Why so secretive?

Five weeks ago now, on 7 November, the Minister of Finance announced a process for his review of the Reserve Bank Act.    There was to be a two-stage process: the first stage led by Treasury to come up with specific recommendations on how to implement the Labour Party promises around monetary policy (goal and decisionmaking issues), and then an amorphous second stage, to be jointly led by the Reserve Bank and Treasury, to look at other  –  as yet undefined – issues around the Reserve Bank Act.  We were told that the phase one would be completed, with a report to the Minister, in early 2018.

Presumably the work is well underway.  At the post-Cabinet press conference the other day, we were told that the new Policy Targets Agreement –  which has to be signed by the Minister and the Governor-designate before Adrian Orr can be formally appointed  – will be informed by the recommendations of the first phase of the review.    As Orr is scheduled to take office on 27 March, you’d have to suppose that the report of the review would have gone to the Minister of Finance at least a couple of weeks prior to that.    After all, Orr himself would need to consider any proposed changes to the PTA, and might wish to take his own advice from Reserve Bank staff.

But if the work is well underway it is being kept very secretive, something that seems quite out of step with how things were portrayed when the Minister announced the terms of reference and associated process five weeks ago.

For example, we were told that an Independent Expert Advisory Panel was to be appointed.  According to the Q&A sheet issued on 7 November

Who will be on the Independent Expert Advisory Panel?

The panel members will be announced once they have been confirmed, but they will be individuals with independence and stature in the field of monetary policy, including in governance roles.

But there has been no announcement.   Either members haven’t been appointed yet –  in which case, how is the work going to be well done in the remaining time? –  or the Minister has gone back on his commitment to openness.  I have Official Information Act requests in with both Treasury and the Minister seeking the names.  The expectation of openness was confirmed with this q&a

Will their views be made public?

In commissioning the review, I have asked officials for advice on the terms of engagement of the Independent Expert Advisory Panel. This will include how their views are made public, and further details will be made public once that has been confirmed.

Note the “how”, not “whether”.   But, five weeks on, still no details.

The Minister also promised more details about a timeline for the whole review.  Five weeks on, heading into Christmas, still no details.  At yet the first stage is supposed to be completed by early March.

When will it conclude/report?

I expect the Treasury to report to me on phase one of the review early in 2018.

In commissioning the review, I have also asked officials to develop a detailed timeline for the review, and more details will be provided once they have been agreed.

I had supposed that the review would be seeking submissions or public input.  I wondered if that was just my imagination, but no.  Going back to the Q&As

Will there be public consultation? When?

I have also asked officials to develop a detailed timeline for the review, including how public consultation can best be facilitated. More details will be made public once they have been agreed.

Five weeks on, heading into Christmas, still nothing.   If the underlying review by officials is well underway, it makes a mockery of any sort of public consultation if views are only to be invited very late in the piece, if at all.

I’m not sure what the Minister of Finance can possibly have to hide.  The Labour Party campaigned on making changes along these lines, and the first stage of the review is supposed to be largely about giving that effect, and associated consequential issues.  But whatever the reason, it isn’t a particulary look, and again undermines any suggestion that the government might be committed to a more open approach.   Rhetoric around the Official Information Act is fine, but this stuff should be easy –  and it was explicitly promised weeks ago, in a review that is operating to tight timeframes.

It also isn’t clear why the Minister and Treasury are still keeping secret the Rennie review and associated documents.  The Rennie review of Reserve Bank goverance was commissioned by Treasury, at the request of the previous Minister of Finance.  The report was completed in April, and yet Treasury has repeatedly refused to release it and associated material (eg comments from expert reviewers), even though it is clearly official information and should be highly relevant to discussion/debate/submissions around the new government’s own proposals and review.      I have appealed the latest denial to the Ombudsman, and had confirmation this morning that the Ombudsman has opened an investigation.      But such investigations simply shouldn’t be needed, if we had any semblance of an open government.

As noted above, a new Policy Targets Agreement has to be agreed and signed by March.    The Policy Targets Agreement is the major document guiding short-term stabilisation policy for the next five years –  it affects us all.   And yet it seems that deliberations will continue to go on in secret (as has been the custom).    Again, it would be a good opportunity for a more open approach.  I’ve pointed previously to the Canadian model of conducting the research leading up to the renewal of the inflation target early and openly discussing/reviewing/debating it in public seminars/workshops.  It would be a good practice to adopt here, but it is probably too late for this time round.  But it wouldn’t be too late for the papers the Reserve Bank and Treasury have inevitably already prepared on the topic to be made public, in a way that would enable market economists and other observers to provide input on how this major macroeconomic tool is to be specificied and managed for the next five years.    We’d never pass legislation as secretly as the PTA is done. Indeed, the Reserve Bank couldn’t even put on the latest iteration of LVR controls  –  half-life perhaps one year – without proper serious consultation.  It is time for a more open and consultative approach to shaping macroeconomic policy.   Robertson (and Orr) could lead the way.

In addition to the work Treasury and Reserve Bank staff have done, consultation could take account of the comments the Minister made recently about contemplating removing references to the target midpoint from the PTA (I have mixed feelings about that idea, but think it is probably a bad idea, reinforcing the weakness of inflation expectations).  And there were other suggestions at the post-Cabinet press conference –  Robertson talking of how the government doesn’t just want the Bank to focus on price stability, or employment, but on “the overalll wellbeing of New Zealanders” –  that dread Treasury phrase once again, as devoid of specific meaning as ever.   But in case he isn’t aware, the 4th Labour government already included its own “virtue signalling” mandate in the Reserve Bank Act

169 Bank to exhibit sense of social responsibility

It shall be an objective of the Bank to exhibit a sense of social responsibility in exercising its powers under this Act.

38 years on and still no one knows what it means, if anything. But it probably felt good to include it.  Perhaps those words could be carried up into the Policy Targets Agreement, and the Governor could cite them every so often?

 

 

 

 

 

 

Towards a definition of the (un)employment objective

In my post the other day, I outlined one way in which the unemployment concerns that appear to be behind the Labour Party’s desire to amend the statutory objective for monetary policy could be implemented in a new Policy Targets Agreement, even before the Reserve Bank Act itself is amended.

We still have no specifics as to how the Labour Party (and now the Labour-led government) envisages changing the Act.  But in an interview on Radio New Zealand this morning I heard the Minister of Finance talking about looking to the specifics of the Australian and US legislation.   I didn’t find that very enlightening or reassuring.

The Reserve Bank of Australia was set up in 1959, and the section of its legislation relating to monetary policy goals and objectives was in the original.

It is the duty of the Reserve Bank Board, within the limits of its powers, to ensure that the monetary and banking policy of the Bank is directed to the greatest advantage of the people of Australia and that the powers of the Bank … are exercised in such a manner as, in the opinion of the Reserve Bank Board, will best contribute to:

a.  the stability of the currency of Australia;

b.  the maintenance of full employment in Australia; and

c.  the economic prosperity and welfare of the people of Australia.

In 1959, Australia –  like most countries –  had a fixed exchange rate, so that “the stability of the currency of Australia” meant the external value of the currency.  The provision has since been re-interpreted, and as is now taken as meaning the domestic value of the currency (ie domestic price stability), but no one would write the provision that way today.

This wording is also legitimately subject to the criticism made by those who disagree with what Labour is proposing.  It makes no attempt to distinguish between the short and long run, and thus does not recognise that monetary policy cannot affect the longer-term rate of unemployment at all.    The Australian legislation also has nothing like a Policy Targets Agreement (the document that resembles a PTA is informal and non-binding) and provides far too much discretion to the Reserve Bank.  That discretion has not been blatantly misused in recent decades –  a period when the actual conduct of monetary policy in New Zealand and Australia have mostly been quite similar –  but the legislation should not provide any sort of model for New Zealand as to how best to specify the goals of monetary policy.

What of the United States?   Much is made of the “dual mandate” that has guided the Federal Reserve over the decades.   But even that, mostly quite sensible, conduct of policy rests on a rather slender and unreliable legislative footing.    The statutory objectives in the Federal Reserve Act were set out in 1977, around the high tide of monetarism, and read as follows:

Section 2A. Monetary policy objectives

The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.

In other words, the Fed is actually mandated to pursue long-term money and credit growth targets, in the belief that doing so will promote (a) maximum employment, (b) stable prices, and (c) moderate long-term interest rates.  Again, no one would write the statutory objectives that way today, and the formulation should offer little or no guide to anyone looking to overhaul the objectives of our own central bank.  In practice, of course, the Federal Reserve works around the statutory formulation, rarely citing it directly.  I think they way they run monetary policy in practice is quite sensible –  and typically not that different to the way the Reserve Bank here has often run policy –  but I bet they wish Congress had written the goal a bit differently in 1977.

In an ideal world, both the Australian and US statutory provisions would be updated and amended.  It isn’t desirable to have powerful autonomous agencies working under the mandates that don’t reflect today’s understandings of policy, leading those agencies to creatively reinvent their own mandates.  Those reinventions probably lead to better policy in the short-run, but the process of doing so undermines confidence in the role of legislatures in mandating, and holding to account, such agencies.

If one looks around the advanced world, there are lots of different ways of specifying central bank objectives. In most cases, the wording is considerably more recent than either the US and Australian examples.  A few years ago a colleague and I did a Reserve Bank Bulletin article reviewing those formulations –  the work initially prompted by the approach of the 2014 election, when Labour was also proposing changes.   As we noted,

Despite the similarities in how monetary policy is operated, there is a wide range of ways in which legislation and supplementary documents specify the medium- and longer-run aims societies have for monetary policy. In some countries the focus is more on the economic outcomes that a successful monetary policy could contribute to over the longer-term.  In others it is more on what monetary policy can more directly achieve. These differences do not seem to primarily reflect very different views of what monetary policy could reasonably accomplish. Specific national circumstances influence how formal documents are written. And older legislation often looks different than legislation adopted in the past 10-20 years, with the latter typically having a more explicit focus on domestic price stability. In some countries, formal documents say relatively little about what monetary policy is expected to achieve, while in other countries the formal documentation is more extensive.

As I’ve noted here previously, I think the sort of statutory change Labour seems to be talking about makes some sense.  In part, that is because monetary policy has –  ever since the late 80s –  been a divisive political issue here in a way that it hasn’t been in other countries.  In part, it is because of the failings of the Reserve Bank –  with many fewer constraints than their peers in many other advanced countries –  over the Wheeler years in particular.    But I’m not sure that the way other countries have worded their legislation is going to be of very much assistance to Treasury and the Minister of Finance as they attempt to come up with some specific proposals.     If I was to offer them specific suggestions, they would involve changes to the purpose clauses , to the clause governing the primary function of monetary policy, to clause 10, and to the clause governing Monetary Policy Statements.

It is perhaps worth remembering that over the life of the Reserve Bank –  now 83 years –  there have been various different formulations of the statutory goals of monetary policy.  Those changing goals were also discussed in a Bulletin article a few years ago.  When the first legislation was enacted in 1933, the statutory goal was simple, if not specific

It shall be the primary duty of the Reserve Bank to exercise control […] over monetary circulation and credit in New Zealand, to the end that the economic welfare of the Dominion may be promoted and maintained (1933, s12).

It is worth remembering that it simply isn’t possible to write down, whether in statute or in a PTA, all that one wants a good central bank to do in conducting monetary policy.  Or, at least, it hasn’t been since we went off the Gold Standard in 1914.     There is no perfect formulation, and good people –  sound judgement and a good understanding of the issues and constraints –  matter as much as precise wording.  Each generation faces differing shocks, differing sets of circumstances, and different things that aren’t well understood.  It is easy, and tempting, simply to set out simple wording like what is in the Reserve Bank Act now.  So long as it is understood not to capture everything –  and successive Governors and Ministers have recognised that –  it may not do much harm, and it keeps a focus on the long-term limitations of monetary policy.  But, equally, we have active discretionary monetary policy because we believe that monetary policy can do other useful stuff in the short to medium term.  Finding ways that reflect that understanding and translating them into legislative wording has its risks –  as not doing so does –  and can’t be done perfectly, but that isn’t a reason for not doing it at all.

And finally, it is worth remembering that, whatever the precise statutory wording, past research has found that, on average, the Federal Reserve, the Reserve Bank of Australia, and the Reserve Bank of New Zealand have tended to conduct monetary policy in much the same way, faced with similar shocks.

 

 

 

A possible new Policy Targets Agreement

“we have unemployment stuck stubbornly at 5% when it should be below 4%”

Those were the words of the Prime Minister in her speech to the CTU on Wednesday.  The latest published unemployment rate was a bit below 5 per cent.   But the average for the last four quarters is 4.95 per cent, and that for the last seven quarters is 5.0 per cent.

And “it should be below 4%”?   That’s a great aspiration –  ideally the unemployment rate should be much lower than 4 per cent, because even 2.5 per cent means that over a 40 year working life the average person spends a whole year unemployed – ie without any work, but ready to start work, and actively looking for work.     But I presume the reference to “below 4%” is more than that, and is something about what is attainable (sustainably) on, broadly speaking, the current labour market regulations, demographics, and welfare provisions.   Most observers think that the rate of unemployment consistent with stable inflation near the target is around 4 per cent.    Some, plausibly –  but we won’t know unless/until we get there – think it is lower than that.   Certainly there has been no sign of any acceleration in wage inflation with the unemployment rate near 5 per cent.

Most material deviations of the unemployment rate from the true (but not directly observable) long-run sustainable rate are, to a first approximation, due to monetary policy choices.    That was true in years leading up to 2008, when the unemployment rate was lower than the long-run sustainable rate –  monetary policy was too loose, and inflation was rising to outside the target band.  It has been true for the last eight or nine years when, at least with hindsight, monetary policy has mostly been a bit too tight. People who are unemployed, unnecessarily, have paid the price.    It isn’t the done thing to mention this in polite society –  few of whose members are affected directly by unemployment –  but it is true nonetheless.

And so I welcome the fact that we have a government that says it is serious about expecting the Reserve Bank to run monetary policy in a way that promotes full employment –  keeping unemployment as low as is consistent with a sustainable low and stable inflation rate.     I like the fact that the Prime Minister talks about lowering unemployment in her first speech.  (Whether she will do so as readily later in her term is another question).    And I’ve come to agree that adding some reference to unemployment to the mandate given to the Reserve Bank is desirable.     It has always been implicit.  We have active discretionary monetary policy to minimise the output and employment losses when severe adverse shocks hit.  Otherwise, we’d have stuck with the Gold Standard, which was really good for delivering long-run average price stability but –  by design –  less good at short-term stabilisation.

The New Zealand Initiative –  from the right –  disagrees.   In their newsletter this week Oliver Hartwich writes

Yet the real problem is that dual mandates do not work, not even in theory. They are the result of a misunderstanding as anyone who studied economics over the past half a century would know.

The best way for a central bank to achieve both low inflation and low unemployment is to make it pursue price stability alone.

The next RBNZ governor will no doubt be aware of that. In which case, she could safely ignore any dual mandate passed down from the new Government. And keep focussing on targeting inflation.

But that is simply not so.    It is certainly true that over the medium to longer-term monetary policy can only affect nominal variables (inflation, nominal GDP or whatever) and has no impact on real ones such as unemployment.  Most everyone agrees on that.  But it is equally true that monetary policy actions have a short to medium term impact on real variables, not just on prices.  Indeed, in the short-term the real effects are often larger than the price ones.   It isn’t something one can exploit to get unemployment permanently lower –  the long-run Phillips curve is more or less vertical – but it does mean that all discretionary choices about monetary policy are simultaneously choices about both inflation and output/unemployment.  The Reserve Bank knows that.  In fact, every advanced country central bank –  in countries with fairly stable inflation expectations –  knows that.

There is also some disagreement from the left.  In his column in yesterday’s Herald, Brian Fallow was sceptical about Labour’s proposed changes (the details of which we have not yet seen)

…in a later speech outlining his approach, Robertson said: “Had a mandate to maintain full employment been in operation in New Zealand it is likely that it would have constrained the bank’s [subsequently] aborted tightening of the official cash rate in 2010 and 2014. This would in turn likely have seen a faster return to target inflation and faster economic growth.”

Well, maybe. But counterfactual assertions about what would have happened if what did happen had not happened stand on epistemologically boggy ground.

Back here in the actual world, data from the OECD last week shows that New Zealand’s employment rate – the proportion of people aged between 15 and 64 who are employed – is at 76.2 per cent, the fourth highest level among the OECD’s 35 members.

Fallow goes on at some length about employment rates.   But employment rates simply aren’t the relevant variable for monetary policy (although they might tell us about all sorts of other areas of labour market, tax, retirement income etc policies): unemployment rates (and other measures of excess capacity) are.   People who want a job, are available now to start work, who are actively searching for a job, but just can’t find one.

(Having said that, as I’ve written previously I’m not sure that simply a different mandate would have changed the policy mistake of 2014.    With most reasonable possible formulations of an unemployment objective, a hawkish Governor misreading the data (as Wheeler was) would have been likely to have made the same mistake: the right person (“people” when they move to a committee model) matter at least as much as any tweaks to the formal mandate.)

I noticed in the Dominion-Post this morning what appeared to be a suggestion that amendments to the statutory goal for monetary policy might find their way onto the government’s 100 day plan, perhaps in part to ensure that the new mandate was in place before the new Governor is due to take office in March.

No doubt such a limited statutory change could be done quite quickly.  To simply make that narrow change would involve quite a short piece of legislation.  But getting the words right matters – and it isn’t something Parliament should be changing frequently.

Then again, all parties to the new government have also favoured changes to the governance model of the Reserve Bank, and that isn’t something that should be rushed.  The focus to date has been on monetary policy decisionmaking, but the case for reform is probably stronger for the Bank’s financial regulatory functions (where there is nothing akin to the PTA, and too much depends on what is little more than personal gubernatorial whim).   Getting the right governance model for these two quite different functions, and for all the remaining functions of the Bank, and all the consequential changes, takes time to do properly, and would benefit from a full Select Committee process.

As it happens, much of what the government appears to want to achieve can be done through the Policy Targets Agreement anyway.   There is no (lawful) Policy Targets Agreement at present, but a new one needs to be agreed with the incoming Governor before he or she is appointed.   Since the proposed emphasis on unemployment is implicit in the existing framework anyway – it is what a Governor doing his or her job should be keeping a keen eye on in determining the appropriate stance of policy –  simply writing it down more explicitly in the PTA does not raise any particular issues of inconsistency with the existing legislation.

Some might question that, but I’ve had a go at producing a concrete draft of a PTA that captures what seems likely to be the sorts of issues that motivated the Labour Party to promote legislative change.     The resulting text (below) isn’t my ideal framing of the PTA.  Instead, I worked with the text of the most recent document and made as few changes as possible while (a) capturing the spirit of the proposed changes, and (b) avoiding any inconsistency with the existing legislation.  I’ve highlighted the three paragraphs where I’ve proposed changes:

  • 1(b), a now-customary part of the document, where the government of the day lays out briefly its economic objectives, and how it sees monetary policy fitting in,
  • 3(b) where I’ve added words to make clear what has been well-understood since day 1 of inflation targeting, that in managing deviations of inflation from target a key consideration is to minimise short-term output and employment costs, and
  • a new 4(c) which would require the Bank to publish NAIRU estimates, explain why any (actual or forecast) deviations of the actual rate from those estimates was occurring, and to explain what steps it was taking (with monetary policy) to minimise the extent (magnitude and time) of those deviations.

There might well be improvements to this suggested wording.  But these, relatively simple, changes could quickly give effect to what seems to be the thrust of Labour’s proposals.   I’d welcome any comments or alternative suggestions.

Of course, if the government is serious about making a difference –  rather than just signalling one – words alone won’t suffice, whether in the PTA or the Act.  They need to take steps also to find, and put in office, the right people.  The combination –  people and mandate –  gives us a more serious chance of getting unemployment down to around the long-run sustainable rate, and keeping it near there as much as possible, than continuation of the status quo.

These are changes of the sort that the leading academic who reviewed the Reserve Bank’s handling of monetary policy for the previous Labour goverment  (Lars Svensson) would seem likely to endorse.  Svensson served subsequently for several years on the Monetary Policy Board of the central bank of Sweden, where his firm advocacy of an unemployment focus helped get Swedish monetary policy back on track, delivering lower unemployment and inflation nearer the target.  He might be worth consulting again.

Policy Targets Agreement

This agreement between the Minister of Finance and the Governor of the Reserve Bank of New Zealand (the Bank) is made under section 9 of the Reserve Bank of New Zealand Act 1989 (the Act). The Minister and the Governor agree as follows:

1. Price stability

a) Under Section 8 of the Act the Reserve Bank is required to conduct monetary policy with the goal of maintaining a stable general level of prices.

b) The Government’s economic objective is to promote a growing economy in which full employment is achieved and maintained.   The management of monetary policy, subject to the medium-term constraint of a low and stable inflation rate, plays an important part in supporting this objective.

2. Policy target

a) In pursuing the objective of a stable general level of prices, the Bank shall monitor prices, including asset prices, as measured by a range of price indices. The price stability target will be defined in terms of the All Groups Consumers Price Index (CPI), as published by Statistics New Zealand.

b) For the purpose of this agreement, the policy target shall be to keep future CPI inflation outcomes between 1 per cent and 3 per cent on average over the medium term, with a focus on keeping future average inflation near the 2 per cent target midpoint.

3. Inflation variations around target

a) For a variety of reasons, the actual annual rate of CPI inflation will vary around the medium-term trend of inflation, which is the focus of the policy target. Amongst these reasons, there is a range of events whose impact would normally be temporary. Such events include, for example, shifts in the aggregate price level as a result of exceptional movements in the prices of commodities traded in world markets, changes in indirect taxes, significant government policy changes that directly affect prices, or a natural disaster affecting a major part of the economy.

b) When disturbances of the kind described in clause 3(a) arise, and consistent with a goal of minimising the short-term output and employment costs, the Bank will respond consistent with meeting its medium-term target.

4. Communication, implementation and accountability

a) On occasions when the annual rate of inflation is outside the medium-term target range, or when such occasions are projected, the Bank shall explain in Policy Statements made under section 15 of the Act why such outcomes have occurred, or are projected to occur, and what measures it has taken, or proposes to take, to ensure that inflation outcomes remain consistent with the medium-term target.

b) In pursuing its price stability objective, the Bank shall implement monetary policy in a sustainable, consistent and transparent manner, have regard to the efficiency and soundness of the financial system, and seek to avoid unnecessary instability in output, interest rates and the exchange rate.

c) The Bank shall publish its estimates of the sustainable long-run rate of unemployment in each Policy Statement made under section 15 of the Act.   When the unemployment rate (as measured in the HLFS) deviates, or is forecast to deviate, from this estimate the Bank shall explain why these outcomes are occurring, or are expected to occur, and what steps it is taking to minimise the extent to which the unemployment rate deviates from its estimate of the long-run sustainable rate.

c) The Bank shall be fully accountable for its judgements and actions in implementing monetary policy.

Grant Robertson
Minister of FInance

 

…….
Governor Designate
Reserve Bank of New Zealand

Dated at Wellington this ..th day of …. 201….

 

 

 

 

Implications of a new government for monetary policy

Whichever way New Zealand First decides to go, we’ll have a different government than we’ve had for the last few years.   Whatever form that government takes –  coalition, confidence and supply agreements, or just sitting on the cross-benches – New Zealand First’s votes will typically be vital for passing any legislation, and whichever party leads the government will constantly be needing to consult with New Zealand First to avoid inadvertently getting offside with them.

As issues around the Reserve Bank and the exchange rate have been a significant part of Winston Peters’ stated concerns over the years (including attempts to amend the Act through a private members’ bill, and repeated references to a Singaporean style of monetary policy), it is interesting to speculate on what difference his bloc of votes in Parliament might make to these issues over the next few years.  A journalist asked for my thoughts the other day, and this post fleshes out what I said in response to those questions.

There are probably at least three –  separable – areas worth touching on (simply as regards the Bank’s monetary policy roles):

  • the specification of the target for monetary policy, whether in the Act or the Policy Targets Agreement,
  • any changes to the legislated decisionmaking and accountability provisions for monetary policy, and
  • the type of person appointed as Governor.

I find it worthwhile to recall that Winston Peters has history in this area.  In 1996, New Zealand First was campaigning vigorously on bringing about change at the Reserve Bank.  At the time, the particular concern was that in focusing on price stability (0 to 2 per cent inflation at the time) we were encouraging/causing an overvalued exchange rate.  The proposed remedy was that we should instead target inflation around the average of our main trading partners (then a bit higher than New Zealand).    What actually happened was that as part of the horse-trading for the coalition agreement with National, Don Brash agreed to an amended Policy Targets Agreement, in which the target was raised from 0 to 2 per cent annual inflation, to 0 to 3 per cent annual inflation.  Actual inflation had been averaging about 1.5 per  cent anyway, so although the change made a small difference to policy for a short period, the difference was pretty minimal.  After that, Winston Peters –  as Treasurer – displayed little real interest in monetary policy and never bothered the Bank again.

So my starting point, in thinking about New Zealand First influence on Reserve Bank matters now, is that although I’m quite sure that the concerns Peters expresses –  including around overvalued real exchange rates –  are quite real (and in many respects valid –  shared as they’ve been by people spanning the range from Graeme Wheeler to me), in the end not much about the conduct of monetary policy is likely to change at his insistence.  And that is probably as it should be –  our real exchange rate problems are not primarily grounded in monetary policy problems.

We also know that although Peters has repeatedly talked of preferring a Singaporean model of monetary policy (a guided exchange rate, without an officially-set OCR), both Steven Joyce and Grant Robertson during the campaign flatly ruled out such a change.  They were right to do so.  I’ve explained why in a post earlier this year.    Even if such a system was desirable, it isn’t workable (at all) for New Zealand unless and until the structural demand factors behind our interest rates being persistently higher than those abroad are tackled –  and that isn’t a matter for monetary policy.

And the Singaporean model is not one of an absolutely fixed exchange rate.  It is a managed regime (historically, “managed” in all sorts of ways, including direct controls and strong moral suasion).  It produces a fairly high degree of short-term stability in the basket measure of the Singapore dollar.      But it works, to the extent it does, mostly because the SGD interest rates consistent with domestic medium-term price stability in Singapore are typically a bit lower than those in other advanced countries (in turn a reflection of the large current account surpluses Singapore now runs –  national savings rates far outstripping desired domestic investment).  As the Reserve Bank paper I linked to earlier noted

“From 1990 to 2011, the average short term Singapore government borrowing rate was 1.8 percent p.a. below returns on the US Treasury bill.”

Those are big differences (materially larger than the difference between the two countries’ average inflation rates).  And they mean that Singapore dollar fixed income assets are not particularly attractive to foreign investment funds.  By contrast, New Zealand’s short-term real and nominal interest rates are almost always materially higher than those in other advanced countries.   Partly as a result, even though Singapore’s economy is now materially larger than New Zealand’s, there is less international trade in the Singapore dollar than in the New Zealand dollar.

So a Singaporean model just is not going to be launched in New Zealand any time soon.

If Peters sides with National, what then might he secure in this area?

An obvious possibility would be a change to the Policy Targets Agreement.  There has to be a new one when a Governor is appointed, and (if they think the current interim one is lawful and binding –  which I don’t) they could also seek an immediate change.  Such changes immediately upon a change of government have been the norm rather than the exception (having happened, to a greater ot lesser extent, in 1990, 1996, 1999, and 2008).

At the start of each Policy Targets Agreement it has become customary (Peters began the pattern in 1996) to have a preamble about what the government is hoping to achieve.  The current government’s preamble reads this way:

The Government’s economic objective is to promote a growing, open and competitive economy as the best means of delivering permanently higher incomes and living standards for New Zealanders. Price stability plays an important part in supporting this objective.

It would be easy enough to craft a form of words that talked about avoiding an overvalued and excessively volatile exchange rate and promoting the tradables sector of the New Zealand economy.

But it won’t make any difference –  one iota of difference –  to the way monetary policy is conducted.  It is a statement of political aspiration –  and can perhaps be sold to the base as such –  not a mandate for the Governor.

Recall too that the Policy Targets Agreements since 1999 have required the Bank, while pursuing price stability to” seek to avoid unnecessary instability in output, interest rates and the exchange rate”.  On occasion, that provision has (modestly) influenced monetary policy choices at the margin (one reason I’ve favoured removing it), at least with a Governor who was that way inclined anyway.  In principle, the exchange rate element could be singled out and given more prominence further up the document.

Winston Peters’ private members bill sought to amend the statutory goal of monetary policy (section 8 of the Act) this way (adding the bolded words)

The primary function of the Bank is to formulate and implement monetary policy directed to the economic objective of maintaining stability in the general level of prices while maintaining an exchange rate that is conducive to real export growth and job creation.

I simply cannot see the National Party agreeing to that specific formulation. I hope they wouldn’t.  It goes too far and asks the Reserve Bank to do something that is impossible (real exchange rates are real phenomena, not monetary ones).   But could they consider a formulation like this one?

The primary function of the Bank is to formulate and implement monetary policy directed to the economic objective of maintaining stability in the general level of prices while promoting the highest levels of production, trade and employment that can be achieved by monetary policy.

It is very similar to the legislative provisions introduced by the National government in 1950, in providing a greater degree of (formal) independence for the Reserve Bank and a new focus on price stability.  But in that framing the caveat “the highest levels…that can be achieved by monetary policy” is vital.   Beyond the short to medium term, monetary policy can’t do much other than maintain stable prices.

Perhaps they could find, and agree on, some clever wording.   It would be a rhetorical victory for Peters, and since rhetoric and symbolism do matter not necessarily an insignificant one.

But, so I would argue, not one that would, on its own, make any practical difference to the conduct of monetary policy.  Reflecting back on the 25 years of advice I gave to successive Governors on the appropriate OCR, I can’t think of a single occasion when the advice would have been likely to be different under this formulation than under the current wording.

What about possible governance changes –  to the formal statutory provisions around monetary policy decisionmaking?  At present, all power is vested in the Governor personally, the Governor’s appointment is largely controlled by the Bank’s Board (unlike most countries where the Minister of Finance has the main power).

I can’t imagine that the National Party would be averse to some changes in this area.  After all, Steven Joyce commissioned the Rennie review and in doing so was presumably open to at least some modest changes (perhaps legislating something like the current internal advisory committee).   But equally, it is difficult to see why New Zealand First would regard it as any sort of win to hand power to more internal technocrats.  To the extent New Zealand First favours governance changes they probably prefer a decisionmaking Board dominated by outsiders, with a strong export sector orientation.  Perhaps it isn’t a die in the ditch issue for National, but it is harder to see the two parties reaching agreement on that sort of change, even if it did produce something that looked rather like the (generally highly-regarded) Reserve Bank of Australia.

But if Peters and New Zealand First care about making a difference to the actual conduct of monetary policy over the next few years, or even to how the Bank talks about monetary policy, the key consideration is who becomes Governor.   Whatever the formal specification of the target, whatever flowery words exist around goals, the personality, instincts, “models”, and preferences of whoever is appointed Governor matters a great deal.  Partly because it is a single decisionmaker system, and partly because as chief executive the Governor (inevitably and appropriately) has a big influence on how the institution evolves, where it focuses its analytical energies and advice etc.

But the Governor selection process has been underway for months, and the Bank’s Board – all appointed by the National government –  must be getting close to delivering an initial recommendation to whoever is appointed as Minister of Finance.   No doubt the Minister of Finance would consult New Zealand First –  whether through the Cabinet appointments process, or outside it –  and the Minister can reject a Board nomination.  But the Minister can’t impose his or her own candidate, they just have to consider the next person the Board puts forward.  Since the Board were (a) appointed under the current system, and (b) have had no concerns at all about the conduct of monetary policy or the leadership of the Bank in recent years, it seems reasonable to assume they’ll be putting forward a status quo candidate (there are no known exceptional candidates).  If so, my money is on Deputy Governor Geoff Bascand who –  as I’ve written about recently –  might be a safe pair of hands, but is unlikely to be more than that, and about whom there are some concerns (especially if, as Peters appears to, one cares about the interests of bank depositors.)

In short, if National leads the next government I wouldn’t expect any material differences on the monetary policy front, even if there are some symbolic wins for New Zealand First.  Even governance reform –  which most people think desirable –  might be hard to actually deliver (the status quo will avoid any conflicts).

And what if Labour leads the next government, requiring support of the Greens and New Zealand First for legislation?

In that case, legislative reforms are more certain, but somewhat similar questions remain about what difference they might make.

Thus, the Labour Party campaigned on amending section 8 of the Act to include some sort of full employment objective.   They haven’t provided specific suggested wording, and would no doubt want official advice on that.  The Greens have endorsed that proposal and there is no obvious reason why New Zealand First would oppose it. But they might want to try to get some reference to the exchange rate or the tradables sector included, whether in the Act itself or in the Policy Targets Agreement.  The sort of wording I floated earlier in this post might provide a basis for something workable.

I’ve also previously suggested that if Labour is serious about the full employment concern, it might make sense to amend section 15 of the Act (governing monetary policy statements) to require the Bank to periodically publish its estimates of a non-inflationary unemployment rate (a NAIRU), and explain deviations of the actual unemployment rate from that (moving) estimate.  In principle, something similar could be done for the real exchange rate, but the (theoretical) grounds for doing so are rather weaker.  Perhaps the political grounds are stronger, and such a change might encourage the Bank to devote more of its research efforts to real exchange rate and economic performance issues.

But –  and I deliberately use the same words I used above –  such legislative changes are not ones that would, on their own, make any practical difference to the conduct of monetary policy.  Reflecting back on the 25 years of advice I gave to successive Governors on the appropriate OCR, I can’t think of a single occasion when the advice would have been likely to be different under this formulation than under the current wording.

The Labour Party and the Greens also campaigned on legislative reforms to the monetary policy governance model (including a decisionmaking committee with a mix of insiders and relatively expert outsiders, and the timely publication of the minutes of such a committee.)   Although those proposals would represent a step in the right direction, they are rather weak. In particular, since Labour proposed that all the committee members would be appointed by the Governor, the change would largely just cement-in the undue dominance of the Governor.    But I’d be surprised if they were wedded to those details, and it shouldn’t be too hard to reach a tri-party agreement on a decisionmaking structure for monetary policy –  probably one that put more of the appointment powers in the hands of the Minister of Finance (as elsewhere) and allowed for non-expert members (as is quite common on Crown boards –  or, indeed, in Cabinet).

So legislative change in that area –  probably quite significant change –  seems like something we could count on under a Labour-led government.

But whether it would make much difference to the actual conduct of policy over the next few years still depends considerably on who is appointed as Governor.   Not only will whoever is appointed as Governor going to be the sole decisionmaker until new legislation is passed and implemented –  which could easily be 12 to 18 months away –  but that individual will be an important part of the design of the new legislation and the sort of culture that is built (or rebuilt) at the Reserve Bank.

As I noted earlier, the appointment process for the Governor has been underway for months.  Applications closed at a time –  early July –  when few people would have given the left much chance of forming a government.  And the Board, all appointed by the current government and strong public backers of the conduct of policy in recent years, have the lead role in the appointment.   Perhaps a new Labour-led government would reject a Bascand nomination.  But even if they did so, they have no idea which name would be wheeled up next.

There are alternatives, if the parties to a left-led government actually wanted things done differently at the Bank.   First, they could insist that the Bank’s Board reopen the selection process, working within the sorts of priorities such a new government would be legislating for.  Or they could simply pass a very simple and short amending Act to give the appointment power to the Minister of Finance (which is how things work almost everywhere else).  Of course, there is still the question of who would be the right candidate, but at least they would establish alignment of vision from the start –  a reasonable aspiration, given that the Reserve Bank Governor has more influence on short-term macro outcomes than the Minister of Finance, and yet the Minister of Finance has to live with the electoral consequences.

Over time, governance changes are important as part of putting things at the Reserve Bank on a more conventional footing (relative to other central banks, and to the rest of the New Zealand public sector).   I think some legislative respecification of the statutory goal for monetary policy  –  along the lines Labour has suggested –  is probably appropriate: if nothing else, it reminds people why we do active monetary policy at all.   But on their own, those changes won’t make any material difference to the conduct of monetary policy  –  or even to the way the Bank communicates –  in the shorter-term (next couple of years) unless the right person is chosen as Governor.  Perhaps so much shouldn’t hang on one unelected individual, but in our system at present it does.

Symbols matter, but so does substance.  It will be interesting to see which turns out to matter more to a new government with New Zealand First support.

In closing, there is a long and interesting article in today’s Financial Times on some of the challenges – technical and political –  facing central bankers.  As the author notes, in many countries authorities are grappling with a mix that includes very low unemployment and little wage inflation.  In appointing a Governor for the Reserve Bank of New Zealand, it would be highly desirable to find someone who recognises, and internalises, that the challenges here are rather different.  Unlike the US, UK, or Japan (for example) New Zealand’s unemployment rate is still well above pre-recessionary levels –  when demographic factors are probably lowering the NAIRU –  and real wage inflation, while quite low in absolute terms, is running well ahead of (non-existent) productivity growth.    There are some other countries – the UK and Finland notably –  that also have non-existent productivity growth, but it is far from a universal story.  Productivity growth carries on in the US and Australia and (according to a commentary I read last night) in Japan real output per hour worked is up 8.5 per cent in the last five years (comparable number for New Zealand, zero).

Some of these issues are relevant to monetary policy (eg unemployment gaps) and some are relevant to medium-term competitiveness (wages rising ahead of productivity growth).  We should expect a Governor who can recognise the similarities between New Zealand’s experiences and those abroad, but also the significant differences, and who can talk authoritatively about what monetary policy can, and cannot, do to help.  Perhaps even, as a bonus, one who might even be able to provide some research and advice to governments on the nature of the economic issues that only governments can act to fix.

 

 

 

 

“Considerable public interest”?

As I noted yesterday, the Minister of Finance and Grant Spencer have signed a document purporting to be a Policy Targets Agreement, to cover the management of monetary policy between the end of Graeme Wheeler’s term and 26 March 2018.   I also noted that I had lodged OIA requests with the Bank and Treasury for the documents relevant to the pseudo-PTA.

As it happens, Treasury had already beaten me to it, and they rang this morning to point me to the obscure corner of their website where they had yesterday pro-actively released the one substantive relevant document.   Pro-active release of papers by minister and public servants is to be strongly encouraged, and welcomed when it occurs.  Not only is it consistent with the principles that underpin the Official Information Act, but it is also cheaper and easier for the agency concerned.    I probably wouldn’t have bothered with this post if I hadn’t wanted to commend Treasury.

Just occasionally one gets a sense of having made a very slight difference.   In recommending pro-active release Treasury noted

There is considerable public interest in Mr Spencer’s appointment, and a proactive release would pre-empt an expected OIA request.

It (more or less) did that, but to be honest I’ve not seen any one much other than me writing about the Spencer appointment.   Treasury went on

We also consider the proactive release of this report desirable as it would help to ensure that future public commentary on Mr Spencer’s appointment is well-informed. This is because some commentary about Mr Spencer’s appointment has questioned whether the appointment is legal, based on an inappropriate interpretation of the Act and an erroneous assumption that you would not be signing a PTA with Mr Spencer.

I had certainly misunderstood the implication of earlier statements from the Minister about the PTA.  I remain convinced that both the appointment is illegal, and that there is no statutory provision for a PTA with an acting Governor.  My interpretation of the Act may well be erroneous, but the best way to clear that up would be for the Minister, the Treasury, or the Bank’s Board to explain –  or provide –  their own legal advice and interpretation of the relevant provisions.  They continue to refuse to do that (although I will refer this paper to the Ombudsman’s office, for consideration in reviewing whether it would be in the public interest for the relevant legal advice, or a summary of it, to be released).

What else do we learn from the Treasury’s advice to the Minister?

First,

A PTA is required for the appointment of both a permanent and an interim Governor.

It is clearly Treasury’s interpretation, but they provide no justification for that interpretation.  There is, after all, no mention of an interim or acting Governor in any of the provisions of the Act dealing with PTAs.   Again, a summary of the legal advice would help clarify the matter.

Second,

The Board recommends that Mr Spencer be appointed on the same terms and conditions as the current Governor. This is also the basis upon which Mr Spencer has accepted the appointment.

I don’t have any real problem with that, but…..an acting appointee doesn’t really have the same responsibilities as a substantive Governor (medium-term planning and positioning of the institution etc), and has no effective accountability (monetary policy, for example, works with a lag of more than six months, and Spencer will be long gone before the impact of any of his choices are apparent.  But I guess Spencer was doing them a favour in taking the job.

The Treasury appears to be relying on a creative interpretation of the Act in which every reference to the Governor is somehow construed to also mean an acting Governor.  But they aren’t even consistent about that.   They note that

The process of agreeing the conditions of employment is complicated by the Act requiring you to agree the conditions of employment, including remuneration, with the Governor. As Mr Spencer will not be the Governor until after assuming the office of Governor, the conditions of employment should not be formally signed until Mr Spencer’s appointment takes effect.

In fact, of course, Mr Spencer will never be Governor, only acting Governor.   But it seems a rather literal interpretation of the relevant section of the Act to suppose that the terms and conditions can’t be agreed until a person (acting or substantive) has actually taken office.  I wonder if the same approach was applied when Messrs Bollard and Wheeler were appointed?  If it really is a correct interpretation, it looks like a case for a minor amendment to the Act (joining a long list of necessary reforms).

To repeat, kudos to Treasury for the pro-active release.  I do hope they will adopt the same approach next year when a new longer-term PTA is signed with the new permanent Governor, and would encourage the Reserve Bank to consider following Treasury’s lead.  In the meantime, as they are no doubt aware, Treasury is still to respond to a request for the papers relevant to the 2012 PTA.  Pro-active release at the time would have been much simpler.

 

 

 

A pseudo-PTA and other miscellania

This morning it was announced that something that purports to be a Policy Targets Agreement, to cover the conduct of monetary policy during the six months after Graeme Wheeler leaves office, had been signed between the Minister of Finance and Grant Spencer, currently the deputy chief executive of the Reserve Bank.  The Minister announced some months ago that he intended to appoint Spencer as acting Governor for six months, to get the appointment of a permanent Governor clear of the election period.

There are a number of problems with this:

  • first, the Minister has no statutory power to appoint an acting Governor, except where a Governor resigns or otherwise leaves office during an uncompleted term, and
  • second, even if it were argued, contrary to the clear sense of the legislation, that the Minister had such appointment powers, there is also no statutory provision for a Policy Targets Agreement between an acting Governor and the Minister (rather, the Act envisages that the acting Governor would run monetary policy under the PTA already signed with the substantive Governor for his/her unexpectedly foreshortened term).

You might respond that even if there is no statutory provision, there is nothing to stop the Minister and the “acting Governor” signing an agreed statement about how monetary policy would be run during the “acting Governor’s” term.  And if the acting Governor appointment was itself lawful, I would agree with you.   But the so-called Policy Targets Agreement signed yesterday explicitly states the parties believe it to be the genuine binding article, not just some informal statement of agreed intentions.

This agreement between the Minister of Finance and the Governor  of the Reserve  Bank of New Zealand (the Bank) is made under section 9 of the Reserve Bank of New Zealand Act 1989 (the Act).

The Reserve Bank’s statement stressed that there were no changes in this new (pseudo) PTA, relative to the current PTA applying during Graeme Wheeler’s term.   Unfortunately they seem to have taken that a bit too literally.  You’ll notice that in that extract (immediately above) it is referred to as an agreement between “the Governor” and the Minister.  But the Minister’s announcement in February was that Spencer would only be “acting Governor”.  Indeed, there is no way that Spencer could have been appointed as “Governor”, because any new person appointed as Governor has to be appointed for a term of five years, and any such appointment would have defeated the whole point of not making a long-term appointment in or around the election period.

It wasn’t just a slip either.  At the bottom of the document it is signed by Steven Joyce as Minister of Finance and by Grant Spencer as “Governor Designate”  (the “designate” bit matters, because real PTAs have to be agreed before the appointment is formally made).  But Spencer isn’t “Governor designate” at all, he is “acting Governor designate”.     I guess they are trying to slip him in under the provisions of section 9 (rules governing the PTAs) which refer only to the Governor, not to any acting Governors.  As I said before, the Act does not provide for acting Governors to sign proper PTAs.  So the document resembles a PTA, but it can’t in fact be one.

Does it matter?  In one sense, perhaps not.  But laws matter, and details matter, and this appointment, and the purported PTA, appear to be in breach of the law.   If nothing goes wrong and there are no legal challenges during the “acting Governor’s” term, then there probably won’t be any practical problems. But the Governor exercises a lot of powers, including in crises, and the last thing one needs in crises –  which one never foresees correctly the timing of – is uncertainty as to whether a purported Governor really has powers to do what he is trying to do.

(As I have noted previously, there are remedies, even if awkward ones.  For example, Graeme Wheeler –  as an existing Governor – could have been reappointed for six months, and a new PTA signed with him, all while he announced his intention to resign after one day.  Nothing then would prevent the Minister appointing Spencer as lawful acting Governor, operating under a fully lawful PTA.)

I have put in OIA requests with both the Bank and Treasury for the papers relevant to today’s purported PTA.

Being in a slightly flippant mood this evening, I thought I’d throw a few curiosities from the day.

First, on looking on the blog statistics page I discovered that someone had got to my blog today by searching under  “functions of weet bix to the unborn”.    Quite why anyone would be searching for anything using those words for a search at all is a beyond my understanding.   On scrolling down several pages of search results I discovered that I had once, long ago, referred to Weetbix, but not to nutrition or the unborn.

Second, the Reserve Bank might find my OIA requests annoying (they did, after all, launch a whole charging regime in response).   But other people lodge requests too.  I occasionally have a look at the ones the Bank releases.   Some are easy to answer, but distinctly strange.   A few weeks ago they responded to this one

I would like a categorical response to the question­ ” What influence does the Rothschild family exert over the reserve bank of New Zealand?

The categorical answer, of course, is none whatever, although the Bank gave the person a slightly fuller response.

It has been quite a while since I’d seen such a New Zealand-focused example of the old conspiracy theory, in which bankers –  especially perhaps Jewish bankers –  had the central banks of the world under their thumb.  It is a fascinating, if unnerving, phenomenon.  On a par, I suppose, with the whole “one world government” conspiracy stories:  I have on my shelves a book which claims that Don Brash was installed as Reserve Bank Governor by the one world government, as a safe pair of hands, as the son of someone who himself had been part of the conspiracy, as a leading figure in the World Council of Churches.

And finally, looking back at Steven Joyce’s statement on 7 February announcing that Graeme Wheeler was retiring, I noticed the Minister’s description of the Governor’s conduct

The Governor has performed his role calmly and expertly during a highly unusual period for the world economy

Calmness having been so prominently highlighted as a feature of the Governor’s stewardship, I can only assume that the story I heard a while ago on the grapevine, that the Governor had, as it were, tossed his toys out of the cot when someone wrote something the Governor disagreed with, couldn’t possibly be true.

 

 

Weak inflation expectations – again

A couple of weeks ago I wrote about the results of the Reserve Bank’s Survey of Expectations  –  the quarterly survey of relatively well-informed participants and commentators.     Those expectations were still very subdued, with little sign of any expectation that (for example) core inflation would soon return to the 2 per cent target midpoint, which the Governor has undertaken to focus on.

Since then a couple of other inflation expectations surveys have come out.  Both the ANZBO business survey and the Reserve Bank’s household expectations survey question on inflation have had an upward bias for many years.  Reported expectations are, on average, well above both actual inflation at the time the survey was taken, and above the actual inflation rate for the period to which the expectations related.  Both are measures of year-ahead expectations.

The Reserve Bank’s household expectations measures remain very subdued.   In the 20 year history of the survey median year ahead expectations have never been lower than they have been over the last few quarters.  And when the survey started, the inflation target midpoint was 1 per cent inflation not 2 per cent.    Unless the relationship between core inflation (ie excluding the “noisy” bits like swings in oil prices) has suddenly changed, if inflation actually picks up materially over the coming year –  as the Reserve Bank keeps telling us it will –  these respondents will be surprised.

household expecs

The survey also asks respondents directly whether they think inflation over the next year will go up, down, or stay the same.   Again, there is a systematic bias in the survey –  net, respondents have always expected inflation to rise.  But outside the depths of the 2008/09 recession –  the inflation effects of which people then thought would be short-lived –  expectations for headline inflation rising have never been weaker.  And, as a reminder, the most recent headline annual inflation rate was a mere 0.3 per cent

household expecs 2

The survey now also asks about five year ahead expectations.  We only have data since December 2008, but for what it is worth these longer-term expectations have never been lower than they are now.

The latest ANZBO survey came out yesterday.  Inflation expectations dropped slightly, and looking at the chart that also seems to be a record low for the series.  The Reserve Bank might claim to take comfort from the fact that expectations are still 1.6 per cent, not too far from the target midpoint.  They shouldn’t.  Again there has been a persistent bias in this series, and no obvious reason to think that that relationship has changed.

ANZBO inflation expectations

At the other end of the range of measures, New Zealand has a 10 year conventional government bond and a 10 year inflation indexed government bond.  The gap between the two isn’t a pure measure of inflation expectations, but in normal circumstances it won’t be too far from what investors are implicitly thinking that inflation will be.   The monthly average difference for November, as reported on the Reserve Bank website, was 1.40 per cent.

There is talk today of business confidence being a little stronger than it was.  Perhaps, but the Reserve Bank’s job is to target inflation, near 2 per cent.  It hasn’t done that successfully for some years now, through the ebbs and flows of business confidence, commodity prices, and the Christchurch repair process.  And there is no sign in any of the recent surveys and related measures that that failure is about to remedied any time soon.

As the Governor contemplates his final OCR decision for the year, he should be thinking very carefully about these rather disconcertingly low expectations.  The Governor often tells us that he wants to stabilise the business cycle.  But if inflation expectations do become, in effect, entrenched at levels inconsistent with the inflation target, it can be very difficult –  and potentionally quite destabilising –  to get them up back again.

On a slightly different topic, I noticed the other day that the Bank of Canada has a page on its website about the extensive research programme it is planning in advance of next year’s quinquennial review of the Canadian inflation target (a non-binding agreement reached with the Minister of Finance).  The Bank of Canada has a strong track record of undertaking serious research in advance of these reviews.  They plan to undertake significant work on each of the following three topics:

  • The level of the inflation target
  • Measuring core inflation, and
  • Financial stability considerations in the formulation of monetary policy.

The first of these topics particularly caught my eye.  As they note:

 Canada targets 2 per cent inflation, the midpoint of a 1 to 3 per cent inflation-control target range. Since the last renewal of the agreement in 2011, the experience of advanced economies with interest rates near the zero lower bound has put the 2 per cent target under increased scrutiny. After taking all factors into consideration, the Bank will undertake a careful analysis of the costs and benefits of adjusting the target.

The process is an admirable one.  I have previously urged that, with the next (legally binding) PTA due to be negotiated in New Zealand in not much more than 18 months that a similar, open, process should be getting underway here –  commissioned jointly by the Minister of Finance, the current Governor, and the Secretary to the Treasury.  That would be quite a contrast to the very secretive way these things are typically done in New Zealand –  in the case of the 2012 PTA, secretive even after the event.

Doing the work is vitally important, but so is getting it out into the public domain and ensuring open scrutiny and debate of material that will influence the key document in short-term macroeconomic management for the next five years.   It would be valuable at any time, but should be particularly so now, after years of undershooting the target, and as the near-zero lower bound moves uncomfortably close again.  For example, with the benefit of hindsight was the move to a focus on the midpoint a mistake for New Zealand?  I don’t think so, but in view of his track record the Governor may, and there could be reasonable arguments on either side of the issue –  particularly in view of the potential interaction with financial stability considerations.

But what I thought was particularly praiseworthy was the Bank of Canada’s willingness to openly acknowledge that questions should be asked, in the light of changed circumstances, as to whether the 2 per cent target midpoint is still appropriate.  The issues are a little more pressing for them than for us, since Canadian interest rates are much near zero than ours are, but we cannot afford to be complacent.  And if it was decided that a higher inflation target was appropriate, the time to make that call is when there is still conventional monetary policy leverage available.  I’d probably still prefer authorities to take serious legislative steps to remove the zero lower bound, but the questions and issues should be asked and examined.  In New Zealand to date  –  including in the Bank’s Statement of Intent –  the issues and risks are not even acknowledged.