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.

 

Perhaps they should start a bank?

In the last few days speeches by two of the Reserve Bank’s senior managers have been published.   The first was from the Deputy Governor Geoff Bascand –  delivered on no obvious occasion to “banking industry representatives in Wellington” –  and the second by Toby Fiennes, formerly head of supervision (operations and policy) but now reduced to Head of Financial System Policy Analysis, at one of those commercial training ventures that are always keen to have (free) speakers from places like the Bank.

Bascand and Fiennes have often been among the better people in the upper reaches of the Reserve Bank.  I’ve been on record suggesting –  before the appointment and since –  that Bascand, if not ideal, would have been a better appointee as Governor.  His speeches have typically been quite materially better than those of his senior management colleagues –  more akin to what we see from people at Deputy Governor level in other advanced country central banks –  although that is true more of his speeches on economic topics than those on banking and financial stability.    Perhaps that isn’t surprising –  his background was in economics, and he had no background in financial stability or regulation until he took up something like his current job three or four years ago.

In this post I want to focus mostly on Bascand’s speech.  He is the more senior figure and is across all the functions of the Bank –  including apparently enjoying the confidence of the Minister as a member of the statutory Monetary Policy Committee.   And if Fiennes’s speech raises one or two points, Bascand’s is really quite egregious in places.

As befits one of Orr’s deputies, the speech pays due obeisance to the public sector employees’ campaign to change the name of the country.     The title?  “Banking the economy in post-COVID Aotearoa”.    As it happens, they the drop one more “Aotearoa” into the first page before reverting, almost without exception, to “New Zealand” (actual name of the country, actual name of the Reserve Bank of New Zealand) for the rest of the speech.

The bottom line message of the speech, however, seemed to be an injunction to banks to lend more.  So much so that, as per the title of this post, one was left wondering why if Messrs Orr and Bascand know so well what the profitable risk-adjusted opportunities are they don’t step down from their secure and quite highly-paid public sector perches and start a bank, or at least offer their services to the credit and risk departments of some existing insurgent bank.

It starts on the first page

In the face of these challenges, the banking sector could choose to hunker down and seek to ride out the storm until the good times roll again. Or, the banking system could continue to step up and play a crucial part in supporting New Zealand’s economic recovery and maximise its potential competitive advantage of relationship lending and customer information. …..

Maintaining institutional resilience while continuing to serve customers in an uncertain environment will demand expertise, courage and an unwavering belief that the people and businesses of Aotearoa will find a way to come out of these challenges.

In periods of extreme uncertainty, isn’t the rational –  and prudent – response of most people to “hunker down”?   And this is an environment of really quite extreme uncertainty –  a point I’m sure we will hear emphasised (again) by Orr and Bascand next week when they put their monetary policy hats on and deliver the Monetary Policy Statement.

But here –  playing with other peoples’ money – they want bank managers to ride blindly –  but “courageously”-  into the cannon fire, as if they (Orr and Bascand) either know better than the shareholders what is in those shareholders’ interests, or just don’t care.   And it is pretty rich coming from people who, with their monetary policy hat on (the tool actually designed to support recoveries) are doing almost nothing.

It is really remarkable for the lack of nuance and subtlety.  I scrawled in the margin against that first paragraph “presumably some mix?”     I doubt there has ever been a market-oriented banking system that-  in a severe downturn – has ever either called in every loan possible at the first sign of trouble, or rushed out boldly to encourage a wide range of borrowers to take more credit.    But there is nothing of this in Bascand’s speech, nothing either about how serious downturns should prompt both lenders and borrowers to reassess the assumptions they were working on, in turn prompting greater caution –  the more so, the more uncertain the path ahead.     Thus it is fine for central bankers to fling out rhetoric about “unwavering belief”, but no one knows which forward path the economy will actually take, how long it will take to get securely on that path, or what crevices there might yet be along the road.  It will make quite a difference to plenty of credit assessments –  whether for existing debt, or those interested in taking on new debt (around many of whom there may be adverse selection risks).

A bit later on there is an entire section of the speech on “Reserve Bank actions to support bank lending”.    It is about as thin.

For example, we get overblown claims like this

Cash flow and confidence became key to New Zealand’s financial stability.

I know “cash flow and confidence” was a mantra of the Governor’s but –  and as the Bank itself would tell us any other time –  the financial system’s soundness was much greater than implied by this assertion of Bascand’s, reinforced a sentence later when he tries to claim that various initiatives had “kept the financial system stable”.   These measures, apparently, included the small cut in the OCR (virtually no change in real terms), whatever the LSAP did to long-term rates, and a list of other regulatory measures which –  useful as most may have been –  will have done little or nothing to “keep the financial system stable”.   System stability is mostly about disciplined lending in the good times.  All evidence suggests –  and other Reserve Bank commentary suggests they agree –  we had that.  One of the risks at present is that if anyone in the banks paid much heed to the Reserve Bank’s rhetoric, those lending standards could be considerably debauched now.

Bascand goes on, being really rather self-congratulatory

Taken together – and without being too self-congratulatory – these initiatives have had a significant impact on supporting the short-term financial needs of households and businesses. This was important to limit failures of businesses with good long-term income prospects, and prevent mortgage defaults and foreclosures for borrowers facing temporary decreases in income.

All this without a shred of evidence to support his claims to have made much difference at all.   In this Bascand world, banks would have been rushing into mortgagee sales, closing businesses galore, without any regard at all for longer-term relationship prospects etc, if it hadn’t been for the Reserve Bank.    It is the same spin we used to get from the Governor, and the same lack of evidence.     We’ve had fairly sound and well-managed banks for 100 years or more –  recall that the closest to a bank failure in the immediate post-liberalisation period were two government-owned entities-  but the Governor and his Deputy believe that they are the hope and salvation.

Bascand goes on to talk threateningly about banks retaining their “social licence to operate” –  if there is such a thing, it is really no business of a central bank charged only with prudential supervision of banks.  And then we get to what seems to be the climax of his lecture on lending

But a key determinant of the success of New Zealand’s economic recovery to come will be the willingness of banks to lend to productive, job-rich sectors of the economy so that we can collectively take advantage of New Zealand’s enviable position of having eliminated community transmission. Now is the time for banks to prudently drawdown on their buffers to support their customers. Shareholders will have to be patient for longer-term payoffs, but this forward-thinking, long-term approach will stand bank customers, banks, shareholders, the financial system and Aotearoa in the best position.

Given banks are anticipating a deterioration of their loan portfolios, hunkering down and tightening lending standards may seem to them to be the optimal response to perceived increased risk. However, given banks dominant role in New Zealand’s financial system a synchronised lending contraction across the banking sector would risk a ‘credit crunch’ amplifying the economic downturn (Figure D). Therefore ultimately it is in banks’ own interest to maintain the flow of credit and contribute to the long-term stability of the banking system by preventing large scale borrower defaults and disorderly corrections in asset markets.

There is so much problematic about this it is difficult to know where to start.  There is. for example, the small point that highly productive sectors tend –  almost by definition, and it is a good thing –  not to be ‘job rich”.  For the rest, as noted earlier, you get the impression that people with no experience in banking at all –  or indeed in Bascand’s case any in business at all –  are best-placed to tell private businesses and their shareholders what is in their own best interests.  Based on what evidence, what analysis?   And isn’t it all rather lacking in nuance, since few of these sorts of decisions are ever all or nothing.   And despite the wider economic responsibilities of the Bank, it isn’t even obvious where Bascand thinks these profitable creditworthy projects are to be found –  or how he could be confident of his judgement even if he and his staff could identify some.     Surely a more general answer would be that private agents (banks and other firms and households) are best placed to make their own assessments about choices and risks, but that macro policy (and perhaps now public health policy) can provide the best possible supporting climate for those private decisions to be made.  As it is, even later in this speech Bascand concedes that “our economic challenges remain severe”.   Not exactly a climate for much private sector risk-taking, whether by banks, firms or households.  But it might, for example, be time for a monetary policy central bank to start doing its job.

Risking other peoples’ money was the theme of that bit of the speech. But Bascand also took the opportunity to comment on the Governor’s bank capital review –  the one that will require a huge increase in bank capital to support the existing level of business.   The one that banks, and many outside experts –  not, contrary to the Governor’s claims, just those paid by banks –  warned would lead to some credit contraction, some disintermediation from the banking system, and some higher costs.

Likewise, capital metrics were strong going into this crisis, boosted by Basel III regulatory requirements, a number of years of favourable economic performance, and preparations for the impending implementation of the Reserve Bank’s Capital Review. The COVID-19 crisis has underscored the importance of banks having sound capital buffers; increased provisions for expected credit losses have, so far, been easily absorbed by existing capital buffers. Healthy capital buffers are necessary not only to ensure banks survive crises, but to ensure banks survive ‘well’ and are able to continue to lend to creditworthy borrowers throughout a downturn. The Reserve Bank remains committed to fully implementing the outcomes of the Capital Review. However, as we indicated this past March, this will be delayed one year and not occur until July 20212. We expect to communicate further on the implementation of the Capital Review by the end of the year.

There are really two main points here.  The first is the claim –  that Orr has made repeatedly –  that banks were well-positioned this year partly because they had been acting preemptively to raise more capital in anticipation of the higher capital requirements, which were supposed to be phased in from this year.  Victoria University banking academic Martien Lubberink has addressed directly this claim in a post on his blog.   As everyone recognises, capital ratios have increased since prior to the previous (2008/09) recession, under the influence of some mix of regulatory and market/ratings agency pressure.  But here is Martien’s chart showing total capital ratios for several of main banks operating here for the period, in early 2018, since Orr took office.

total capital ratios

He has another chart showing core (CET1) capital ratios, which also suggests no lift in capital ratios over the last couple of years.

The Bank has been attempting a difficult balancing act: trying to assure us (of what is almost certainly true) that the local banks are very sound, but at the same time trying to get cover for the scheduled large increase in capital requirements.  There would be some reconciliation if banks had been raising actual capital in anticipation of those new requirements but….the Bank’s own data, the useful dashboard, confirms that it just isn’t so.    It is just spin, it is a lot worse than that.

Oh, and note that Bascand reaffirms that the Bank is still committed to moving ahead with the higher capital requirements –  even though it expects the banks to come through the current severe test just fine.    The implementation was delayed by a year back in March, but that is now five months ago, and July 2021 really isn’t far away –  particularly in a climate of heightened uncertainty, including about likely loan losses out of the current recession.  So on the one hand the Deputy Governor and his boss are out their urging banks –  almost suggesting it is some sort of moral duty –  to lend more freely, and on the other hand they are still pushing ahead with their plans to hugely increase actual capital requirements, something even their own modelling suggested would have adverse transitional effects in more-normal times. (Oh, and did I mention all while doing nothing to actually lower real interest rates across the economy, in ways that might improve servicing capacity on current debt, and provide a boost to aggregate demand and –  over time – to credit demand.)

And here I want to refer to the other speech, by Toby Fiennes; in particular this extract (emphasis added)

At the end of May we released our six monthly Financial Stability Report (FSR) which assesses the health of the financial system. This assessment presents particular challenges during more volatile and uncertain times; we want to report openly and fully about the state of financial stability and the risks that we see, but we have to be mindful of the risk of exacerbating the situation, and further undermining confidence.

We used stress tests to inform ourselves and our audience about banks’ and insurers’ resilience. We developed two scenarios to test the banking system, which had similar economic projections to the Treasury’s COVID-19 scenarios 4. Results from our modelling indicated banks would be able to maintain capital above their minimum capital requirements under a scenario where unemployment increased to over 13 percent and house prices fell by a third. However, a second more severe scenario showed the limits of bank resilience. Under this scenario with unemployment of over 18 percent and house prices falling by half, banks would likely fall below minimum capital requirements without significant mitigating actions.

I should note that bank capital buffers have increased significantly in the past decade, in response to actual and forthcoming increases in regulatory requirements; therefore the banks entered the Covid-19 pandemic in a sound position. Additionally, since early April the Reserve Bank has prohibited banks from paying dividends to their shareholders, which further supported the capital positions of New Zealand banks. This gives banks headroom to continue to supply credit, which will play a large role in supporting the economic recovery.

Note that he repeats the same outright misrepresentation –  the bolded phrase –  as his boss.

But it was the rest I was more interested in.  He highlights again the updated stress tests reported in the FSR.    I might be more pessimistic than most economists, so I reckon the 13 per cent unemployment scenario sounds like a good and demanding test.  As with previous similar RB stress tests, Fiennes reports that the banks come through just fine –  at least so long as they don’t markedly lower their lending standards in response to regulatory pressure.  But again –  as was argued during the capital review debates last year –  if the system is resilent to such an adverse shock before capital ratios are raised, what possible credible case can their be for markedly further raising capital requirements?  Especially when the Bank is trying to twist banks’ arms to maintain/increase new lending?   There is just no apparent rigour or coherence to the Bank’s position.

Much the same goes for the line about prohibiting dividends.  I didn’t have too much problem with the temporary ban when it was announced  – on good prudential grounds that in the very unlikely event that our banks got into serious trouble we didn’t want resources being transferred back to the parent, leaving larger losses for New Zealand creditors and taxpayers.   But it is just bizarre to suppose that banning banks from paying dividends will increase their willingness to make new good loans.  If anything, it is only likely to reinforce unease about doing business in New Zealand (at the margin), and since credit demand has fallen notably –  a point Bascand acknowledges-  and actual capital ratios were well above current regulatory minima it isn’t obvious that some shortage of capital in the New Zealand business was likely to be a big influence on lending policy just now.  The suggestion that suspending dividends will “play a large role in supporting the economic recovery” is without support, and if seriously intended is almost laughable.

There is more in Bascand’s speech I could devote space to.   At least what I’ve covered up to here is within the Bank’s statutory mandate re the soundness of the financial system as a whole.    The same can’t be said for this stuff, pursuing the Governor’s personal political agendas on issues where there may be real issues, but they have nothing to do with the Bank’s mandate or powers.

Financial inclusion has become an increasingly important part of the Reserve Bank’s policy agenda in our capacity as a Council of Financial Regulator member and our own Te Ao Māori strategy. The Strategy helps to guide the bank in understanding the unique prospects of the Māori economy, how Māori businesses operate, and what lessons the Bank may learn in setting systemically-important policy with this view in mind. An important part of the Strategy is making clearer the unintended consequences of our policies on unique economies like the Māori economy.

Or one of the Governor’s favourites, climate change.  Here I will just quote one line from the speech

Managing major and systemic risks to the economy, such as climate change, sits squarely within our core mandates.

It simply doesn’t    The Bank has an important, but narrow, statutory role and set of powers around the soundness of the financial system.  Climate change(and policy responses to it) may well represent a significant threat to our economy, our way of life, and so on. But unless –  and even then only to the extent –  it poses a threat to financial stability, not taken account of by private borrowers and lenders, it is really no particular business of the Bank.  Any more than other serious risks –  management of Covid itself as just a contemporary example –  are anything much to do with the Bank.

But the Governor has personal ideological agendas to pursue, and (ab)uses public resources and staff to pursue them.

Standing back from the Bascand speech, what is really rather striking –  and disappointing –  is the lack of an overall framework, the lack of any real rigour or discipline, and a lack of straightforwardness.  Clearly his boss has a cause –  more lending –  to pursue, but like Orr Bascand offers no reason to suppose, or evidence to support the implication, that banks are not acting prudently or appropriately.  And never seriously engages with the implication that if the banking system is sound now and has plenty of headroom, why would it make sense for the Bank to be imposing big new capital requirements, which will assuredly be reducing the willingness of banks to lend.

But, as I noted earlier, if the opportunities are so real no one is stopping Orr and Bascand leaving their safe official perches and starting –  or joining –  a risk-taking bank.  A good supervisor would, however, be keeping a very close eye on any bank riding courageously into the cannon fire –  of extreme economic uncertainty, severe challenges –  in the way Bascand appears to suggest.

Perhaps better if Orr and Bascand turned their minds, and attention, to using monetary policy in the way it was designed to be used, instead of sitting idly by six months into a severe economic shock, with real interest rates barely changed, and the real exchange rate not changed at all.

 

 

 

 

Not expecting enough inflation

I’ve been banging on about the decline in inflation expectations, and the apparent indifference of the Reserve Bank to that, for most of this year.

It was different late last year.  Then, the Bank was making the case –  at least after the event –  for easing monetary policy fairly aggressively with one of the considerations being avoiding the risk of inflation expectations settling lower than was really consistent with the target.  Then –  last year –  the Governor went so far as to suggest that he would prefer to be in a situation where hindsight proved that they had overdone things a little, with expectations rising, and needing to think about raising the OCR again.   They were totally conventional sorts of line for central bankers to enunciate, especially if they were getting uneasy about approaching the conventional limits of the OCR.  I commended the Bank at the time.

This year the Bank –  Governor and MPC –  seem to have given up again, just when it matters; amid the most severe economic downturn in ages, amid significant actual falls in inflation expectations.  As a reminder, unless steps have been taken to remove the effective lower bound on nominal interest rates (and that has not been done anywhere yet) then the lower inflation expectations are, all else equal, the less monetary policy capacity there is to do the core macro-stabilisation job of monetary policy.   And that risks being a self-reinforcing dynamic.

There is no single or ideal measure of inflation expectations.  There are different classes of people/firms for whom such expectations matter, and different time horizons that matter.   Very short-term expectations get thrown around by the short-term noise (notably fluctuations in oil prices).  Very long-term expectations (a) may not matter much (since there are few very long-term nominal contracts) and (b) probably won’t tell one much about the current conduct of macro policy (whatever inflation is going to be between, say, 2045 and 2050 isn’t likely to much influenced by whatever is going on now, or those –  ministers or MPCs –  making monetary policy decisions now.

For a long time, the Reserve Bank’s preferred measure of inflation expectations was the two-year ahead measure from the Bank’s survey of the expectations of several dozen moderately-informed or expert observers.  Two years got beyond the high-frequency noise, and the survey only added questions about five and ten years expectations in 2017.

2 yr expecs july 2020

In the latest published survey expectations fall very sharply.    There will be an update on this series published next week.  I wouldn’t be surprised if there was a bit of a bounce, but I wouldn’t expect it to be large.  The Reserve Bank’s own Monetary Policy Statement will be released the following week.  Perhaps they may have become a bit more optimistic, but recall that in May their inflation outlook –  even backed by their beliefs about the efficacy of their LSAP bond purchases –  was very weak.   Two years ahead their preferred scenario had inflation just getting back up to about 1 per cent.

Now, of course, things are somewhat freer in New Zealand than they were back when those earlier surveys and forecasts were done –  perhaps even more so, sooner, than most expected back then.  On the other hand, the border restrictions remain firmly in place and the wider world economy –  which seems to get all too little comment here –  is only getting worse.   I noticed in the Dom-Post this morning that that is now the official advice of The Treasury to the Minister of Finance.

All of this is, however, known by people participating in the government bond market.  And since the New Zealand government now issues a fairly wide range of bonds, and a mix of conventional bonds and inflation-indexed bonds, we can get a timely read on the inflation rates that, if realised, would leave investors equally well off having held a conventional bond or an inflation-indexed bond (the “breakevens”).   They aren’t a formal measure of inflation expectations, and at times can be affected by extreme illiquidity events, but it is also unlikely there is no relevant information (although Reserve Bank commentary tends to act as if this data can/should be completely ignored).

For a long time, there was only a single indexed bond on issue in New Zealand.  The Bank had persuaded the government to issue them back in the mid 1990s, but then emerging budget surpluses meant issuance was discontinued.  The single indexed bond matured in February 2016.  For a long time the longest conventional bond was a 10 year maturity.  But even with all those limitations, the gap between the indexed bond yield and the Bank’s 10 year conventional bond rate looked plausibly consistent with “true” inflation expectations.  Through much of the 00s, for example, the breakeven was edging up to average about 2.5 per cent.   Recall that there was never much of the indexed bond on issue, and never much liquidity either.

Since 2012 there has been a new programme of inflation-indexed bond issuance, and there are now four maturities on issue (September 2025. 2030. 2035, and 2040).   Go back five or six years to the time when the Reserve Bank (and most the market) thought higher interest rates were in order and you find that the breakevens were close to 2 per cent.  Given that in 2012 the government had slightly reframed the Reserve Bank’s monetary policy goal to require them to focus on the target midpoint of 2 per cent, breakevens around that level were what one would have hoped to see.  And did.

After that, things started to go wrong, with the breakevens beginning to fall persistently below target.  As it happens, of course, by this time it was increasingly realised that actual core inflation was also falling below target.

But what of the more recent period?   One problem in doing this sort of analysis, if you don’t have access to a Bloomberg terminal, is that the data on the Reserve Bank website used to provide yields for the four individual inflation-indexed bonds, but only benchmark five and ten year yields for conventional bonds (ie not yields on specifically identified individual bonds).  That didn’t much over very short-term horizon –  there just aren’t that many bonds on issue –  but potentially did for slightly longer-term comparisons.  However, in the last week the Bank has started releasing daily data on yields on all the individual government bonds on issue, indexed and conventional, back to the start of 2018.  That is most welcome.  As it happens, the government has also now started issuing a conventional bond maturing in May 2041, reasonably close to the maturity of the longest inflation-indexed bond.

In this chart I’ve calculated breakevens as follows:

  • take each of the indexed bond maturity (September 2025, 2030, 2035 and 2040)
  • use conventional bonds maturing in April 2025 and May 2041, and interpolated between bonds maturity in April 2027 and April 2033, and between bonds maturing in April 2033 and April 2037 (to give implied conventional bond yield for April 2030 and April 2035)
  • calculate the difference between each indexed bond and the yield on the conventional bond with the closest maturity date.

long-term breakevens

These breakevens, or implied inflation expectations, were uncomfortably low (relative to the target) even back in 2018. Things have only got worse since then.

Not that these are not breakeven inflation rates (or expectations) for a single year –  say 2025-  in the way that survey expectations (including the RB survey) are.  They are indications about average CPI inflation over the whole period to, say, 2025.

I thought there were several things that were interesting about the chart:

  • breakevens seemed to be trending downwards (if only modestly) well before the current recession began.  That seemed pretty rational –  the growth phase (here or abroad) wasn’t likely to last forever, and it was becoming increasingly clear that central banks were likely to feel quite constrained in the next downturn,
  • the divergence between the blue line and the other two this time last year.  That was when the Reserve Bank felt obliged to cut the OCR quite bit, and to start running those lines I referred to at the start of this post about downside risks around inflation expectations.  One could interpret the subsequent closure of the gap as a mark of some credibility for the Reserve Bank.  Expectations of inflation over the next five years rose a bit, and the gap between the 2025 and later expectations closed up again.
  • the sharp decline in the breakevens, for all three maturities, beginning in March.  Some of that will have been about the extreme illiquidity event in global (and local) bond markets in mid-March (something similar happened in 2008/09), prompting various central banks, including our own, to intervene in bond markets,
  • perhaps most importantly, the substantial divergence that has now opened up between the breakevens for the period to 2025 and those for the longer maturities.  All three lines picked up to some extent after the Reserve Bank added inflation-indexed bonds to the list of assets they would buy under LSAP, but since then the breakeven for the period to 2025 has gone basically nowhere, sitting at just above 0.4 per cent per annum (compared to an inflation target over the period of 2 per cent per annum).  By contrast, the grey line is back close to 1 per cent, not that much below where it was last year.   Even these lines understate the extent of divergence, because the breakeven to 2035 includes the five years to 2025.    If we could back out an implied breakeven just for the five years from 2030 to 2035 it might be around 1.3 per cent –  still not great, still not consistent with the target, but no worse than last year.
  • to the extent one can yet read anything into the 20 year numbers, and implied breakeven inflation rate for 2035 to 2040 would be higher still, although still below 2 per cent.

There are pluses and minus to be taken from all this.

The positive feature is that if one looks 15 years ahead, markets don’t expect New Zealand to deliver on a 2 per cent inflation target, but their (implied) view on that is no worse now than it was last year.  That isn’t great but it is better than the alternative.   On the other hand, it tells you almost nothing about the current conduct of monetary policy, since (a) current monetary policy won’t be affecting inflation outcomes 15 years hence, and (b) almost certainly, neither will the current key players (Orr or Robertson).

The negative feature is just how weak those five-year average expectations are, averaging around 0.4 per cent, well below the bottom of the target range, let alone the 2 per cent midpoint the MPC is supposed to focus on.   And this is the horizon that current monetary policy is affecting, and which the current key players (Orr, Robertson, and the MPC) will be affecting.    And these breakevens are down so far this year that real interest rates have not fallen much at all.   Here, for example, is the real yield on the 2025 inflation-indexed bond.

2025 real yield

No change over a year.  Or even if there was something odd going on at the end of July last year, no material change since (say) February this year, even as a severe recession and deflationary shock hit New Zealand and the world.  Even with the Reserve Bank intervening to support this market.   That is a pretty damning commentary on monetary policy simply not doing its job –  real yields over a five year horizon will always be heavily influenced by expected changes in short-term real policy rates.

As a final cautionary note, the deflationary shock was pretty much global in its effect, but here is the five year breakeven chart for the United States since the start of 2018.

US 5 yr

Not only can you see how much closer the breakeven has been to the Fed’s target for the inflation rate but, more importantly in the current context, how strongly the five-year breakeven has rebounded since March.   It is a very different picture to what we’ve seen in New Zealand.   There are some differences: the respective inflation-indexed bonds are slightly differently specified, and the Fed is not buying indexed bonds (unlike the RBNZ). But all else equal, the fact that the RB is buying indexed bonds and the Fed is not should be pushing New Zealand breakevens up relative to those in the US.  [UPDATE: A reader  draws my attention to the fact that the Fed is buying TIPS.]

The Governor and the MPC seem to have been all too keen to abdicate responsibility in this crisis, deferring almost everything to fiscal policy and simply refusing to cut the OCR further.  How much fiscal stimulus to do is a political matter outside the Bank’s control, but however much the government has done –  and it will soon be doing less, as the wage subsidy ends –  it is increasingly clear that the Reserve Bank is simply not doing enough.  Low and falling inflation expectations are inappropriate, inconsistent with the mandate, at the best of times, but far more troubling when central banks are unwilling to take official short-term rates deeply negative.  The Governor and his colleagues seemed to know that last year when it wasn’t much of an issue, but to have forgotten –  or simply chosen to ignore it –  this year.  It is as if they are simply indifferent to the (un)employment consequences.  That shouldn’t be acceptable, including to the Bank’s Board and the Minister of Finance who are responsible to us for the MPC’s stewardship.

 

Empty vessels

A month or so ago I went along to hear the Governor of the Reserve Bank speak at the Law and Economics Association in Wellington.   LEANZ is a pretty geeky sort of organisation (or attracts pretty geeky sorts of people) and against the background it was quite surprising how little substance there was to the Governor’s speech, which was billed as “Delivering on Great and Best” at the Reserve Bank.  That is the Governor’s grandiose vision: his predecessor claimed to want the Bank to be the “best small central bank” in the world (although did little or nothing about it, including no relevant benchmarking) but Orr takes that a giant step further and claims to want to be the best central bank in the world.   You might think that harmless –  always good to aim high etc –  but in a small country, not very prosperous, it isn’t clear that it is even a sensible goal, and in practice it seems to function mainly as a way of distracting attention from the manifest inadequacies of the Bank, especially under the stewardship of Orr.

I don’t want to spend any time on last month’s speech –  there really isn’t much there –  but it came to mind when I read yet another empty piece from the Governor yesterday, this time a column in the Sunday Star-Times. I don’t suppose economists were the target audience, but a couple of non-economists I talked it over with seemed to have much the same reaction to it that I did.

It is framed as some sort of disclosure of the inner secrets of the central bankers’ temples.

As New Zealand’s Reserve Bank we hear directly ‘from the horse’s mouth’ what our global colleagues are experiencing and doing.

Thing is, there is this new-fangled invention called the internet, and we too can read all about the activities of other central banks, the speeches of their bosses, the minutes of their decision-making committees.    In New Zealand’s case, of course, there has been not a single serious speech on monetary policy or the economic situation from the Governor or any other member of the MPC since they finally woke up to the economic threat Covid, and associated responses (public and private), posed.  But that generally isn’t the case in other advanced countries.   Check out, just as examples, the websites of the Fed, the ECB, the RBA, or the Bank of England.   We can read them, or media reports of them, for ourselves.

But, setting that to one side for the moment, what fresh insights does the Governor have for us from his chats with his central banking peers abroad?

From our most recent interactions it is clear that the common and (almost) simultaneous Covid-19 health shock is impacting nations in similar ways, but the policy reactions and outlooks ahead vary greatly.

Hard to know what the first part of this is actually supposed to mean –  after all, the health risk might have been similar across countries, but the actual experience of the “health shock” varied, and varies still, very greatly.  And as for the second half of the sentence, it isn’t clear whether he is talking about economic policy responses, public health responses or what, let alone which outlook –  economic or virus – he is talking about.  It seems to be the economic side of things, judging from the next sentence.

The differences are in large part explained by the initial health of their economy, the underlying drivers of economic activity, and the degree of success in containing Covid-19.

But then it is not clear at all what he is basing anything of this on.   Some countries have a rich array of high frequency official data, in some cases even monthly GDP data.  Here in New Zealand, our latest official labour market relates to the March quarter.     We’ll get an update on that –  for the whole of a quarter centred back in mid-May –  early next month, but we’ll have no read at all on GDP for that June quarter until mid-September.  Not that long ago there was a general sense that our June quarter GDP might have fallen quite a bit further than that in most other advanced countries –  sufficiently onerous (rightly or wrongly) was our “lockdown” – but we are still flying blind even on that.

The column appears to be some sort of effort to suggest the New Zealand economy is now doing (relatively) well, but Orr cites no data to support that implication, unsurprisingly perhaps as there really is little such data.

He goes on

The more robust an economy was when first impacted by the pandemic, the more options and flexibility its local policymakers had to respond.

I guess it must be some sort of self-reinforcing conventional wisdom among economic policy elites, but where is the evidence for the claim?   Almost every advanced country has done very little very monetary policy and a great deal with fiscal policy –  whether it is the highly indebted US and UK, or countries with little public debt like New Zealand and Australia.

Orr continues

Amongst this ‘robust’ group, the initial policy actions have been very similar.

They generally included: ensuring credit and cash is cheap and accessible, increased government spending and investment, support for employers to pay wages and access credit, and additional welfare payments.

Although, of course, as already noted the typical central bank –  including the RBNZ –  has done very little that matters (lots of sound and fury though), and although I haven’t checked I’d surprised if credit conditions haven’t tightened in other countries too, as they have in New Zealand.   And what Orr doesn’t seem to want you to reflect on is that most of the sorts of measures he lists are palliatives: there is place for those, but they do little or nothing to get economies promptly back towards full employment.    That is/was the job of monetary policy, but central banks –  including our MPC –  seem to have abdicated that responsibility, with politicians (including ours) apparently content to let them.

However, the economic impact has varied significantly, especially across sectors of each economy.

The more reliant a nation is on primary production (especially food export revenue) and the manufacture of durable goods (especially e-technology), the better it has fared.

By contrast, the more reliant a nation is on the provision of face-to-face services (e.g., tourism and hospitality) the bigger their fall.

There seems to be no evidence for the loose claims in the second sentence.  At least in the OECD there is really only one country heavily reliant on “food export revenue”, and we just don’t have any data yet on how overall economic performance is doing, let alone how it will do as, for example, the wage subsidy ends.   (Oh, and if you are tantalised by, say, PMI readings above 50 –  as I heard the Minister of Finance going on about in the House last week –  recall that (a) these are directional measures only, and (b) our initial trough, even on these surveys was deep)

Then there was this odd comment

Common for all nations is that uncertainty and economic confidence is highly-related to perceptions that the pandemic is regionally ‘contained’.

Not quite sure what “regionally” has in mind here, but in New Zealand itself at present there appears to be no locally-transmitted Covid, in the wider South Pacific and east Asian region there isn’t much, and yet uncertainty remains high, confidence remains modest, because people realise (a) how easily things could unravel, and (b) increasingly, the severity of the worldwide economic downturn.

There was then this loose comment

The common view amongst our international colleagues is that their local economy cannot perform at capacity with the pandemic.

I guess it depends how you define capacity, but sure when people were forced by state edict to stay home many could not work at all.  Once we are beyond that point, again Orr’s interpretation of what his colleagues are saying seems like an abdication of responsibility by central bankers.  There are market-clearing interest rates (and exchange rates), but central bankers have decided to do little or nothing about getting actual rates to line up with those market-clearing rates.  They are simply content, it seems, to accommodate sustained higher unemployment.  Coming from someone who last year was only too keen to talk up the new employment references in the Bank’s mandate, it is somewhat surprising.

In general, household spending and business investment continues to lag behind incomes and earnings. This highlights one limitation of easy monetary conditions in expanding demand.

It does nothing of the sort.  What it highlights is the utter failure of macro policy in current conditions.  The first sentence of the Governor’s comment –  re saving and investment – is almost a classic statement of the case for temporarily much lower interest rates.  And yet, in New Zealand, the Governor and the MPC have pledged not to do anything about the OCR until at least March, never mind the attendant excess capacity.

The Governor turns to the future

Looking ahead, accurate prediction is impossible, but preparedness is necessary and feasible.

The type of scenarios policymakers are mulling include: options for when/if a vaccine is developed; the establishment of Covid-19 ‘safe’ trade and travel bubbles; and the management of rolling waves of regionally-contained Covid-19 outbreaks.

Accurate prediction is always impossible.  But that second paragraph is all about stuff that has nothing whatever to do with central banks.  And as he comes towards the end of his columns we get a series of content-lite bromides.  Thus

Globally, the general conclusions are that economic activity needs ongoing support by both government and central banks, and that government fiscal policy is the most potent.

Yes, we know that central banks have done almost nothing, so it is hardly surprising that whatever mitigation of the economic damage is being done by fiscal policy.  The Governor seems unable to distinguish timeframes: fiscal policy is/was good at offsetting immediate income losses, but monetary policy works powerfully on slightly longer lags, and the economic challenges aren’t going away.

Oh, and even the Governor recognises the limitations –  technical, or more likely political – to fiscal policy

There is also much awareness that fiscal policy cannot subsidise everyone forever. Examples of more targeted government interventions – such as sustainable infrastructure initiatives, and retraining and people mobility are being shared.

These policies are more complex to create and implement, especially at pace and scale.

Interest rates and exchange rates, by contrast, adjust almost instantly, get in all the cracks, and require no state mortgage on all our futures.

The Governor moves on to matters perhaps a bit closer to his responsibility.

Financial stability is also a key focus. The current broad consensus is that banks must be focused on the long-term interests of their customers, which will take strong regional bank leadership.

But it is not clear, at all, what that second sentence means.  Whose “broad consensus”?  And what about the interests, short or long term, of the people who actually own the banks.  And what is this “strong regional bank leadership” all about.   Oh, and how does the Governor square whatever it is with the (apparently entirely rational) tightening in credit conditions reported in the Bank’s recent survey.

Then we get this strange paragraph

The financial markets’ tools for measuring risk and allocating money must also be switched on and working, to best assist the reallocation of economic effort. The current big change drivers are more local-regional trade, simpler supply chains, and the rapid adoption of technology to deliver services.

Whatever it is supposed to mean, you might suppose that adjustments in interest rates and exchange rates would be among those “financial market tools”.  And quite what relevance does “simpler supply chains” have in a New Zealand, where few firms are part of complex supply chains, and I’d have thought we really didn’t want many people focused on “more local-regional trade” when our ministers and officials keep talking up keeping international trade connections strong.

And he ends

New Zealand had a robust economic starting point at the onset of the pandemic. We have a backbone of primary production and exports. And, for now, a credible containment of the Covid-19 virus.

But, we also have significant reliance on services that require face-to-face interaction. We need to be prepared for multiple health and economic scenarios so as to best manage through the pandemic and arrive at a more sustainable economic place.

But even if you agree with each of those individual sentence (and, at a pinch, I probably could) aren’t you left wondering “so what?”   And with no sense at all that whatever happens here, we in the teeth of a worsening global economic downturn, with monetary policy doing little or nothing and even the Governor –  most vocal champion of more use of fiscal policy in recent years – articulating a view that fiscal policy has its limits.

Surely we deserve more substance, on stuff the Bank is actually responsible for, from the Governor?  And from his senior management members of the MPC.  As for the external members, they collect a lot of money from the taxpayer each year, and yet seem to operate as if being invisible, silent, and unaccountable is some sort of badge of honour.

One would like to think that there is more depth, more substance, to offer but the Bank refuses to release any supporting analysis, publishes no relevant research, exposes most of the MPC members to no public scrutiny, and for those we do hear from –  the Governor foremost –  there is a disturbing sense of people really rather out of their depth, and perhaps just not that interested.  More fun to play tree gods and talk climate change than to actually do the core macro stabilisation role Parliament has charged them with, in the midst of the most severe global downturn in a long time, one in which little beyond immediate mitigation is being done to get countries quickly back to full employment.  Policymakers here are no better, but whatever is being done here, the less that is being done abroad, the more we need our own policymakers to be doing.  Unemployment is a terrible thing, and yet it barely rates an allusion in the Governor’s column.  As for inflation, it is a core part of the Bank’s responsibility, expectations have been falling here and abroad –  risking compounding the macrostabilisation challenges –  and it got not a mention at all.

Back in that speech a month ago, the Governor indicated that the government would be introducing new legislation reforming Reserve Bank governance before the House rises for the election (so this week or next).  That reform is long overdue, but under current stewardship –  Governor, Minister –  we should no more expect improvement from these next changes that we secured from the establishment of the MPC.  You’ll recall that the Governor and Minister got together to blackball anyone with current monetary policy or macro expertise from serving on the MPC.    That gap is really starting to show up now.

Credit conditions

The Reserve Bank conducts a six-monthly survey of banks on aspects of credit conditions, trying to get at things not just captured in headline base bank lending rates.  The last regular survey was conducted in March but, of course, quite a lot has happened since then.  So, to their credit, the Bank has conducted a one-off additional survey in June to try to get a sense of how Covid and the associated economic disruption has changed things.    The numbers and the Bank’s write-up are here.  There is a good series of summary charts at the back of the write-up, some of which I will be using in what follows.

The survey has both current/backward looking questions and questions about the outlook, differentiated by type of borrower (SME (turnover less than $50m per annum), household, corporate, agriculture, and commercial property).   Here is the Bank’s note

The June Survey was completed in the last two weeks of June 2020 by 12 New Zealand registered banks, including all of the five largest banks. The period covers credit conditions observed over the first six months of 2020 and asks how banks expect them to evolve over the second half of the year.

In the face of a severe, unexpected, economic downturn, and a substantial lift in uncertainty about the outlook, you’d probably have expected credit conditions to have tightened.  For any given level of interest rates, banks would be less willing to lend.   That would be an entirely rational response, even if banks were quite confident about their overall financial health based on the existing loan book.  Credit demand –  which respondents are also asked about –  is a bit more ambiguous: credit demand for new activities might reasonably be expected to take a hit, but some borrowers will have a heightened demand for credit to tide them over a sudden unexpected loss of income.

What we see in the survey is, more or less, what one might have expected.  Sadly, the survey hasn’t been running long enough to benchmark the data against developments in previous recessions.

On the demand side, the two competing effects are most visible in the responses for SMEs.

cconditions 1

Working capital demand has increased a lot, and is expected to increase a lot more in the second half of the year, while demand to finance capital expenditure has fallen quite a bit and is expected to fall a lot further.     The picture for bigger corporates is similar, if perhaps not as stark.   Overall demand for credit increased for these two business categories, but fell for all the others.  “Credit availability” fell, as one would expect, across all these subsectors, and is expected to tighten further in the second half of the year.

One of the good things about this release write-up is that the Reserve Bank has released detailed disaggregated data from the survey that they do not usually publish.  Quite why they don’t publish it routinely is an interesting question, but then this is an organisation not exactly known for its routine transparency –  although you’d think that data collected under a statutory mandate, collated at tsaxpayers’ expense, should be routinely published.

Anyway, the data are there this time.    First, there is a distinction between the price and non-price aspects of credit availability, actual and expected.  Higher credit spreads will be the key aspect of price.

For households (mortgage and personal lending) all the actual and expected tightening in credit availability took the form of non-price measures, but for all four business categories the price effect (higher credit margins over base lending rates) dominated.  Here again, as illustration, is the chart for SMEs.

c conditions 2

There is a further degree of disaggregation on the aspects of the credit availability responses, but only for the period already been.  For each subsector respondents are asked about:

  • collateral requirements,
  • serviceability requirements,
  • maturity and repayment terms,
  • covenants,
  • interest markups
  • other price factors.

For households, the only material changes were (tighter) serviceability requirements.  That is interesting –  if not too surprising –  given (a) slightly lower interest rates, and (b) some temporary easing in the Bank’s LVR restrictions.

Here is the chart for SMEs

CC SME

and for larger corporates

CC corporate

There are some interesting differences, but the stark similarity is in the higher interest rate mark-ups.  For both subgroups, covenant requirements appear to have eased – one guesses semi-involuntarily as many borrowers will probably have blown through previous loan covenants.  I don’t know quite what to make of the differences in the green bars –  “other price factors” – but would welcome any comments/suggestions.

What of commercial property loans?

cc comm property

That’s pretty stark.  For every component, policies and conditions have tightened, apparently quite materially.  Perhaps not too surprising –  and in many past downturns –  commercial property loans, especially those on new developments, have been a key source of bank losses-  but interesting nonetheless.

And, finally, agricultural loans.  Farmers keep farming, and –  for the moment anyway –  commodity prices have held up. But in any global economic downturn, commodity prices often bear the brunt. In this case, the adjustment by lenders appears to have been mostly in the interest mark-up agricultural borrowers face.  As the graph shows, credit spreads have been widening for some time, in the face of some mix of factors including the Bank’s markedly increased capital requirements (farm borrowers tend to have alternative sources of finance).

cc agric

The final component of the survey asks about factors influencing the availability of credit.  There isn’t a line for “severe unexpected recession etc”, but here were the interesting aggregate responses to the standard list of items.

cc factors

Cost of funds is almost invisible as an issue –  whether wider credit spreads in funding markets or lower base (OCR etc) rates –  and so is any change in competitive pressures.

Respondents suggested that regulatory changes had been helpful –  presumably this will refer to the temporary suspension of the OCR restrictions, the temporary delay in the increase in minimum capital ratios, and perhaps the temporary reduction in the minimum core funding ratios.  Together these changes have, as one might expect, worked to mitigate a tightening in credit availability, but note the aggregate effect is not that large.   On the other side of course, the two material effects are an adverse change in the banks’ assessment of risk, and in the willingness of banks to take any given level of risk.  Both seem highly rational and sensible responses in a climate like that of recent months.

What to make of it all?   Probably none of the results is terribly surprising, and it will be interesting to see how these results compare with those of the next regular survey in September (when we must hope the Bank will again release more-disaggregated data).

I guess what struck me was the widening in the credit spreads business borrowers have been facing.  The published time series data from the Reserve Bank on business lending rate is pretty lousy –  a single series for “SME new overdraft rate”.   That headline rate has fallen only about 70 basis points this year.   That isn’t too surprising –  since the OCR has fallen 75 basis points, and floating mortgage and bank bill rates not much more.  The credit conditions survey tells us that typical business credit spreads over base rates have risen (probably quite rationally so in the changed economic climate).  But we also know that inflation expectations have fallen quite a lot –  data from the indexed bond market suggests about 70 basis points this year.  In other words, the combination of increased risk perceptions and a passive central bank doing little or nothing, in the face of one of the most severe economic downturns, here and abroad, for many decades, real business lending rates are rising.     That is quite insane outcome, but a choice made by Orr and the MPC, and apparently condoned by the government (and the Opposition for that matter).  It is quite extraordinary, almost certainly without precedent in a country with (a) a floating exchange rate, and (b) a sound financial system, and (c) sound government finances.

One half of the government’s brain seems to recognise the issue.  They just extended the scheme whereby small businesses can get interest-free loans from the government.   Quite why they think those favoured few –  in many cases, probably some of the worst credits –  should be able to borrow at zero while the rest of the economy  (but especially the business sector) borrows at materially positive real interest rates, often complemented by tightening non-price conditions is a bit beyond me.

Oh, and remember that this surveys suggest banks expect credit conditions to tighten further from here.

National’s five-point plan

At the end of my post yesterday morning I noted briefly

Of course, if Labour’s approach is bad, at least (being the government) it is on the table.  It is now less than two months until voting starts and we have no idea what National’s approach might be, but no reason to suppose it would be materially different or better.

Within a couple of hours we had a plan from National, or at least what Todd Muller describes as “the framework for the party’s Plan to create more jobs and a better economy”.   Just like the Prime Minister, he has a five-point plan, outlined in a speech given in Christchurch yesterday.   If you want the potted version there is even a one-page graphic.

graphic nat

I was no more impressed than with Muller’s previous speech, although at least he has dropped the (historically ill-grounded) paeans to Michael Joseph Savage.   There still seems to be a great deal of me-too-ism about it: we’ll be just like Labour only more competent.   If he has values and a political philosophy, they seem to bear little or no relationship to those the National Party was built on.    It is the sort of speech any (losing) centrist Labour Party leader could have given.

It is explicitly an economic speech, but there was no obvious economic framework, no sign that he or his advisers had thought hard about what has ailed the New Zealand economy for a long time, about how National might fix it, and how that might tie together with the immediate recovery needs (having been accused by one commenter yesterday of being an “armchair theorist”, here was my post-Covid note on such issues).

Anyway, to step through the speech.  First, there was the flawed framing.

According to the Reserve Bank, New Zealand faces its worst economic downturn for 160 years. I don’t think the magnitude of that has yet sunk in to the public or the media. That’s partly because, these past few weeks, everyone has quite rightly been more preoccupied with the shambles at the border and in our quarantine centres. But, if the Reserve Bank is to be believed, ahead of us lies the greatest economic and jobs crisis that anyone in this room has ever known.

Even though the fall in the GDP in the month of April was absolutely huge –  could we have measured it, perhaps 40 per cent –  no one supposes that what lies ahead is worse than New Zealand’s experience of the Great Depression.   Most likely, what we face is something more like, perhaps a bit worse than, the severity of the late 80s and early 90s.  That’s quite bad enough.

And a scale of loss and dislocation that National, at least in this framework speech, appears to have no answer for.

Thus, we learn that they are quite happy with macro policy as it stands and don’t appear to think the Reserve Bank needs to be doing anything more (than the little they have done so far).  And we get rather florid rhetoric on fiscal policy, supported by (it appears) nothing.

Since the Fiscal Responsibility Act, the economic and political debate in New Zealand has tended to be on the quantity of borrowing or debt repayment each year. These remain critically important. Getting back to fiscal surplus and then paying down debt to 20 per cent of GDP is necessary, not least because New Zealand will inevitably confront another natural, economic or health disaster in the next couple of decades or beyond. But just as important is to focus on the quality of spending.

Labour forecasts net core debt will reach 53.6 per cent of GDP in 2024 under their policies. That’s an eye-wateringly high level. We will work hard to try to keep it lower than that, which would put New Zealand in a better position to recover. But of far greater longer-term importance is that Labour projects that under its policies, but with a far stronger economic environment than we face today, net core debt will still be as high as 42 per cent by 2034. That means Labour intends a mere 11 per cent reduction in net core debt, over a decade. At that rate, we will not get back to the safe 20 per cent mark until perhaps the mid-2050s.

National does not regard Labour’s attitude as anything like prudent. It would leave an enormous debt, not so much to our children but to our grandchildren. And it would leave our children and grandchildren – and also ourselves – profoundly vulnerable were the global economic and strategic outlook anything other blissful for three successive decades. Covid-19, the trade war between the US and China and this city’s recent history all say that is not a safe bet.

There aren’t many specifics there but Muller is clear that National would be spending less (not necessarily a lot less, but less) than Labour, so that source of support for a faster demand recovery is apparently off the table.   He plays up the debt numbers but never mentions the large assets (NZSF) on the other side, which mean that even the peak debt numbers would last year have put us among the less indebted half of the OECD.  He never engages at all with the possibility that lower long-term interest rates might –  just might –  make a higher long-term debt ratio sensible.  And, of course, there is no hint of when he expects to get back to 20 per cent of GDP, or on what sort of path.

(To be clear, I am not a fan of high levels of public debt, but on a proper measure we’d peak at around 40 per cent of GDP even on this government’s numbers.  And like most rhetorical fiscal hawks in the current context, he offers no other path for a prompt return to full employment).

And then, of course, there is the question of how seriously to take the talk of future fiscal restraint. There was this, for example,

Let me tell you what that means in practice. In 2020/21 and 2021/22, my Government will not be scared of investing more in retraining, if we are confident it will genuinely improve productivity, lower unemployment, increase the tax take, reduce the cost of welfare and improve wellbeing over the following decade. My Government will not be scared of investing over the next decade more in the first 1000 days of life, if we are confident it will improve outcomes from the school system for a generation. Similarly, social housing and mental health. Nor will my Government be afraid of investing more in roads and public transport, if we are confident they will still be improving New Zealand’s productivity 50 or 100 years hence. And my Government will not be afraid to invest more in water storage or carbon-replacement technologies, if they will support higher living standards and greater wellbeing on an even longer timeframe.

It would be surprising if a public transport project now were boosting productivity 100 years hence, but you are left wondering what Muller wouldn’t be spending on.

Now, to be fair, he tells us there will be a series of major speeches outlining details of the five point plan.   But the gist –  what was in yesterday’s speech –  wasn’t encouraging,   Of their headings

Responsible Economic Management consisted of nothing but rhetoric.  We can probably all agree that quality of spending matters, but there is little in National’s track record suggesting they’ve done much better on that in the past (just different specific waste) and –  more importantly –  no clue as to why we’d think they’d better in future.  Labour has been spraying money at favoured entities in recent weeks, but which ones (specifically) is National opposing?

Delivering infrastructure had this promise

Before the end of this month, I will announce the biggest infrastructure package in this country’s history. It will include roads, rail, public transport, hospitals, schools and water.

My heart sank somewhat.  A new and different Think Big? But lets see the specifics.

Muller boasts of delivery, but wasn’t it the previous National government that put in place the contracting structure for Transmission Gully.  And I’m always a bit surprised at National using the Christchurch repair and rebuild process as a plus.

Reskilling and retraining our workers is flavour of the day (it was a big part of the PM’s speech the other day too), this time with rhetoric about capturing something called the “Creativity Wave” in the 2020s.    But from a party offering no more macro stimulus to demand (see above), uninterested in our high real exchange rate, and (previously) opposed to fees-free it all has the feel of rhetoric and displacing headline unemployment figures at present.   When there are jobs on offer, firms and individuals tend to invest in the skill development required.

A Greener, Smarter Future may be good political rhetoric, or the sort most Labour ministers could have delivered, but seems about as empty.   This section concludes thus

National’s vision is of a post-Covid economy that is greener, smarter and better than the one we had before.

Sounds fine, but what (specifically) is the government’s role in getting there, and what is National proposing to do to give us some hope of achieving all this environmental stuff while also reversing the decades-long decline in relative productivity?  Nothing was on offer in this speech.

And finally, there was

Building Stronger Communities.  I’m sure Muller is genuine about some of this, but what of this gratuitous line

Every community needs strong community institutions to maintain and enhance their social capital. Many of those institutions were damaged a generation ago, and I don’t believe they have been repaired.

Another opportunity for Muller to have a go at the reforms instituted by the 4th Labour government and by his own mentor and former boss Jim Bolger?  So the decline of churches, sport clubs, Scouts and Guides, marriage and so on is down the evil reforms of the 80s and 90s is it?  If so, which of those reforms does he think specifically contributed and which is he proposing to undo?    Of course, the answer to the latter question is “none of them”.  It is just shallow opportunistic political rhetoric.

I don’t really disagree with Muller that

our opponent doesn’t believe in having a plan, hasn’t delivered on her promises, and has a track record of failure across the board.

But when he claims

Ladies and Gentlemen, in the end, I have a very simple message for you and all New Zealanders this election campaign: National has a plan to rebuild our communities and our economy, to get Kiwis back to work and to deal with the economic and jobs crisis.

There was nothing at all in the speech to lead any reasonable observer to think it was so.   Perhaps those future “major speeches” will give us something concrete, as part of a serious well-thought-out strategy that links the immediate challenges with the longer-term deep-seated problems in the New Zealand economy.  But on what we’ve seen so far, I wouldn’t be optimistic about that.

 

Economic policy malaise

Reflecting on the economic outlook, it hasn’t been the best of weeks.

Across the Tasman, a large chunk of Australia –  key market/source of exports, imports, investment etc – is locked down again for six weeks.   It is a reminder, including to anyone contemplating investment decisions, how easily things can be blown off track again.  And that is in a country with a death rate still (slightly) lower than New Zealand’s.  The coronavirus situation in much of the rest of the world doesn’t look that great either, and with it the outlook for the world economy.  Perhaps, at the margin, that troubled world economy contributed to the decision announced this morning to close Comalco.

Closer to home, the NZIER QSBO results were out.   ANZ’s commentary summed it up succinctly but bleakly under the heading “Worrying”.  Of course the June quarter outcomes will have been dreadful, but the forward-looking indicators weren’t really much better.   These sorts of surveys don’t always have much predictive power –  more unexpected stuff happens –  but they paint a pretty bleak picture of how businesses were seeing things just a couple of weeks ago.  Again from the ANZ

Today’s data will be worrying for the RBNZ and Government; firms are reportedly hunkering down, shedding workers, and cutting prices. But more monetary stimulus is needed, and an aggressive, front-loaded approach is warranted.

And all that is despite the massive fiscal spend over the last four months, which has for now replaced a fair chunk of the lost private sector income during that period, even as it saddles us –  and future governments –  with much more severe constraints on fiscal freedom of action in the years to come.    All that income support (in one form or another) will have helped keep private spending quite a bit higher than otherwise.  All the talk was about “tiding over”, but to what, to when?  It has always had the feel of a policy approach dreamed up back in late February/early March when the government (and Reserve Bank) were still refusing to take very seriously that economic shock that was already engulfing the world.

In that context, it was interesting to have confirmation from the Prime Minister that the wage subsidy scheme will not be extended further –  and given that firms get it as a lump sum, presumably the bulk of what will ever be paid out even under the extended scheme will already have been paid out.     Ending the scheme seems appropriate –  extending it the first time was probably more about politics than economics.    Anything else would have looked like a bizarre attempt to freeze chunks of the economy as they were six months ago, refusing to face the reality of a changed world.    But the scheme was putting large amounts of cash in the pockets of people in the private sector, supporting spending and holding GDP higher than otherwise.  And what comes after it?

Part of the answer, of course, is the higher-than-otherwise benefit paid to those who’ve lost their jobs as a result of Covid.   But it is only for 12 weeks, is still mostly about income replacement (buying time) rather than supporting a self-sustaining recovery in underlying economic activity, and of course many people just won’t be eligible for it.  Perhaps the government will decide to extend this scheme, but even if that were to happen it has its own problems (deterring the search for a new job).

One might, perhaps, have hoped for signs of a serious, rigorous, well-thought-out strategy from the Prime Minister.  As it happens, she gave a pre-election speech to her party’s Congress on Sunday.   As her party is odds-on favourite to dominate the next government I read it, twice actually.  In the speech the Prime Minister purported to offer a plan – a five-point plan even.

Today I am announcing our 5 point plan for our economic recovery.

It’s about investing in our people, it’s about jobs, preparing for our future, supporting our small businesses, entrepreneurs and job creators and positioning ourselves globally.

Sadly, she showed no sign of actually understanding how economies work or prosperity arises.    Anyone, what of the five points?

Which brings me to point one of our plan – investing in our people.

Whence follows a list of handouts, which might (or might not) individually make sense, but by no stretch of the imagination or language can be called investments.  Income support is fine, but it is no basis for recovery.

Perhaps this was a little closer to “investment”

That’s why we made a $1.6 billion investment in trades and apprenticeships training, which includes making all apprenticeships free.

We’ve also made those areas of vocational training where we need people the most like building and construction and mental health support workers – all free. The potential impact of these policies is huge.

Except that this is the government that had already introduced the fees-free policy, only for it be revealed that it was mostly income support too (transfers to people who would already have been undertaking tertiary education anyway).    And the new measures could have a feel of measures designed more to keep headline unemployment down than to actually revive the economy.

Even the Prime Minister recognises that training isn’t much use if there are no jobs.

But retraining isn’t enough if there aren’t jobs to go into at the end of it.

And this is where the second part of our plan kicks in, what I like to simply call, jobs, jobs, jobs.

She proceeds to run through some government initiatives.

First is the Big New Zealand Upgrade Programme designed to tackle our core infrastructure deficit. We announced it at the beginning of the year, and it amounts to $12 billion of road, rail, public transport, school and health capital funding. It could not have come at a better time.

That programme may or may not have merit, but as she says it was announced in January,  judged appropriate/necessary then –  pre-Covid.  It was factored into economic forecasts, including those of the Reserve Bank, then.  On to some other spending.

As part of our COVID response we have committed funding to providing an additional 8000 public houses, bring the total number of state and transitional houses to be built by this Government to over 18,000 by 2024 – thank you Megan Woods and Kainga Ora.

It is the largest house building programme of any Government in decades, and I’m proud of it.

But when we’re talking about infrastructure, it’s not just about the projects we in the government are responsible for, we also have the opportunity to partner with communities, with iwi and local government.

That’s what the $2.6 billion worth of shovel ready projects we announced earlier this week were all about.

Things like Home Ground, a project by the Auckland City Mission that will provide 80 apartments with wrap-around support and care, or the Poverty Bay Rugby Park Grandstand, least Kiri Allen stage a sit-in, right through to the Invercargill inner-city development.

It would take someone closer to the detailed data than I am to unpick quite how much of this is really new spending, and how much is just putting details to spending programmes (like the PGF) already allowed for.  Nor is there any sense of (a) displacement (lots more state houses will, almost certainly, mean fewer private houses being built) or (b) value-for-money (what is the taxpayer doing funding the Invercargill city redevelopment, throwing more money at KiwiRail or –  wonder of wonders –  tens of millions at the Wanganui port.

And then at the end of the “jobs, jobs, jobs” section we get this

Collectively these projects are estimated to create over 20,000 jobs in the next five years.

No analysis to support that number (and we’ve seen before how PGF job estimates are concocted) but even if it is correct, total employment in New Zealand is about 2.8 million people.   “Jobs, jobs, jobs”, even on the PM’s numbers, looks tiny.

She goes on to list a few environmental jobs projects.  Perhaps they are worthwhile, but they certainly aren’t a private sector led recovery.

But moving along

That brings me to the third plank of our plan – preparing for the future.

The whole of that plank is here

Restoring our environment is one thing, decarbonising it is another.

Investments in waste management and improving energy generation will be key- and this is where I am signalling there is more to come.

Preparing for the future also means supporting our businesses to innovate, especially as we go through a period of digital transformation.

There will be few among us who haven’t changed our routines and habits as a result of COVID-19. By the end of lockdown I can confirm that Damien O’Connor did indeed discover the unmute button on zoom.

We want to support our small businesses through this digital transition, which is why we established a $10 million fund to incentivise e-commerce and train more digital advisors.

It’s also why we will keep encouraging innovation in all forms. So we’ve created a $150 million fund to provide loans to R&D-intensive businesses.

Well, okay.  If you are of the left, you might find that appealing, but even then you’d have to concede there wasn’t much to it, not much that will help generate a rapid and strong economic recovery.

But there is, it appears, a role for the private sector.

All of this builds to the fourth part of our plan, supporting our small businesses, our entrepreneurs and our job creators

Which sounds good, until you read the text and realise that all she has to offer is the wage subsidy scheme, and the small business interest-free loan scheme, which was extended for a few months.    Income support etc has its place, but it isn’t the foundation for a strong robust economy or a rapid return to full employment.

And what of the final plank?

And the final plank of our five-point plan is to continue to position New Zealand globally as a place to trade with, to invest in, and eventually to visit again.

This has been an export-led lockdown, and so too will it be an export-led recovery.

Sounds good as an aspiration, but frankly seems unlikely.   What does Labour have to offer specifically?

That’s why a few months ago we provided $200m to help exporters re-engage with international markets, and support firms looking to export for the first time.

It’s also why we continue to expand our trade relationships. The limitations of the last few months didn’t stop us launching our free trade agreement talks with the UK …

We are investing $400 million in tourism because we know it is part of our future, and because open borders will be again too. It is not a matter of if, but when it is safe.

And on that, we already have work underway.

We are progressing with all the checks and balances needed for a trans-Tasman bubble, and also on reconnecting with our Pacific neighbours. We have a framework in place that will help Cabinet make a decision on when quarantine free travel with these parts of the world should resume.

All pretty small beer really.  No one supposes that a UK preferential trade agreement is going to matter very much, and in recent weeks we’ve heard David Parker fulminating about the frustrations of the EU’s position on trade negotiations with them.   And, of course, this is the economy that –  for all the talk of trade agreements –  has had foreign trade shares (exports and imports) falling as a share of GDP this century, the high point of this wave of globalisation.   There is also no sense of recognising that the real exchange rate remains very high –  not down at all, despite the big hit to one of our main tradables sectors.   And all this was nicely complemented by the government’s primary industries strategy announced early in the week and now championed as Labour Party policy, which (as the economist Cameron Bagrie pointed out) involved primary exports falling as a share of GDP over the next decade, even as that sector was supposedly going to help lead the recovery.

And that was it.  That, apparently, was the government’s economic recovery plan.

Typically we look to monetary policy at the main counter-cyclical stabilisation tool.  Ideally, it might be complemented by good pro-productivity structural reforms – of that sort successive New Zealand governments have lost interest in –  but they take time to design well and implement –  whereas monetary policy can be deployed very quickly.

Of course, in the context of the Covid shock it would have made sense to have deployed fiscal policy and monetary policy together.  Even if monetary policy can be deployed very quickly, it does not put money in the pockets of households instantly (and in the context of a “lockdown” and the immediate (quite rational) fear-induced drop in economic activity, there was a place for immediate income support.  But if monetary policy does not work instantly that is why it should be being deployed aggressively and early.  Had monetary policy been used aggressively and early –  starting back in February when the first OCR cut should have been done – by now we would be seeing quite a lot of the fruits (the full effects of monetary policy adjustments typically take 12-18 months), providing a stimulus to demand and activity as the fiscal support is wound back (as it is being, on announced government policy).

As it is, we have had almost nothing from monetary policy.  The OCR was cut belatedly, then an irrational floor was put on the OCR by a Monetary Policy Committee that was still struggling to comprehend the severity of what they were facing.  And because the Reserve Bank reacted only slowly and to a very limited extent, we’ve ended up with hardly any fall in real interest rates at all (inflation expectations have fallen almost as much as the OCR).   The exchange rate hasn’t fallen at all.  The Reserve Bank likes to make great play of their LSAP programme, but it mostly works –  if at all –  by lowering interest rates and underpinning inflation expectations.  And since we know expectations have fallen, and real interest rates have barely fallen, at the very best the LSAP programme can only have stopped things tightening.  In the Prime Minister’s words, this is a really severe global economic downturn……and yet monetary policy has done almost nothing; none of that necessary support is now in place even as the fiscal income support winds back and the domestic and world economies remain deeply troubled.

Of course, the failure of the Reserve Bank to do anything much useful rests initially with the Governor and his committee (the one he so dominates that we’ve never heard a word from any of the three external members, the one he ensured had no one with serious ongoing expertise in monetary policy appointed to it).  But they are officials, ultimately accountable to the elected government.  In fact, ever since the Parliament made the Bank operationally autonomous in 1989, the Act has always recognised that officials could get things wrong, and allowed for the Minister of Finance to directly override (transparently) the Bank.  The current government carried those provisions into its reform of the Reserve Bank, but now –  in a really severe economic downturn, in which the Reserve Bank is simply not doing its job –  they seem too conservative, too scared, to use well-established statutory powers.  They are happy to put in place limited zero-interest loan schemes for small businesses, but unwilling to ensure that –  amid the bleak economic outlook –  market prices for business and household credit are anywhere near that low.   In effect, that means they prefer to let more businesses fail, more people end up languishing on the dole, more “scarring” (a point the PM made in her speech) as if wishful thinking and idle hope was a substitute for serious policy.

Right from the start of the coronavirus, this government’s approach has been –  in essence –  to provide lots of income support and hope that the world gets back to normal pretty quickly.   It was a dangerous and deluded approach from the start, something that becomes more evident with each passing month.  All the more so as other countries’ governments are similarly failing to do much that might support a robust recovery elsewhere.  The current New Zealand government seems to have no ideas, no plan, to be unwilling to use the (low cost) powers they do have to help get relative prices better attuned to supporting recovery.  There is a growing risk that we are drifting into another of those periods –  perhaps worse this time –  as we saw after 2008, when it took 10 years to get the unemployment rate back to something like normal (with little or no productivity growth), and no one much among the political elites (either side) seemed to really care.

Of course, if Labour’s approach is bad, at least (being the government) it is on the table.  It is now less than two months until voting starts and we have no idea what National’s approach might be, but no reason to suppose it would be materially different or better.

 

On the trail of negative interest rates

I’m still less than entirely well, so posts here will stay less frequent and less regular than usual for a while yet.   That means things like last week’s OCR decision pass by with little comment (my only one will be, in what conceivable world five years ago would a severe global recession, the drying up of a major local export industry, falling inflation and inflation expectations here and abroad, and recognised downside risks be met with precisely no monetary policy action?).

But I see that the Governor has been out giving interviews –  the ones I noticed were with Stuff and the Herald – and some of his comments conveniently tie in with what I was wanting to write about the results of an OIA request to the Bank that belatedly turned up in my inbox on Monday, on the elusive question of what the Bank is (and isn’t) doing about negative interest rates.

You’ll recall that in the second half of last year the Governor was dead-keen on the option of negative interest rates.  It wasn’t just a passing comment, but a very substantial interview.   Who knows, perhaps the rest of the MPC didn’t agree with him, but he was supposed to be the spokesman for the Committee as a whole.  We don’t know what the other MPC members –  the ones who don’t, at least on paper, work for Orr –  think, and they seem to exist in a state of purdah, refusing ever to make speeches or give interviews.

As recently as the Governor’s speech on 10 March this year –  when he and his colleagues were still attempting to play down the economic challenges of Covid – the Governor outlined his preferred tools.  He promised then that

We will provide our full analysis of each of these tools against the principles we hold in coming weeks – so that people can fully understand our thinking and, of course, provide input.

None of that analysis has ever been published.  The list of tools was clearly organised in order of the Governor’s then preference: forward guidance (just a variant on what they always do) was first, and then

Negative OCR

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

Not only did a negative OCR appear to be in play, but that really encouraging second sentence suggested they might actually have considered doing something –  they are technically easy things to do – to allow the OCR to have been cut even further below the negative levels which at present could lead to large-scale shifts into physical cash.

That was then.  A few days later the MPC decreed that in fact that OCR would not be changed, up or down, from 0.25 per cent for a year, claiming the matter was really ou of their hands as “banks weren’t ready”.

It was, and remains, a very strange argument given that:

  • several other advanced countries had had negative official rates for some years,
  • a large share of global government bonds had been trading with negative yields for some years,
  • in New Zealand the first negative yields (on indexed government bonds) were recorded last year, at about the time of that interview the Governor gave,
  • the Reserve Bank had shown revived interest in these issues for a couple of years, and
  • that eight years previously an internal working group (set up by the then Governor, chaired by me) recommended that relevant departments should ensure that (a) the Bank’s own operating systems, and (b) commercial banks’ systems could cope with negative interest rates.  Those recommendations were accepted at the time.

In other words, if the Bank’s claims now are really true, commercial banks seem to have been astonishingly (or conveniently, since banks hate negative interest rates) remiss and (more importantly, since it is a powerful public agency) the Reserve Bank ((Governor, Deputy Governor, MPC –  and the Board paid to hold them to account) had to have been asleep at the wheel.  Given a decade’s advance notice of the risk that market-clearing interest rates would go negative here too, they would appear to have done nothing.  That would be egregious neglect –  for which people at the bottom, the involuntarily unemployed, would pay the price.

The Bank, of course, likes to claim that it is highly transparent –  they have been at it again this week – even as they remain as obstructive as possible on anything they don’t want to be transparent about.    The negative interest rates situation has been one of those topics.  For example, they’ve staunchly refused to release any of the background or advisory papers the MPC received running up to 16 March, on this or any aspect of monetary policy (as a reminder, the government itself has been pro-actively open, even with papers that may embarrass some or other bits of government).

I had one go with an Official Information Act request that got nowhere.  But it is a bit harder to stonewall Parliament, and thanks to the efforts of the National Party members of the Epidemic Response Committee we got some useful material out of the Bank.    The Bank didn’t want to draw any attention to this material, but it was there on Parliament’s website, and I wrote about it here.

The Bank told MPs that they’d started to take things seriously at the end of last year

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

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

By late January, of course, Wuhan was already locked-down.

The Bank told the MPs that there had been a range of issues identified, and while they hoped banks were doing something about them, it didn’t want to put any pressure on banks because they were busy people, and had other priorities (which, even if so, would not have been the case had the Bank done its job several years earlier).

None of this was very satisfactory.  They never explained –  or were pressured to –  their own past failures, nor why these alleged readiness issues had not been obstacles in other advanced countries (the euro-area, Sweden, Switzerland, Denmark, Japan), the prevalence of negative wholesale rates abroad.

A few weeks later again, the Governor told the Finance and Expenditure Committee (hearing on the May MPS) that a letter had gone out to banks just the previous week apparently urging or requiring them to have systems ready by the end of the year.   I then lodged a further OIA request

OIA 16 may

Section 105 is the dreadful provision in the Reserve Bank Act which allows the Bank to avoid any scrutiny of its bank regulatory activities under the OIA.  When the response to this OIA arrived this week, they had invoked it to allow themselves (so they claimed) to refuse to release anything in response to item (a) in my request.    This is a provision that, to the extent it had any merit, is designed to protect highly sensitive individual institution material in the middle of a banking crisis (in fact, of course, anything commercially confidential is already protected, and reasonably so, under the OIA).  The readiness of banks’ systems and document for negative interest rates is clearly not primarily –  barely at all – a prudential issue, but primarily a monetary policy one.  But that doesn’t stop the Bank –  the ones that always claim to be so transparent.

However, the Bank did belatedly release what I was after under the second and third strands of my request.  The full response is here.

The 29 January letter is on page 4 of the response.  It is a catch-all letter from the head of bank supervision drawing attention to various issues large and small that the Bank wanted to deal with this year (among the latter, the Bank’s Maori strategy).  Here is the relevant text on negative interest rates

wood negative

Okay I guess, but with little or no sense of urgency.

There is a three page table summarising the responses from each individual bank (although remarkably one banks appears to have never even responded), complete with this interesting  somewhat defensive observation from the Reserve Bank which I had not initially noticed.

“We acknowledge the banks’ responses to our letter of 29 January were a preliminary assessment of their readiness to implement negative interest rates.”

The table is interesting.  Of the 19 banks, a fair number are described as ready, but it is fair to note that a number of issues are also highlighted, in some cases in enough detail to be genuinely somewhat enlightening.    This is all, however, material that could have been pro-actively published in March, and which the Governor –  and those commenting on his draft speech –  must have been aware of on 10 March.

Perhaps it is also worth noting that these are individual bank responses, without the benefit of any RB pushing and prodding to better understand how binding perceived constraints might be, what workarounds might be possible, let alone with any sign of the Bank itself having learned from the experience of their counterparts in countries that had operated with negative interest rates for years.

Anyway, all this was then somewhat overtaken by the new letter, dated 7 May.  It is from the Deputy Governor, Geoff Bascand to the chief executives of banks.    This must have represented the Bank’s (or MPC’s) thinking at the time of the May MPS, although there is no hint –  of course –  of it in the minutes of the MPC meeting.   The letter set out a deadline of 1 December 2020 for banks to ensure that they were capable (with status reports due yesterday).  That wasn’t news, but what was was how limited the Bank’s requirement’s (and ambitions) now are, in the middle of the deepest economic slump in a long time.

Bascand letter

In other words, they’ve just given up on negative retail interest rates.    It isn’t true that in other countries there have been no negative retail interest rates, even with policy rates slightly negative (here is story from just last year of negative retail mortgage rates in Denmark, and recall that lending rates are usually higher than funding rates).  And, of course, look back up to the quote from the Governor’s March speech –  as recently as then they were open to the possibility of taking the steps that might allow the OCR usefully to be cut more deeply than other countries have done.

Coming back to today, what also interested me was that the Governor continues to muddy the waters on this.  In his interview with Stuff there are quite a few comments about negative interest rates.

The Reserve Bank is still warning retail banks to get ready for a negative official cash rate. Rolling this out has been said to be difficult because banks systems weren’t ready and some contracts with depositors didn’t envisage a negative interest rate – effectively a charge on depositors.

Orr said most banks were in a good position to deal with negative rates.

“Some large multinational banks have been dealing with negative interest rates for a long time and some of the smaller banks, which have much simpler systems, are good to go,” Orr said.

“Only a handful of banks” were having difficulty with negative rates.

Orr appeared to downplay the extent to which a negative rate would impact all areas of a bank.

“What we’re doing at the moment is double checking with all of the banks, so they’re not trying to get absolutely everything capable of a negative [rate] because we don’t need absolutely everything.

“We’re saying it’s a small proportion; it’s the wholesale side of the business,” Orr said.

Ordinary depositors likely wouldn’t notice a difference because rates would still be positive for depositors.

“Internationally the experience has been that banks have been highly reluctant to go below zero for a deposit.

“In fact, retail banks’ reluctance to pass on negative rates to consumers are likely to act as a brake on the Reserve Bank’s appetite to push rates lower.

“There is a limit to how far negative wholesale rates can go in large part because the retail rates end up holding up,” he said.

Read that and you wouldn’t know that the Reserve Bank had told banks they didn’t need to bother about negative retail rates –  in fact, you’d get the impression it was banks that could never envisage offering such products, even though they are on offer in other countries.

But you’d also get the impression that the Governor was more concerned for banks than for the New Zealand economy and the people who become unemployed because monetary policy isn’t doing its job.  If his Committee had aggressively cut the OCR another 100 basis points, to (say) the -0.75 per cent often envisaged as an effective floor until steps are taken to disincentivise cash hoarding, not only would the banks that had prepared themselves got on with things, and presumably been advantaged, but the others would have snapped to pretty quickly and got workarounds in place.  (That, after all, must have been what happened in other countries, and is more like the way the rest of government operated –  when a wage subsidy was decided on, MSD wasn’t given nine months to do systems testing etc; when a small business loan scheme was decided on IRD didn’t months to prepare).

And there is no sign at all of the Reserve Bank taking seriously steps to remove the obstacles to a more deeply negative OCR, even though those obstacles are all of the public sector’s making.

Perhaps none of this would matter very much if you believed the spin about what good monetary policy was doing overall, including through the LSAP programme.    But it is just spin.   Benchmark term deposit rates have been falling a bit more recently, but that means they are now 85-90 basis points lower than they were at the start of the year.  But, of course, expectations of future inflation have also fallen quite a lot.  There is a range of possible measures, but a reasonable pick might be a fall of about 60 basis points.  In other words, real retail deposit rates are down perhaps 30 basis points in the midst of a savage slump for which there is no obvious end.   The exchange rate is usually a key buffer for New Zealand, a significant part of how the monetary transmission mechanism works.  It bounces around a bit, but at present the TWI is sitting almost bang-on the average level for the second half of last year.  For all the handwaving and big numbers (around the LSAP) monetary policy just isn’t doing its job, and the Bank seems to have little interest in it doing so.

On Monday I went to hear a speech the Governor gave.  In the course of that address he seemed to defend monetary policy doing not much on the grounds that “the expenditure had to be immediate”.  And at one level, for the March/June quarters no one is really going to dispute that –  monetary policy doesn’t work that fast, and there was a need (or a good case) for lots of immediate income support, especially for people rendered unable to work by government fiat.  But that was then.    Wage subsidies have replaced lost income (a large chunk of it) for a few months –  at the expense of an increased involuntary burden on taxpayers to come – but meanwhile we are still in a deep recession, still have our borders largely closed, and the state of the world economy appears to be worsening.  Monetary policy should have been positioned –  and should now be positioned, it isn’t too late –  to support domestic demand and activity through the (probably protracted) recovery phase –  much lower interest rates, and a much lower exchange rate.  As it is, monetary policy –  designed as the primary countercylical tool – has done almost nothing and the Bank seems quite unbothered about that.

It isn’t good enough.  We need better from the Governor and his Committee (including, for example, to actually hear the excuses of the rest of the Committee members), and we need the Bank’s Board –  hopeless cause I guess –  to be doing its job holding the Committee to account.  But, of course, the person who could make this all happen is the Minister of Finance, who has long-established directive powers, but seems to prefer to do nothing, content to spend taxpayers’ money while doing nothing to remove the roadblock to getting market price signals better aligned with responding aggressively to our economic plight.  Don’t rock the boat, don’t be bold, don’t worry too much about the actual unemployed seems to be the government’s approach.  Robertson and his boss like to invoke memories of the first Labour government, but it is hard to imagine those big figures in Labour’s history being happy to sit by and see a central bank wave its arms and do nothing to get us quickly back to full employment.

 

 

 

 

 

Measuring how much monetary policy has eased

A couple of months ago I wrote a post about the work former Reserve Bank researcher Leo Krippner had been doing – over much of the last decade –  on trying to reduce all the influences on the government bond yield curve to a single number, to represent the effects not just of changes in the OCR (or similar rates in other countries) but also what are loosely called ‘unconventional policies’ undertake in the presence of the (actual or effective) lower bound on the OCR itself, whether central bank jawboning or, for example, asset purchase programmes.

As I noted then

This work wasn’t very relevant to New Zealand itself for a long time (there were internal sceptics as to whether it should even be done)….and yet now it is. (In his speech a couple of weeks ago the Governor even suggested the Bank might publish a semi-official series of such a measure.)   Leo’s work has been recognised in various places abroad –  cited in public by at least one Fed Reserve president, and honoured by the house journal of the central banking community, Central Banking magazine ..,  Leo left the Reserve Bank last year, but is continuing to update his work and earlier this week circulated a note with a Shadow Short Rate series for New Zealand, now that we operate with a formal OCR floor (and ceiling) and in the presence of the MPC’s commitment to buy $30 billion of government bonds over the coming year.

The size of the LSAP programme has been increased substantially since then.

Still more recently, Leo has updated his models for the other advanced economies he looks at, in a way that enables us to look at consistent estimates of the extent of monetary easing across eight advanced economies/areas.

Here is Leo’s estimate of the extent of the overall easing, as reflected in the Shadow Short Rate estimates for each country, since the end of last year (to the end of May).

SSR

Perhaps three things stand out from this chart:

  • little or no effective easing in the countries/monetary areas where the official short-term rate was already negative.  Perhaps central bank interventions were relevant in other markets, perhaps for a time they stopped government bond rates rising much, but on this metric, no effective easing relative to the position just a few months back.
  • the largest easing has been in the United States and Canada.  That is no surprise: official short-term rates late last year were quite a bit higher in the US and Canada than anywhere else in this group of advanced economies,
  • Leo’s estimate of the New Zealand SSR suggests an easing equivalent to 117 basis points.    Recall that the OCR itself was cut by 75 basis points and so, if one accepts this as a good estimate for how much some mix of the LSAP programme and forward guidance is doing, all the rest is not thought to be worth more than about 40 basis points.    Not exactly consistent with the tone of the continued rhetoric from the Governor, who repeatedly insists –  he was at again on CNN yesterday (whoever runs their Twitter account seemed breathlessly excited that the Governor was on CNN) –  how much difference his MPC’s LSAP programme is making.

Leo has taken his estimates of the SSRs all the way back to the 1990s (the more yield curve information the better for trying to distill what is normal and what is not).  So out of interest I had a look at what happened in the previous severe recession.

When the recession of 2008/09 started all these countries except Japan had official policy rates clearly above zero.  In those circumstances, the SSR is much the same as the official rate.

In this chart, I’ve shown the median SSRs for (a) the big 4 central banks in the sample (US, euro-area, UK, Japan) and (b)  all eight central banks from mid-2007 to the end of 2014.

SSR2

On these measures, monetary policy kept easing (on the whole) until well into 2013 –  in some cases by official rate cuts, in some by QE measures, in some cases by forward guidance (or perhaps just growing doubts in markets about when official rates might ever need to rise).

In this chart, I’ve shown the fall in the estimated SSRs for each country from mid-2007 (about the peak in rates, including in New Zealand) to (a) mid-2009, and (b) to the lowest point in the period in the chart.

SSR3

One almost needs a different scale to compare these estimates with those for the  –  more savage –  economic downturn we are now in the midst of (see first chart).

And bear in the mind that in both episodes inflation expectations have fallen quite a lot in many most of these countries.  Adjust for that and the differences in the falls in the real (inflation-adjusted) SSRs would be even more stark.

Now it is certainly true that back in 2013 (say) longer-term government bond yields were still quite a bit higher than they are now (in the US, for example, 10 year rates in mid 2013 were about 2 per cent).  But then estimates of neutral rates have also fallen over that period.

I’m not entirely convinced by the SSR approach.  I set out some of the reasons in my earlier post, and in exchanging notes with Leo I don’t think he would disagree with any of those individual points.   Perhaps the simplest to explain point is one Leo himself included in his paper releasing the New Zealand results: the SSR is not a rate that can be transacted (unlike an OCR), and in New Zealand longer-term interest rates don’t tend to directly affect many borrowers other than the government itself (and monetary policy isn’t supposed to be about shaping the government’s behaviour –  it is a market mechanism, designed to change relative prices facing private sector firms and households).    I’m also a little uneasy about the fact that the Reserve Bank’s LSAP is explicitly targeting mainly long-term interest rates –  which, among other things, is impairing what information might be in those rates, which relate to periods well beyond the current crisis –  while, say, the Australian and US asset purchase programmes are (sensibly) targeted at the shorter end of the bond yield curve (horizons relevant to this recession, and in a sense trying to mimic what a lower policy rate itself will tend to bring about directly if those central banks were willing to cut their policy rates further).

There is also the point I noted in my earlier post that for New Zealand Leo treats the effective floor on the OCR as being 0.25 per cent.  But since that last post, the Governor has explicitly reiterated that it is a temporary floor only –  now only 9 months until the commitment expires –  as he did again yesterday in his CNN interview.  Leo advises that if the effective floor were set a bit lower, the SSR estimate itself would be closer to the OCR.  In other words, the extent of the fall in the New Zealand SSR may actually be skewed higher than is really warranted.

If I have my doubts about the indicator, it is still of some value in providing summary estimates across both time and country, it is the sort of methodology the Bank has in the past expressed enthusiasm for (without tying itself to specific numbers), his approach has received approbation from his peers in yield curve modelling etc, and Leo’s estimates are made available, including on his website.   And they leave us with the twin points that:

  • the extent of monetary policy easing in New Zealand this time is little more than that of the cut in the OCR itself,
  • the extent of the falls in the SSRs in all countries (even Japan) is much less than we saw in the period of the last serious recession.

It is fine for central bankers to talk –  as the Governor does –  of fiscal policy carrying the main load at present but

a)  there was significant fiscal support provided in all these economies (including New Zealand)  in the last episode as well,

b) fiscal policy operates coercively (relying wholly on the sovereign power to tax) and for many purposes –  other, say, than basic income support –  is inferior to monetary policy for stabilisation and recovery purposes,

c) in most if not all these countries recovery after 2008/09  –  best proxied probably by a return to normal of unemployment rates –  took (a) far longer than was expected then, and (b) far longer than most are still envisaging for a recovery now from this more severe downturn, and

d) fiscal policy has its limits (quite probably close to being reached, and more “political” than technical), in a way that monetary policy properly run –  ie not imposing an artificial floor on policy rates –  does not.  It is all the odder that central banks like ours (with the acquiescence of excessively conservative politicians) are acting so starkly to hold up interest rates at time when very  weak investment demand and a high precautionary savings demand would almost certainly deliver short-term market-clearing interest rates that are deeply negative (and while “market-clearing” might seem bloodless to you, what it means in practice is clearing the labour market and supporting a prompt return to full employment).