” work, it presumably also won’t all be able to involve picking up litter, or carving out roadways with nothing more advanced than shovels.  Modern jobs typically involve capital (machines, buildings, computers etc) –  it accompanies labour to enable us to earn reasonable incomes –  and putting in place the capital for all these workers will relatively quickly put pressure on real resources (ie boosting inflation).   If the work isn’t “meaningful”, where is the alleged “dignity of work”  –  people know artificial job creation schemes when they see them –  and if the work is meaningful, why would people want to come off these government jobs to take existing low wage jobs in the private market?

And much of Kelton’s idealistic discussion of the job guarantee rather overlooked the potential corruption of the process –  favoured causes, favoured individuals, favoured local authorities getting funding.  It is a risk in New Zealand, but it seems a near-certainty in the United States.

Choices and options, public and private

I was going to move on to another topic, but last night University of Waikato economics academic John Gibson sent me the links to a couple of other papers I hadn’t seen, and I thought it might be worth writing about them. Gibson is one of New Zealand leading empirical research economists and during the lockdown I wrote about one of his efforts to think through, and put numbers on, the costs and benefits of the lockdown, linking lost GDP to possible reductions in life expectancy.

The first of the links Gibson sent through probably won’t appeal to most readers. In this paper, two Motu research economists, Arthur Grimes and Benjmain Davies, set out to formalise how one would apply what is known as “real options analysis” to the choices the government made in late March.   Real options analysis was an addition to the economics literature in the 1990s.  In many ways, it was one of those blindingly obvious ways of looking at things that was probably second nature –  often unconsciously so – to many people making all sorts of decisions in life, but which hadn’t been part of the formal economics toolkit until then.   As Grimes and Davies describe it

A standard result from real options theory (Dixit & Pindyck, 1994; Guthrie, 2009) is that delaying decisions to act can be valuable when (i) decision timing is flexible, (ii) some outcomes are partially or fully irreversible once action is taken, (iii) uncertainty exists about the evolution of an exogenous process that impacts the outcomes of interest, and (iv) the decision-maker can learn about the evolution of the exogenous process over time. Delaying action preserves the option to make a future decision without locking in irreversible costs prior to new information arriving.

It is often applied to private sector investment decisions, but can just as much be applied (and probably should be more often) to some government investment or regulatory etc decisions (or other private choices –  one might think, for example, of a proposal of marriage).

But as Davies and Grimes note, in the choices the government faced in late March, there was uncertainty and potentially irreversible losses whichever direction the government took. In their words

Conditions (i)–(iv) were all met at the outset of COVID-19. However, the two-sided uncertainty at that time made it unclear which option should be preserved: the option to protect economic output initially (by avoiding lockdown) or the option to preserve the chance to eliminate COVID-19 (by entering lockdown).

This is, of course, something of an oversimplification, since there were degrees of possible regulatory responses (and “elimination” itself was not yet the government’s stated goal at the time),  and many –  but probably not all –  of the economic losses would have happened anyway, as individuals and firms responded to perceived risks –  but the point of the short paper is to illustrate the framework, not to offer empirical answers.   The authors chose the March lockdown decision to illustrate the framework, but they could just as well –  or so it seems to me –  have applied it to, for example, the decision to close the border to travellers from the PRC in early February, or to the decisions the government took last week regarding the latest Covid outbreak.

It would seem, also, to be a useful framework in which to think about the way ahead from here –  not in any mechanical sense, but as a way of helping to organise thinking.

The second paper, by Gibson himself, is likely to be of more general interest and –  since it does reach a specific conclusion –  controversial.  I’m a little surprised it doesn’t seem to have been covered elsewhere already.  An earlier version of Gibson’s paper is available here as a University of Waikato Working Paper, and although I will be quoting from a more recent version that Gibson sent me, the abstracts of the two versions are word-for-word identical.

On this occasion the conclusion is well-captured in the title of the paper, “Government Mandated Lockdowns Do Not Reduce Covid-19 Deaths: Implications for Evaluating the Stringent New Zealand Response”.    Capture your interest?  It certainly did mine.

It is an empirical paper using US county-level data, and thus taking advantage of the fact that regulatory powers on these matters typically do not rest at federal level.

Gibson begins by noting that epidemiologists’ simulation models are simply not fit for purpose when it comes to evaluating likely deaths (and, thus, deaths saved from interventions).  Writing of the apparent influence such models had –  whether for support or illumination –  in New Zealand, Gibson writes

It is unfortunate that epidemiological simulations had such impact. The Susceptible,
Infected, Recovered (SIR) epidemiological model, and variants with Exposed and Dead (SEIRD), have infectious people mixing (homogeneously) with others; each person has equal chances to meet any other, regardless of their health status. Yet in reality, people engage in preventative behaviour to reduce risk of exposure; allow for this, and some public actions designed to reduce disease spread may do more harm (Toxvaerd, 2019). These models also have too many degrees of freedom, so are poorly identified from short-run data on cases. For example, Korolev (2020) shows long-run forecasts of U.S. COVID-19 deaths from observationally equivalent SEIRD models ranged from about 30,000 to over a million.

Forecast deaths depend on arbitrary choices by researchers, and data at the time cannot show which forecast is right as so many models are observationally equivalent in the short-run. Elsewhere, Swedish researchers using the Imperial College approach forecast (in mid-April) 80,000 Covid-19 deaths by mid-May (Gardner et al, 2020). In fact, just 3500 died by May 15, with the forecast more than 20-times too high. A final example is the Otago forecasts, which had assumed no case tracing and isolation; using the same simulation model, Harrison (2020) set tracing and isolation success at 50% and forecast deaths fell by 96%.

Harrison(2020) is Ian Harrison’s paper that I have previously written about here.

Gibson’s approach is different

My research design exploits variation among U.S. counties, over one-fifth of which just had social distancing rather than lockdown. Political drivers of lockdown provide identification. If the Prime Ministerial claim, that sans lockdown tens of thousands of New Zealanders would die, is correct then one would expect to see more deaths in places without a lockdown. This may explain global fascination with Sweden, as a country without lockdown. However a within-country research design has two benefits; less variation in measuring Covid-19 deaths than for between-country comparisons, and it better suits the highly clustered nature of Covid-19. For example, Lombardy’s Covid-19 death rate was 1500 per million versus 300 per million elsewhere in Italy. The New York death rate (by May 15) was 1410 per million but just 190 per million in the other 49 states. Taking China’s data at face value, Hubei’s death rate was 76 per million versus 0.12 per million elsewhere. With such clustering, analyses using national averages may mislead.

In practical terms, his regression model is as follows

The regressions use 22 control variables, including county population and density, the elder share, the share in nursing homes, nine other demographic and economic characteristics and a set of regional fixed effects. These controls explain about two-thirds of variation in log deaths (as of mid-May). Even with these controls, the errors for the log death equations may correlate with treatment status, if selection into the treatment group (77% of counties) is due to unobservables. Political drivers of lockdown are plausible instruments; counties without lockdown are all in states with Republican governors and if a gubernatorial election is set for November 2020 (11 are) lockdown was more likely. Conditional on the state-level factors, the extent a county became more partisan between the 2012 and 2016 Presidential elections, relative to the state-level change, affects odds of lockdown. It is hard to think of other paths for these variables to affect Covid-19 deaths than via political calculations about lockdown.

There is a fair amount of technical detail in the paper. Many of the expected things do turn out to have mattered.  Thus

…almost two-thirds of variation is explained by early May. The models show deaths are higher if the elderly or those in nursing homes are more of the population; patterns noted in popular discussion of Covid-19. Deaths are higher if whites are a lower share and blacks a higher share of the population, as noted by Millett et al (2020). Counties with higher inequality and more people without health insurance experience more deaths. Fewer deaths occur if the smoking rate is higher, similar to what is found in the U.K. for 17 million NHS patients, where Williamson et al (2020) find current smokers less likely than others to die (as hospital in-patients) with confirmed COVID-19

But this is Gibson’s summary of his results

So the firmest conclusion is that over more than two months after New Zealand’s March 23 lockdown decision, there was no evidence of more Covid-19 deaths in places without lockdowns.

Moreover, he suggests that this was apparent from data that would have been available to New Zealand policymakers when they made lockdown decisions from March to May (and, presumably, of course for this month’s decisions).

Some readers may be inclined to instantly dismiss Gibson as some sort of off-the-planet person simply out to get the government.  I have no idea of his personal politics – and, as I’ve noted, he is a highly regarded New Zealand economists who seems to go where the data lead – but in any case as he notes it isn’t as if he is the only one to find similar results

This ineffectiveness has several causes: real-time activity indicators suggest threat of Covid-19, rather than lockdown per se, drives behaviour (Chetty et al, 2020). Just one-tenth of the 60% fall in consumer mobility in the U.S. was from legal restrictions, with the rest from people voluntarily staying home to avoid infection (Goolsbee and Syverson, 2020).

I don’t suppose anyone has Raj Chetty pegged as (say) a Trump supporter, and as for Goolsbee, that is Austan Goolsbee, former chairman of the Council of Economic Advisers in the Obama administration.  In addition to his paper, there is an accessible interview with Goolsbee here.   This bit captures the point

Adi Kumar: You and Chad Syverson recently published a paper with the National Bureau of Economic Research called, Fear, lockdown, and diversion: Comparing drivers of pandemic economic decline 2020.1 There you attribute most of the drop in business activity in the United States to people’s own decisions to stay at home, rather than government-imposed restrictions. Can you explain your hypothesis and its implications for policy makers grappling with strategies to reopen the economy?

Austan Goolsbee: We looked at phone records that tracked the locations of 2.3 million businesses around the country. These were mostly retail and services, the kinds of places people physically visit. When we plotted business activity against lockdown timelines through the pandemic, we found that consumer behavior was not aligning with lockdown orders. The visits had trailed off before these were imposed.

We began asking whether government orders drive behavior or not. It’s the classic “identification problem” in economist language—was it causation or just correlation? The disease triggered fear and led people to stop going outside. Then authorities passed laws requiring that they stay at home. So it’s important to figure out how much of what happened next—the sharp fall-off in consumer activity—came from individual choice and how much from public policy.

Our basic idea is to compare places where policies are different on either side of a state border. In Illinois we had shutdown orders, but across the border in Iowa they didn’t. Several metro areas span that border and we have 110 different industries. Take barber shops as an example. If the policies were driving the activity, then we should have seen people still getting haircuts in Iowa but not in Illinois. But that didn’t happen. In the same week, everyone stopped getting their hair cut by similar amounts. That kind of evidence leads to the conclusion that the 60 percent drop in consumer activity from pre-COVID-19 times to the depths of the pandemic was more about individuals’ own decision to stay home. We found that only about 7 percent of the fall-off was due to the policy. Everything else we attribute to other factors, mostly fear.

Those results aren’t about deaths directly, but about mobility and economic activity, but of course the logic of the case for lockdowns is that it is those reductions – forced interpersonal distancing –  that reduces future case and death numbers.

We saw this in New Zealand itself before official restrictions were put in place.  I guess everyone has their own story: mine was of a trip to Auckland on 19 March, before there were any domestic restrictions in place.  Flights were already being cancelled, Wellington airport mid-morning was largely deserted, and my taxi drivers in Auckland told of the hours they had spent waiting for a single fare.

So what are the implications?  This is from Gibson’s abstract

Instead, I use empirical data, based on variation amongst United States counties, over one-fifth of which just had social distancing rather than lockdown. Political drivers of lockdown provide identification. Lockdowns do not reduce Covid-19 deaths. This pattern is visible on each date that key lockdown decisions were made in New Zealand. The ineffectiveness of lockdowns implies New Zealand suffered large economic costs for little benefit in terms of lives saved.

He is, at least implicitly, arguing that we’d have had just as much distancing, in aggregate, without lockdowns (in this case he refers to so-called Level 3 and Level 4 restrictions), as with them.  (As he and others –  including Grimes and Davies – have noted, official advice later released reveals that as late as 20 March official advice to the government had been to stay at the new “Level 2” for 30 days.)

From the final page of his paper

In terms of implications for the future, these results add to the evidence that lockdowns are ineffective. This was also the prior view in public health; for example Inglesby et al (2006: 371) noted: “It is difficult to identify circumstances in the past half century when large-scale quarantine has been effectively used in the control of any disease.”  So when the next pandemic occurs, the Covid-19 lockdowns should not be considered a success that should be replicated. …..If decision-making from March and April is reviewed, any claim that lockdown was necessary to save lives can be treated with strong scepticism. It is especially concerning that there were data available, on the dates of those key decisions, to show that lockdowns are ineffective at reducing Covid-19 deaths.

How plausible is all this?   Perhaps experts in the specific data Gibson uses, or specialist econometricians, can pick some holes and raise some specific doubts.   But as Gibson notes his isn’t the only paper pointing in this sort of direction (and he tells he is finishing another paper suggesting that for a major emerging country “the mobility declines predated the local lockdown orders by two weeks”.   One should probably never revise one’s view too much based on a single set of results, but they can’t be discounted either.

Note also that these results are about “lockdowns”, and are not a direct commentary on the role and value of things like enforced isolation of those found to have the infection or, at least as I read it, on border closures and associated managed isolation policies.  If so, perhaps it is plausible to suppose that private choices –   firms, households, rest homes, community, sporting and religious groups etc –  would have brought about sufficient distancing in New Zealand to have resulted in eventual (domestic) elimination, perhaps at no more deaths than actually occurred in New Zealand.   Perhaps.

If that were so, of course, it would pose questions about the value of the partial lockdown Auckland is currently experiencing.

As Gibson notes, the response of some people is likely to be along the lines of saying that even if his results are (a) robust and (b) applicable to New Zealand, why does it matter?  We (and those US counties that saw deaths fall) got there anyway.

A non-economist might say “what difference does it make?” If people would reduce
interactions anyway, due to perceived Covid-19 risks, having government force them to stay home would seem costless. Yet as economists know, a government diktat approach runs into the central planning problem; no central planner has all the information (collectively) held by parties involved in voluntary exchange (Hayek, 1945). For example, absent lockdown, if a butcher felt they could operate safely and if customers felt they could safely shop at this butchery, voluntary and beneficial exchange could occur. Instead, under the central planning approach applied in New Zealand, butchers were shut but supermarkets selling meat were not. Potentially, much economic surplus (for both consumers and producers) was lost.

And that would seem to be just a small part of it (Gibson was tightly word-count constrained).   We currently have massive overlays of officials deciding who/what is or isn’t a permitted exception to the internal border restrictions –  the sort of thing that should have been sorted out months ago, given the lockdown policy was always potentially regional –  and associated delays, rather than private firms and households making their own choices about what risks to run, or not.   Or we had the official gross over-reach that prohibited you from going for a quiet solo swim at a calm suburban beach in mid-autumn, that makes rules on where, when and what you could hunt  –  none of which had anything to do with public health.  Or that prohibited a priest attending in person to a dying – or bereaved – parishoner, or that prohibited funerals altogether for a time.  Or that banned people from making choices to have small distanced outdoor services –  having advice to hand about risks –  to celebrate Easter, because presumably such things were too hard for officials, unimportant to our ministers etc.   Or –  in my case, and perhaps trivially –  the lockdown rules prohibited me taking my son out for driving lessons, again with no public health implications for anyone.

All that of course, assumes that Gibson’s results are robust.  But it all goes to the more general point that proper marginal cost-benefit analyses should have been being done by officials and ministers –  should now be being done –  and aren’t.  It has been known from the start that private distancing choices would make a material difference, but those rational private choices have too rarely been seen factored into New Zealand official decisionmaking.

There is, however, one area in which I think Gibson overstates his case, perhaps quite materially, and that is on the economic consequences of the lockdown choices.   He notes that

Treasury assume that output at Level 4 was reduced by 40%, at Level 3 by 25%, and
at Level 2 by 10-15% (Treasury, 2020). So even with a V-shaped shock and recovery rather than a U or L shape, 33 days of Level 4 and 19 of Level 3 (that ended May 13) would reduce output by ten billion dollars (ca. 3.3% of GDP) compared to staying in Level 2 throughout.

and

 In terms of the (recent) past, the ineffectiveness of lockdowns implies that New Zealand suffered large output losses, of ten billion dollars or more, for no likely benefit in terms of lives saved as a result of the decision to move almost immediately from Level 2 to Level 4.

But this is almost certainly wrong, and in fact inconsistent with many of the other sorts of results re mobility etc that Gibson cites.   We simply do not know how large a share of those (guessed) Level 3 and Level 4 losses would have occurred anyway, as people and firms wound back their own activity.  I know that I had already decided that our children would not have been going to school the next day, if the government had not pre-emptively closed the schools.  Not many people would have been at restaurants, cafes, movie theatres or perhaps even churches in late March and early April, no matter what the government had decided (perhaps especially if they’d still been waving around scary death predictions).   Quite possibly much of the construction sector would have stayed working throughout –  even officials wanted to keep that open in Level 4 but ministers refused –  but a large chunk of the lost output would have happened anyway, at least for several weeks.  From my exchange with him last night, I get the impression Gibson is more optimistic about the economic difference than I would be, but the 3.3 per cent of GDP number must be seen as an overstatement of the economic cost of the lockdown itself.

As I’ve said repeatedly in this series of posts, I’m not championing any particular policy approach from here (although I have been inclined to the view –  in March and now – that the government itself has been inclined to over-react, using sledgehammers (at little or no cost to themselves and officials, in fact possibly feeding saviour narratives) when something more nuanced could credibly have done the job).  I’m not even fully convinced by the Gibson story but  –  in particular coming from someone of his stature –  it deserves to be taken seriously, tested and critiqued rather than –  as some will be tempted to, for a variety of different reasons –  dismissed out of hand.

 

 

Reflecting on choices and options

In my post late last week I wrote about Martin Lally’s attempt at a cost-benefit analysis around the current government’s strategy of eliminating Covid from (the wider community in) New Zealand.    I was interested in it as much as anything because there was, and is, no sign that the government –  or official agencies (notably Health and Treasury) – has attempted anything of the sort.  As I noted in the body of the post, whatever view one takes on events of the last six months, decision-making from here requires a genuinely marginal analysis, setting aside sunk costs and benefits and focusing just on things that can be controlled or influenced from here on, by New Zealand.

Prompted by that observation, Martin Lally modified his paper slightly to introduce an explicit forward-looking dimension (both versions are now linked to in the earlier post).  He ended up with this strong conclusion

“Switching to a Sweden-style approach is therefore clearly warranted.”

For various reasons, I didn’t think his analysis supported such a strong conclusion.  But as I said in the earlier post, and will no doubt reiterate at the end of this, I don’t have a strong view myself on what the appropriate approach for New Zealand now to take is.    And that is so even though if a coordinated global lockdown for six weeks would in fact wipe out the virus –  and I don’t purport to know if it would – I could imagine endorsing such an approach.   New Zealand voters, New Zealand governments, have to take the rest of the world as it is, not as we might wish it to be.

Probably like quite a lot of other people, I’ve spent a fair amount of time over the last few days trying to think through even how to think about the best answer to the “what approach should New Zealand take?” question. I was prompted initially by the columns by Matthew Hooton and Kate MacNamara in Friday’s Herald, but I’ve been trying to work through my own thoughts, not theirs.

There are too-easy approaches on both sides of the arguments.  As one extreme, there was this the other day from a Nobel (Memorial) Prize winning economist.

Which demonstrates about as little as, say, contrasting New Zealand’s expected fall in June quarter GDP (about 15 per cent) with the (much smaller) reported fall in Swedish GDP, and in turn contrasting those numbers with the respective number of Covid deaths.    Neither set of comparisons sheds almost any light at all, even on the handling of the last 5-6 months, let alone on the way forward.    Samples of one comparator rarely do, unless you are really confident that in all other respects your comparator is near-identical to your country.

But I’ve increasingly come to wonder whether GDP comparisons can tell us much at all for these purposes.    Perhaps they would do so, at least in principle, if governments only took –  or failed to take – public health measures, but in fact they do palliative economic stuff as well.    In principle, it isn’t that hard to keep measured GDP up even in a tight lockdown –  all sorts of government-funded make-work activities could achieve that (measured) effect.  But even without going to that extreme, a government that throws huge amounts of income support at people whose normal business/work is impeded by lockdowns –  or private social distancing –  will, in the short-run, generate more GDP than an alternative strategy (simply not letting people starve).    And yet in doing so it constrains future fiscal policy choices –  real choices around government goods and services and future income support and taxes –  in ways that won’t show up in short-term GDP calculations, perhaps not even in long-term ones.

No actual advanced country government has gone to either extreme –  keeping GDP all the way up “artificially”, or providing just enough support to avoid starvation –  but there is quite a range of support measures that have been put in place, differing in generosity,  duration, incentives effect, etc etc.   And it is very hard to do good cross-country comparisons.  I noticed on Stuff an op-ed from the local economist Shamubeel Eaqub.   He seems to be a supporter of the current elimination approach,  and believes it is a win-win (health and economics approach).   In many respects his short article is a not-unreasonable discussion of some of the issues.  But then notice this line, used in discussing this year’s economic outcomes for New Zealand and Sweden

The scale of fiscal stimulus has been larger than in Sweden. The IMF’s tallies show Sweden’s stimulus of 11 per cent to 17 per cent of GDP, compared to 21 per cent in New Zealand. It is difficult to tell how much of the difference is because of the public health approach versus other considerations. But the fiscal stimulus is around $15b to $33b larger, some of which will be simply spent (for example wage subsidies), while others will add infrastructure and future economic growth. These are not yet possible to tease out – but gives a sense of the difference in government response.

Which on the one hand acknowledges that our economic outcomes might in part simply reflect a choice to put more of a fiscal mortgage on our future, but on the other fails to distinguish what has been spent over recent months, what is just provisions either uncommitted or for future years, let alone the composition of that support.   The New Zealand government’s total commitments might be 20+ per cent of GDP, but what has been actually paid out this year is some relatively modest fraction of that.  Presumably there are similar issues with every country’s numbers.   In New Zealand the immediate relevance is the point many commentators have made: as the wage subsidy ends it is likely our economic activity will fall away, independent of any different choices around public health interventions.

There are similar issues down the track.  For example, Lally attempted to use the comparison between The Treasury’s December 2019 and May 2020 economic projections as a base for thinking about what economic difference the health intervention might have made.  But if fiscal policy can support incomes/GDP in the short-term, as it has done this year, macro policy more generally (fiscal and monetary policy) can support demand and activity over the sort of multi-year horizon (a) Treasury’s forecasts looked at, and (b) that we realistically face on current policies, given the needed border restrictions.  A sufficiently aggressive macro policy could get us back to full employment fairly quickly, and if Treasury or the Bank don’t forecast that that is a reflection on expected stabilisation policy choices, not on the merits, cost, or otherwise of the elimination strategy.     And, on the other hand, even achieving full employment that way might result in its own distortions.

It is likely that a national elimination strategy will lower potential output relative to the pre-Covid counterfactual but that effect might be quite modest, relative to the gains from getting actual output and employment quickly back to potential.    And it still doesn’t answer the question –  the important economic question – of whether, for New Zealand, a national elimination strategy will lower potential output (including per capita) over (say) the next five years in total by more or less than some mitigation strategy would.  And again, specifics are likely to matter.  If you are in an economy in which foreign tourism matters enormously the answers may differ somewhat than if your economy is one that prospers almost entirely by exporting things (without needing much people movement).   “May” in part because we don’t know how much travel would occur voluntarily even if travel were relatively unrestricted among a (hypothetical) group of countries pursuing something less than elimination.   European evidence this (northern) summer suggests that would not be close to zero.

And as I noted the other day, one of the biggest problems in all this is that no one –  certainly no one championing the elimination strategy –  can articulate a credible exit strategy from the regime of tight border controls, with –  in effect – heavy effective taxes on people who do move.  I read an interesting piece on Newsroom this morning by a journalist who appears to have fully convinced himself of the case for the status quo.   But there was no discussion at all as to where and how it all ends.   We cannot –  it seems from all I read –  simply assume a widely available fully effective vaccine in short order.  We cannot, it seems, simply assume the virus will go away in short order.  And we cannot assume the rest of the world suddenly adopts strategies that might lead to general suppression and/or elimination.

Now perhaps we can move to a model in which the testing at the border is finally being done consistently, competently and comprehensively –  as we were promised a couple of months ago – so that the threat of lurching into fresh lockdowns with no notice (and, evidently, with grossly inadequate preparations by ministers and officials) is largely, if never completely removed.    That sounds more or less plausible.  But it had better be true, since the fresh uncertainty that last week’s episode reintroduced is itself no small thing.

But even managing that won’t change the border being largely closed, indefinitely (even if at some point there is a pleasing travel “bubble” with Taiwan and the Cook Islands).   At a personal level, the border doesn’t greatly affect me now.  I wasn’t planning on going anywhere any time soon, and I’m among what might be a small minority of New Zealanders (let alone resident foreigners) with no close relatives living/working overseas (very few distant ones either).  No one in my family depends on the tourism sector.  But some 28 per cent of people resident in New Zealand are foreign born, and a fair chunk of those born in New Zealand in recent decades are now living overseas.  A large chunk of people work in businesses that depend on foreign tourism, export education etc.

Personal connections matter, even if they don’t show up in GDP numbers.   Weddings missed, funeral missed, Christmases not shared, grandchildren/grandparents not hugged all matter. They are the sort of things that make for a full life.  And sure technology helps, but no one really thinks it is the same, not for years and years anyway.

Now, a reasonable counter to these points is a reminder that New Zealand can only control what we do.  The rest of the world will do what it will.  Australians aren’t even free to leave the country at present –  whether for New Zealand or anywhere – and won’t let New Zealanders in anyway.  They’d presumably be even less likely to if we took a mitigation path instead.

If I were really forced to make a pick, I would probably go with the view that a well-managed  elimination approach will have a lower GDP cost (even with all the caveats above) than a mitigation approach.  But no one really knows do they?   As an example, case numbers and deaths have tailed off in Sweden too, but no one knows whether that is sustainable, or what the longer-term costs of their (private and government) restrictions and distancing measures might be (or what they might be applied to another country, like New Zealand.

And then one is still left trying to weigh the other costs and risks and implications of what maintaining the elimination strategy might mean, especially if we continued to have a government that didn’t do the basics well and then relied on extreme measures to contain relatively limited outbreaks (as happened in April –  recall the toughest lockdown in the world, the ban on swimming, the ban on funerals).     Tough restrictions might be tolerable in a very time-limited scenario –  the big wave of the 1918 flu in New Zealand swept through in about six weeks – but we are already months into Covid and, to repeat, there is no obvious end in sight.

There is a group of people –  presumably mostly on the left –  who seem only to happy to coerce populations without limit, talking (for example) of mandatory masks apparently indefinitely, or constraining capacity on individual buses and trains while doing nothing to increase capacity, or having lockdowns on a whim (even with compensation).  These same people are probably also quite happy to have people increasingly dependent on the grace and favour of governments, for handouts (new wage subsidies), for favoured stimulus programmes (the reward to lobbying and connections), and who are quite unbothered by –  for example –  banning the public celebration of Easter this year, even outdoors, even in modest gatherings.   Or banning funerals, some of the sorts of things that define our culture, our humanity.   There are people, even on the right, who seem only too happy to have privacy protections tossed out the window, allowing the state to track us all for the (indefinite) duration.  Of course, Covid is not some conspiracy to enable bigger more powerful governments –  any more than, say, World War Two was – but it, and the indefinite elimination approach, tends to have that effect anyway.

There don’t seem to be easy answers.  I –  unaffected much by the border – might prefer something like a highly-capably managed version of our elimination approach for now.  If it works, we mostly keep our freedoms, even if we are poorer.  There is also the option value of waiting –  if we abandon the elimination approach, it would be expensive to reinstate it later, and there are no commitment mechanisms to keep a government to a mitigation path after once it decided to try it.

But I can understand that for many the freedom to travel – without huge effective taxes –  is one of the important freedoms.   And again not one really captured in GDP.

I haven’t said much here about the likely increase in lives lost (and impairment of quality of life for some who didn’t die) were we to move to a mitigation strategy.  That is not because those effects are unimportant.  I touched on them in the earlier post, but I don’t purport to have a distinctive perspective on anything around how the virus itself might then progress through New Zealand.  But again, the absence of a credible exit strategy puts those costs, those people (who could be you, or me, or our families) in a different light.  One parallel that struck me some months ago were the lives we put on the line in World War Two.   No one really wanted a war, but in the end no one could see a satisfactory outcome unless we committed to war, knowing that would involved –  almost certainly –  large losses of lives of young men (mostly).    The parallel isn’t exact by any means, but I still find it worth reflecting on.

This has all been rather discursive, and inconclusive –  as much about helping to sort through my own thinking as anything else.  To repeat, I am not championing any specific strategy for New Zealand at present.  And I remain worried about the apparently weak levels of capability in our public service and political system to evaluate options and/or effective and efficiently operate whatever option is chosen from time to time.

For those interested in understanding Sweden itself, I saw a link the other day – I think on Marginal Revolution –  to this interesting, but avowedly incomplete, look at some of the distinctive features of the Swedish experience and system.

Evaluating choices

Back in the last “lockdown” I linked to various pieces of work by other economists attempting to make sense of, evaluate etc, choices the government was making.   There was Ian Harrison’s work challenging some of the modelling estimates the Prime Minister liked to wave around and some aspects of the “Level 4” restrictions.  There was an early attempt at a cost-benefit analysis by Bryce Wilkinson of the New Zealand Initiative, and another exercise looking at a similar question in a different way by John Gibson at Waikato University.  There was another exercise that I never wrote about, but which is reported and linked to here, by Martin Lally, a consultant economist and former Victoria University academic.

What was striking, even at the time, was that there was no sign that the government had commissioned from officials, or officials had undertaken anyway, any sort of serious cost-benefit analysis of the sorts of intervention they were looking at and imposed.  It always seemed likely at the time that there was nothing of the sort –  the public sector had, after all, been woefully underprepared, sluggish in getting any serious planning underway, and complacent for too long that this was largely someone else’s (PRC’s) problem  Anyway, when the government finally got round to publishing the relevant documents, sure enough there was no serious structured attempt to cost and evaluate alternative policy options.  (It is not, I hasten to add, that any cost-benefit analysis can give one “the” answers, but it provides a disciplined framework to analyse the options, assumpions and sensitivities.)  But there was nothing –  even though the New Zealand authorities had the best part of two months of lead time.

These issues take on a fresh salience with this week’s out-of-the-blue partial lockdown of Auckland, and the government decision later today.  It prompted me to finally go and take a look at an exercise undertaken by an economist at the Productivity Commission in early May, illustrating for the benefit of The Treasury –  who we used to assume were the champions of robust cost-benefit analysis –  how the decision in late April on whether to extend “Level 4” for another five days might have been rigorously analysed in a careful cost-benefit framework, looking only at the marginal costs and benefits of the two options the government had had in front of it.    The author concluded that, with the information available at the time, the extension was probably not justified, but that is less relevant than the fact that an economist at another agency was having to do this for The Treasury after the event.  Apparently neither The Treasury nor ministers had been interested in getting such analysis done when the decisions were being made.

Restrictions –  border restrictions –  have remained in place, but there seems to have been relatively little interest in evaluating the costs and benefits of those choices.  But this week’s restrictions have brought the issue back into focus.     There have been a couple of newspaper articles, notably in today’s Herald: this by Kate MacNamara, and a column by (newly returned from working for the National Party) Matthew Hooton.  MacNamara explicitly ends her piece with the argument

“There will be a time when the best option is to ease border restrictions, abandon lockdowns, and let our health system, including tracking and tracing, do the heavy lifting. We need credible analysis to help us know if that time is now.”

I’d say “perhaps” to the first sentence –  and it remains troubling that there is no identified or championed (by the government) credible exit strategy from our current eliminationist/closed-borders model – but would strongly echo the call for serious, open, analysis on the issue and options.

Martin Lally’s latest paper on a cost-benefit approach isn’t that analysis –  we need proper marginal analysis on the costs and benefits from here, with what has happened to now in principle largely irrelevant (sunk costs and all that).  But Martin’s paper, which he has given me permission to share

Martin Lally cost-benefit assessment of Covid lockdown August 2020

is still a useful look back at the merits of choices made over recent months, and probably sheds at least some light –  poses some questions –  on how the choices going forward might look.

His conclusion is as follows (QALY = “quality-adjusted life year”)

This paper considers the effect of the New Zealand government adopting a suppression policy versus a milder mitigation policy, with the actions of other governments taken as given. The cost per QALY saved from doing so would seem to have been vastly in excess of the currently used value for a QALY of $45,000. Consideration of alternative parameter values and recognition of factors omitted from the analysis would not likely reverse this imbalance in cost per QALY saved versus currently accepted figures for the value of a QALY. The suppression policy was therefore dramatically inconsistent with long-established views about the value of a QALY.

The broad approach is to look at lives saved by the government’s elimination approach and the (primarily) economic costs of that strategy.   Neither is necessarily straightforward.  On the economic side, one sometimes hears champions of the government touting a view that there is no such economic cost –  in fact, I heard former Labour leader Phil Goff make exactly that claim this morning. Locking down hard, while costly initially, is –  these champions conveniently claim – its own reward; initial losses more than outweighed by the subsequent gains (faster sustained recovery etc).  But there is no actual evidence for these claims –  at best such an outcome could be considered as one scenario.  (In the early days, the PM was claiming support from 1918, suggestions I looked at here.)

Perhaps that line might have seemed more plausible to some just a few days ago.  But then, with essentially no notice, our largest city was flung back into a partial-lockdown, and whatever choices the government announces today, we are told to expect more of these events, timing and size of course unknown and unknowable.    So we take further real output losses now and –  perhaps at least importantly – fresh huge uncertainty (affecting all manner of firms, and households too).    Perhaps the government can finally fix up border testing –  isn’t it just staggering that two-thirds of people working at aiports/MIQ facilities etc haven’t been tested at all? – reducing the chance of further outbreaks/lockdowns.  But even if that were done as best as humanly possible, it wouldn’t change the limitations of the closed border itself.

And the difficulty for champions of the “own reward” model is the absence of a compelling exit strategy.   If we could count on the virus simply dying out, going away, by some clearly defined date next year, the calculations change quite a lot.  There is a credible exit strategy then, and we just have to hold on til then.  Similarly it we could count on a highly effective vaccine being generally available by some clearly defined date next year, again things look more encouraging for the “own reward” story.   Perhaps those too are scenarios to add into a serious evaluation of the strategy.  Along with scenarios in which there is never a very effective vaccine and/or the virus remains much as it is indefinitely.

In any case, what Lally does is to assume that some –  quite moderate –  proportion of the difference between the Treasury’s GDP forecasts from last December and those from this year’s Budget should be treated as the cost of the elimination approach.  His central case assumes 25 per cent.  That may be too high.

The other side of the equation is, of course, lives saved (and reductions in impairments to the quality of life, of those with serious but non-fatal Covid).  Of course, some of that early modelling suggested catastrophic losses if we hadn’t gone to a fairly severe lockdown.  But if, as Harrison suggested, those numbers didn’t look that plausible at the time, they look much less so now.    Lally focuses on the case of Sweden, which has pursued –  not always well –  something closer to a mitigation policy.

To date Sweden has suffered 570 deaths per 1m of population and the increase in the rate is tailing away to zero.  New Zealand’s population of 5m implies 2,850 deaths under a Sweden-style mitigation policy. The QALYs saved would then be (2,850 – 22)*5*0.5 = 7,070.

It is a sample of one, but again he illustrates that you can assume a materially higher numbers of QALYs saved and the calculations still don’t end up very favourable to the New Zealand approach.   A further caveat is that, although he notes the point, Lally does not explicitly allow for the QALYs saved in respect of the people with serious non-fatal Covid cases.  The Productivity Commission piece does include some estimates, and if I’ve read document correctly, the effect is to double the overall QALYs saved.

Lally is very conscious of the sensitivities in his analysis. This is the last extract I’m going to quote.

The parameters used in this analysis are debatable. The death rate under a mitigation policy may be much larger than estimated here. If it is doubled, the cost per QALY saved would halve to $4.25m, but would still be 94 times the usually accepted figure. The GDP loss from the current path relative to that if there is no curtailment in economic activity could be smaller. If it were halved, in addition to the death rate being doubled, the cost per QALY saved would fall further to $2.12m but this would still be 47 times the usually accepted figure. The remaining parameter is the proportion of the GDP loss due to lockdown rather than mitigation, which is unknown. However, any reasonable proportion will produce a cost per QALY saved well in excess of the usual figure of $45,000.

(Incidentally, I prefer a high number for the value of a QALY –  the Productivity Commission paper discusses some of the options.)

My point in this post is not to articulate a strong personal view on what the government should have done, or should do now.  As I’ve said in past posts, my visceral reactions tends to be more cautious than my analytical one, and one shouldn’t discount visceral reactions.  And in the last lockdowns, my bigger concerns were about the overreach in many of the non-economic restrictions –  remember the government that totally banned funerals, or a solitary swim at a quiet suburban beach.

But I reckon there is crying need for more analysis –  open and transparent, disciplined analysis, exploring a wide range of asssumptions and scenarios.  As I noted, Lally’s paper isn’t that for the period ahead –  we need marginal analysis from here, that explicitly takes account of the uncertainty of the relevant end dates –  but it is still worth reading, perhaps especially so in conjunction with the (slightly longer, more detailed, and better-tabulated) Productivity Commission piece, which represents the sort of analysis we should be expecting from our core government officials –  notably The Treasury –  were they adequately (well, excellently) doing their job.   And as the government ploughs on –  apparently supported by all other parties –  with their eliminationist approach, we deserve a credible, carefully evaluated, exit strategy.  At present, there is none.

UPDATE: Lally has responded to my point that his paper is not a marginal approach (costs and benefits from here) and so can’t shed light on choices from here, and has added a paragraph (in this version) offering one way of looking at that question concluding that

“Switching to a Sweden-style approach is therefore clearly warranted.”

Those who believe that virtue is its own reward (as above) will certainly not be persuaded.   My own reaction is that  –  as per my final paragraph –  more analysis is needed, drawing on the combined expertise of economists and epidemiologists.