I suggested last week that I might devote a post to picking through the arguments that the New Zealand Initiative’s Bryce Wilkinson and the Social Credit group have been making –  including in attacks on each other – about fiscal policy, monetary financing etc.  Even with another round of full-page adverts from Social Credit in the weekend papers, I’ve decided to set that to one side for now.  I guess my bottom line is that I think Social Credit is quite wrong in the longer-term.   I disagree with them less about the near-term, in fact there (as I put it in my previous post) I think they are insufficiently ambitious.  Anyone interested can read that previous post (I had a polite and engaging email from the leader of Social Credit who thought the post was “most even handed”, even though he disagreed with my bottom lines).

Instead, I want to work through a post on how one might best respond to a really sharp and substantial economic contraction – partly government-induced, but increasingly just a response to seriously adverse exogenous events.  In this case, of course, the issue is, the global pandemic, the effects of which seem likely to be with us for some time (quite possibly at least several years).

Before doing so, while there will be lots about governments and central banks here, it is worth remembering that economies (firms, households etc) can and would adjust themselves anyway.  But there is a fairly strong consensus that macroeconomic policies, done reasonably well, can asssist in getting the economy back to full employment faster (perhaps quite a bit faster, but we don’t know the counterfactuals with any certainty) than by simply leaving people to sort things out themselves.  That won’t always be the case –  there is a reasonable case that governments made things worse for quite a bit of the Great Depression – but I’m happy to take it as a starting presumption.   And whether or not you or I agree, government agencies are going to do stuff anyway.  This is an attempt to contribute to debate about what they should do.  My worry, to put my cards on the table, is that they won’t do enough, and that what is done will be quite misfocused.

In a really severe downturn we typically look to some mix of monetary policy and fiscal policy to help out.  In the case of fiscal policy, the default is mostly about being helpful by sharing the losses.   In effect, our tax system makes the government something like an equity partner in all economic activities:  when times are good government revenues rise strongly and when times are bad revenue falls away a lot.  Typically, we look to governments to position themselves to ride through most of the cyclical fluctations, such that debt ratios fall (somewhat) in good times and rise (somewhat) in bad times.  That is what is known as “letting the automatic stabilisers work”.  The biggest effects are on the revenue side, but there is some expenditure impact as well: more unemployed people means more spending on unemployment benefits.

On the monetary policy side, central banks have to actually act to be helpful.  That is because our system works through central banks setting a short-term policy rate (here the OCR) at a level economic conditions (including inflation) call for.  When circumstances change, only the central bank can change that policy rate.  Longer-term rates are, of course, free to move, but they are influenced not just be savings and investment preferences –  the core fundamentals that drive where interest rates should be –  but by what people think central banks will do.

For really big adverse shocks, those fiscal effects (the “automatic stabilisers”) aren’t small.   Suppose that GDP for the year to March 2021 were to be 15 per cent less than normal –  not a forecast, but not a wildly implausible number either.  If there was a balanced budget at the start of the period, it would be easy to envisage a  deficit of 5-6 per cent of GDP, just by doing nothing.   That would, typically, be regarded as a “good” deficit –  the sort any well-managed government should certainly be willing to run in such circumstances.

Then again, think about the –  quite serious –  recession we had in 2008/09.  The level of GDP fell then by about 3 per cent.  Underlying trend growth might have been about 2 per cent per annum, so a gap of about 5 per cent of GDP (similar to the peak output gap estimates for that period).   Automatic stabilisers might then be worth only 1-2 per cent of GDP.

By contrast, the OCR was cut by 575 basis points during that period.  Short-term retail rates fell by less than that, and inflation expectations also fell during the period, but there were significant reductions in real retail interest rates.  In addition, the exchange rate fell, by 25 per cent or more.   As was typical in floating exchange rate countries –  ie ones that could set their own monetary policy –  the bulk of the adjustment burden was put on monetary policy.

In quite a few countries there were also quite big discretionary fiscal stimulus packages as well, on top of the automatic stabilisers.   Nothing of that sort was done in New Zealand after the recession became apparent,  However, as it happens, the Labour government (in office until November 2008) had put in place a fairly stimulatory fiscal policy anyway, when they (and their Treasury advisers) assumed times would stay good.  On OECD metrics  –  cyclically-adjusted and underlying balance estimates – those measures generated a fiscal impulse equivalent to 4 per cent of GDP (the change in the structural balance from the position in 2007 to that in 2009).  It was a larger stimulatory effect than seen in some countries that launched crisis discretionary stimulus packages.   If it hadn’t been for that fiscal stimulus that happened to be in place anyway, the case for even deeper OCR cuts would have been strong.

In combination these were really quite large effects:

• 575 basis points of OCR cuts,
• a 25 per cent fall in the exchange rate,
• a four per cent of GDP fiscal impulse

as well as all sorts of guarantees and liquidity measures to limit the extent to which monetary conditions tightened.

And yet it is worth remembering that it was 10 years before New Zealand’s  unemployment rate got back to about the sort of rate many economists –  and the Reserve Bank I think –  would think of as the normal level (or NAIRU) given labour market restrictions etc.  It took seven years for the employment rate –  which has been trending up over time –  to get back to pre-recession level.

And that was even with the fair winds of a robust terms of trade and a big boost to demand from the Canterbury repair and rebuild project.   And from a starting point in 2007 in which there was not that much cyclically wrong with the New Zealand economy.

What about our previous really severe recession –  worse in almost every regard for us than 2008/09 – at the end of the 1980s and early 1990s?  Of course, there was lots else going on –  lots of reforms and structural change that were shaking loose from the labour market, and a mania that had huge amounts of very bad lending, and misallocation of investment resources, in the run up.  In addition, policy was still trying to drive inflation down.     And, of course, there were structural tightenings going on in fiscal policy –  although by this time less than is often supposed (perhaps a couple of percentage points of GDP, on OECD numbers).    The unemployment rate rose from about 4 per cent to about 11 per cent.

In response, and in real terms, the short-term interest rate fell by probably 700 basis points (over several years).  The exchange rate fell by 20 per cent.   But even then it took years to get us back to something akin to full employment.

So typically with very nasty recessions we see very big macro policy responses, sometimes passive (those automatic stabilisers, which are weaker in New Zealand than in many OECD countries).

Monetary policy typically does the bulk of the work.  There is good reason for that:

• official interest rates can be adjusted very quickly (basically instantaneously) and –  as it happens –  can be unwound quickly too,
• interest rate “get in all the cracks” –  affect people and firms across the economy,
• at a time when the economy has got poorer (even if just for a time), interest rate cuts spread losses, taking income away from existing savers and redistributing it back to existing borrowers (at least those among both classes who have voluntarily contracted to live with the risk of variable interest rates).
• lower interest rates tend to draw spending forward in time (to the period now where there is excess capacity and a shortfall in demand) –  not just, or even primarily, by encouraging new borrowing from banks, but simply by prompting people to think that the reasons to put off spending aren’t as strong as previously,
• particularly for a country like New Zealand (it is different in the US, or countries with big positive NIIP positions like Switzerland or Japan) lower interest rates also tend to lower the exchange, encouraging New Zealanders (at the margin) to consume locally, increasing returns to those selling abroad, and attracting some demand from abroad towards New Zealand producers rather than foreign ones.

In fact, big reductions in (real) interest rates are what would happen in a market economy if a central bank were not setting a policy rate.  In the end, what interest rates do in an economy is to reconcile savings preferences and investment intentions.  In severe downturns, all else equal, investment intentions at any given interest rate plummet (whether by firms or households), and private savings preferences (firms or households) also tend to increase at any given interest rate.  The reconcilation of those two forces is that the equilibrium interest rate –  including the one consistent with promoting a speedy return to full employment –  will fall, quite a lot.  Broadly speaking, the job of the central bank is to follow those changes, and get market rates into line  (that might involve specific liquidity interventions in quasi-crisis conditions, but it will certainly involve OCR adjustments).

And the beauty of relying –  as countries were typically doing previously –  on interest rates and monetary policy is that no one is compelled to do anything.  If you didn’t want to be exposed to interest rate risk, you’d have taken a fixed-rate contract.  If you didn’t want near-term exchange rate exposure, you’d hedge as much as you could.  And if the interest rates fell sharply and you didn’t want to change your behaviour in response, you didn’t have to.  Those with the most flexibility, those with the best opportunities, did the adjustment.  It might be unsatisfying to politicians – no big announceables, no specific identifiable spender –  but there is nonetheless a pervasive stabilising and supportive effect.

But this isn’t at all what is going on in the present savage recession –  the one that, even as the most severe of the regulatory restrictions is lifted, is likely to see us left with a recession, and excess capacity in the economy, as severe as anything we’ve seen for a very long time almost nothing is happening with monetary policy.    Real interest rates have barely moved: that’s true whether one looks as short-rates and adjusts for the fall in surveyed inflation expectations, or looks at the yields on the range of inflation-indexed bonds the government has on issue (where yields are no lower now than they were late last year).   Oh, and the exchange rate hasn’t fallen by much at all either.

Sure, there has been plenty of activity to support liquidity in financial market.  That has stopped conditions tightening, but done nothing material to ease conditions.

Instead, all the talk is of fiscal policy.

The automatic stabilisers will be at work, and although we haven’t yet seen much of that effect in the numbers it will be real in time.   Plausibly, the automatic stabilisers alone could yet add 15 percentage points to the ratio of public debt to GDP over the next few years.

But the talk isn’t really of those pre-set conditions, but off the discretationary measures already announced with the prospect of more to come (perhaps including in Thursday’s Budget).

We’ve seen big dollops of money already, notably the $10 billion of so (just over 3 per cent of pre-crisis GDP) for the wage subsidy programme paid out already.   Amid the numerous other big numbers tossed around, it isn’t clear how much else has actually been paid out (let alone how much of that will represent net fiscal costs over time).   There have been additional real resources committed to the health sector, but in the macro scheme of things those effects are likely to be fairly small.

Probably no one really begrudges spending of that sort over recent weeks (even if there might be reasonable debate over some of the parameters of the wage subsidy scheme), but big as the numbers are, they also aren’t really the issue now:  the money has already been spent, and probably even held up (to some extent) actual spending (on the little that was permissible) during the “Level 4” and “Level 3” periods.

But that issue is where to from here, as we head out of the worst of the restrictions into an environment where even later this year GDP might still be 15 per cent below normal –  stop and ponder that gap; it is too easy to get too used to really big numbers.  An environment where the world economy is in deep recession, where the virus and uncertainty about it still stalks the earth (and even affects directly New Zealanders, who can’t safely assume there will be no return of the virus or restrictions) and where there is little prospect of our borders being very open at all.  It isn’t as if it looks likely that we can simply count on animal spirits or even just the rest of the world to lift demand quickly in a way that would promptly get us back close to full employment.

Almost certainly, a prompt return to full employment will take a great deal more policy stimulus.   But there is little sign it is likely.

The Reserve Bank is clearly reluctant to cut the OCR further, and has actually pledged not to do so before March.  They talk (a lot) about their bond purchase programme being in some sense equivalent to substantial OCR cuts, but frankly that is just unsubstantiated nonsense (when neither the exchange rate nor real interest rates –  anywhere along the curve – have fallen much if at all, all they’ve done is limit any unintended tightening).   What scarces me is that people who count –  notably the Cabinet, and the Minister of Finance in particular – may believe them.

And there seem to be a growing number of signals suggesting not that much can be expected from fiscal policy – whether comments from the Minister of Finance and the Prime Minister or, for example, the thoughtful column on the Herald  website by Pattrick Smellie (once upon a time press secretary to Roger Douglas as Minister of Finance).  I’m sure there will be baubles thrown around, old programmes repackaged, and some genuine stimulus proposals (some of which may never actually begin before the economy is pretty close to fully-employed anyway, even if that takes years).  But this is a huge recession, it isn’t going away quickly, and for now the Minister of Finance seems content to have the Reserve Bank do nothing.   It is a recipe for economic activity lingering unnecessarily below capacity for years, for unemployment lingering high for years –  permanently scarring the lives of many of those affected.

At one extreme of the current debate there people who reckon going big on fiscal policy is something closely akin to a “free lunch” (Social Credit may actually believe it, but others come close).   That almost certainly is not true.

If, perchance, monetary policy does nothing and stimulatory fiscal policy could speed up the recovery somewhat, then there is a modicum of truth in the “free lunch” concept –  at least some resources which would never otherwise have been used will have been employed and productive.  Even then, of course, the people who gain and the people who pay will be two different groups.

Ah, but some say, the additional debt just never needs to be repaid.   And it is certainly true that (a) a well-governed market economy with a flexible exchange rate can run reasonably high levels of public debt, and (b) with very low long-term interest rates there may be a reasonable argument that the sustainable level of public debt (share of GDP) is higher than it was.  It is also true that in a growing economy, so long as the budget gets back to balance (even if it takes five years from now), the debt to GDP ratio will gradually erode (with 2.5 per cent nominal GDP growth, the debt ratio would halve in 30 years).

(Oh, and ideas about the Reserve Bank somehow “writing off” the government debt it holds also change nothing –  there would be just an intra-government book-keeping entry.)

But even having made all those points, there is still an opportunity cost to consider.    Suppose that it really was now prudent to aim for a public debt to GDP ratio of 60 per cent, rather than something like 20 per cent hitherto.   That gives government some additional deficit capacity for some years –  getting to the new higher level –  but surely we should want that capacity used for the highest returning projects.   To some, that might (for example) be lower taxes on business income.  To others, it might be better quality schools, or investment in public R&D, or even just higher benefit levels for those genuinely unable to provide for themselves (views will differ).   Simply throwing money willy-nilly now at things that might help return to full employment quickly will preclude those options being exercised.

That is especially so when the monetary policy option is on the table.  If the Governor and the MPC refuse to use it aggressively, the Minister of Finance could simply insist.  The law was written that way 30 years ago, and the provisions were reaffirmed when this government reviewed the monetary policy aspects of the Act just a couple of years ago.    Or he could get a new Governor/MPC, since the incumbents clearly aren’t doing their jobs.  Shocking?  Perhaps, but so should persistent high unemployment be.

All that is especially so when there are a variety of reasons why using monetary policy aggressively now should be attractive:

• savings just aren’t very valuable to anyone else right now (what should drive the returns), when there is a strong desire to save, and little willingness to invest, and yet term depositors are still earning positive after-tax real interest rates on very low risk investment (as the economy goes backwards),
• the government finds it appropriate to lend to businesses at zero interest rates (via the IRD, to people who presumably can’t fund themselves elsewhere) and yet the typical retail interest rate for existing borrowers –  most of whom will be highly creditworthy taken together –  is still significantly positive,
• for all the reported angst about commercial rents –  which mostly are fixed-term commitments –  there seems to be little focus on lowering explicitly variable-rate interest rates (plenty of attention on deferring interest, even though –  as above – the market would naturally lower those interest rates significantly),
• the biggest winners from avoiding using monetary policy are (a) the relatively older segments of the population (those with the largest term deposit base, directly or through managed funds), (b) while the opportunity cost of using up fiscal space now will fall most heavily on the relatively younger segments of the population, as does the burden of servicing the existing private debt at interest rates the Reserve Bank refuses to cut.   Not to be too delicate about these things, the older segements of the population were/are most at risk from the virus,
• all else equal, heavy reliance on fiscal policy will hold up the real exchange rate and tends to advantage (a) urban consumers, and (b) inwards-focused New Zealand firms relative to those in the tradables sector.  Given that foreign trade as a share of GDP has been falling this century, that skew would not seem well-aligned with what we might need to be a more highly productive economy longer-term.
• and, as noted above, monetary policy takes effect immediately and has a pervasive effect, while leaving individual choices open to each individual and firm.

By contrast, fiscal policy involves politicians’ grubby fingers all over choices about who benefits and how (for example, the proposed temporary RMA reform which might empower projects that get the imprimatur of the Minister, but do nothing for genuine private sector opportunities), and serious policie/projects often taken rather a long time to implement, especially if done well.  I was exchanging notes with Tony Burton, until last year deputy chief economist at The Treasury  –  and occupying a very different spot on the political/social spectrum than I do.   He has a fairly brutal and succinct style when he chooses and his comment this morning (passed on with permission) on the notion of national-level “shovel-ready projects” as “complete drivel”  caught my eye.  It was hard to disagree.

Of course, it is fair to ask if there are things fiscal policy could usefully do that monetary can’t right now (after all, there will inevitably be some fiscal component to any effective and aggressive policy response).

One possibility is that banks might be more hesistant than usual to lend at present.  Of course, additional private spending does not have to involve more borrowing, but some would.  Governments can take risks private banks might not be willing to, but…….the caution of banks is likely to be largely quite rational (they don’t know the future any more than the government does), and that in turn should be a caution to governments rushing in where the private sector (with more on the line) would not.

Perhaps there really are some very high value projects all ready to initiate –  things the government was planning to do next year anyway. To the extent there are some such things, it might be perfectly rational to bring them forward (just as someone who was planning to buy a car next year anyway might bring the purchase forward if the forecast glut of rentals really does hit the market, or someone planning to paint the house next year might do it this year if painters are cheaper).

And, of course, the government may be able to offer something like the sort of “national; pandemic income insurance”, of the sort I’ve proposed: a bit more certainty, paid for through the “premium” of slightly higher taxes in normal times, might support private spending and credit now, complementing what monetary policy could achieve.

As I come to the end of this (long) post, which was partly for me about getting some lines straight, I want to stress that I am not opposed to the use of fiscal policy in this crisis –  if anything, in the short-term I have argued for an approach more generous than the government’s to date, and I’ve also suggested another pervasive instrument (a temporary reduction in GST) as one possible component of a whole-of-government stimulus approach.

But when monetary policy options are open but policymakers simply refuse to use them, I worry that too little will be done in aggregate (monetary policy has always been a key part in countering any serious downturn).  Perhaps there will be a really big fiscal policy push but, as above, that has a lot of downsides, including that it would materially constrain future policy options in a wide range of areas.

But I suspect that perhaps heeding all the caveats about fiscal policy, the authorities will simply be content to let unemployment linger at unnecessarily high levels for years.  That happened after 2008/09, from a relatively low peak of unemployment.  It would be shameful if it were allowed to happen again –  perhaps especially so if it happened under a Labour-led government.

Fiscal policy should not, and probably cannot, effectively carry the main burden of the huge additional policy stimulus the current situation calls for.

Monetary policy needs to be set to do its job, and do it aggressively.  At present, it is simply playing distraction theatre (here and in most other countries).  As the golden fetters had to be broken in the early 1930s, so what I’ve called the “paper chains” (so easy to break, and yet central bankers won’t do it) that stop interest rates going deeply negative as they should be for for time need to broken decisively, here and abroad.

 

 

 

 

Having mentioned yesterday the Oxford Covid-19 Government Response Stringency Index, I was playing around with variants of this chart, tracing the responses of various governments through time.

On this variant I’ve included the Anglo countries and most of the countries of western Europe.

It is only one index, and only as good as the presumptions about what mattered of those who put it together, but it is now quite widely used and cited.

In detail of course it is hard to read, but my main interest was in New Zealand relative to where the generality of other western countries were, and you can read the New Zealand line: throughout the “Level 4 lockdown” the compilers of the index judged our restrictions to be the most stringent of any of the countries, although as at the last updates –  and they aren’t updating every country every day – we had dropped a bit below Italy and France.   The Australia line is hard to see individually, but you can see from the listing at the right that as of now it has the third least stringent regime of any of the countries shown.

(Note that some countries –  including Australia and the United States –  are federal systems with differing degrees of restrictions in individual states: I presume the index is capturing some sort of representative degree of restrictiveness.)

Here is the same chart showing New Zealand, Australia and the east Asian advanced countries.

Singapore is, of course, the salutary case.

Those who read my post yesterday will have seen that I reckon it is plausible that GDP will fall by about 25 per cent in the June quarter, similar to the Bank of England expectation for the UK.  I was interested yesterday afternoon to see that the Reserve Bank of Australia is expecting “only” a 10 per cent fall in GDP in the June quarter.   Even our market economists are materially more pessimistic than that for New Zealand.

Now, as everyone recognises, big GDP losses were going to happen whatever governments did.  The data in the US indicate clearly, across states, how much economic activity had already fallen away before state or city governments imposed severe restrictions.  We saw signs of that here too – I recall going to Auckland a few days before the move to “Level 4” was announced and talking to taxi drivers who’d waited six hours for a single ride.    But, equally, there is little doubt that the extent of the restrictions has affected the extent of the loss of economic activity now (it is an open question whether there are large trade-offs re future losses of activity: only time and lots of research will tell fairly conclusively).   New Zealand’s near-term economic loss looks likely to have been larger than most –  a lot larger than Australia’s, at least if the RBA is to be taken seriously.

Perhaps some will think of this as just a perspective of hindsight.  But there is reason to think it shouldn’t be seen that way.

For example, my interest was piqued when I saw this this morning

I haven’t yet read the Ministry of Health paper referred to  (the pro-active release documents are all here), but I did watch the interview and James Shaw didn’t dispute that it was an accurate account of the Ministry’s advice, apparently on 21 March.

And one can add to the mix the paper Ian Harrison, of Tailrisk Economics, wrote several weeks ago casting doubt on the modelling that the Prime Minister has cited in defence of her government’s stance.

At very least, it should lead to some quite stringent questioning for the Prime Minister and other senior Cabinet ministers about the robustness of their advice and their decisionmaking.  I will look forward to tracking down, among the papers released, the cost-benefit work (formal or informal) that The Treasury and/or the Ministry of Health provided Cabinet before the decisions were made.   Perhaps if these papers had been released contemporaneously –  given that magnitude of the decisions involved –  not six weeks later, these questions might have been posed much earlier, when doing so might have made a difference to outcomes.  Of course, no one can know counterfactuals with any certainty –  partly because no one can also know quite what difference the marginal interventions themselves made – but that shouldn’t stop the scrutiny and challenge, even if it only highlights other failures in our systems that perhaps might have made such intense restrictions, such large near-term economic losses, more necessary or justifiable.

I was going to attempt to articulate today where I agreed and disagreed with both the New Zealand Initiative’s Bryce Wilkinson and Social Credit on money, banking, fiscal policy etc (Social Credit having taken out a half page advert in Saturday’s Herald to attempt to rebut Bryce’s recent Herald op-ed, itself drawing on a longer recent Initiative publication).  Perhaps tomorrow.

But in this morning’s papers I saw reference to a new plan (and/or critique of other plans) for policy in responding to the economic challenges of Covid, under the joint authorship of former Minister of Finance Roger Douglas and Auckland University economics professor Robert MacCulloch.  MacCulloch kindly sent me a copy of the ten page underlying paper which goes under the title “In a New World, New Thinking is Required: Why Prioritization of Resources is Crucial to New Zealand’s Economic Recovery in the Wake of Covid-19”.  MacCulloch’s Herald op-ed puts it more pointedly and succinctly under the headline “The time has come for trickle-up economics“.

Here is their Executive Summary

The Covid-19 outbreak has not only precipitated a health emergency, but also an economic crisis, unparalleled in modern history.  For New Zealand to emerge from that crisis in a relatively healthy state, the Labour government will need to provide a clear framework for recovery, implementing policies which clearly prioritize those most affected by the societal and economic lockdown necessitated by the outbreak. To date, such prioritization has been lacking, with the Wage Subsidy Scheme unfairly advantaging big business and the professional elite, at the cost of money and resources which could have been better directed towards assisting the newly unemployed – namely workers, their families, and small business owners.

Ultimately, poorly targeted support in the form of helicopter payments, wage subsidies, or broad-based tax cuts (such as a moratorium on GST) is wasteful, and will only serve to entrench inequalities that existed prior to the pandemic.  Equally, the time and costs inherent in planning large-scale new infrastructure projects – and the fact that they offer little practical help to the majority of workers who require help now – means that they should not be regarded as a panacea, aiding economic recovery.

Instead, clear, innovative policies, which not only prioritize those most in need, but which also lay the groundwork for further social and economic reform in the medium to long term, are required.  For workers and their families, support can be offered via the mechanism of special risk accounts, tailored to meet their individual needs.  For small business, help can be provided by facilitating conversations between businesses, landlords, and banks, as well as providing – upon the provision of an approved business plan – forgivable government loans.

Finally, to help manage the recovery, and ensure our younger generations are not saddled with debt, the government must also identify, and eliminate, unnecessary spending, privilege, and waste.  It can find an extra $15 billion per annum by doing so, contributing to the recovery in the short term, and – more generally – to implementing wider scale reform once the immediate crisis has been put behind it.

It is an interesting argument.   If it weren’t already a sadly-debased word, one might almost be tempted to label it “populist”.  Douglas and MacCulloch don’t seem to have a problem with the idea of a wage subsidy scheme per se, but object to big businesses having claimed it.

Whilst the scheme, which already comes at a cost of $10 billion, has undoubtedly provided short term support to those who needed it – workers and small businesses – it has also been used to prop up corporate monoliths and institutions who should have been left to fend for themselves or – at the very least – should have received assistance in the form of a loan, instead of a handout.

But it isn’t clear why they think small businesses are worthy but big businesses (and the employees of the respective businesses) aren’t.     Big businesses can often operate on very tight margins, and plenty of small businesses have had no special problems at all.

Personally, I’m not persuaded of the merits of how the wage subsidy was designed: as I’ve noted before the roots were in that perspective from months ago when the government thought the coronavirus issues were about China and the slow recovery of New Zealand exporters to China (including tourism).  You had only to affirm that your revenues would be down 30 per cent in one month to get three months of wage subsidies, even though the “Level 4 lockdown” – the worst, government-imposed, period for many – was only about five weeks.   But the large vs small company distinction simply doesn’t make a lot of sense to me, and (relative to need) there is no obvious reason why large companies should have more resources to tap than small companies.

My own unease about large companies is the special unit the government has set up in The Treasury to assist big companies.  Since the initial Air New Zealand bailout not much has been heard of its activities, but the risk is that prominent, persuasive and well-connected big firms will end up much better treated than the small firms.  Partly as a result, as far as possible, I favour one model for all.   Done openly and transparently (there being all too little of that, not just around eg Cabinet papers and associated advice, but I think I saw an article recently noting that the deeds under which the Business Finance Guarantee Scheme are operating are also not being disclosed).

In many respects, however, the focus of the Douglas/MacCulloch paper is more forward looking from here.

They start with a point on which I totally agree with them

To date, there has been little sense that the government has a cohesive economic plan to take us forward, either in terms of building the solid foundations required to help navigate our way out of the crisis (the short term response), or in terms of preparing the policies that will help New Zealand not simply recover, but stand stronger than ever (the medium to long term response).

They set out quite a lengthy list of “objectives for reform”, most of which I’d agree with, before moving on to some specifics, noting that

Right now, the protection of individual New Zealanders and their families must be the government’s number one priority.

They propose moving away from a model that has worked by funding employers to funding households/individuals directly

The mechanism for such support would be a special risk account, tailored to meet the specific needs of individuals and their families (if they have one). It would operate as follows:

• Step One: A company or employer makes it clear in writing that they cannot support an employee during the crisis or in its immediate aftermath.

• Step Two: The employee is either made redundant, or temporarily underemployed/unemployed, with the expectation that they will be re-employed once the crisis has passed and the business – inasmuch as it is possible – resumes its normal footing.

• Step Three:  A special risk account is set up and documentation downloaded into that account for the employee to fill out.  This documentation will help him/her identify any special support they require, including meeting mortgage or rent payments, as well as family, sickness, or any other (pre-qualified) payments.

• Step Four: Government provides payment (for a prescribed term and up to a specified limit) directly into the special risk account. If the account holder is already receiving unemployment support, which will be the case in many instances, then this payment will top up that support.

It does seem materially more resource-intensive than the wage subsidy scheme, so could not have been put in place at scale as quickly.  I suppose it has the advantage of directly getting money in the hands of households, but then the established welfare system does that anyway (complete with supplements like the Accommodation Supplement).

The authors argue

By tailoring assistance to individual workers, the government can ensure that the support it provides meets specific needs, in a way that poorly targeted helicopter payments, subsidies provided to businesses, or even broad based tax cuts (such as a moratorium on GST) cannot.  Not only that, such support also provides workers with a measure of respect, as well as a sense of autonomy and self-responsibility, that can only help to engender confidence, both at an individual and societal level.

There is something to the first sentence, relative (say) to those favouring lump sum handouts to everyone. On the other hand, some of the other ideas they seem to be pushing back against are more about demand stimulus in a recovery phase, rather than dealing with the direct income support issues.

The second section of the plan is about small business.  It begins

Small businesses are the lifeblood of New Zealand’s economy.  Sadly, not all of them are going to survive the health imperatives of the Covid-19 outbreak, which saw their closure.  It is important, however, that as much as can be done, is done, to help viable businesses recover.  In the short term at least, this will require other interested parties to step up, including banks and landlords, proffering help to small business owners by sharing their burden.

Not too sure about that “lifeblood” bit –  there are lots of them but the smaller number of much larger businesses also employ a lot of people and are the vehicles through which much GDP is generated.  But set that to one side now.   What about those “banks and landlords”?

In such an environment, the hard-nosed approach adopted by some landlords is short-sighted.  If a small business owner cannot meet the costs of a lease, and is forced to relinquish his/her business, then the property is likely to sit empty, with little prospect that it will be leased again in the short term. Much better – and more realistic – is the approach taken by groups like Westfield, who have signaled their intent to drop rents in their malls.

One might well agree with all that – and it would be consistent with an interesting post from Bob Jones a day or two back from his perspective as a large landlord –  but it isn’t really clear what it has to do with the government.  After all, tenants and landlords agree on how to allocate risk within their relationship, and they can also agree to vary those provisions, so what role for the government.

Similarly, the banks

 Here, the banks have an important role to play, coming to the party by negotiating adjustments to mortgage payments that reflect the new economic realities of life, post-Covid.

And, of course, banks have put in place residential mortgages “holidays” (delayed payments) and put a lot of commercial customers temporarily onto an interest-only basis.   But again, if customers have taken a fixed interest rate that was an agreed commercial risk-sharing arrangement.  And if they are on a variable rate, it might be better to look to our central bank, which sets the short-term interest rates that influence variable loan rates –  and which, thus far, refuses to cut them any further come what may.  Surprisingly, in a piece on macrostabilisation and recovery, monetary policy isn’t mentioned at all.

Douglas and MacCulloch go on

Of course, simply reducing rents, or even imposing a ‘rent holiday’ for a couple of months, will not be enough to save many businesses.  It is here that the government has a role to play, supporting viable businesses in the form of forgivable loans.

And their plan?

The following, four-step strategy, is suggested as a way of supporting small businesses in trouble:

• If a business is unable to meet the costs required to open its doors again, or faces short-term difficulties, it will be required to meet with a business consultant, accountant, or government appointed consultant.

• As part of the consultation, it will be determined whether or not the business has a viable future.  If a path forward can be found, then a business plan will be created.

• In the first instance, this plan will form part of any conversation that takes place between the business owner and his landlord, as a means of setting new, realistic rent payments that will help keep the business afloat.  If necessary (and in the manner outlined above), the landlord’s bank should also be party to this conversation.

• Should rent mitigation not be enough, the business owner can also approach the government for a forgivable loan.  An assessment will be made at this point about the viability of the business plan, and – if successful – a tailored loan will be provided to help the business recover.

It should be noted that the intent of this plan is not to provide loans to companies that have access to plenty of liquidity and other sources of capital.  Rather, given the large sums that will inevitably be involved, the plan is for the benefit of those businesses that have been unduly affected by the lockdown and which need our support in the short-term.

It isn’t clear what the criteria would be for forgiveness?  Presumably many businesses will end up defaulting anyway –  as under the government’s IRD scheme for SMEs –  but is the debt forgiven if your business survives or if it fails?

What is also striking –  and this is a point I’ve made about many schemes –  is that there are likely to be many businesses that, in principle, could be viable if we could simply wipe 2020 from the calendar and resume life in 12-18 months time.  But in many cases it simply will not be worthwhile –  the business will never generate enough –  to justify taking on a lot more debt now.

The third strand of their plan is under the heading Infrastructure.  They are sceptical of large-scale infrastructure projects

Put simply, large scale infrastructure projects are not only expensive, they take a long time to plan and implement; time we simply don’t have right now.

Mostly, as I’ve written elsewhere, I agree, although not always for their reasons (I rather doubt availability of labour is going to be a big constraint).    They are keener on the housing side

If the government is to institute a big infrastructure push, then housing is perhaps the one area where this makes sense.  It is an industry that employs a large number of people, and new housing stock can help resolve a long-standing social and economic problem confronted by many New Zealanders – the inability to afford their own home.

Perhaps, but as they surely know land prices –  not houses –  are the biggest obstacle.  Not in the paper itself, but included in a Stuff article on the paper, Sir Roger is quoted thus

One area where there should be increased stimulatory spending is housing. In this area, Douglas described something like a supercharged KiwiBuild paired with planning reform and a shared-equity scheme.

Douglas said the key to getting housing right was “making a large quantity [of houses] available”.

The Government had to go into section development, while making sure land was released for building by reforming planning laws. There was plenty of land out there, but not enough capital to develop it.

Low-income people could be helped into housing through a shared-equity scheme, where the Government would take on part of their mortgage.

When asked how his state-backed building scheme would succeed where KiwiBuild failed, Douglas said it was a matter of getting the right people involved to notch up big productivity gains.

Among other issues one could raise, it isn’t fully clear to me how they can tell big business to look after themselves because there is plenty of capital available, while telling us the problem around housing is lack of capital to develop land.   And I’m not sure the label KiwiBuild should really ever be used again for something an advocate wants taken seriously.

The penultimate section of the paper is headed “Where Will the Money Come From?”, which doesn’t really seem to distinguish between the large deficits that are more or less inevitable (even on their reckoning) right now, and the fiscal prospects in say five years time (which don’t look bad at present to me, especially given our low starting level of debt and low debt service costs).    Anyway, their specifics are

It is also why we must look to eliminate privilege and waste, both of which have been part of New Zealand’s economy for too long. In total, there are $15-16 billion dollars of savings we might make per annum, simply by removing unnecessary government spending:
1. Ending Waste: By removing Kiwi Saver tax breaks and subsidies, by ending future government contributions to the New Zealand Super Fund, by retargeting income derived from those funds, and by reducing the excessive Votes available to government departments, we can quickly access approximately $9 billion per annum

2. Eliminating Privilege: Unnecessary privilege is entrenched in New Zealand society.  By ending corporate grants and tax breaks, by stopping the Provincial Fund, by removing high income families (approximately 15% of the population) from access to Working for Families and Winter Energy subsidies, and by ending tertiary education grants for students other than those from low capital and low income families, we can make further savings around $7 billion per annum.

That is a bit of a mixed bag.  They aren’t specific on the “corporate grants and tax breaks” they want to end, although if that includes film subsidies I’d certainly agree with them.  But not all these savings are real savings, except within the current government accounting framework.  I might (do) agree we shouldn’t be putting money into NZSF, but it is still government money – it is why when I talk about net debt I always use an NZSF-inclusive figure.  Stopping contributions might free up some cash, but cash isn’t the real constraint here.  Similarly, they might want to take NZSF earnings straight into the Budget, but it doesn’t change the substance – the earnings still improve the Crown’s position.    I could happily sign up to a list of perhaps 20 government agencies to abolish entirely, but……sadly or otherwise, those aren’t where the big bucks are.

Douglas and MacCulloch end their paper with a section on “Building a Better Future”.    Like me, they are energised by the continuing relative decline in New Zealand’s productivity performance (and, I think, fearful that things may only worsen relatively in a post-Covid world).  Douglas and MacCulloch have written previous papers about far-reaching welfare reforms –  I wrote (sceptically) about one such presentation here –  and it is clear that that is still a focus now.  They end this way

In an upcoming paper, the authors will examine in more detail what has gone wrong, why we should immediately set up working committees (SOE style) to make recommendations for the future, how we can free up an extra $20 billion via vastly improved productivity outcomes thanks to structural social welfare reform, and how we can use that money (along with the $15 billion previously freed up thanks to the elimination of waste and privilege) to institute innovative policies in areas as diverse as health, housing, education, welfare, personal tax, company tax, and superannuation.

Ultimately, we have a choice. We can either muddle through as we are – relying on policies that haven’t worked since the 1950s and which are ill-suited to our quickly changing world – or we can opt for a reset, introducing social and economic policies that will make New Zealand not only a richer but more equitable place to live; a country where every New Zealander has the chance to take control of their lives and secure a better future for themselves and their families.

It will be interesting to see their fuller plans.  I wholly agree on the need for something quite different, although am more sceptical than they are that the welfare system as currently configured can explain any material amount of our continuing long-term relative economic decline.

I ended that earlier post this way

In many respects, the saddest line of the day was one made almost in passing by Professor MacCulloch. He told us that he administers a fairly generously-funded visiting professorship at the University of Auckland, which aims to bring in distinguished or innovative, leading international thinkers to contribute to policy debate and development in New Zealand. But the last three people who had been invited had declined the invitation to come. There was, so far as they could tell, nothing bold or interesting on the table here, no real prospect of significant reform, or interest in it from our political leaders.

Things were very different, in that regard, 20 or 30 years ago. It is not as if, sadly, we have in the interim solved all our problems, and re-establishing a position as a world-leading economy, or a world-leader in dealing with the various social dysfunctions. We just drift, and allow our elites to tell themselves (and us) tales about how everything is really just fine.

I guess at least we know things aren’t fine right now, but the contest ahead at present seems to be mostly between those who think New Zealand as it was last year is fine and those keen on building some version of new inward-focused Jerusalem that does not involve successfully earning our way in the world.

As for me, I still think some variant of my “national pandemic insurance” approach is the best – and most equitable – way to frame and think about immediate assistance, continue to think that monetary policy should have a key stabilisation, support and recovery role, and that we need to be looking outwards much more, with activity led from the private sector if we are (a) to get back to full employment as quickly as possible (not repeating the very slow post-2009 fall in unemployment) and (b) have some chance of finally building a more productive and prosperous New Zealand, reversing the gaps to much of the rest of the advanced world that have opened up and kept widening for decades now.

 

 

 

In the Western tradition, the idea of the year of jubilee comes to us from the Old Testament.    The idea was to avoid permanent alienation of people from their ancestral land –  in effect, land transfers were term-limited leases, and if by recklessness or bad luck or whatever people lost their land it was for no more than fifty years. In the fiftieth year –  the Year of Jubilee –  all would be restored: land to the original owners and hired workers could return to their land.   It wasn’t a recipe for absolute equality –  the income earned wasn’t returned etc –  but about secure long-term economic and social foundations.

For many –  for me –  it has an appeal, although one could argue that in many respects modern society already reflects some of the vision underlying the original near-eastern ideas: after all, we prohibit slavery, we allow personal bankruptcy (and discharge from bankruptcy without paying all the original debts), we provide education free at the point of use, and a welfare system for those who might otherwise fall through the cracks.

But this post isn’t about exploring those ideas, but about one very specific modern championing of the idea that we hear a bit more of again at present: the idea of some sort of debt jubilee in which, in a highly-indebted system, the outstanding debt is, in some form or another, simply written off.

One person who has been championing such a scheme for some time is Professor Steve Keen, an Australian economist now teaching at a university in London.   He has quite a following in some circles – I used to read his blog moderately regularly for a time, and perhaps 7 or 8 years ago The Treasury hosted a visit here (in the course of which his stocks sank among most officials).  However, he was interviewed a few weeks ago by Gareth Vaughan at interest.co.nz on his ideas for policy in the wake of the coronavirus.  He and I share the view that the biggest macroeconomic risks at present are deflationary rather than inflationary but, it would seem, we agree on little else.   You can read or listen to his other ideas for yourselves if you choose, but one strand of what he was championing was a “modern debt jubilee”.

I do not wish to be seen to be critiquing or attacking a straw man, but I have had difficulty finding anything online that sets out in very specific terms exactly what he has in mind.

Here is what he said in the interview

Firstly, Keen says, they should be implementing a modern debt jubilee now.

“It’s quite feasible to do it [but] I never thought it would happen. People asked me what chance I thought this had of happening. I said it’s less than a snowflake’s chance in hell. We are in hell now and the only way out of hell, as well as getting a vaccine for the virus, is to reduce this burden of private debt otherwise we’ll have a financial collapse after the coronavirus,” says Keen.

The alternative, he argues, is mass loan defaults.

“You simply have to accept that debt can’t be repaid when too much debt has been issued. So we have to reduce private debt and we have to do it now. [We] should do a debt jubilee now, not once we get through this crisis. Otherwise there’ll be many people who can’t pay their rent, as well as people who can’t pay their mortgages,” says Keen.

“If we do it now we’ll enable the payments system to continue functioning. If we don’t do it now then it’s quite possible the payments system will collapse. Small businesses won’t get any cash income, households won’t get wages. Everybody will end up having no money in their bank accounts because that money will be used to pay off debt.”

What Keen’s advocating for is governments’ capacity to create fiat money being utilised to distribute an equal amount of money per person across entire countries.

“And people who were in debt would get their debts reduced, either by an offset account or by actually paying their debts down. People who are not in debt get a cash injection. And that cash injection can also be used to buy newly issued corporate shares which are used to pay down private debt. So as well as reducing household debt, you reduce corporate debt and you also democratise the ownership of corporations,” says Keen.

And although I have found a couple of other references (including here and here)  there is still no sight of some critical parameters.

Nonetheless, it is worth bearing in mind that elsewhere in the interview he describes the large increase in household debt in recent decades as “unconscionable debt” and repeatedly highlights the very large increase in the ratio of household debt to GDP in New Zealand since about 1990 (about 30 per cent then, about 100 per cent now).   And although he talks about “reducing” household debt, “jubilees” have connotations of very substantial writedowns, so he clearly isn’t talking about something like dishing out, say, a mere $10000 per household/person.  The Reserve Bank tells us that as at the end of last year recorded household debt was about $310 billion.

Moreover, Keen also tells us (see extract above) that he thinks the same amount should be distributed to everyone.  I’m not sure whether he really means “everyone” or just adults, but since under-18s can’t contract binding debts there shouldn’t be any need for jubilees for them.  That still leaves 3.8 million residents (and here I’ll just ignore the fact that a significant number of them are temporary non-citizen residents; I just want to get a sense of the plausible scale of what Keen might be calling for, not tie down every detail).

As we all know, recent first home buyers in Auckland typically have to take on fearsome levels of debt.   They appear to be the sort of people Keen focuses on, since he blames the rise in house prices on banks and their over-aggressive (“unconscionable”) lending setting up a house of cards that might otherwise be about to tumble.  I presume a $500000 mortgage isn’t at all uncommon (last year the nationwide average first home buyer mortgage was about $400000) and many will be larger than that.

Now, of course the typical new buyers are a couple, but for those marginal Auckland purchasers that might still be $250000 each.

I presume Keen does not have in mind giving them –  and all the rest of us –  $250000 each, although doing so would certainly allow most (but not all) mortgage debt to be fully repaid.     But even if we wanted to make possible a 60 per cent writedown for those couples with the new unconscionable $500000 mortgage, he’d still have to be looking at $150000 each, as gift/grant from the Crown.  Across 3.8 million adults, that seems to come to $570 billion dollars.

All paid for, in his own words, through the Crown’s ability to create fiat money –  change the Reserve Bank Act and get for the Crown an (interest-free) overdraft of $570 billion.  Halve the payment and it is still serious money.

You’ll have noted that Keen is also concerned about corporate debt –  a big concern at present in some countries (where it has grown rapidly in recent years) but much less so in New Zealand.  For those –  most of us –  without mortgages (whether because we have paid them off, or never been able to get into the housing market in the first place), we get a rather large addition to our bank balances.   Keen notes that the proceeds could be used to buy “newly issued corporate shares which are used to pay down private debt”.

I don’t know about you but I know what I would be doing not just with my $150000 but with all my non-indexed financial wealth the minute I thought that anything like what Keen was proposing was likely to be implemented: I’d be looking to put it into real property (houses, gold, whatever) or getting it into the currency of a country not adopting such a policy.  Anyone with non-indexed debt at present would prudently be doing the same –  and locking in a long-term fixed interest rate – not using the proceeds to pay off debt.  It might be hard to generate inflation at present, under present –  largely self-imposed – constraints, but simply handing $570 billion will do it.

I hope all regular readers will recognise that I am not one of those looking for inflation under every stone.  I worry about deflationary risks at present –  as does the market – and I do not believe monetary policy is doing anything like enough to respond to those risks at present.  Much as I am sceptical of the idea of giving out some modest amount (say $2000) to everyone as some sort of stimulus, in the current climate – large negative output gap, little or no inflation –  such a payment, even funded directly by the Reserve Bank –  would be net stimulatory in the near-term.  There is a considerable amount that can be done to get us back towards full employment as soon as possible.

But not by simply handing out $570 billion, with no obligation to repay.

(Presumably Keen does not think his scheme would dissolve into very high inflation, but I’ve never seen him anywhere articulate the case for why not.)

When I think of debt writeoffs, I think of explicitly recognising that someone has to bear those costs –  on any very substantial scale there are few/no free lunches.  Banks will have to write off some debt –  perhaps quite a lot –  over the next few years, and their shareholders will bear that cost.  That is the business they went into.  Writing off mortgage debt more generally on the sort of scale Keen seems to envisage can only be done by imposing fearsome losses on others.  It is so utterly different from that Old Testament conception (which, in effect, limited the scale of liabilities anyone could run up in the first place).

I have some sympathy with the view that requiring young –  and now not so young –  people to take on multiple hundreds of thousands of dollars of debt to get into a basic house in our cities is pretty unconscionable and deeply unjust. But, frankly, that isn’t fault of the banks but of the central and governments that make land –  a resource we have in abundance – artificially scarce.  In fact, I’ve even gone so far as to argue that if ever we managed a government with the courage to fix the land market, it might be both opportune (building coalitions) and just to offer some compensation to the losers –  those more or less compelled to take on very high debt in recent years just to get a foot on the ladder.   But there would be an explicit, shared, cost to that.

And more generally I’m not persuaded that current debt levels –  public, private or total –  in New Zealand pose any vast threat of economic or financial collapse.  Keen likes to highlight how much debt has risen since, say, 1990, but it isn’t obvious why that is the most relevant benchmark.  In a speech I wrote with Alan Bollard a few years ago, I included a chart showing that mortgage debt (house and farm) was materially lower then  as a per cent of GDP than it had been in 1920s New Zealand,  I rechecked the numbers this morning and the picture today is the same as it was in 2011.  Contrary to Keen, our banking system looks pretty robust, not ricketty.

I also take the view that there is plenty that can and should be done to assist individuals and firms through the next few months.  There is a strong case for income support (broadly defined) or even income insurance (of the sort I’ve championed here) but that is very different proposition than somehow looking to wipe out debt without identifying whose claims to real resources will be wiped out to pay the economic cost of that (as distinct from the “which account to write the cheque on” issue that Keen deals with).

You might be wondering why I bothered with this post, or dealing this extensively with a pretty extreme idea.  The reason is that Radio New Zealand is recording tomorrow (for broadcast on Sunday morning) an interview with both me and Keen. I might have more to say about some of his other ideas –  some of which make Winston Peters championing New Zealand manufacturing seem moderate –  next week. In the meantime I wanted to understand as well as I could what Keen was actuallly championing on the debt front.  As I said, I don’t want to attack a straw man –  that never persuades anyone –  but I simply haven’t yet found an articulation of what he is proposing that looks economically feasible or sensible.