Parliament should fund the Reserve Bank annually

Readers may well be getting a little tired of the run of posts this year on issues relating to the review of the Reserve Bank Act.  In truth, so am I.    However, The Treasury is inviting comments, with a deadline of later this month.

There are two stages to the review.  The first, led by Treasury, is around implementing reforms Labour campaigned on (a statutory monetary policy committee, and adding some sort of employment goal).  The second –  as yet ill-defined – is to be led jointly by the Reserve Bank and Treasury and is to look at any other issues that the Minister agrees warrant review.  For now, The Treasury is inviting views on what issues should be looked at in Stage 2.

My broad response to them on that question has been “anything and everything”.  The Reserve Bank Act –  and the other Acts the Bank operates under –  has grown like topsy over 30 years.  Roles and functions have changed.  Expectations around transparency have changed. And models that might have seemed sensible in 1989 – eg the role of the Board –  no longer do so today.   Probably the Act should be rewritten from scratch, but even if that doesn’t happen, no part of the current Act should be outside the scope of the review.   My post the other day proposed structural separation –  spinning out of the Bank a new Prudential Regulatory Agency.

Today I want to focus on funding the Reserve Bank’s operations, an aspect of the Act that could be easily overlooked as part of the review, but where current legislation falls far short of best practice.

Historically, there were typically no checks on the spending of a central bank.  Central banks “printed money” –  physically or electronically – and didn’t need to rely on tax revenue appropriated by Parliament.   They typically earned a lot of income by issuing (zero interest) bank notes, and investing the proceeds (often in government bonds).  I regaled my kids recently with the tale of the night –  the RBNZ 50th anniversary –  when the Bank took over the Michael Fowler Centre and hosted a banquet and dance (free) for staff and spouses, includng a McPhail and Gadsby floor show.  The kids asked who paid for it, and struggled to get their minds around the notion that “we just printed the money”, but that was the way things were.  These days –  rightly –  the Taxpayers’ Union would be all over such extravagance –  or the chauffeur for the Governor (and, if I recall rightly, even the Deputy Governor).  There was an Annual Report, of course, but little detail and no effective spending control or accountability.  It wasn’t that the Bank was always extravagant –  it wasn’t – but there were few or no external constraints.

The reformers of the late 1980s recognised the need for things to change.   But expenditure control took a distinctly secondary place to promoting and preserving the operational independence of the Bank in the conduct of monetary policy (recall that at the time the Bank was conceived of largely as a monetary policy agency).    There was much less concern about controlling spending than about closing off backdoor ways for a Minister of Finance to exert pressure on the Bank’s monetary policy.  The ability to threaten an annual parliamentary appropriation –  “go easy on monetary policy or I’ll cut your funding”  –  was seen as an important risk

And thus we ended up with the Funding Agreement model.  Under this model, the Governor and the Minister of Finance may reach a five-yearly agreement, which has to be ratified by Parliament,  on how much of the Bank’s income can be used for operating expenses in each of the subsequent five years.   I wrote about the model when the current funding agreement was ratified in 2015.

There had even been talk –  probably not welcomed at The Treasury –  of using the Permanent Legislative Authority route (a model used for judges’ salaries and Crown debt servicing), a model under which no parliamentary authority would ever have been required for the Bank’s spending.  Even at the time, that seemed a little self-important.

The Funding Agreement model certainly means that for most of any five year period, the Reserve Bank does not need to worry about ministerial pressure exerted via its budget.  And, as it happens, there has always been a Funding Agreement in place, and those funding agreements did help to lower substantially the level of spending at the Bank.  In that sense, they were a step forward relative to what had gone before.   But they are very far from best practice.

Treasury has a nice document on its website outlining the principle and process of parliamentary authorisation of public spending.  It begins this way

A long-standing principle under the Westminster style of government is that no expenditure of public money can take place without the prior approval of Parliament. In New Zealand, both the Constitution Act 1986 and the Public Finance Act 1989 continue this historical requirement.

Appropriation ensures that Parliament, on behalf of the taxpayer, has adequate scrutiny of how public resources are to be used and that the Government is held accountable for how it has used the public resources entrusted. The Estimates specify for each appropriation:
• a maximum amount of resources that can be consumed
• the purpose for which the appropriation can be used.

As they go on to note, most appropriations are for only a year at a time.

The Reserve Bank model falls short in a whole variety of ways:

  • there is no legislative requirement for there to be a funding agreement at all, and no (formal) consequences if the Governor and Minister do not (or cannot) agree on one,
  • there is no breakdown of the agreed level of spending between the Bank’s (quite different) stautory functions, and thus no restriction on the ability of the Bank to spend the money  in one area rather than another as it chooses,
  • there are no penalties or formal adverse consequences if the Bank spends beyond the limits set out in the funding agreement,
  • while the Minister and the Governor can agree to a variation in the level of the funding agreement during its term there is no ability for the Minister (say, a new government) to override the agreement, even temporarily (as, say, there is in respect of monetary policy itself),
  • in (almost?) all areas of public spending, the Minister asks Parliament for approval, and Parliament approves (or rejects) the proposed level of spending.  Officials make bids and try to persuade ministers of a need for more money for their department or agency, but they have no ability to block or formally constrain choices of the Minister and Parliament.  But the Reserve Bank Governor –  himself, in effect, appointed by unelected people (the Board) –  has that degree of control (no agreement needed, any agreement needs the Governor’s assent, and no consequences from failure to agree).

And it isn’t even that workable a model.  No corporate sets operating expenditure budgets five years in advance –  circumstances change, the price level changes, and so on.

And this is not some trivial government entity doing some unimportant function.  It isn’t primarily a trading entity spending money to make money.  The Reserve Bank is the key entity responsible for short to medium-term macroeconomic management, and has a huge range of discretionary power in areas of financial sector regulation.   And it has several billion dollars of Crown capital. The financial expenditure provisions are a glaring anomaly, out of step with one of the fundamental principle of our system of government.

The system hasn’t been grossly abused: mostly the Reserve Bank seems to spend fairly responsibly, and the Minister is advised by Treasury at the point of renegotiation.   But, equally, it is not as if the Minister and the Bank have gone above and beyond the formal statutory provisions: they could, for example, lay out detailed annual estimates, by functions, at the time the Funding Agreement was released, and report actuals against those estimates over the following five years.  But they don’t even do that: it is the sort of lack of transparency that led me to suggest earlier that there is no more transparency around the Bank’s spending plans –  one line item per year –  than there is around that of, say, the SIS.  And unlike the Bank, the SIS needs an annual parliamentary appropriation or it can’t spend anything at all.

A common argument –  at least among central bankers –  is that somehow central banks are different.  There is only one important respect in which they are: they earn far more than they spend.  But even that isn’t very important here.  Central banks make money largely through the statutory monopoly on currency issue, which is just (in effect) another form of taxation.  And spending and revenue are two quite different bits of government finance: IRD might collect lots of money, but it can only spend what Parliament appropriates.

And what of those arguments about avoiding back-door pressure?  Even they don’t mark out central banks.  After all, we don’t want ministers interfering in Police decisions either (a rather more important issue than a central bank), but Police are funded by parliamentary appropriation.  So is the Independent Police Complaints Authority.   There are plenty of regulatory agencies where policy might be set by politicians, but the implementation of that policy is set by an independent Board, and where backdoor pressure could –  in principle be applied.  Other bodies publish awkward reports that make life difficult for politicians.  But those bodies too are typically funded each year by parliamentary appropriation.  It is just how our system of government works.

When I wrote about this issue in 2015 (having only recently emerged from the Bank), I was hesitant about calling for radical change.   The funding agreement system itself could be tightened up in various ways, which might represent an improvement on what we have now.   But there isn’t any very obvious reason not to start with a clean sheet of paper, and build a new system –  aligned with how we manage public spending in the rest of government –  starting from the principle of annual appropriations, with a clear delineation by functions (monetary policy, financial system regulation, physical currency etc), and standard restrictions on the ability of ministers to reallocate funds across votes).

I’m not aware of any country that funds it central bank by annual appropriation.  But historically, central bank spending all round the world was subject to weak parliamentary control.  This is one of those areas where the international models aren’t attractive, and the standard should instead be the way in which we authorise spending across the rest of government.   This is a policy and regulatory agency –  not, say, primarily a trading entity (like, eg, the New Zealand Superannuation Fund) –  and should be funded, and held to account, accordingly.

Should the Reserve Bank be broken in two?

I’ve come to think so.

The Reserve Bank has two main functions:

  • conduct of monetary policy (and supporting activities –  currency issues, foreign reserves management, interbank settlement accounts), and
  • prudential regulation of banks, non-bank deposit-takers, insurance companies (and roles around payments system and AML thrown in for good measure.

These quite different functions are conducted in one institution, but they needn’t be.  In fact, in most advanced countries they aren’t.

Historically, there wasn’t much prudential regulation in New Zealand at all.  There was lots of direct regulation of various types of financial intermediaries (banks, building societies, savings banks and so on) but most of the regulation (reserve ratios, interest rate controls etc) was macro policy focused, not about financial system stability or depositor protection per se.   That regulation –  often administered by the Reserve Bank, but individually approved by the Minister of Finance –  was a substitute for the sort of market-based monetary policy all advanced countries now rely on.   As interest and exchange rates were freed up, the panoply of direct controls was stripped away.   Our great bonfire of such controls took place in 1984 and 85.

By the time what became the Reserve Bank of New Zealand Act 1989 was going through Parliament, the primary conception of the Reserve Bank was as a monetary policy agency.   Sure, there were some regulatory provisions –  and in particular provisions around the handling of bank failures –  but it was seen as pretty peripheral activity.  If anything, it became more peripheral as the 1990s unfolded: the framework covered only banks (increasingly a foreign-owned group), there was a shift to a largely disclosure-based regime, and the function took very few staff  (from memory, only around 10 or 12 staff).  For practical purposes it probably wasn’t too much of an issue that the two functions were in one institution.

But as the 21st century unfolded so too did a dramatic change in the supervisory and regulatory activities the Reserve Bank was involved in.    There were new classes of entities to regulate or supervise, new functions (payments system and AML) to regulate or supervise, new statutory reporting obligations, a reduced reliance on disclosure (even for banks), and new powers and new appetite for more direct and discretionary regulatory interventions (culminating, for example, in the numerous iterations of LVR controls in recent years).  The Reserve Bank now is at least as much of a financial regulatory and supervisory agency as it is a monetary policy one.  A large share of the staff, a large share of the budget, and a large share of the Govenor’s time is now devoted to these functions.

I’m not here offering a view on the merits, or otherwise, of these new activities.  The point is simply that Parliament has either specifically mandated the Bank to do these new things, or written legislation that has allowed the Bank to do them.    And those functions don’t look like going away any time soon.  After all, if many details are a bit different from models used in other countries, the broad direction –  more comprehensive, more intensive, controls –  isn’t exactly some idiosyncratic New Zealand thing.  It is the way of the world, for good or ill.

At times, the Reserve Bank has tried to make a virtue of this “all in one” model.  In the wake of the 2008/09 recession, the former Governor Alan Bollard made much of the idea of a “full-service central bank”, very well-positioned to carry out the variety of different functions because they were all located in a single institution.    More often, the Bank has pointed out that there is a range of ways of organising these activities, suggesting that no one model is clearly superior.

There is certainly a range of models used in other countries, but once one looks a bit more closely there are also some pretty clear patterns which emerge.  Specifically, New Zealand’s current model is out of step with the main stream of advanced countries.

People here often, and naturally, look to Australia.  Once upon a time their Reserve Bank and ours had a lot in common in what the institutions were responsible for, and both had evolved through a phase where direct controls had been mostly about monetary policy.  But about 20 years ago, the emerging regulatory functions were spun out of the Reserve Bank and a separate Australian Prudential Regulatory Authority (APRA) was established.     There has been no sign that the Australian authorities are unhappy with that model, which seems to work well, allowing both the RBA and APRA to concentrate on their own primary areas of responsibility.

There are plenty of advanced country central banks which are responsible for bank supervision.  But in most cases now those national central banks are part of the euro-area: they don’t themselves set monetary policy (although each Governor has a vote at the ECB), and would struggle to justify existing as independent entities were it not for the supervisory roles.

But if we look at advanced countries that do have their own monetary policies, I could find only three others –  Czech Republic, Israel, and the United Kingdom –  in which the same agency is responsible for monetary policy as for prudential supervision.   The US is –  in this area as so many –  a curious hybrid system, in which the Federal Reserve has some –  but not remotely all – responsibility for prudential supervision.  But as far as I could tell, the following OECD countries have monetary policy and prudential supervision conducted by separate agencies:

Canada, Australia, Norway, Sweden, Korea, Japan, Poland, Chile, Turkey, Mexico, Switzerland, and Iceland

I’m not sure that Turkey or Mexico offer models of governance for New Zealand, but the presence on that list of small well-governed countries like Norway, Sweden and Switzerland –  as well as tiny Iceland –   gave me pause for thought.

And the more I reflected on the issue, the harder it was to identify good reasons why New Zealand should now stay with the all-in-one model:

  • probably the most common argument made is about the possible “synergies” between financial regulatory and monetary policy functions.  But there are snyergies, connections, and potentially valuable information overlaps all over the place.  Between fiscal and monetary policy for example, and yet we –  and every other advanced country –  keeps fiscal policy advice and governance quite separate from monetary policy.   And I could mount arguments of possible synergies between the Reserve Bank’s financial market activities and the role of the Financial Markets Authority, and yet no one seriously argues for putting the FMA into a mega Reserve Bank.     Specialisation, and specialist agencies, has tended to be the way in which advanced country governments have organised themselves (often backed by information-sharing protocols, and effective working relationships across agencies –  eg a typical Cabinet paper will reflect perspectives or comments from a range of agencies with relevant perspectives on the topic),
  • as it is, the synergies between the monetary policy related functions and the prudential regulatory ones are generally pretty slight –  almost vanishingly so in normal times (and there are some conflicts).   The timeframes are different, the instruments are different (indirect influence vs direct controls), the required mindsets are different, the Bank’s own financial market operations are typically quite mundane, and its research capability (developed mostly for monetary policy purposes) has rarely been used to produce research around the regulatory or supervisory functions.     One of my former colleagues likes to argue that one should conceptualise the Bank’s regulatory role as akin to that of a banker knowing his or her customers, and (eg) maintaining covenants on the credit facilities of those customers.  But mostly monetary policy isn’t about lending to banks –  and certainly not to insurers or credit unions –  and when there is lending involved in monetary policy, the Bank typically seeks to expose itself to minimum credit risk.   Crises can be, and are, different –  lender of last resort, and provision of emergency liquidity is a core part of a central bank role –  but it doesn’t seem to have been an obstacle to other small well-governed countries separating out the monetary policy and regulatory functions into different institutions.
  • organisational cohesion and culture are likely to be better-fostered in institutions that have a single main purpose,
  • the same goes for the senior leadership of the organisation.  20 years ago it would have been inconceivable that the Governor would be focused primarily on anything other than monetary policy –  that was overwhelmingly the Bank’s role –  but now it is not so at all, and yet the sort of skills, expertise, and even relationships that might be needed to be responsible for monetary policy –  with considerable macroeconomic discretion, and associated accountability, may be quite different from what best suits a regulatory agency.   We might well benefit from having both a highly capable macro and markets focused Governor of the (monetary policy) central bank, and the head of a specialised financial regulatory agency.
  • governance structures and accountability models would be likely to develop more naturally if the two main functions were structurally separated into different institutions.   (And it is more difficult than it should be to hold the Governor effectively to account when he is responsible for two, quite different. big areas of policy).
  • Specifically, the Bank’s regulatory activities would quite naturally fit with something much closer to a standard Crown entity sort of model (as with the FMA) –  in which key big picture policy matters were decided by the Minister of Finance (with advice from Treasury and the agency), while the Board of the agency was responsible (with operational autonomy) for the implementation of the framework.  The monetary policy (and related) functions don’t fit that sort of model, partly because of the inevitable quite substantial degree of policy discretion –  and hence need for ongoing transparency and accountability –  that are (largely rightly) seen to need to go with monetary policy.

I’ve argued previously that it seems mistake to push ahead with the proposed Stage 1 reforms flowing from the review of the Reserve Bank Act, without first completing an overall review of how the functions the Bank currently undertakes should best be organised, governed and held to account.

And so here is my model:

  • the Reserve Bank becomes responsible for the conduct of monetary policy (and directly associated functions –  interbank settlement, notes and coins, foreign reserves management.   In my post on Monday I outlined how I would establish a statutory Monetary Policy Committee.   The same people, appointed the same way, would comprise the Board of the Reserve Bank, and would be responsible for all the functions of the Reserve Bank.  Specific statutory provisions –  of the sort outlined in Monday’s post –  would cover them when meeting as the Monetary Policy Committee.  Note that this model would also increase the chances that the executive members of the Monetary Policy Committee would be genuine experts in the area, devoting of their time and energy to monetary policy,
  • a New Zealand Prudential Regulatory Agency –  parallel to APRA –  would be established to take responsibility for the regulatory and supervisory functions the Bank currently has  (but with a revision and streamlining of powers, so that  major policy framework decisions are once again matters for the Minister of Finance).    There is a variety of possible structures.  A typical Crown entity would have a non-executive Board responsbile for the institution, employing a chief executive to run the day to say organisation, generate advice, and implement the policies of the Board.   But a small executive Board (akin to APRA) is an alternative approach.
  • perhaps the (formal) establishment of a Financial System Council, with representation from the Reserve Bank, the NZPRA, and the FMA, to offer advice –   perhaps especially systemic advice –  to relevant ministers.

There is no role in this model for anything like the current Reserve Bank Board.    That Board is almost totally useless, and I’m not aware of anyone who thinks it adds value.  In many ways that isn’t surprising.   The Board was designed as agent for the Minister and the public holding the Governor to account, in particular for his conduct of monetary policy (but also for his more general stewardship).   It isn’t a model found anywhere else in the New Zealand public sector, and for good reason.  The Reserve Bank Board has no independent resources, it meets at the Reserve Bank, its Secretary is a senior Reserve Bank manager, and the Governor himself sits on a Board whose prime purpose is to hold the Governor to account.   It is a highly successful recipe for “duchessing”:  the Board comes to see itself more as part of the Reserve Bank, acting to defend the Bank and the Governor, lulled by all the smart people who present to it (and with few/no formal powers), rather than as some sort of independent source of scrutiny or critical analysis.

Part of the failure is structural –  the system was set up in a way that meant it would almost inevitably fail (at least once monetary policy was conceived of as anything other than mechanical, and once the functions broadened out) –  but that doesn’t remove responsibility from the people (often otherwise quite able) who have served on the Board over the years.   In the 15 years the Board has been required to publish Annual Reports –  which, bad sign, they choose to publish buried in the midst of the Governor’s Annual Report –  they have never once made even a slightly critical or sceptical comment about the performance of the Governor or Bank, on policy or other areas of performance.  Disgracefully, they stood by silently while Graeme Wheeler and his senior management tried to silence Stephen Toplis’s criticism –  and, of course, they cheered on Wheeler’s public attack on me when I drew the Bank’s attention to an apparent leak of an OCR decision.    They serve no useful function, and should be disbanded as part of the current review, and amended legislation.

Of course, that doesn’t mean there is a reduced need for scrutiny and accountability.  My point about the Board is that, in effect, over almost 30 years they simply haven’t served that role –  they just function as a department of the Bank, protectors of the insiders.  Effective accountability doesn’t really involve the power to fire –  or to recommend dismissal –  the main formal accountability power the Board has: no Governor (or MPC member) will ever be fired for policy-incompetence related cause during their term (and nor should they be), and the same goes (and should) for independent financial regulators.  But reappointment is another matter altogether.  And much about accountability is the quality of the questions, the bringing to bear of alternative perspectives etc.    The new government has proposed –  in fact promised before the election, although nothing has been heard of it since –  to establish a Fiscal Council, to help provide genuinely independent scrutiny of fiscal policy and associated analysis.  I’ve argued previously –  and repeat the call today –  that this new entity should actually be set up as a Macroeconomic Review Council, responsible for independent scrutiny (published reports etc) on fiscal policy, monetary policy, and systemic financial regulatory policy.  Operating at arms-length from all the agencies –  Treasury, Reserve Bank, NZPRA, and FMA –  and not resourced by them, it would have a better chance of making a material contribution than the Reserve Bank Board has done, and could help promote scrutiny and associated debate.

A little anecdote of how the Reserve Bank’s Board seems to allow itself to be subsumed into the Bank

A month or so ago I lodged an Official Information Act request with the Reserve Bank’s Board –  explicitly asking for it to be delivered to the Board chair – asking them

  • how many OIA requests the Board had received in 2016 and 2017, and
  • for copies of the Board’s policies and procedures for handling OIA requests.

It seemed to be a pretty straightforward request.   The Board is, after all, statutorily distinct from the Bank, is required to publish its own Annual Report, and (in my experience) had good, well-filed, sets of Board papers.   With a new emphasis from SSC on agencies reporting on performance with OIA requests, I felt sure it would be an easy request to answer.  At most, surely, counting the number of OIA requests might require a quick flick through, say, 10 sets of minutes for each year.  I guess I also –  naively –  assumed that, with the current review underway, the Board would be keen to demonstrate the independent way in which it operated.

More fool me.

A couple of weeks ago, I had a response from one Roger Marwick in the Reserve Bank’s Communications Department telling me that under the Reserve Bank’s charging policy –  note nothing about the Board –  they would want to charge for this information, but noting that I might be able to reduce the charges by narrowing the scope of my request.

So I asked them what the cost would be if I simply restricted the request to the number of OIA requests.     And Mr Marwick responded that it would make no difference because all the costs were associated with that limb of the request.

So I then went back to him –  this was 12 days ago now –  suggesting that if that was the case, I presumed he could now provide me with the Board’s policies and procedures (since he’d just told me that all the costs were associated with the other limb of the original request.

I’ve heard nothing more since.  Last Friday, I went back to Mr Marwick and specifically asked for clarification as to whether the Board was refusing to release the policies and procedures, or were still considering the matter (as fast as reasonably practicable –  the statutory standard).  And again, I’ve heard nothing more.  My suspicion is that there are no Board policies and procedures for handling OIA requests, and that even though the Board’s whole role is to operate at arms-length from the Bank, holding it to account, they’ve just made themselves part of the institution, and left the same management they are paid to hold to account to handle such things.  And, clearly, have no interest themselves in the number or nature of requests being made of them.

In short, they are useless and ineffectual, at least for anything other than giving cover to the Governor.   But perhaps it shouldn’t really be surprising: this was the same Board that, on the basis of their own disclosed papers, doesn’t even comply with such basic requirements of good public sector governance as the Public Records Act.

UPDATE: A day after posting this, I had an email from the Reserve Bank backing down.  I have now been provided with the number of OIA requests made to the Board, and a copy of the Bank’s policies for handling OIA requests, with this observation

requests addressed to the Board are processed in the same way as those addressed to any other part of the Bank. The policy for handling OIA requests addressed to the Board is the same as the Reserve Bank’s policy. In the case of OIA requests made of the Board, the Bank informs and consults the Chair on the requests, and the Chair informs the Bank of the preferred response.

But since the decision to waive charges –  and thus avoid an appeal to the Ombudsman –  is described as having been made by the Bank, not the Board, I think it largely serves to illustrate my point, that the Board works hand in glove with management rather than serving as an sort of independent check on them.

 

 

Towards a statutory monetary policy committee

As part of the review of (parts of) the Reserve Bank Act, The Treasury is inviting comments and suggestions, on how the changes in stage 1 of the review (statutory goal of monetary policy, establishment of a statutory monetary policy committee) should be implemented, and on what else should be reviewed in the forthcoming stage 2 of the review.

Last Thursday I went along to a Stakeholder Engagement Roundtable, in which Treasury had invited various private economists in to offer our perspectives on those issues.  My post on Thursday –  on the statutory goal of monetary policy –  was, in effect, part of my notes in preparation for that meeting.   In the discussion, opinion was fairly mixed on the merits of making a change, but it was generally recognised that the government had committed to change and so the main issue was how best to give it legislative form.

The second chunk of the discussion was about the establishment of a statutory monetary policy committee.  Here there seemed to be greater unanimity that reform was desirable, and that part of any reform should be a greater emphasis on transparency, including individual accountability.

I’ve covered my own views on various of these points in earlier posts, but for ease of future reference, I thought I’d bring them together in a single post.  My model would not replicate that in any single other country, but is probably closest to the monetary policy committees in the United Kingdom and Sweden.

Who should appoint the members of the committee?

All of the members should be appointed by the Minister of Finance.   People who exercise significant statutory power –  and the conduct of monetary policy is certainly that –  sholu.d either be elected themselves or appointed by those who are themselves elected.  That is the general approach we take to governing New Zealand:  whether it is Cabinet, the courts, the boards of Crown entities, the Commissioner of Police, or the Auditor-General.  There is no particularly good reason why members of a Monetary Policy Committee should be different.    There are probably unique aspects to all governance appointments, but nothing around monetary policy marks it out as warranting putting another layer between the elected and the decisionmakers.

This is, of course, in contrast both to the current model (single decisionmaker –  the Governor –  in effect appointed by the Bank’s Board), and to the model Labour campaigned on (where external members would be appointed by the Governor –  putting them at a further removes from someone who has to actually face the voters).  Allowing the Governor to appoint the external members would risk substantially undermining the reasons for the reforms.

In the United States nominees for the Federal Reserve Board of Governors are required to win Senate confirmation.  That isn’t our constitutional model.  In the United Kingdom, appointees are required to face a parliamentary select committee hearing before taking up the role.  The committee can’t block the appointment, but can report on the suitability of otherwise of the nominee.   This might be a useful feature to add here.  It isn’t an approach we take generally, but monetary policy makers exercise wide powers of discretion (much more, say, than a typical Crown entity Board member) and, with ex post accountability difficult to maintain, it seems reasonable that those taking up such roles should face some open scrutiny at the start.

There is a counter-argument that the Governor should be free to appoint his or her own Deputy (as might be normal in a commercial context).  To which my response would be that if the deputy was not serving on a statutory committee, exercising statutory powers, that model would be fine.  But if the Deputy Governor is to exercise statutory powers, they should be appointed by someone who was elected, and who is accountable to voters: as far as I can tell, that is the typical model (including, for example, in Australia and the United Kingdom).

How many members should there be?

I’d favour either five or seven.  Any larger number would make it unduly difficult to fill the roles with good people consistently through time.

Either way, I’d favour having two internals (executives) – the Governor and a Deputy Governor –  with the remaining members being part-time non-executives.  It is highly desirable to have a majority of members who are outside the managerial hierarchy of the Bank.  Put the structure the other way round and there is a high risk that, over time, the non-executive members will be neutered (with management coming to block vote), and that  then good people will be unwilling to put themselves forward to serve on the committee.  Non-executives will always be at some disadvantage –  re access to analysis, and ability to influence the research agenda etc – and only be holding the majority of votes on the committee will they be able, if they choose, to consistently push back against that pressure.

The counter-argument often made is often about technical expertise: the choice between internals and externals is often presented as a choice between experts and non-experts.  To which there are several responses to be made.  First, as the Reserve Bank is currently structured, the internals will often not be “experts” on monetary policy at all –  none of the Governors since 1989 could really be classed as “experts” on monetary policy, although of course over time they acquired considerable experience, and even among Deputy Governors there have been considerable differences of expertise and background.  And the skills of being a good chief executive –  running the organisation, generating the analysis, managing the operations –  also aren’t necessarily those of a leading monetary policy expert.

But perhaps as importantly, while I think it is vital to have expert advice and analysis, as inputs to decisionmaking, it isn’t clear that we want technical experts making policy decisions, and exercising the (inevitable) degree of discretion that monetary policy makers do.  Some people with technical expertise may be able to serve effectively as decisionmakers (and communicators) but the skills aren’t the same at all.  And if the internal members of a Monetary Policy Committee, with all the technical resources of the Bank staff at their command, cannot convince one or two non-executive members of the merits of their case, it seems unlikely that they will be able to convince the wider public.

What sort of non-executive members should be appointed?

I’m wary of making much of an internal vs external distinction, and instead focus on that between executives and non-executives.  After all, there has been no internal candidate appointed as Governor since 1982.

But in considering non-executive appointments (three or five in my model) there are a few relevant considerations:

  • no one should be appointed to represent a particular interest group.  Of course, everyone has a background, but once one takes up a position on an MPC your commitment has to be to implementing the Act and serving the interests of the country as a whole,
  • there should be no prohibition on non-resident or non-citizen members (although I would favour no more than one at a time).   We are a small country, and there can at times be valuable perspectives that people employed abroad can offer (and it is a model the UK has used), as one vote among five or seven,
  • it would be desirable to have one member with some reasonable academic exposure to monetary policy, but undesirable to think of a Monetary Policy Committee as, say, a research conference or an academic seminar,
  • people with sound general Board-level skills can make a valuable contribution to an MPC, regardless of their formal academic background.  One doesn’t typical won’t an telecoms company Board stuffed full of tech people, and there isn’t any obvious reason why a Reserve Bank MPC should be different.  The ability, and willingness, to ask hard questions, and even just to say “tell me that again, in ways I can understand” is a valuable part of the mix.

How long should MPC members’ terms be?

I would favour five year terms, perhaps with a limit of one reappointment each.  With five or seven members, one appointment would come up every year or so, enabling a government is the course of a three year term to replace gradually around half the members of the committee, but not to launch a purge on newly taking office.   Terms of this length seem reasonably conventional (and are the same as those of the Governor, and Board members, at present).

Individualistic or collegial?

I’ve outlined here previously why I strongly favour the sort of individualistic model adopted in the UK, the USA and in Sweden, in which individual members of the MPC are individually accountable for their votes.  The current management of the Reserve Bank really dislikes the model, but they have never been willing, or able, to articulate –  from the experience of other countries –  what the nature of their concerns is, and how they balance any such concerns against the interests of democratic accountability, in a model in which decisionmakers exercise considerable discretion.

As I’ve documented here over the years, formal effective accountability for monetary policy decisions is hard –  much harder than those who devised the current law thought at the time it was drafted.  In practice, accountability can be exercised only through public scrutiny and challenge, and at the point where a member of the MPC is up for reappointment.  Against that backdrop –  and in a game where there is so much uncertainty – it is highly desirable that individual MPC members’ votes should be recorded and published, and that members should have the opportunity to have their views recorded in minutes that are published in a fairly timely fashion.  The Reserve Bank’s management has at times expressed concerns about this approach –  used elsewhere –  “muddying the message”, but in fact there is so much uncertainty about the way ahead (what is going on with the economy and inflation) that over time it will usually be preferable to have in public the sorts of issues and concerns that were bothering decisionmakers, rather than just some sort of somewhat-artificial consensus about an immediate OCR decision.

In a similar vein, MPC members should all be free to make speeches, give interviews etc articulating their own views on the issues the MPC is facing.  I’m not suggesting some sort of chaotic free for all: it would no doubt be desirable for members to develop protocols in which members ensured that other members were aware of forthcoming speeches and interviews, agreed to circulate draft texts to each other in advance, and perhaps agreed to avoid comment altogether in the week or so (say) prior to an OCR announcement.  Commonsense and common courtesy can resolve many potential issues.

Who should chair the MPC?

The Governor.  I hadn’t particularly thought of this issue, but it came up at the Treasury meeting the other day. There is an argument for a non-executive chair –  the approach in most Crown entities – but provided there is a majority of non-executive members I’m not sure I see the case for departing from the universal international practice, in which the Governor chairs the MPC.    (It is also perhaps worth noting here that in other countries –  including the UK – it has not been a problem if the Governor has at times voted with the minority.  Smart people will often view the same data quite differently.)

Transparency

The amended Act should require the publication of minutes, and the record of individual votes, within a reasonable time –  perhaps to be determined by the Minister –  of the particular OCR decision.  As I’ve noted previously, I do not favour either keeping, or eventually publishing (even with very long lags), transcripts of MPC meetings.

I would also favour moving to a system where the background papers for MPC meetings are routinely and pro-actively published (perhaps six weeks after the OCR decisions to which they relate).  Ideally, I would not consider this something that should be legislated, but given the obstructiveness of the Bank, and the willingness of successive Ombudsmen to aid and abet the Bank in keeping such papers secret even well after the relevant decision, the legislative option may need to be considered.

As I’ve noted repeatedly before, the Reserve Bank is quite transparent about stuff it knows little abour –  eg where the OCR might be a couple of years hence –  but isn’t very transparent at all about what it does know about.  Transparency is valuable in itself –  an essential part of democracy –  but in a small country with limited pools of expertise, the ability of greater transparency to facilitate more informed and debate and scrutiny of the issues is almost instrumentally useful.

Should there be a Treasury representative on the MPC (in a non-voting capacity)?

I don’t have a strong view on this issue, but it is a model that is used in a number of countries, and could help to formalise a recognition of the relationship between various bits of economic policy.    The model appears to have worked, without undue problems, in the UK.     But if it is to be done, it needs to be recognised that it would involvement a non-trivial time commitment by someone reasonably senior in Treasury –  and time/resources are scarce.

The Policy Targets Agreement

At present, Policy Targets Agreements are (a) signed with the Governor personally, consistent with the single decisionmaker model, and (b) have to be agreed with an incoming Governor before that person is formally appointed or takes office.  It is a poor model, and not one that is much imitated abroad.

Under my reform model, the MPC as a whole would be responsible for monetary policy and the onus of a PTA should also rest on them.  To do that probably requires rethinking the PTA model, and might suggest moving to the system adopted in some countries –  eg the UK –  where the goal (PTA) is specified by the Minister of Finance, and the MPC is simply responsible for conducting policy consistent with that goal.  The UK model isn’t ideal – the target can be changed at the Chancellor’s whim in the annual Budget –  but a system in which the target is specified every few years, after  advance consultation with the MPC of the day (and ideally with the wider public, and with FEC), would seem to have some attractions.  To get the right balance between responsibility for setting overall goals –  resting with the elected government –  and a degree of stability, perhaps the appropriate review period might be six months after a change of government (with provisions for other changes to the PTA only in exceptional circumstances –  say with the agreement of the majority of the MPC.)

The final issue Treasury asked us about under this heading was about the role of the Bank’s Board.  There seemed to be pretty universal agreement among attendeees that the Board adds little or no value.  But, as I’ve noted here previously, you can’t really answer the question about the appropriate role of the Board without thinking harder about the overall organisation of the institution (rather than simply one function –  monetary policy).  I’ll come back to that on Wednesday.

And on a completely different topic

Regular readers will know that I live in Island Bay.  Some will have seen the story in yesterday’s Sunday Star-Times suggesting that our local primary school was “New Zealand’s richest primary school”, based on reported donations in 2016 of $490000.    This qualifies as pretty poor journalism.  Island Bay School is a decile 10 school (although I suspect in the poorest 10 per cent of the top 10 per cent of neighbourhoods).  It was reported that

“Island Bay school’s 460 students contributed $490000 donations in 2016 –  an average of $1065.46 per student for the year’s schooling”

In fact, those parents who paid the scheduled annual donation paid around $250 per child, in other words only around a quarter of the total.   But one, very wealthy, old boy made one very generous donation.  Here is the Principal’s newsletter from 10 March 2016

I awoke to the best news ever this morning: Sir Ron Brierley, an old boy of the school, has generously agreed to donate a sizeable sum to the Rimu Block modernisation project. This gift, combined with Ministry of Education funding, gives us sufficient funding to realise our full vision for the modernisation of Rimu. This would not have been achieved without the generosity of Sir Ron, who has been a wonderful friend and supporter of Island Bay School over the years. In 2011 he kindly contributed towards the Learning Hub and now he has made this contribution towards Rimu Block.

As a parent, it always amused me that such a left-leaning school (and successive Principals) were taking such large amounts of money from a generous capitalist.  It is a real gain to the school, but it is almost totally irrelevant to the debate around the “donations” that parents are asked for each year.

 

The statutory goal for monetary policy

The government has a review of the Reserve Bank Act underway at present.    It is an odd beast.    There is a rushed process going on to review and amend the monetary policy bits of the Act, led by Treasury and assisted to some modest extent by an Independent Expert Advisory Panel –  itself chaired by someone with no experience in monetary policy.   And then there might be a second stage review, to be jointly run by the Treasury and the Reserve Bank, which might –  or might not –  have the same Independent Expert Advisory Panel.  If well-intentioned, it is pretty unsatisfactory: lightly-resourced, potentially giving too much influence to the Reserve Bank itself, and not working from a coherent overview of the Bank as an institution (thus, part of the first stage review is looking at the role of the Bank’s Board as regards monetary policy, without having engaged properly with how the whole organisation should be structured, managed, and held to account, or even looking at the interactions between the Bank’s various functions).  How much better it would have been to have had a proper independent review, looking at all the roles/functions of the Bank at the same time, with a view to legislating next year.    That was, for example, what was done in Norway recently with central banking legislation of similar vintage to our own.    It would also reduce the chances that, with a patch-protecting new Governor, the second stage of the review will just peter out and come to nothing.

There are two main bits to the first stage of the review:

  • amending the statutory goal of monetary policy to add a focus on maximising employment (or minimising unemployment), and
  • introducing a statutory committee, including non-executive members, to make monetary policy decisions.

For the time being, much of what the government says they want to achieve around the first bullet  (the objective for monetary policy) could be done through a new Policy Targets Agreement  –  one needs to be signed before Adrian Orr can formally be appointed as Governor (and thus will be necessary even before Stage 1 reforms can be legislated.  I outlined some suggested wording in a post last year.   Sadly, with the rushed review focused on the Act, there is no sign of any public process looking at the content of the Policy Targets Agreement, even though it is the main policy instrument for short-term macroeconomic management.

But how should the statutory goal be restated?  Since 1989 the key clause of the Reserve Bank Act (section 8) 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.

And 10 years ago, a revised purpose clause was added to the Act, and around monetary policy this is what it said

The purpose of this Act is to provide for the Reserve Bank of New Zealand, as the central bank, to be responsible for—formulating and implementing monetary policy designed to promote stability in the general level of prices, while recognising the Crown’s right to determine economic policy;

Policy Targets Agreements have to be consistent with section 8 –  ie “achieve and maintain” price stability, not just “promote” it.

The Labour Party, in Opposition and now in government, have offered various takes on what they want to do with the statutory goal without (sensibly enough at this stage) specifying a precise set of words.  Presumably they are serious about taking advice.

When the policy was launched last April the suggestion was to broaden “the objective of the Bank from just price stability to also include a commitment to full employment”.

In the terms of reference for the current review, agreed by Cabinet, the phraseology is as follows

recommend changes to the Act to provide for requiring monetary policy decisionmakers to give due consideration to maximising employment alongside the price stability framework;

The Minister of Finance has also talked about looking to the wording used in the central bank laws of Australia and the United States.

As I’ve outlined here previously, I favour changing the wording of section 8, as much as anything because the current wording does not adequately capture why we have a central bank running discretionary monetary policy.   One doesn’t need such an active central bank to maintain a broadly stable general level of prices; indeed, the introduction of fiat money systems over the last hundred years or so has led to less stability in the general level of prices than prevailed previously.

The existing wording of section 8 was an understandable –  and generally helpful –  reaction to the very poor inflation track record New Zealand (and many other countries) had run from the 1960s onwards.  Inflation has been lower and more stable than it was previously –  although not just because of the change in the Act.  But it still didn’t capture what we really wanted the central bank to do.    Active discretionary monetary policy is really about attempting to manage the business cycle –  and especially to be able to respond aggressively to extreme circumstances –  subject to the constraint of not letting inflation get away on us.    To word it that way doesn’t diminish the significance of keeping inflation in check –  any more than saying that fiscal policy should be managed to meet various government goals, subject to the constraint of not letting debt blow-out.

This way of thinking about active monetary policy is quite consistent with what we learned from the Great Depression –  countries that acted earliest to break the golden fetters rebounded earliest and saw resources (including unemployed people) back in work most quickly.  But, more mundanely, it is also consistent with the way in which inflation targeting central banks have (a) run things, and (b) specified their practical mandates.     Thus, from the earliest days of inflation targeting, there have been numerous events –  notably oil price shocks or indirect tax changes –  where the Bank has been expected to let inflation rise (fall) temporarily away from target, to minimise the output and employment consequences of such shocks  (trying to keep inflation on target in face of a big oil price increase would typically be expected to require inducing a recession).  Policymakers recognised that, actually, avoiding unnecessary surges in unemployment –  or recessions –  was locally more important than keeping inflation at, say, 2 per cent all the time.  But that calculus changes if it looked as though inflation was going to drift permanently higher.     The wording of the current legislation is unhelpful if –  and to the extent – it leaves voters fearing otherwise – that policymakers don’t care about unemployment/employment in its own right.

The other thing worth bearing in mind is that no central bank act –  not even something more specific like a Policy Targets Agreement –  can specify everything about how we want a central bank to run monetary policy.  Circumstances change, and the unexpected combinations of shocks happen.    There was a degree of naivete around that in the early days of the current Act, encapsulated in Don Brash’s unconditional answer to a radio interviewer indicating that he would lose his job if inflation went above 2 per cent (the then top of the target range).   But everyone recognises the limits now.

Thus, it is not possible to sensibly write down –  whether in the Act or the PTA – a numerical objective for “full employment”, “maximum employment” or the like (and the government has repeatedly stated that it has no intention of doing so).  But that doesn’t make it less worthwhile writing such considerations into legislation, requiring the Bank to report against them, and expecting those holding the Bank to account to take serious account of them.   And if even that was thought to be impossible, it might sensibly lead to some reconsideration as to whether having an independent central bank set policy –  rather than just advice on it –  was really the best way to organise things.

But how best to word things?  There have been suggestions from the Minister of looking at the specific wording in the Australian and US legislation.  I don’t think that will –  or should –  get people far.   Here is what I had to say on those options from an earlier post.

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.

So we need some fresh wording, and as far as I can tell there are no excellent models abroad to look to.

My strong preference would be to focus any new wording on minimising unemployment (or concepts like “full employment” –  a traditional Labour Party focus) rather than on maximising employment.       The concept of unemployment is about avoiding a situation where people who want to work, and are available for work, are unable to find work.   A simple focus on employment suggests that the more employment there is the better, whether people want (or need) to work or not.     I’ve seen political leaders boast that New Zealand has one of the highest employment rates in the advanced world, but to my mind at least that isn’t a sensible or legitimate boast –  or even a matter of public policy interest (speaking as someone who is, entirely voluntarily, not in the paid workforce).  It has Stakhanovite connotations.  By contrast, situations where people who want work, need work, can’t find work should be a matter of real public policy concern, and it is also something that  – in some but not all circumstances –  monetary policy can do something about, since most of the fluctuations in unemployment are a response to demand shocks.

So I’d suggest wording along these lines

“the goal of monetary policy shall be to promote the lowest rate of unemployment consistent with maintaining a low and stable rate of inflation on average over time”

But that might be too stark for some, too radical for others.   Another way of saying much the same thing, while keeping low inflation first in sequence, might be this sort of wording

“the goal of monetary policy is to maintain a low and stable rate of inflation on average over time. In pursuing this goal. the Bank shall do all that can be achieved by monetary policy to avoid unnecessary deviations of the unemployment rate from the rate that would resulting from those regulatory, structural, and demographic factors beyond the influence of monetary policy”

(You will note that I’ve suggested deleting altogether both the suggestion that monetary policy is the “primary function” of the Bank –  these days it is one of two prime functions –  and the references to a “stable general level of prices”.  The Bank has never targeted the price level, and the price level is not stable.    Some argue for a price level focus rather than an inflation rate focus, but there is no easy way for the statute to encompass both options without using even vaguer language.    Arguably, a “low and stable inflation” rate encompasses options for price level targeting, while “a stable general level of prices” does not really encompass a price level growing on average at up to 3 per cent per annum. )

Of course, the new wording for section 8 –  whichever formulation is chosen –  does not (or should not) stand alone.  Appropriate wording for a Policy Targets Agreement would still need to be found.  I’d have no problem with a continuing focus on a 2 per cent target midpoint –  as some sort of medium-term reference point for people to use in their planning.  But there should be a stronger emphasis in the Policy Targets Agreement on the cyclical management responsibilities –  including, in particular, preparation for the next big downturn (when, at present, monetary policy looks to be quite severely constrained in limiting the output and unemployment consequences).

And, as I’ve suggested previously, in both the Policy Targets Agreement, and in section 15 of the Act (governing Monetary Policy Statements) it would be appropriate to add some explicit wording requiring the Bank to report periodically on its estimates of the long-run sustainable rate of unemployment (and/or the NAIRU), on to report regularly on the relationship between actual unemployment rates and those estimates, and one what the Bank is, and is not, able to do about the gap.  These reports would serve several functions:

  • they would help focus the Bank’s attention (policy and research/analysis) on its raison d’etre  –  doing what it can to avoid unnecessary excess capacity, and
  • they would provide a formal and routine vehicle for articulating the limits of monetary policy.  It won’t, for example, be sensible to focus heavily on the unemployment rate for the time being if inflation really looks to be moving permanently much higher, but even in those circumstances, it is useful to require policymakers to contribute to the conversation about the appropriate balance of short-term focus –  what risks can and should be run (or not) and at what cost, even when everyone recognises the constraint that medium-term inflation needs to be kept in check.

One might even provide for the Bank to offer periodic advice to the Minister of Finance on what measures could contribute to lowering the structural rate of unemployment.    There are risks in such a provision –  many of those sorts of choices are almoat inherently political –  but again they help ensure a recognition that if monetary policy can, and should, do a lot about cyclical unemployment, it is unable to do anything much to alter the baseline structural rates of unemployment, which are mostly about political and social choices.

Those opposing change will emphasise the risks aroud these sorts of statutory changes.  And those risks need to be taken seriously.     But it is hardly as if the status quo is without risks or problems –  after all, we’ve spent the entire decade so far with the unemployment rate above domestic estimates of a NAIRU, and if that is no cost to most economists and policymakers, it has been for many ordinary New Zealanders.

Precisely because one can’t write down all that one wants a discretionary central bank to do with monetary policy in all conceivable circumstances, any particularly specification of the goal will be less than ideal.     So whatever the precise specification the government chooses, it is at least as important that an intelligent conversation be maintained about what monetary policy can and can’t do – not just in general, but in particular circumstances –  and that the Reserve Bank be encouraged (and compelled by law where appropropriate) to maintain an open and transparent approach, not just to the final fruit of its deliberations, but to its research, analysis, and the genuine uncertainty everyone faces in making sense of economic developments and the outlook for resource utilisation and inflation.

 

Some (Chilean) perspectives on monetary policy decisionmaking and communications

I’d had more or less enough for this week of thinking/writing about Reserve Bank reform issues, when a (central banker) reader sent me a link to an interesting new survey article by a couple of researchers at the central bank of Chile looking at various institutional arrangements, including decision-making and communications, at 15 inflation-targeting central banks (all from OECD countries).    I’d suggest The Treasury, and the Independent Expert Advisory Panel appointed by the Minister to assist with the review of the Reserve Bank Act, take a look at the paper.

It isn’t perfect by any means –  and there were a surprising number of small errors of detail or emphasis, including in places about New Zealand – but there is a lot of interesting material nonetheless.  For a start, they seem to have chosen pretty much the right group for comparison: the well-established market economies, with reasonably well-governed democratic societies.   One might quibble about the inclusion of Poland, or note that if Poland is included perhaps Hungary should be too, but if you are looking for insights and ideas as to how our central bank (in its monetary policy dimensions) should be organised –   and wanting something to read to complement the Reserve Bank piece I posted here yesterday –  this list of central banks/countries seems about right:

ECB, USA, UK, Japan, Canada, Korea, Norway, Sweden, Australia, Israel, Chile, Poland, Czech Republic, Iceland (plus New Zealand)

I wasn’t too interested in, and won’t comment further on, the detailed material on the specification of the inflation target itself (except to note to the authors that the New Zealand target now has an explicit midpoint reference) –  ground well-covered in various earlier Reserve Bank articles.

What of statutory decision-making structures?  Of the 15 central banks, only New Zealand and Canada do not have a statutory committee making monetary policy decisions.   That is well known.   What is less well-known perhaps is that all those 13 central banks with statutory committees operate by vote.     The authors note that Canada and New Zealand describe themselves as attempting to operate by consensus, but in fact of course in both places only one vote formally counts –   that of the Governor, who has the legal responsibility.     And even in New Zealand, although the three man Governing Committee is claimed to operate by consensus –  they refuse to release any minutes, even under the Official Information Act, to allow us to really know – the members of the wider advisory group make written OCR recommendations, in effect a non-binding vote.

In some of their writings, the Reserve Bank likes to claim that consensus-building models of decision-making are superior.   There may be some arguments on that side of the issue, but actually voting –  after examination of the issues, discussion and debate –  is typically how we make decisions in free societies: be it in elections themselves, decisions of a local tennis club committee, or our higher courts (five judges on the Supreme Court: the verdict supported by the majority rules).  There is no particular reason to think monetary policy decisions are not as well made the same way –  indeed, since there is a great deal of uncertainty, and decisions are revisited every eight weeks or so (so there are few irreversibilities) it seems a pretty demonstrably efficient approach.

The Reserve Bank has also sought to claim that small committees are generally better than large committees.  Again, at some point no doubt there is truth to that –  with all due respect to the Cabinet, the 20th person on any committee is unlikely to be adding much marginal value, and the incentives for any specific member of a committee that large to slack off (put in little effort or fresh thought) can be real.   But of the 13 inflation targeting central banks with statutory monetary policy committees, the median number of members is eight.    For a smaller country, a statutory monetary policy committee with five or seven members sounds about right for New Zealand (none of these statutory committees in other countries has fewer than five members).     Membership numbers don’t seem to be a luxury good: the authors present a chart showing no relationship between GDP per capita and the number of MPC members in an inflation-targeting country.

It is also clear that members of the statutory monetary policy committes are almost entirely appointed by politicians –  as most key positions in our societies typically are (from Chief Justice or Police Commissioner down).   There are some exceptions –  eg regional Fed Presidents in the US (who rotate through voting membership of the FOMC), but even that situation is now raising some concerns among scholars in the US.   And almost all of the central banks with statutory MPCs have external members, in some form or another (sometimes part-time, sometimes becoming temporary full-time executives, sometimes full-time non-executive): governments rarely seem to see monetary policy decisions as matters only for some career “priesthood of the temple”.

I was also interested in some analysis the authors had done on the extent of unanimity, or otherwise, among monetary policy committees where voting decisions are published.

To listen to our Reserve Bank, if voting records were published, or minutes in which individual members could outline their views on specific monetary policy decisions, it would be a recipe for mayhem.  They’ve talked of it creating confusion, and uncertainty, undermining confidence in, and the credibility of, the central bank.

Here is what the Chilean authors have to say about such individualistic committees.

In individualistic committees each member is held publicly accountable for their decisions, and each member is empowered with one vote. Decisions tend to be reached by majority vote, where the Governor tends to have the deciding vote in case of a tie. The high degree of individual accountability results in regular reservations, dissents, or minority votes against the final policy decision. Two regularly cited examples of this type of committee are those of the UK and Sweden. Importantly, when a certain degree of public disagreement among committee members occurs, market participants are generally not surprised and understand the differences as part of the policy process.

That is more or less the point I’ve been making.  One could say the same about the United States.  And recall that these authors are themselves from a central bank with a committee more towards the “collegial” end of the scale.

And, in any case, as they illustrate, even in individualistic committees raging dissent is hardly the norm.

central bank dissents

Roughly half of all the monetary policy decisions in the UK and Sweden in the last decade have been unanimous.  (On the other hand, even for central banks at the collegial end of the spectrum, not all decisions are unanimous).   I’m not sure why they didn’t include the Federal Reserve in this particular analysis, but I suspect the numbers there would show something similar to the UK or Swedish experiences.

There was also some interesting material on communications practices.  For example, all 13 of the central banks with statutory monetary policy committees publish minutes –  to repeat, every single one of them.   The timeliness varies –  the UK and Norway publish the same day as the monetary policy announcement, but a more typical lag in about two weeks –  and of course the nature of the content differs: some are pretty bland, while others (notably those of Sweden) although a full and careful articulations of the arguments and issues of concern to individual members.

But there was also some surprises (at least to me).  Our Reserve Bank grudgingly released background papers to a 10 year old interest rate decision, and consistently refused to release any background papers –  no matter how topical –  used in the preparation  of their interest rate decision or Monetary Policy Statement (eg the recent refusal to provide any background analysis papers on the impact of various policies of the new government).  By contrast, and at the other extreme, according to the Chilean paper the central banks of the Czech Republic and Norway “publish a version of the staff MPM [monetary policy meeting] presentations shortly after the meetings”.    I struggle to see any good reason why such background analysis should not be released publically with, say, an eight week lag (eg released after the OCR decision one after the decision to which the background material relates)

And a bigger surprise still was the publication of transcripts of monetary policy meetings.  I knew that the Federal Reserve was doing so, and had heard the odd mention of it happening elsewhere.  In fact, the authors show that seven of their central banks are now doing so (including the Fed, the ECB, the Bank of Japan, and the Bank of England).  The lags are quite long –  the Fed is the shortest at five years.  But, fascinating as some of the old Fed transcripts are, especially from the era before members knew they would be published, even I have my limits around transparency, and this is one of them.  As the Chilean authors note

as highlighted by the Warsh Review (2014), the publication of meeting transcripts (and minutes) may to a certain extent impair a candid discussion of policy options among policy-makers, and lead them to limit their interventions to written statements that express their view (and vote) without the consideration of the perspectives of other members. In this context, it is possible that policy deliberations may be driven to other settings where a formal record is not being taken. Moreover, some existing evidence for the U.S (Meade and Stasavage, 2008) suggests that the publication of FOMC transcripts reduced the likelihood of dissent among committee members, and made members less willing to change their positions over time.

But the fact that various major (and minor) central banks are publishing such transcripts again helps give the lie to our Reserve Bank’s constant claim that it is one of the most transparent monetary policy central banks in the world.

One final aspect the Chilean authors covered was the role (if at all) of a Treasury or government representative in monetary policy decision meetings.    In the Reserve Bank paper I linked to yesterday, the Bank authors attempted to minimise this issue.   They noted that in Australia the Secretary to the Treasury is a voting member of the Reserve Bank (monetary policy making) Board and that in the UK there is a non-voting Treasury observer  who attends (statutory) MPC meetings.   Of our 15 central banks, that is all they note (although in Colombia, one of the countries they look at, the Minister of Finance is himself a voting member).

But here is part of the fuller Chilean treatment of the issue

In a second large group of central banks, an important authority of the administration, such as the Minister of Finance or his delegate, is invited to attend and speak in the MPMs, but does not have the right to vote on the monetary policy decision. Within this second group, the degree of potential government involvement differs. In Japan for example, the representatives of the government (Minister of Finance, Minister of State for Economic & Fiscal Policy) may propose issues to be discussed in the MPMs, and may even formally ask the MPC to postpone a vote on monetary policy until the following meeting. In the case of the Bank of Korea, the representative of the government (Minister of Strategy & Finance) may publicly request the MPC to reconsider a monetary policy decision if it perceives that the decision conflicts with the government’s economic policy.

Their tables also lists Chile, the Czech Republic and the UK as having non-voting Treasury representatives.  In the comments on the Rennie review report from Charles Goodhart (ex UK MPC) and Don Kohn (a current member of the UK FPC) no concerns were raised about this aspect of the UK model.

I don’t have a strong view on the possible role of a Treasury representative on either a monetary policy or financial policy committee in New Zealand.  But there is enough precedent in other countries to suggest that option deserves more serious consideration than the Reserve Bank –  always keen to keep Treasury out of its hair –  gives it.     If there was to be non-voting observer, the rules of the game might be quite important –  the person would be there to inform, answer questions, and report (as in the UK) and shouldn’t see themselves as having a role to try to shape decisions.

The Chilean piece was interesting and refreshing.     They make it clear –  without directly engaging with New Zealand issues at all – that if the government reforms our Reserve Bank Act to provide for:

  • a statutory monetary policy committee,
  • all appointed directly by the Minister,
  • with a good mix of internals and non-executive internals,
  • and timely publication of minutes and vote number,
  • with perhaps even details of dissenting members’ views, and even
  • delayed publication of background papers

It would be placing the Reserve Bank of New Zealand’s new model of governance. decisionmaking and communications right in the mainstream of international practice for countries of our type.

As it happens, I saw last night one other snippet reminding us of how far central bank transparency could go.  The Financial Times had an interesting piece outlining concerns in some quarters about senior central bankers getting too close to private bankers (in the New Zealand in recent times –  but probably not generally –  the problem is more the opposite), with particular concerns about ECB head Mario Draghi.    Partly in response

The ECB also now publishes the diaries of its six executive board members after officials were found to have met private sector representatives around the time of monetary policy decisions.

It might be a worthwhile model for our new central bank Governor to consider emulating, along with (in time) his deputies and members of the new statutory decisionmaking committees.

Our central bank was once at the forefront of (some aspects) of central bank transparency.  These days, it has weak (formal) decisionmaking processes and doesn’t do at all well on the transparency front either.  Those issues should be tackled properly as part of the current review.

 

The Reserve Bank’s case for minimal reform

In early December, the Reserve Bank’s briefing to the incoming Minister of Finance  (BIM) was released, as part of the general release by the new government of the set of BIMs.     I wrote about the Bank’s briefing, and in particular about the appendix they included on the governance and decisionmaking issues.  In a departure from the now-common practice of including nothing of substance in BIMs the (unlawful) “acting” Governor –  I think I’ve gone a whole month without using that description –  took the opportunity to make his case in writing for minimal reform.

The Bank indicated that the appendix was itself a summary of a fuller document that they would make available to the Minister on request.  So I lodged an Official Information Act request for the fuller document, which they have released in full to me today.     It is really the sort of document that should be included with the collection Treasury has made available as part of the current Treasury-led review of the Reserve Bank Act, but as it isn’t there, I thought I should make it available for anyone interested ( RBNZ Memo – Review of policy decision process 16 Oct 2017 (1) ).

The paper was written by a couple of Reserve Bank managers –  Roger Perry, who manages a monetary policy analysis team, and Bernard Hodgetts who head the macrofinancial stability area –  and is dated 16 October, a few days before it became clear who would form the next government.   The paper itself is not described as Bank policy, but in the release I got today it is stated that

Please be aware that the document encapsulates Reserve Bank thinking at the time it was prepared.

Which suggests that at time it did represent an official view –  probably workshopped with senior management before the completed version we now have.     There is a pretty strong tone to the document suggesting that the authors did not expect a change a government (with only a couple of footnote references to possible implications of Labour Party policy positions in this area).

But, frankly, I was surprised how weak, and self-serving, the document was.  The Reserve Bank has been doing work on these issues off and on for several years –  there was the secretive bid a few years ago by Graeme Wheeler to get his Governing Committee enshrined in statute –  and yet there was little evidence of any particularly deep thought, and no sign of any self-awareness or self-criticism (over 30 years was there really nothing the authors –  or Bank –  could identify as not having worked well?).

There was also, surprisingly, no sign of any engagement with the analysis or recommendations of the Rennie report.  It is hard to believe that a report, on Reserve Bank governance issues, completed months earlier had not been shown to the Reserve Bank itself.   There was no substantive engagement with the models adopted in various countries that we tend to be closest too, or which are generally regarded as world-leaders in the field (by contrast, several references to the Armenian model –  to which my reaction was mostly “who cares”).    There was no reference at all to how Crown entities are typically governed in New Zealand –  that omission isn’t that surprising, given the Bank’s track record, but it should be (the Bank is after all just another government agency).  There wasn’t even any reference to how other economic and financial regulatory agencies in New Zealand are governed, even though the Financial Markets Authority is a new creation with a markedly different (but more conventional Crown entity) governance and decisionmaking model.

For what it is worth, on 16 October, the Bank seemed to favour:

  • enshrining the idea of the Governing Committee in law, but perhaps with slightly different versions of membership for monetary policy and financial stability functions,
  • legal decisionmaking power continuing to rest with the Governor,
  • the Governor’s appointment continuing to be largely controlled by the Board,
  • no publication of minutes or votes,
  • no external members of the committee(s).

But they make no serious attempt at critical analysis to support their case, let alone to engage with the risks of a system in which a single decisionmaker is key, and where that single decisionmaker is the boss of the other members of (what is really just) an advisory committee.   Or the anomalous nature of such a system in the New Zealand system of government, where even elected individuals rarely have such unconstrained authority, where committee-decisions are the norm (from Cabinet, the higher courts, through major Crown entities to school Boards of Trustees) and where Cabinet ministers (or Cabinet collectively) typically have the key role in appointing those who exercise considerable statutory powers.

The management of a central bank that can’t come up with better analysis than this really makes it own case for change –  legislative change, personnel change, and cultural change.

The Reserve Bank and financial regulation

Still working my way through the various articles and documents that turned up just before Christmas, I got to a lengthy issue of the Reserve Bank Bulletin, headed “Independence with acccountability: financial system regulation and the Reserve Bank”.   It is, I suspect, designed to fend off calls for any significant reform.

The Bulletin speaks for the Bank, and although as I read through the article I noticed distinct authorial touches and tendencies, when all is boiled down the author was sent into the lists to make the case for how things are done now: powers, governance, and accountability.  He does a pretty good job of presenting the party-line, against significant odds in many areas.    Even where one disagrees with the Bank’s case, it is a useful and accessible addition, in part because the Bank’s powers and responsibilities in regulatory areas have grown like topsy over the years and are scattered across various pieces of legislation.

Much of the first half of the article is designed to make a case for an independent prudential regulator, by reference to the theory and to the writings of the Productivity Commission.  But, for my tastes, it was far too broad-brush to add much value.  Probably no one disputes that we want the rules applied fairly and impartially, with politicians largely kept out of the process.  In the same way, we don’t want politicians deciding which person gets arrested and which not –  we want an operationally independent Police for that –  or who gets convicted  –  independent courts – or which airline passes safety standards and which not, and so on, so we don’t want politicians deciding to look favourably on one bank’s risk models and not on another’s.   There are many independent regulatory agencies –  or even government departments where the chief executive exercises responsibility in independently applying the rules –  but to a very substantial extent they apply and administer the rules, while other people make the policy/rules.

The Reserve Bank wants to make the case that in its area the rules/policy shouldn’t be set by elected people (whether Parliament itself, or ministers by regulation), but by an independent agency, and that the same agency should both make and apply the rules (without any possibility of substantive appeal).  It is the “administrative state” at its most ambitious –  unelected officials (a single one at present, not even directly appointed by a Minister) are lawmakers, prosecutor, judge and jury (and quite possibly the equivalent of the Department of Corrections as well).

The Bank seeks to rest a lot on the notion of time-inconsistency, a notion from the academic literature that is sometimes used to try to explain the high inflation of the 60s and 70s, and to make the case for an independent central bank to make monetary policy.  The idea is that even though one knows what is good in the long-run, the short-term benefits of departing from that strategy (and endless repeats of the short-term) mean that the long-term gains are never realised.  The solution, so it was argued, was to remove the short-term management of the business cycle from politicians.    I’m not particularly persuaded by the model as it applies to monetary policy (a topic for another day), and it is curious to see a central bank putting so much weight on that model after year upon year of inflation below target.  But today’s topic is financial regulation and financial stability, where the Bank would have us believe it is desirable/important to have the rules themselves –  the policy –  set by someone other than politicians.

No doubt it is true that there can be some tension between the short and the long-term around financial stability.  But that is surely so in almost every area of government life and public policy?  Underspending on defence now frees up more resources for other things now, but one might severely regret doing so if an unexpected war happens later.  Skimping on educational spending now won’t make much difference (adversely) to economic performance or the earnings of anyone (teachers aside I suppose) for a decade or two.  Running big fiscal deficits now can offer some short-term benefits, but at the risk of heightened vulnerability etc a decade or two down the track.   But in none of these areas do we outsource policymaking: they are political choices, and we then employ officials and public agencies to administer and deliver those choices.     The Reserve Bank has, as far as I’m aware, never offered any explanation as to what makes their specific area of policy different.   Sometimes they draw on academic authors writing about financial regulation, but many of those specialists fall into the same trap –  they see their own field, but never stand back and think about how democratic societies organise themselves across a wide range of policy.

As it happens, the current system around the Reserve Bank and financial regulation is a bit ad hoc and inconsistent to say the least, a point that the article more or less acknowledges.     Thus, for banks the Reserve Bank can vary the “conditions of registration” to change all sorts of big policy parameters, without any formal involvement from elected politicians at all (all the variants of LVR policy, from the first Wheeler whim were done this way).  But even for banks rules around disclosure have to be done by Order-in-Council, and thus require ministerial approval.  No one would write the law that way –  such different regimes for two different aspects of  bank regulation –  if starting from scratch (the actual legislation has evolved since 1986).

For insurance companies, the Reserve Bank itself can issues solvency standards (effectively, capital requirements for insurers), but for non-bank deposit-takers capital rules (and other main prudential controls) can only be set by regulation, again requiring the involvement and approval of the Minister of Finance.   (Incidentally, this is why LVR rules apply to banks but not non-bank deposit-takers: Wheeler could regulated banks directly, but couldn’t do the same for non-bank deposit-takers.

(And, as the Bank notes, it has “no direct role in developing rules associated with AMLCFT”, even though it administers and applies those rules for banks.)

At very least, there would appear to be a case for streamlining and standardising the procedures for setting the rules.     It isn’t clear why the Reserve Bank Governor should have almost a free hand when it comes to banks, but such limited scope to set policy when it comes to non-bank deposit-takers.   And, if anything, the case for ministerial involvement in settting the rules for banks is greater than that for the other types of institutions because (as the Bank acknowledges) bailouts and recessions associated with financial crises etc have major fiscal implications, and one might reasonably expect elected ministers to have a key role in setting parameters that influence the risk of systemic bank failures.   And, again as the Bank acknowledges, it isn’t easy to pre-specifiy a charter –  akin to say the Policy Targets Agreement –  for financial stability policy.

The Bank attempts to cover itself against suggestions that it might be, in some sense and in some areas, a law unto itself, by highlighting various ways in which the Minister of Finance might have some say.   There are, for example, the (non-binding) letters of expectation, the need to consult on Statements of Intent, and the potential for the Minister to issue directions requiring the Bank to “have regard” for or other area of government policy.     These aren’t nothing, but they aren’t much either –  and as the Rennie report noted, the power to issue “have regard” directions has never been used.    Even budgetary discipline is so weak as to be almost non-existent: there is a five-yearly funding agreement, but it isn’t mandatory  (something that needs fixing in the current review), isn’t particularly binding, and doesn’t control the allocation of spending across the Bank’s various functions.   The Minister of Finance doesn’t even get to make his own choice of Governor –  and all Bank powers still rest with the Governor personally.

The contrast with the other main New Zealand financial regulatory agency, the FMA, is pretty striking.   Policy is mostly set by the Minister (by regulation), advised by MBIE (to whom the FMA is accountable), and the powers of the organisation itself rest with the FMA’s Board, all the members of which are appointed directly by a Minister, and all of whom –  under standard Crown entity rules – can be removed, for cause, by the Minister.  Employees, including the chief executive, only have powers as delegated by the Board.    The FMA model is now a pretty standard New Zealand regulatory model, and an obvious point of comparison with the Reserve Bank.

Somewhat cheekily, the Reserve Bank attempts to present their own model as providing more scope for ministerial input than for the FMA  (see footnote 16, in which they note that for the FMA there is no power of government direction).   As regards policy, it isn’t necessary, since the government sets policy and appoints (or dismisses) the Board.   As regards the application of rules, one wouldn’t want –  and doesn’t have –  powers of government direction in either case.   As regards the banking system, mostly ministers can’t set policy, can’t hire their own Governor, and can’t fire him (re financial system policy) either.   The Governor and the Bank have far more policy power than is typical –  across other regulatory agencies –  appropriate, or safe.

The second half of the article is about accountability.  As they reasonably note, when considerable power is delegated to unelected agencies, effective accountability needs to provided for.    In their words “accountability therefore generates legitimacy and legitimacy in turn supports independence”.

It is, therefore, unfortunate that the Bank’s very considerable powers are matched, in this area in particular, by such weak accountability.   After pages of attempting to explain themselves and what they see as the various aspects of accountability, even they end up largely conceding the point.     These sentences are from the last page of the article

the BIS (2011) argues that financial sector accountability mechanisms should be focussed more on the decision making process rather than outcomes per se. This is because of the more intrusive nature of financial sector policy, and the issues associated with observing outcomes (lack of quantification and very long lags). Put another way, there should be less reliance on ex post accountability mechanisms and more obligations placed on ensuring decision-makers are transparent about the basis for their actions.

I’m not sure I entirely agree –  although there is certainly the well-recognised point that absence of crisis is evidence of nothing –  but at very least a focus on strong process might argue for:

  • a more effective separation between policymaking and policy administration (as is customary for many regulatory entities, but largely not for New Zealand bank supervision),
  • a decisionmaking structure in which power did not rest simply with a single individual, who is himself not directly appointed by an elected person,
  • decisionmaking structures that involve real power with non-executive decisionmakers,
  • effective and binding budgetary accountability,
  • a high degree of commitment to transparency and to ongoing external engagement,
  • a culture that is self-critical and open to debate,
  • perhaps some more effective scope for judicical review (including on the merits, rather than just process),
  • monitors with the expertise, mandate, and resources to ask hard questions and to critically review and challenge choices being made around policy and its application.

At present, as far as I can see, we have none of these for the Reserve Bank of New Zealand as financial regulator.

Take the formal monitors for example.  Parliament’s Finance and Expenditure Committee has little time, no resources, and little expertise.  The Treasury has no formal role, no routine access to Bank materials (or eg Board papers) and is probably quite resource-constrained in developing the expertise.

And what of the Bank’s Board?   By law, they play a key role, as agent for the Minister of Finance in monitoring the Governor, and (now) obliged to report publically each year on the Bank’s performance.    The Bank often likes to talk up the role of the Board –  doing so provides them cover, suggesting the presence of robust accountability –  but the latest article is surprisingly honest.  The Board gets a single paragraph, which simply describes the legislative provisions.  There is no suggestion of the Board have actually played a key role in holding the Bank (Governor) to account – not surprisingly, since in the 15 years they have been publishing Annual Reports, there has never been so much as a critical or sceptical word uttered.  Of course, it isn’t surprising that the Board doesn’t do a good job: it has no independent resources at all (even its Secretary is a senior Bank staffer), the Governor himself sits on a Board (whose main role, notionally, is to hold the Governor to account) and the Board members themselves typically have little expertise in the areas (quite diverse) around which they are expected to hold the Governor to account for.   (Their job is, of course, made harder by the rather non-specific mandate the Bank has in regulatory areas –  there is nothing akin to the Policy Targets Agreement (which has its own challenges in monitoring).)

What of some of the other claims about accountability?  The Bank points out that it is required to do regulatory impact assessments –  but these are typically done by the same people proposing the policies, and there is (or was when I was there) nothing akin to the sort of process some government departments have for independent panels vetting the quality of the regulatory impact assessments.

They are also required to consult on regulatory initiatives, and must “have regard” to the submissions.  But, except perhaps on the most technical points, there is little evidence that they actually do pay any real heed to submissions.    For a long time, they also kept the submissions themselves secret –  even attempting to claim that they were required by law to do so.  They’d publish a “summary of submissions”, which highlighted only the issues they themselves chose to identify.   As they note, and in a small win for a campaign by this blog, they have now started publishing individual submissions, belatedly bringing them into line with, say, Select Committees of Parliament or most other regulatory bodies.  But there is no sign of much change in the overall attitude, or of any greater openness to ongoing debate and critical scrutiny.

Then, of course, there is the Official Information Act.  The Bank is subject to the Act, but chafes under the bit, is very reluctant to release much, threatens to charge requesters, and generally seems to see the Act as a nuisance, rather than an integral part of an open and accountable government.

We had a good example just a couple of months ago as to how unaccountable the Bank is in its prudential regulatory areas.  It emerged that Westpac had not had appropriate regulatory approval for some model changes used in its risk-modelling and capital calculations.   But, as I noted at the time, the short Bank statement left many more questions than it answered, and no one –  including journalists asking directly –  has been able to get straight answers from them, even though capital modelling is at the heart of the regulatory system.

And, of course, if the formal monitors are lightly (or not at all) resourced, there isn’t much other sustained scrutiny.   Banks are scared –  and more –  to speak out: this is where culture matters a great deal, as banks will always have a lot of balls in the air with the regulator, and in an open society should feel free to openly challenge the regulator, without fair of undue repercussions.   Academics with much expertise in the area are thin on the ground, as are journalists with the time or expertise.

Mostly, in its exercise of its extensive financial regulatory powers, our Reserve Bank isn’t very accountable at all.   Providing it jumps through the right, minimal, process hoops it can do pretty much what it likes in many areas of policy, and the public is left just having to take the Bank’s word (or not) that things are okay.  That needs to change –  and thus phase 2 of the current review of the Bank’s Act needs to be taken seriously.    Making the changes isn’t about one single measure, and there are plenty of details that will take a lot of work, and thought, to get right.   Part of it is about building a better internal culture, one that (from the top) really wants to engage, and which welcomes challenge and critical review.

After yesterday’s post I had an email from a reader with considerable senior-level experience in the banking sector noting just how weak much of the formal scrutiny of the Bank is in these areas.

From my perspective the Bank would benefit from independent challenge about their prudential responsibilities, and cost-benefit analysis. I am unsure if they have reviewed this post the Westpac capital model issues.

I am unsure how the Board discharges the independent prudential review role effectively given their experience – two Directors have insurance experience  and no directors have Banking, payments system or other non-bank financial experience. Likewise experience of Insurance/Banking/Payments technology systems and risks. While there are some very good RBNZ executives they are not particularly strong in banking risk experience – funding, liquidity, credit etc.

…. I think it would be useful for the RBNZ at a governance level to have experience of how financial balance sheets, and liquidity operate under stress, they will have some very important decisions to make when the next financial crisis occurs.

Much of that rings true to me.    We have typically had Governors with more experience of macro policy, and perhaps financial markets, than of banking –  and yet financial regulation is a hugely important role in what the Bank does – and now have a new Head of Financial Stability with no background in banking or finance at all.   We have a Board responsible for monitoring the Bank across monetary and regulatory responsibilities, and with little specialist expertise.   The contrast with, say, the FMA is quite stark.

Quite what the right balance of a solution is, I’m not quite sure.   I favour moving to a committee-based decision-making structure, and moving more of the policy back to the Minister (with the Bank as a key adviser), but even a Financial Policy Committee might only have three or four externals on it, and no such group is going to encompass all the right bits of expertise.   As often, I guess it is partly about the willingness to ask the hard questions, and to be willing to commission independent expertise (whether from New Zealand or abroad, from academics or people with industry background) and to engage.   If the Board remains as a monitoring agency –  as Rennie recommends, but I’m sceptical of –  it needs to be provided with resources.   And the Minister needs to be willing to use his statutory powers to commission independent reviews of aspects of the Bank’s stewardship, to enable us (and the Bank) to learn from experience by critically evaluating performance (and process).  Personally, I’m still tantalised by the idea of a small independent agency resourced to pose questions, and commission research, on the stewardship of fiscal, monetary and financial regulatory policy.

If not all the answers are clear, what is clear is that New Zealand is a long way from having got the model right: the right allocation of powers, the right accumulations of expertise in the right places, the right cultures, and the appropriate mix of formal and informal accountability that can really give New Zealanders confidence in the regulation of the financial system.