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?


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.


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… 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.

Should the statutory objective for monetary policy be changed?

Since 1989, section 8 of the Reserve Bank of New Zealand Act has read as follows:

The primary function of the Bank is to formulate and implement monetary policy directed to the economic objective of achieving and maintaining stability in the general level of prices.

That provision was widely seen as one of the centrepieces of the new Reserve Bank Act in 1989. It does not directly guide day-to-day monetary policy, but rather it should constrain the Minister and the Governor in negotiating Policy Targets Agreements (PTAs). PTAs must, by law, be consistent with section 8: as the Act puts it, the targets are “for the carrying out by the Bank of its primary function”.

The wording raises a variety of geeky questions.   Should, for example, the Act really describe monetary policy as the Bank’s “primary function”, or just treat monetary policy as one of a variety of functions Parliament assigns to the Bank?   Is it really sensible to talk of stable levels of prices, when neither the Bank (nor ministers, nor Treasury) has ever shown any interest in stabilising the level of prices, as distinct from the rate of change in those prices (“the inflation rate”). More troublingly, perhaps, can a medium-term trend inflation rate of 3 per cent (which we had got up to prior to the 2008/09 recession, and which would double prices every 24 years) really be described as “price stability”?

I’m not going to try to answer those questions today. But they illustrate that there is no particular reason to think that the current specification of section 8 should be treated as sacrosanct. My impression over many years at the Reserve Bank was of a tendency (I may have shared this attitude at times) to treat section 8 as the battle standard of orthodoxy, such that any change would be akin to allowing the barbarians to overrun the fortress.

Going into last year’s election, each of the Opposition parties (Labour, Greens, New Zealand First, Internet-Mana) was campaigning to change section 8 of the Reserve Bank Act.   Of course, typically they were looking for rather more change than just a change of overarching statutory objective, but two parties were quite specific in what they were looking to do with section 8 itself

In Labour’s case, as I noted a couple of weeks ago, they came up with this formulation

“The primary function of the Bank with respect to monetary policy is to enhance New Zealand’s economic welfare through maintaining stability in the general level of prices in a manner which best assists in achieving a positive external balance over the economic cycle, thereby having the most favourable impact on the stability of economic growth and the level of employment.”

And New Zealand First has sought to introduce legislation amending section 8 to read as follows:

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.”

In both cases, it would appear that the framework of a Policy Targets Agreement would continue.   Labour was quite explicit about maintaining the inflation target.

In fact, looking around the world’s advanced economies there is a wide variety of ways in which countries have written down what they are looking for from their central bank and monetary policy. In a fairly short issue of the Reserve Bank Bulletin published late last year, Amy Wood and I looked at the wide variety of ways legislation is written in 18 advanced countries (or regions in the case of the euro) that now use inflation targets as the day-to-day centrepiece of monetary policy.

There are big differences across countries. Some of those differences are about the age of the legislation. Old legislation looks quite different from newer legislation. Some is probably about the preferences of legislative drafters in different countries. And one important difference that became apparent is that in some countries they have written a limited statement of what a central bank can directly achieve, while in others they have written more about the longer-term desired outcomes that might flow from good monetary policy. And while acts of Parliament are one part of the mix, they often aren’t the only place in which society’s aspirations for monetary policy are set down.

At one extreme, in Sweden the only formal document – the central bank act – simply states that the goal of the Riksbank’s monetary policy is “price stability”. There are no other formal or binding documents (although there are plenty of Riksbank texts on what current governors interpret the Act as meaning).

The US legislation, by contrast, is a mix of medium-term objectives (things the central bank might more directly affectl) and desired outcomes from good policy. The Federal Reserve Act requires the Fed to “maintain long-run growth in the monetary and credit aggregates commensurate with the economy’s long-run potential to increase production”. Stable money growth was the thing the Fed could directly influence. But the Act goes on to state that this is to be done “so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates”. Congress didn’t care about money supply growth for its own sake, but for the things that are thought to flow from it.

The Bank of Canada operates under very old legislation. The Bank is required to “regulate credit and currency to control and protect the external value of the national monetary unit” (this dates back to before the era of floating exchange rates), but again it does not do this simply for its own sake. Rather, Parliament goes on to explain that the desired outcome of monetary policy is “to promote the economic and financial welfare of Canada”

I could go on. Even the ECB, established by treaty rather than by national legislation, operates under provisions which state that while the primary objective is “price stability” a variety of good things that should flow from the work of the ECB specifically and the EU more generally (eg “…stable prices, sound public finances and monetary conditions and a sustainable balance of payments”).  When I first stumbled on that last clause, about a sustainable balance of payments, I wondered if the Labour Party people were aware of it.

In many countries, even with quite recent legislation, there is an explicit obligation on the central bank to work together with, or support, other government economic policies, at least so long as doing so does not threaten the primary price stability goal,

What about the New Zealand situation?

Section 8 of the Act is pretty clear and succinct about what monetary policy is for, but nature tends to abhor a vacuum. Trace through the evolution of the Policy Targets Agreements since 1990 and you will more and more stuff written down, that was previously unwritten and somewhat taken for granted. But political pressures and criticisms of the Bank saw more and more details added in.  The 1992 PTA was perhaps the most cut-down approach.

Price Stability Target Consistent with section 8 of the Act and with the provisions of this agreement, the Reserve Bank shall formulate and implement monetary policy with the intention of maintaining a stable general level of prices

But in late 1996, a revised PTA was signed as part of the National-New Zealand First deal. It moved beyond just writing down the direct stuff the Bank could manage, to articulating what the point of pursuing price stability was.   The ‘so that” language that Winston Peters introduced here paralleled the “so as to” in the Federal Reserve Act.

Price Stability Target

Consistent with section 8 of the Act and with the provisions of this agreement, the Reserve Bank shall formulate and implement monetary policy with the intention of maintaining a stable general level of prices, so that monetary policy can make its maximum contribution to sustainable economic growth, employment and development opportunities within the New Zealand economy.

In 1999, in the wake of the MCI debacle, Michael Cullen added this provision.

In pursuing its price stability objective, the Bank shall implement monetary policy in a sustainable, consistent and transparent manner and shall seek to avoid unnecessary instability in output, interest rates and the exchange rate

It isn’t in the Act, but it is no less binding on the Governor (and successive Governors who have signed it). Unfortunately, as I noted last week, it is a somewhat troublesome clause, in that no one has ever been sure quite what the practical import was. At one level it was uncontroversial – avoid “unnecessary instability” – but quite what is “necessary”?

In 2002, Michael Cullen and Alan Bollard reformulated clause 1, restoring a clean focus on price stability in a), which just mirrors section 8 of the Act, while adding a separate sub-clause outlining what the government’s economic policy was looking for, and a sense of how price stability contributes.

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 objective of the Government’s economic policy is to promote sustainable and balanced economic development in order to create full employment, higher real incomes and a more equitable distribution of incomes. Price stability plays an important part in supporting the achievement of wider economic and social objectives.

With a change of government in 2008 there was a change in economic policy goal

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.

And finally in 2012, the words –  already present in section 10 of the Reserve Bank Act since 1989 – about having regard to the efficiency and soundness of the financial system in conducting monetary policy were added.  Quite what these words mean in practice is also less than clear –  even after 26 years.

No other countries have a binding legal arrangement akin to the Policy Targets Agreement.

There is a wide variety of ways in which countries, with very similar practical monetary policies, write down what they want from their central banks.  So the current wording of section 8 should not be sacrosanct –  the only possible way sound money could be preserved.  Personally, I would have no great objection if the wording introduced to the PTA in 1996 were to be translated in an amended section 8 of the Act.    I’d probably have slightly more problem with the Labour Party’s version from the manifesto last year, but ultimately it is for politicians to lay out higher level objectives for the Reserve Bank, and monetary policy.

But, and in a sense this is the point of the Bulletin article, those sorts of alternative formulations would not, on their own, be likely to make any material difference to the way monetary policy was run.  Practical differences flow from different Governors and different Policy Targets Agreements.  If political parties want actual practical differences in how monetary policy is run, they need to look to what they are negotiating in the PTA, and with whom.  As it stands, although the Reserve Bank has made more than its fair share of policy mistakes, evidence suggests that in normal times it has responded to incoming data in much the same way as central banks in Australia, the US, or Canada do.  And legislatures in each of those countries have written things down in rather different ways, to each other and to New Zealand.

There is no harm in amendments that may have little practical impact.  Symbolism matters, and since few would argue that  price stability should be sought for its own sake, there should be no strong objection to writing down in statute what it is hoped that good monetary policy will help contribute to.  Indeed, I would argue that it is better to write it down in statute than to keep fiddling with the Policy Targets Agreement. PTAs can be signed in the dead of night, perhaps involving two people only, as part of bundles of post-election negotiations.  The first the public know about the new terms is when the parties publish the signed document.  By contrast, even in New Zealand, the legislative process is usually much more open and transparent. Bills typically go to select committees, which invite submissions and review the arguments from outsiders before making recommendations.  And the hurdle of making changes in law is higher than for the PTA –  which has become something each change of government feels obliged to change.

I would favour amending section 8.  We need to face the fact that New Zealand is probably the only advanced country in which monetary policy has been repeatedly an election issue.  There has not been an election since 1987 in which one or other party was not campaigning on changes to the Act or the PTA.  That is no passing discontent.

Changing section 8 isn’t the biggest issue to address is reforming the Reserve Bank, but it shouldn’t be treated as of no importance either.

Since I’m not a die-hard inflation targeter either, I would favour something along these lines

Monetary policy shall be formulated and implemented towards the economic objective of maintaining medium-term stability in the purchasing power of the New Zealand dollar, so as to  maximise the medium-term contribution monetary policy makes to full employment and to the economic and social welfare of the people of New Zealand.

With such a clause, clause 4b –  the troublesome clause about avoiding unnecessary variability – should be able to be junked.  Parliament will have made clear that the whole point of the Bank is to promote good economic outcomes, and the longer-term interests of New Zealanders.  But don’t lose sight of the fact that New Zealand’s real medium-term economic failures have little or nothing to do with the conduct of monetary policy, or the way the Reserve Bank Act is written.

Of course, there still will –  and should  –  be vigorous debates about what intermediate targets the Bank should be required to pursue.  Many will favour the status quo, others might favour NGDP targets, and some might come to favour wage growth targets.  Some might favour a more active role in exchange rate smoothing. But those debates too should be carried on openly.  As I’ve argued before, the Minister of Finance and the Treasury (with or without the cooperation of the Bank) should already be planning an open process for consideration of issues before the next PTA will be due in 2017.  As 2017 is election year, the earlier the better really.

Of course, there is probably another debate to be had, before the Act is next comprehensively reviewed, as to whether there should be a single overarching objective for monetary policy and financial regulatory policy.  I think that would be a step in the wrong direction.  They are two quite different functions, just as monetary policy and fiscal policy are quite different.  But perhaps that is a topic for another day.