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).

 

 

 

 

Recovering

It is very difficult to get a good sense right now of how much excess capacity there is, here or other countries  In New Zealand’s case, part of that is about the gross inadequacies of our official statistics.  We are one of only two OECD countries without official monthly employment/unemployment data (the other is Switzerland) –  and if this has been a long-running deficiency, it seems more striking than ever from a government that amended the central bank act to highlight the focus it wanted on avoiding as much as possible excess labour market capacity.

Of course, there is a variety of less formal, or less fit-for-purpose, partial indicators.  We know how many people get the unemployment benefit but many people looking for work are not (rightly in my view) eligible for the unemployment benefit.  There is a new SNZ indicator using IRD data and providing a monthly employment indicator which should be quite useful in normal times, but isn’t when the government is paying firms to keep people notionally on the payroll, even if doing little or no work.   And although SNZ collects HLFS survey data steadily through the quarter, they seem uninterested in making even that partial monthly data available (larger margins of error as it would inevitably have).    We’ll only finally get the June quarter HLFS data in August.

There are other hints of excess capacity.  The wage subsidy scheme paid out in respect of some staggering share (around half) of New Zealand workers and the self-employed, but that is now very backward-looking since the bulk of the eligibility related to the severe regulatory restrictions on many/most business during the government’s so-called “Level 4” period, from late March to late April.     Most of the employees covered would not have been made unemployed even if no wage subsidy had then been on offer.

The new wage subsidy scheme comes into effect this week.  The rules were tweaked again last week, and although this scheme only covers eight weeks (rather than twelve in the original scheme), the expected cost (close to $3.5 billion) suggests a lot of excess capacity still exists, or is expected to exist.  Not, of course, that we have any official data on that.

Of course, other countries have also had the mix of regulatory restrictions (“lockdowns”), self-chosen reductions in social and commercial activity, and the impact of the sharp disruption to world economic activity.   Labour is generally not being particularly fully-employed at present.  But in most advanced countries, even those with monthly labour force survey data, this excess capacity does not really show up in the official unemployment rate at present –  after all, most other countries have deployed some form or other of fiscal support designed to keep workers attached to firms, even if for now they are doing little or nothing.   In most countries, the monthly official unemployment rate has risen this year, but mostly not by much (and there are vagaries in the statistics such that in Italy the official unemployment rate has fallen).

Only three OECD countries are reporting really large increases in their official unemployment rates.  These are percentage points changes this year to date.

Canada                                                  +8.1

Colombia (new to the OECD)           +9.5

United States                                       +9.8

The US numbers came out on Friday night.  There is some controversy about the monthly change, but all the caveats (including those from the BLS themselves) suggest that the “true” or “underlying” number is even higher than the reported number.

I’m not putting much weight on Colombia (knowing almost nothing about it), but we have every reason to suppose that the dislocation of the economy in New Zealand over recent months in New Zealand was at least as large as those in the US and Canada (whether one looks at a regulatory restrictions index, mobility data, or stylised indicators like the degree of dependence on the labour-intensive foreign tourism sector).  Forecasts of the drop in June quarter GDP are higher for New Zealand than for most other advanced countries.

The “true” increase in excess capacity to last month (the US and Canadian data are for May) in New Zealand is almost certain to have been at least as large as those in the US and Canada.    One might think in terms of an unemployment rate equivalent of at least 13 per cent, which would be (by some margin) the worst New Zealand had experienced since the 1930s.

One can debate the merits of the wage subsidy scheme –  and even more so the extended version, which seems focused on tying workers to firms that are least likely to recover any time soon, if ever – but without it we would have a much clearer sense of just how severe the labout market excess capacity actually is.  (Even if, as I have favoured, one took a more generous approach to individuals facing serious income loss this year.)    Perhaps even when all the wage subsidy schemes have passed the official unemployment rate will be “only” in the high single figure range –  although if the schemes expire in September I’m still sceptical of that –  but for now it is all but certain that the excess capacity in the labour market, that needs reabsorbing one way or the other, is well into double-digit percentages.  And political debate about what needs to be done should operate with those sorts of numbers in mind.

On which note, I’ve been reflecting over the last few days on what it takes to see full employment restored.   It isn’t like, for example, everyone simply coming back to work after the summer holidays.   Everyone –  individuals and firms –  planned on summer holidays and planned on returning.  By contrast, even in New Zealand with (for now) almost no Covid, that isn’t the parallel at all.  The income lost over the last couple of months – probably well in excess of $20 billion, relative to normal expectations – isn’t coming back.  The border is still largely closed. The virus still stalks the earth, with associated heightened uncertainty.  The world economy is in a severe recession and (rightly or wrongly) almost all forecasters think it will take several years for activity levels to get back to normal.  So if wealth has taken a hit already, and some significant sources of external demand are either restricted (by regulation) or impaired, where is the demand going to come from to quickly reabsorb workers who are either already displaced, or who are hanging in some temporary wage-subsidy limbo.

You see occasional talk of people “doing their bit” for New Zealand businesses by going out and spending more than usual, but it is a bit hard to envisage it happening on any significant or sustained scale.  I tried some introspection.  My household hasn’t been materially adversely economically affected by Covid shocks, and there doesn’t seem to be any material employment risk.  And yet we aren’t spending any more than usual, possibly a bit less.  Why would it be otherwise?   We’ll have a break in the school holidays, but then we always do (and when we booked the other day it was a bit shorter than it might have been, Auckland Museum having had to cancel/postpone the exhibition we hoped to see). Many shops are still a pain to go in to.   And I find myself still slightly shell-shocked after the last few months and a bit more cautious and abstemious than otherwise.  And if I thought about “doing my bit” on any serious scale – there are always jobs around the house than could be done –  then I’d contemplate the dramatic change in the fiscal position.  I’m not suggesting some full-blown Ricardian effect here, but (whether I approved of the scheme or not) it seems rather less likely than it was a few months ago that my kids will get fees-free tertiary education, and even if a centre-right government were to be elected  tax cuts seem less likely than they did.  And even prospects for the kids to get part-time jobs don’t seem what they were (and there are probably people needing the jobs more anyway).  Oh, and I’m conscious that another round of Covid restrictions, and economic dislocation, isn’t impossible or even unlikely.

Perhaps you are different.  Perhaps you are energetically contemplating spending more aggressively.  But I suspect most people won’t be, even those (notably in the public sector) fairly confident of keeping their jobs).

In a typical serious recession, changes in incentives (relative prices) do quite a lot of the work.   Lower real interest rates ease pressure on the most-indebted but (more importantly) they draw spending forward.  Often those changes in real interest rates have been rather large.  Sometimes, tax rates (income or consumption) are cut.  And, particularly in countries with a fair bit of foreign debt and not typically treated as international safe-havens (or home bases for pools of savings), the exchange rate falls a lot, drawing demand (from locals and foreigners) towards New Zealand.  Oh, and of course sometimes the government itself does a lot more direct spending on goods and services.

(Oh, and of course there is always pro-productivity and pro-investment micro reforms but…….this is modern New Zealand.)

The key point is that if, at some like current real wages, we are to get back fairly quickly to full employment (which, in my view, should be a high policy priority, given the dreadful scarring effects sustained periods of unemployment can have on some individuals) it needs quite a lot of people to spend quite a bit more than they otherwise would, to replace the demand that has (for now at least) disappeared or been somewhat impaired).

Of those mechanisms:

  • real interest rates have barely changed.    The Reserve Bank can huff and puff all it likes about possible portfolio balance effects etc from its LSAP programme, but if they don’t change prices in ways that encourage more spending than was happening at the start of the year (and they haven’t) it is really little more than sound and fury (and, just possibly, having stopped things getting worse),
  • the exchange rate is now about the same level it averaged last year,
  • consumption tax rates haven’t changed, and although there have been some business tax changes (a) most of the effects will be intra-marginal (flowing to people who woin’t change their behaviour, and (b) uncertainty is very bad for business investment (ie even if the effects are in the right direction, they are likely to be very weak for now)

The government is, of course, spending a lot.  Most of that isn’t direct spending on goods and services  (consumption and investment) but income transfers in one guise or another.  Even there however, the largest and most concentrated spend has already happened over the last three months (with some more in the next couple of months).

From the “fiscal hawk” side of the debate, one hears quite a bit of worry about fiscal excess and heavy future burdens.  I come and go on how sympathetic I am to those complaints and warning, but mostly I end up not being that sympathetic (and I noticed over the weekend a centre-right UK think-tank, Policy Exchange, taking what appeared to be a similar stance, of for different reasons).  And why?  Because if we are concerned at all about getting people back into work faster than simply allowing nature to take its course –  recessions will heal themselves eventually, but it could take quite a few years (perhaps tourism will be back to normal levels in 2025?) –  someone (many actually) have to be willing to spend more now than they were otherwise planning to.  I’d much prefer that monetary policy were doing its job –  not just here, but in Australia and most other developed countries –  because I think much lower interest rates and a much lower exchange rate would do a lot (as they did after 1933, 1967, 1991, 1998, and 2008/09), by changing relative prices/incentives, but it isn’t.   And with a hole this deep –  and borrowing costs this low (which don’t make fiscal policy a “free lunch”) and on-market borrowing this easy – it would imprudent for fiscal policy to be doing no more than just letting the automatic stabilisers work.  And, in truth, at least on the domestic interest rate leg, letting monetary policy do its job also involves people taking on more debt now than they’d otherwise planned to (voluntarily chosen and all that, but debt nonetheless).

If we are starting from (effectively) perhaps double-digits effective rates of unemployment, it is far from clear that anything like enough macro policy stimulus is being done.  If fiscal policy hasn’t reached its political limits –  it is nowhere near the market limits, but neither should we test those –  it must be much closer than it was and, on the other hand, monetary policy is doing almost nothing.  That is really inexcusable, If Orr and the rest of the MPC want to take on themselves some sort of mantle of Hayek or Mellon (as caricatured) as do-nothing liquidationists, Robertson, Ardern Peters, Shaw (and, it seems, Muller and Goldsmith) shouldn’t be standing idly by, by default offering their imprimatur.

(The post was headed “Recovering”: unfortunately, I am doing so only slowly from some bug I’ve picked up, so posts this week may continue to be patchier than I’d like.)

Two charts

….on unrelated matters.

One of the objections sometimes raised to my advocacy of a deeply negative OCR is along the lines of “it will only lift asset prices”, with the implication –  and sometimes directly stated –  that that is what has happened in the last decade or so, even as policy rates in most of the advanced world fell from materially positive numbers to somewhere near zero.   In 2007, policy rates in the US and the UK had been over 5 per cent, in the euro-area 4 per cent, and in New Zealand and Australia higher than all those rates.   Only Japan was then in the extreme low interest rate club.

The asset price that tends to attract most attention in New Zealand is house prices (really house+ land).  The Bank for International Settlements maintain a nice quarterly database of real house prices for a large group of advanced and emerging economies.

Here is what has happened to real house prices for the largest advanced economies, and for the advanced economies as a whole, over the 12 years from the end of 2007 to the end of last year.

house prices to end 2019

Very little change at all.

The aggregate advanced economy measure only starts in December 2007, and for quite a lot of countries the data starts getting thin for earlier periods.   But for the UK, the euro-area, and the US, I had a look at the previous decade –  over which period policy interest rates hadn’t changed much at all (ups and downs of course during the period) – and in each case real house prices increases were much more rapid in that period than in the more recent (extremely low interest rate) one.   The US had experienced a 53 per cent increase in house prices –  and they had already fallen back from peak by the end of 2007 –  and the euro-area a 40 per cent increase.  In Japan –  very low interest rates throughout –  real house prices had fallen substantially over the 1997 to 2007 period.

Of course, within these aggregates for the last decade or so there is a lot of cross-country variation.  We all know real house prices in New Zealand and Australia have risen a lot.   In some other countries, they’ve fallen a lot.    But even in New Zealand, Australia and Canada, the rate of increase has been less in the last (low interest rate) 12 years than it was in the previous decade.

That shouldn’t really be a surprise.  After all, in principle, houses are reproducible assets (some labour, some timber, some concrete, some fittings) and in few countries is very much of land built on.   Moreover, interest rates aren’t where they’ve been as the result of some toss of a coin, or a draw from a random number generator; they reflect underlying changes in savings/investment imbalances, which central banks adjust policy rates to more or less reflect.

When a wide range of countries have had fairly similar interest rate experiences (and inflation outcomes; the check on whether monetary policy is out of step), and yet have had very different house price experiences, it probably suggests that some non-interest rate factors have been at work.   Of course, in some cases, that might just mean working off past crises –  although if you want to cite the US there (a) recall that by the end of 2007 real house prices had already fallen by 15 per cent from peak, and (b) that in the boom years nationwide real house prices in the US never rose as much as they did in, for example, Australia and New Zealand.

A more plausible story is that some combination and land-use restrictions and population pressures continue to explain a lot about differential house prices performance in the years since 2007.   In New Zealand and Australia, for example, we have had tight planning restrictions and rapid population growth.    I don’t know much about planning rules in central and eastern Europe, but there isn’t much population growth (deliberate understatement here) in countries with strong economic growth such as Bulgaria, Romania, Slovenia, Slovakia and the Baltics.   It isn’t a simple one-for-one story, but taken across the advanced economies as a whole it just doesn’t look as though low interest rates are a credible part of the house price story –  house prices, in aggregate, not having done much at all.

Of course, had central banks completely ignored the market signals re savings/investment pressures and simply held policy rates up then no doubt house prices would have been lower.  Then again, we’d also have had persistent deflation and (more importantly) unemployment rates that stayed much higher for longer and more persistent losses of output.

On a completely different topic, I found myself yesterday on an email exchange with some fiscal hawks, very worried about the future level of public debt.

I’ve noted previously that on the Treasury budget numbers our ratio of net debt to GDP in 2023/24 would still be sufficiently modest by international standards that if we had had that high a debt ratio last year, we’d still have been (narrowly) in the less-indebted half of the OECD.

Another way of looking at things is to take the government at their word and assume that by the end of the forecast period the Budget is more or less back to balance, such that the nominal level of debt stabilises at the level forecast for the end of 2023/24.

If that were to happen that what happens to the debt ratio depends on how much growth in nominal GDP the economy manages in the years ahead.   If we assume that the terms of trade is stable (or that the only safe prediction is that we don’t know, so assume no change), then there are three components to the rate of growth of nominal GDP.    As an illustrative experiment I jotted down a range of possible average outcomes for each.

Average annual growth
Low High Average
Population 0 1 0.5
Productivity 0 1.5 0.75
Inflation 1 2 1.5
2.75

So I’d assume growth in nominal GDP averaging 2.75 per cent over the decades beyond 2024.  Of course, there will be booms and recessions in that time, but this is just an average.   And then I’ve taken two alternative scenarios –  one in which nominal GDP growth averages 2.25 per cent, and one in which it averages 3.25 per cent.   Those aren’t extremes, and one could envisage even higher or lower numbers.

But this is what a net debt chart looks like out to 2064.

net debt scenarios

Even on the worst of these scenarios this (exaggerated, because it excludes NZSF assets) net debt measure is back to 30 per cent of GDP by 2050.   That doesn’t seem too bad to me for a one in a hundred year shock (as the government likes to claim) or –  less pardonably –  a one in 160 year shock as the Reserve Bank Governor was talking up the other day.

Of course, fiscal hawks will say, “but what if another really nasty shocks happens in the meantime?”.  Well, of course we would have to face that if it comes –  and it could –  but, as I noted, our net debt at peak is not high by pre-crisis international standards, and isn’t even high by our own longer-term historical standards.

Governments might choose to lower the debt faster, although if real servicing costs remain low it is difficult to see why one would, since faster consolidation involves either higher taxes than otherwise (with real deadweight costs) or less spending than otherwise (and while each bit of spending has its own antagonists, there is a case to be made for most of it).   There is precisely no evidence that anything important would suffer if our net public debt took a trajectory something like the central scenario in that graph.

(Of course, it is a purely illustrative scenario, and the composition of nominal GDP growth does matter to the budgetary implications –  eg faster population growth means more infrastructure demand, faster inflation might mean some unanticipated inflation tax, faster productivity is more like pure gain –  but there is no reason to suppose that if governments can get back to balance (as they repeatedly have now for decades) that we will need anything much beyond that.  Getting back to balance will require discipline and focus –  and a strong credible recovery would help –  but since most of the fiscal measures to date have been avowedly temporary, doing so should not be beyond our political system, whichever group of parties happens to be governing by then.

Doing more

I had a long chat yesterday to a reader who’d read a forward-looking piece I’d written recently and was concerned that in the halls of power there might be insufficient appreciation of just how serious the economic situation is.  My caller was just about to lay off a fairly large chunk of the staff in his company.

I was inclined to share his view –  although it is hard to know what ministers/officials really think, as distinct from the official happy-talk – and have been uneasy that, for example, official forecasts of the unemployment rate getting to, perhaps 7 or 9 per cent were giving some a sense that really things weren’t so bad, and that more or less enough was being done at a policy level.  After all, actual headline unemployment rates are much higher in some other countries (US and Canada), and the unemployment rate here was higher than those forecasts back in 1991/92.  Just this morning on RNZ, the Governor of the Reserve Bank seemed to be suggesting that everything was in hand, and not much more needed to be done by policymakers as a whole.

I went straight from that call to a Zoom seminar put on by the Law and Economics Association on economic policy responses to Covid-19.   There were three economists speaking, none of whom I would usually associate with calls for a more active and interventionist state –  Eric Crampton (New Zealand Initiative), Andreas Heuser (Castalia consultants, and formerly Treasury), and Richard Meade (of Cognitus, also consultants).  The slides for all three presentations are here (and I think they said they are planning to put the video up as well).  None seemed remotely comfortable with the current situation or content that what needed to be done had been done.

I found it interesting that all three were advocating more-liberal state-sponsored/provided access to interest-free credit.

Heuser’s focus was on business credit, noting the risks (of widespread insolvency) that our more onerous lockdown (relative to Australia) had created and the lack of success of the government’s business loan guarantee scheme (and that the new interest-free scheme is available but offers meaningful amounts only for quite small businesses).  He seemed to be arguing for more generous bank-administered schemes (in which, for example, any government credit is more directly subordinated).

Eric Crampton’s focus was mostly on other aspects, but he repeated his enthusiasm for the scheme the Initiative was proposing a couple of months ago, allowing individuals to borrow from the state quite readily.  Repayments would then be made over many years through the tax system –  akin to the way student loan repayments are done – with borrowings to be interest-free up to a reasonable threshold (linked to your past taxable income) and carrying an interest rate for amounts beyond that.

My main interest, though, was in Meade’s proposal, which has apparently been around for a while but which I’d not noticed previously.  He starkly puts the problem this way

meade 1

And goes on to note that both firms and households rely on each other, and (in the large) none could really be confident of their own viability if they cannot be confident of the other’s.  He argues that the numerous support measures rolled out since mid-March have been too scatter-gun and selective to provide any widespread confidence or (thus) willingness to spend.   And they do this, on his telling, even as they rack up a huge fiscal costs, which will be paid (directly, or through foregone options) by generations to come.

His proposal has these features.

meade 2

(Note that his second line means big businesses and existing beneficiaries/public servants would not be eligible.)

As Meade notes, in an ideal world, such a framework would have been put in place three months ago, so that as we headed into the worsening Covid downturn everyone would have had much greater clarity about the buffers that would be in place.  But not having done so then does not mean, so he argues, that it should not be adopted now.

It is an interesting proposal, and among its features Meade sees these

Importantly, they replace government-imposed qualifying criteria and favoured cost lines with “self-selection criteria” and “self-prioritised cost lines”:

– They are “incentive compatible” in that taking out loans is a choice to personally pay higher taxes, which protects against over-borrowing (likely a lesser evil anyway);

– They otherwise rely on households using their private information to determine how much “income insurance” they need to remain able to pay their priority bills, keep their house(etc), and obviate the need for bluntly targeted subsidies.

Relative to the status quo, what Meade is proposing has some appeal, especially around certainty.  If you can’t know what the wider economic environment will look like, at least you can have a sense of what buffers you might have available, and those your customers might have available to them.

But I don’t see what Meade is proposing as viable, in least in the way he proposes (as a substitute for really big additional fiscal outlays).

The first reason is that while he presents it as “ex post income insurance”, it is really nothing of the sort.   When you buy income insurance –  whether privately or through ACC –  you pay your premium along with everyone else and hope you never collect on the policy.  If you do have to collect on the policy, the cost is covered a little by your previous premia, but mostly by the premia of the people who will never claim.

By contrast, Meade’s suggestion isn’t income insurance, but simply “liquidity insurance” –  as he notes, anti-slavery laws mean you can’t generally borrow secured on your future income, but Meade’s scheme ensures you can borrow if your income takes a sharp hit (his concern here is mostly for people for whom the welfare system provides a very low income replacement rate). But you, and only you, will pay every cent of the amount you borrow –  secured, through the tax system, secured against your estate, so really only written off in extremis.    

And he wouldn’t even make it available to big companies, even though big companies employ lots of people, make lots of investment choices etc etc.

And although his aim is to support confidence and demand  –  by giving everyone a sense that everyone else has access to liquidity and, thus, spending power –  I don’t think it would have done that very effectively (even relative to the policies the government has adopted), particularly note for households.  Lots of people –  having just lost their job, or fearing doing so –  would be very very reluctant to take on lots of new debt in the middle of a crisis, and instead would choose to cut their spending to the bone –  precisely what Meade hoped to avoid.    For small and (particularly) medium businesses, what Meade proposes is better than what we have, but still suffers from the weakness that (a) many firms probably won’t be coming back, and there is no particular public interest in them doing so (one motel in Rotorua is much the same as another, and so on) and (b) many businesses simply will not support more debt.

And the political system would just not be willing to stand by and say “well, you are on your own –  you had the option to borrow and chose not to do so”.  It would intervene with grants as well (as it has done, is doing).   That is actually more like (although still not close to) what a risk-pooling insurance scheme looks like –  those of us lucky enough not to lose our jobs help fund the support for those who did lose theirs (in, as Meade puts it, an “unprecedented correlated shock” where people find themselves in deep strife (again in his words) “through no fault of their own”.   (I could also note that many households –  any with significant equity in their house –  have significant borrowing capacity anyway, without a new scheme).

I wrote about Meade’s scheme for two reasons.

The first is that I was struck by the fact that all three speakers at yesterday’s seminar favoured interest-free loans, including to businesses.  Meade’s was the most developed model presented, and encompassed both households and businesses.  The government seems to agree that zero interest is about the right rate at present –  that is the rate it is lending at to those SMEs borrowing under its latest facility, and these won’t be the safest conceivable borrowers around.    So these market-oriented –  perhaps even “right-wing” – economists reckon zero interest makes sense at present, and the centre-left Minister of Finance seems to think so too (his revealed preference). The one person who doesn’t, of course, is the Governor of the Reserve Bank, who was heard on RNZ this morning  saying that retail rates were “about right at present”.    We all have a pretty good idea of where mortgage rates are at present –  nowhere near zero –  but check out interest.co.nz’s table of the multiplicity of business lending rates.     We are in weird position where, faced with a huge deflationary adverse shock, the central bank’s Monetary Policy Committee is holding interest rates, for existing and new customers, well above where they should be.

The second reason for highlighting Meade’s scheme is that it gives me an opportunity to champion again my own proposal, first outlined in mid-March, which was designed to achieve quite a lot of what Meade was looking for.    That was the proposal that the Crown would guarantee 80 per cent of last year’s net income for 2020/21, for individuals and for firms.  Unlike Meade’s scheme, it would be quite costly to the Crown –  although I believe no more costly than the scattergun approach currently being rolled out will end up costing –  but it also offers genuine insurance, in which over time all chip in to cover some of the losses of those who were most severely adversely affected.

The most recent write-up of that proposal was in this post.   That was a while ago now.  I still reckon the basic framework remains the best option for conceptualising assistance (I saw other assistance as, in effect, credits that would be netted off against the “income insurance entitlement”).

In the spirit of ACC, if I were devising the scheme from scratch now, I might consider capping the payout at 80 per cent of individual incomes of up to $150000, with no compensation for losses on the income above that threshold.  I might also consider guaranteeing not 80 per cent of last year’s net income for companies, but guaranteeing company net income at zero (or last year’s reported loss) –  in other words, insuring that hitherto profitable companies did not go deeply negative, while recognising that profit variability is a much more natural phenomenon –  every business every year – than labour income extreme variability.  Each of those refinements would save money, but they would also complexify the system in ways that would have to be carefully considered if any government were to think the broad approach had merit.   The broadbrush simplicity and certainty of the scheme –  not playing favourites, not distinguishing large and small, simply buying time and providing some certainty –  was the appeal of the scheme.

Of course, many of these schemes  –  and the government’s own interventions – are focused on the immediate situation, stabilising things in the short-term.  But a year from now it is most unlikely that the economy –  ours, or those in other advanced countries –  will be anything like right again.  There won’t be huge new fiscal capacity –  not because of technical limits, or market constraints, but the realities of public tolerance –  and that is where monetary policy should be doing its job.  Much lower interest rates now aren’t mostly about boosting demand/activity now (the lags are simply longer than that) but about putting in place the right price signals –  cost of domestic credit, returns to domestic depositors, and (perhaps most importantly) the exchange rate –  that will support bringing private demand forward, and drawing private demand towards New Zealand producers, to get as back to full employment just as quickly as possible.