(Lack of) transparency at the Orr Reserve Bank

Since I have to spend a large chunk of the day at the Reserve Bank –  among other things, checking out how serious the Governor is about customer focus and about remediation when customers have problems (among the things he claims the right to demand from banks and insurers) in the case of the superannuation fund the Bank (=Governor) sponsors –  it seemed fitting to have a brief post focused on a Reserve Bank issue.

Long-term readers will recall that the previous Governor was notoriously secretive, except when it suited him.   Among the things he always refused to release were any minutes of any meetings of the Governing Committee (him and his two or three most senior staff).  The Governing Committee had been set up by Graeme Wheeler, and was sold to the world as the forum in which major decisions were made –  whether monetary policy, regulatory policy or whatever.   You might suppose that the records of such meetings would be of considerable public interest, and it is common internationally for the minutes of the meetings of any body responsible for monetary policy to be published, with a (typically) quite short lag.  But Graeme Wheeler seemed to think there was no legitimate case for such material to be released –  his model was that he should be obliged to tell us only what he wanted to tell us, how he wanted to tell it, and when he wanted to tell it.  That isn’t how the Official Information Act works, but that consideration never seemed to much bother the then-Governor.

But that was then.  Wheeler has left, bearing his CNZM, and we have a new Governor.  He talks a good talk about communicating more or better with outside audiences.  We’ve even had cartoons to help illustrate official documents, and at one press conference I think the assembled journalists were greeted in four languages.

So he seeks to build an impression of a more open Governor –  including by his (ill-judged)  willingness to talk freely about all manner of things that aren’t his responsibility.  And almost simultaneously with the Governor taking office, the Minister of Finance announced reforms he plans to legislate later in the year.  Under those (inadequate) reform proposals, there will be a statutory committee to make monetary policy decisions and –  fulfilling a Labour Party campaign pledge –  the minutes of the meetings of that new Monetary Policy Committee are to be published.  I’m sure that, if the Minister sticks to plan, they will be fairly anodyne minutes, but the indication has been that the minutes will outline any differences of view (even while not putting names to views or votes).  It will be a step forward when it happens.

And so, going into last month’s Monetary Policy Statement I noted that the new Governor could perhaps show his seriousness about being different from his predecessor, and get ahead of the forthcoming legislative provisions, by beginning to publish now the minutes of the Governing Committee (for meetings relevant to that MPS).   Ideally, as I noted, he would also pledge to publish the background papers for each MPS with a suitable lag (perhaps six weeks).

Nothing was forthcoming with the release of the Monetary Policy Statement –  just the cartoons, multi-lingual greetings (and a document itself that seemed to go down well with market economists).  So I lodged a request for the minutes of the Governing Committee meetings relating to the May MPS.

And last week I got my response.

…the Reserve Bank is withholding the information for the following reasons, and under the following provisions, of the Official Information Act (the OIA):

  • section 9(2)(d) – to avoid prejudice to the substantial economic interests of New Zealand; and
  • section 9(2)(g)(i) – to maintain the effective conduct of public affairs through the free and frank expression of opinions by or between officers and employees of the Reserve Bank in the course of their duty.

As advised previously, the Reserve Bank recognises the tension between disclosure and confidentiality and has considered your request in light of that tension. Public disclosure, in summary form, is essentially what happens with monetary policy decisions in a carefully considered media release and the full text of the Monetary Policy Statement. The process of deciding what to publish in these documents recognises and balances the tension between disclosure and confidentiality.

In other words, exactly the same approach adopted by the secretive and defensive Graeme Wheeler, and nothing is released at all.  Thus:

  • the date of the meeting,
  • the place the meeting was held,
  • the attendees at the meeting,
  • confirmation of the minutes of the previous meeting,
  • any subheadings outlining the nature of material discussed at the meeting,
  • and the final OCR (itself already published in the MPS)

all, in the Governor’s view, had to be withheld to protect the “substantial economic interests of New Zealand” or to protect “free and frank expression”.  I wonder if the Governor was worried there might one day be a debate about what day of the week it was.    The claim is so absurd it is hard to believe that serious people –  required to operate according to the principles of the Official Information Act –  could make the claim.  But the Governor does.

I can barely imagine a circumstance in which disclosure of material in such minutes could undermine the “substantial economic interests of New Zealand” (NB these aren’t the same as the “economic interests” of the Bank), especially when released several weeks after the MPS to which the discussion relates.  We aren’t talking about imminent bank failures here.  But perhaps there are such circumstances, in which case specific deletions  could be made and justified under this subsection.  Officials make such specific deletions every day (although not commonly, I gather, under this particular provision of the OIA).

The same goes for “free and frank”.  In the (extremely unlikely event) that the minutes ever recorded that the Deputy Governor (say) thought the Governor’s ideas about the OCR were barking mad, there might be a case for withholding that particular detail.  But no official writes minutes like that.    And recall that the Minister of Finance has already committed to the publication of minutes of the MPC a few months hence, once the legislation is in place.  Differences of view are supposed to be highlighted (even if not attributed by name).  It will be a small step forward, and the Minister has already decided that “free and frank” isn’t a good reason to withhold such material.

But the Governor clearly disagrees.  Perhaps he just wants to enjoy his last few months as the single decisionmaker.   But then –  it suiting him to do so –  he has already told us that all his advisers were unanimous last month that the OCR shouldn’t be changed.  So what can he possibly have to hide in those Governing Committee minutes?  The short answer is likely to be “nothing at all”, but he has quickly imbibed the traditional Reserve Bank resistance to Official Information Act scrutiny.

It is not a good sign.  I’ve been concerned that the reforms the Minister announced will be too weak to make any material difference, and suspicious that they will allow a Governor so inclined to dominate the new committee, suppressing debate and the serious examination of alternative interpretations or policy approaches.  Since Orr has never been one to encourage challenge or debate, that seemed a quite real and specific risk.  Which is why I thought I’d test the waters.  Had the Governor agreed to the release of MPS Governing Committee minutes (even with odd specific deletion) I’d have lauded him, and revised up my probabilities on his governorship, and the new MPC, proceeding well.

By simply refusing to release anything, it looks as though he has once again confirmed some of the fears people held (mostly quietly) about his appointment.  If so, that is a shame.   And however many languages he greets journalists in, however many cartoons he adds, serious scrutiny of powerful independent public agencies –  particularly as at present when all power is vested in one individual –  requires access to official information that won’t always suit the Governor.  Minutes of his policy committees are a good example, one most other Governors in advanced countries have come to live with, or even champion.

I’ve appealed this decision to the Ombudsman –  I might have a response by the end of next year –  but in a sense the point has already been made.  When it comes to things he is responsible for, Adrian Orr is no more open and transparent than his predecessor, who set the benchmark in quite the wrong places.  A government committed to more-open government (as the current one says it is) would have a quiet word to the Bank’s Board, and to the Governor, encouraging the Bank to think again.

Towards the Monetary Policy Statement

Tomorrow brings the first of the Reserve Bank Monetary Policy Statements under the new Governor, Adrian Orr.  I’ve noticed several preview commentaries headed up with plays on the Governor’s surname: BNZ’s was “Either Or”, and ASB’s was “Rowing with a new Orr” .  I was tempted to head up this post with “Rowing with just one Orr”, a reminder that –  for all the promised new legislation (at least in respect of the monetary policy powers) –  for the time being, the Governor governs alone.  One unelected official alone has the legal authority to make OCR decisions –  and to decide on all the other bits of policy and operations the Reserve Bank has statutory responsibility for.   It isn’t a good formula –  failing tests of both legitimacy and robustness.  It isn’t helped by the threadbare nature of the parliamentary scrutiny of the Bank and the Governor.    In the terms Paul Tucker uses in his new book, the Governor is an ‘overmighty citizen’.

That isn’t Orr’s fault.  The law is what it (unfortunately) is, and perhaps will soon be changed.   But the conduct of the Bank, and the Governor personally, is something that Orr has totally under his control.    One of the things former Bank of England Deputy Governor Tucker advocates in his new book is that if central banks want to sustain operational independence, and if that independence is to work for the good of society, an ethos of self-restraint is really important.   It is reiterated in the very last line of his entire book

“Beyond the parameters of the formal regime, an ethic of sefl-restraint should be encouraged and fostered.”

Society delegates a great deal of power to our independent central bank.  It can do us good (we hope, typically) or harm, but unelected officials who exercise such great power need to act, and speak, as if they know their limits.  They aren’t politicians, they have no general mandate, and if they have a platform it is for the purposes Parliament has set down, not to champion personal causes, or even to “help out” governments in other roles.   It is a distinctly limited role.

In his first six weeks in office, there have already been reasons to doubt that the Governor understands, or shares, that view –  itself all the more important when (formally) the Reserve Bank is a one-man show.   We’ve seen him stray well beyond the Reserve Bank’s areas of responsibility in various interviews, and in ways that could often be read as quite politically-aligned.  We’ve seen him all over the place on financial conduct issues, and the politics of possible inquiries –  none of which has anything to do with his mandate –  including rushing to sign on with the FMA’s populist demands of banks, which again have nothing to do with the Reserve Bank’s statutory mandate or powers.   You can win cheap popularity for a time by going with the mob –  or even with popular elite opinions –  but you safeguard the institution and its important role, over the longer-term, by doing what Parliament asks you to do, in a moderate and responsible manner, and leaving other stuff to other people.

The real test for the Governor tomorrow is unlikely to be the Monetary Policy Statement document itself –  much as the analysts will be looking for evidence of a distinctive Orrian perspective.  The test is much more likely to be the press conference an hour later, and perhaps even the Finance and Expenditure Committee hearing later in the day.    Given the Governor’s garrulous style to date, journalists must be almost salivating at the opportunity to tempt the Governor into some rash remark, as he answers questions, live and unscripted, for a prolonged period.   Much of the rest of the Reserve Bank must be ever so slightly uneasy.

The BNZ commentary put it this way

…it goes without saying that Adrian Orr’s presentation style in the post MPS news conference will be more dynamic than his predecessor.

“Dynamic” perhaps being a euphemism for things like freewheeling, unpredictable, entertaining –  not words that (for good reason) one typically associates with a central bank Governor.   Leaders of political parties, yes; central bank Governors, no.  Central bank press conferences shouldn’t an occasion to which to bring the popcorn.

In many ways, I’m sure an Orr press conference will be a welcome relief after many of the Wheeler ones.  The previous Governor often came across as morose and defensive –  and even he wandered off reservation at times (I recall an answer about the possible implications of some North Korean action).  But I hope we don’t see an over-correction from an exuberant new Governor.  We should certainly welcome a more open and frank exchange on monetary policy issues, perhaps even a Governor willing occasionally to acknowledge the odd mistake, but unpredictable free-for-alls aren’t going to be good for the institution, for the individual, or for the country –  gruesomely entertaining as they might well be in the short-term.

One of the last bits of data before the MPS came out yesterday: the Reserve Bank’s quarterly survey of expectations (the Bank itself will have had the data several days earlier).  There wasn’t much of great interest in the the quarter to quarter changes.  But it is worth nothing that respondents seem to think we’ve reached the peak of the economic cycle: after eight years of expecting the unemployment rate to fall further over the medium-term, for the last few quarters they’ve been expecting things to turn around (albeit only a bit).

Looking through the longer runs of data, a couple of things caught my eye.  Analysts  (me included) often don’t pay much attention to year-ahead measures of inflation expectations, which get tossed around by all sort of short-term effects (oil price changes, changes in taxes and government charges, and even climatic effects on fruit and vegetable prices).  On the other hand, it is also a horizon analysts know a little more about –  there are specifics and not just models –  and a horizon where, by the time the expectation is being recorded, the Reserve Bank can’t do much more about the outcome.   So I thought this chart, showing year-ahead inflation expectations since mid-2012 was a sober reminder that monetary policy hasn’t been quite right.

infl expecs 1 year

Recall that the target was 2 per cent inflation.  These expectations – with all their short-term noise –  haven’t been centred on 2 per cent, but something a bit lower.  Not surprisingly, outcomes have also been centred somewhere lower: headline CPI inflation averaged about 1 per cent over this period, and even the Bank’s preferred core inflation rate measure averaged 1.4 per cent.   So even at these sorts of short horizons, the analysts have had an upside bias to their inflation forecasts, and even those forecasts haven’t centred at 2 per cent.  Perhaps a question might be in order for the Governor tomorrow?

I was also interested in another longer-run chart.  The survey asks respondents where they think the 10 year bond rate will be at the end of the current quarter, and in a year’s time.  The difference between those two responses is an indication of how respondents think the underlying trends in interest rate markets will start to play out.  Here is a chart of the actual New Zealand 10 year bond yield going back to 1995 when these survey questions start,

10 yr bond may 18

There are cycles, of course, but the trend has been pretty clearly downwards, especially so since around 2011.

And yet here is what respondents to the Reserve Bank survey expected.

bond expecs

The expected changes are never that large, but what is interesting is the sign of the expected movement.  With the exception of pretty brief periods when domestic interest rates here were particularly high (mid 90s and the couple of years prior to the 2008/09 recession) the Bank’s respondents have persistently expected bond yields to start rising again.   Even the short-term variability in the series has been lower in the  post-recession period, such is the apparent strength of the view.     Respondents  –  no doubt like the Reserve Bank, which has repeatedly told us that in their view neutral interest rates are much higher than current rates –  have mostly just had the wrong model.  (I’m not sure what my views would have been in the early post-recession period, although they were probably similar to the consensus. I’ve been in the survey itself for the last three years and my records suggest that in none of those surveys have I predicted an increase in bond yields –  in all but one I picked a reduction.)

Quite possibly, similar surveys in other countries would have produced similar results, but it is a cautionary reminder of just how wrong the mainstream view has mostly been in the post-recession years.

Last year the Reserve Bank revised the survey to add questions about expectations of inflation five and ten years hence (previously we’d had only two-year ahead expectations).   It is still early days, but the results look much as you might expect: both five and ten year ahead expectations seem centred on 2.1 per cent, just a touch above the midpoint of the inflation target (my own expectations for these horizons, which stretch beyond the current Governor/government, are lower).  Two-year ahead expectations are about the same.   With current 10 year bond rates at around 2.8 per cent, and inflation expectations (in the survey) at around 2.1 per cent over the whole 10 years, respondents seem to think New Zealand real interest rates are very low (only around 0.7 percentage points).

But again we have the contrast between the recorded (and anonymous) views of local survey respondents, and the implied view of people putting money on the outlook for inflation.  The current 10 year nominal government bond yield features in both comparisons.

But what about our inflation-indexed government bond yields?  The 7.5 year bond was at 1.34 per cent yesterday, and the 12.5 year bond was at 1.7 per cent, suggesting a 10 year real government interest rate of around 1.5 percentage points.

And here is the gap between the yield on a 10 year nominal bond, and the two relevant inflation-indexed bonds.

IIBs may 18

There isn’t any sign that markets are trading as if they believe inflation over the next 10 years will average where the respondents to the Reserve Bank survey say it will.  Ten years from now is roughly halfway between those two indexed bond maturity dates: the latest observation of the average of those two series would be around 1.25 per cent.  People with a choice of holding indexed or nominal bonds to maturity (eg long-term superannuation funds) will be worse off holding conventional bonds if inflation is anything like what the survey respondents think than if they held indexed bonds.  It is a real money choice.  Bondholders are positioned consistent with the survey respondents being wrong.

I labour this point for two reasons.  First, one reason for having inflation indexed government bonds is to provide a market check on what people actually transacting are acting as if inflation will be (rightly or wrongly).  And second, because when it regularly tells us that medium to long-term inflation expectations are stable at around 2 per cent, the Reserve Bank relies on survey measures, and appears to put no weight on market measures at all, even though they are telling a quite different story (and in fairly settled times).  The Reserve Bank never attempts to justify this one-eyed approach, and never seems to reference market-based expectations measures at all.

Given that the Bank itself, and survey respondents, have been so persistently wrong about inflation (and about interest rates) it might be worth someone –  journalist or MP –  asking the new Governor tomorrow about whether he is more confident average inflation is finally about to rise than people staking money on the issue appear to be, and if so what is the basis for his confidence.  Open engagement on that sort of issue is just the sort of thing that might have people reasonably thinking more highly of the new Governor.

(In a similar vein, the Minister of Finance has promised that the minutes of meetings of the future statutory Monetary Policy Committee will be published in a timely way.  There would be nothing to stop the Governor taking the lead now and publishing –  tomorrow or with a lag of no more than a couple of weeks – the minutes of any meetings of his Governirng Committee relating to tomorrow’s MPS and the associated OCR decision.  Doing so would be a small, but telling, promissory note, a token foreshadowing a new era of greater transparency.)

Why not split up the Reserve Bank?

That is, deliberately, a slightly ambiguous title for the post.   I favour splitting the Reserve Bank in two, setting up a new New Zealand Prudential Regulatory Authority to pick up the regulatory and supervisory responsibilities the Bank currently has (subject to various refinement).   I’ve made the case here and here, and late last week highlighted my former colleague Geof Mortlock’s new article articulating the case for change.   We know that the Reserve Bank’s conduct of those functions isn’t highly regarded and the minutes (and OIA releases) suggest that the Reserve Bank’s Board –  paid to hold the Governor to account in the public interest –  were asleep at the wheel while this situation was developing.  All told, I reckon there is a pretty clear-cut case – in principle, and based on the actual track record – for structural reform.  Structural reform is never a panacea, but with the right will, and the political determination that things will be done better in future, it can play a part, making a demonstrable break with the past and establishing a new and better institutional culture.

But, of course, there are counter-arguments.  The Reserve Bank is likely to be making them forcefully at present.  I suspect the Governor’s populist participation in the current attack on the banks – not grounded in any of his own legislation, not related to any systemic soundness threats – may be a part of that effort, wanting to appear “useful” to the government and somehow “in touch” with some sort of “public mood”.  (If so, that in itself should be grounds enough for structural and personnel changes.)

If I were the Bank I would probably be trying to arrange a visit from (Sir) Paul Tucker, former Deputy Governor of the Bank of England, who has just published a new book Unelected Power, on the delegation of economic powers to independent agencies, with a particular focus on central banks.  Despite his background on the markets side of the Bank of England, Tucker didn’t leave officialdom to make money in the financial sector, but instead turned to academe and has produced an impressive book.  I’ve already referred to it in a couple of recent posts, and expect to do so in a few more relevant to the current efforts to overhaul the Reserve Bank Act.    As one UK commentator recently described it

….it is mainly about central banking, and on this is it authoritative. It will be an essential read for everybody involved in monetary policy, or researching it.

Not by any means will everything he writes be music to the ears of our central bankers, but Tucker’s views on the structural separation issue will be.  Perhaps that isn’t too surprising, since he was Deputy Governor at a time when the British government was bringing the financial sector supervisory and regulatory functions back inside the Bank of England (albeit with separate government-appointed decisionmaking structures for the various functions).  The Bank of England model informed Iain Rennie’s report last year, and if a decision is finally made to leave all the existing Reserve Bank functions together a structure like that of the Bank of England (but slimmed down for our circumstances) would probably be the way to go.

Tucker doesn’t argue that the regulatory and supervisory functions have to be in the same institution as monetary policy but that, subject to certain important conditions, it is better if they are.    To my mind, one of the weaknesses of his book is that it is very focused on the US and the UK (with some discussion of ECB/Europe but the issues are very different there given the idiosyncratic relationship between the ECB –  set up by international treaty and not really very accountable to anyone –  other EU institutiuons, and the national states of the EU/eurosystem).  Thus he simply doesn’t engage with the experience of the many other advanced countries – in fact, most of those outside the euro –  where the primary role in prudential regulation/supervision is undertaken by an entity other than the central bank.   This was the list of such countries I ran the other day

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

It is a mix of large and small, of countries with very big financial systems operating internationally and countries with mostly domestic banks, of countries where the split has been longstanding (eg Canada) and countries where it has been more recent (eg Australia), and countries that ran into financial crisis in 2008/09 and countries that did not.  I’d find Tucker’s claim for the superiority of his model (essentially the UK one) more compelling if he’d addressed the experience of some of these countries.

As I read his material on this issue, it seemed to me that Tucker had two main arguments for keeping prudential supervision/regulation and monetary policy together.

The first of these is about the central bank’s lender of last resort function (for which the relevant statutory provision in our legislation needs refinement).  A central bank is the only agency with the unquestioned ability to provide immediate liquidity to an individual bank, or to the system as a whole, when severe liquidity pressures arise –  whether it is a run to physical cash, or simply a freezing up of interbank markets leaving some players unable to operate with external injections of liquidity.     Failure to respond to systemwide increases in liquidity demand will, all else equal, be likely to result in the central bank falling short of its inflation target (through the resulting financial crisis and economic shakeout).  Provision of liquidity, and a responsiveness to changes in demand, is an integral part of modern central banking (even though the stress events may not occur even as frequently as once a decade –  in the New Zealand case, Y2K and the liquidity pressures around 2008/09).

Liquidity provision usually involves either buying assets outright from a bank, or lending on the security of those assets (mainly repo agreements).  That is easy when it involves the outright purchase of a well-known widely-traded asset like a government bond.  But it gets trickier when it is a loan (in economic substance, if not legal form) and when the assets involved are pretty opaque and not generally traded at all, and when the general injunction –  enshrined in legislation in some countries –  is that central banks should only lend to solvent institutions (solvency here being a positive net assets test, not an “ability to meet payments as they fall due” test).    To caricature just slightly, Tucker argues that a PhD in macroeconomics won’t be much use in enabling a central bank to decide whether or not to provide funds to a bank that comes knocking.  You need, instead (or as well), detailed banking and credit expertise.  Specifically he notes

Even opponents of “broad central banking” generally accept that, as the lender of last resort, the central bank cannot avoid inspecting banks that want to borrow.

Going on to argue that

A central bank must be in a position to track the health of individual banks during peacetime if it is to be equipped to act as the liquidity cavalry.

I’m not persuaded, for a number of reasons.  First, of course, we don’t “inspect” banks in New Zealand at all (but that is trivial point).   Second, clearly many countries operate with exactly the sort of model Tucker deems impossible or inadmissible (presumably by relying on some peacetime exchange of information, and wartime written recommendations or assurances from the prudential regulatory agency).   Third, the central bank making the decision to lend is not the only option: it would be possible to envisage a model in which the central bank was simply the operational agent, but the credit risk from any crisis support to an individual institution was taken directly by the government, on the advice (and analysis) of the prudential regulatory agency.   And, finally, LLR powers aren’t the only relevant ones.  In the 2008/09 crisis, perhaps the most important single regulatory response in New Zealand was the deployment of the Minister of Finances’s extensive guarantee powers (under the Public Finance Act).    The Minister of Finance doesn’t do prudential supervision, and to the extent he needed comfort that any institutions guaranteed were likely to be solvent, he had to rely on advice from officials.  In this case, it was primarily the Reserve Bank, but it could as easily have been advice from a Prudential Regulatory Authority.   The same goes for choices (regrettable as they may be) to bail out individual institutions.

My claim isn’t that there can never be any advantages in having prudential supervision and central bank liquidity operations in the same entity, just that the case for them to be so isn’t generally compelling once set against the other arguments for structural separation.  In a crisis, it is typically all hands to the deck (including, for example, the Treasury and the Reserve Bank working together, even though they are separate institutions) and. more generally, there are numerous examples of interagency arrangements for information sharing.   It is undoubtedly important for all relevant agencies to coordinate closely, and have in place appropriate protocols and be prepared to run exercises to war-game the handling of crises.  But the functions don’t all need to be in the same agency, and there are likely to be costs in normal times to having them all together.

One point Tucker touches on elsewhere, but not here, is the importance of having people running functions believing in them.  It is, for example, dangerous to have financial supervision (or AML) in an institution where the chief executive doesn’t really believe in the importance or value of the function.  Reasonable people could argue that that –  rather than separation –  was part of the UK’s problem in 2007: the then Governor, Mervyn King, seemed quite averse to lender of last resort responsibilities, even though they were still an intrinsic part of the powers assigned to the Bank of England.

Tucker’s other main argument for keeping prudential and monetary policy functions together is one he lists under a heading “Harnessing the authority of the central bank”. noting that

If an economy’s central bank is already endowed with both authority and legitimacy, giving it responsibility for stability might be preferable to the uncertainties of starting afresh. In particular, the risks of industry capture might be reduced, as monetary policy makers’ standing in the community does not depend on bankers.

I’m not even persuaded by that final sentence – too many central bank policymakers have seen their post-central bank opportunities being among the bankers (just among Governors, Glenn Stevens, Ian Macfarlane, Ben Bernanke).     Tucker’s argument appears to be made in the UK context, where the prudential functions were split out of the Bank of England after 1997, into a new standalone prudential agency.  Perhaps the FSA never had the prestige of the Bank of England but it isn’t obvious that the problems the UK ran into were a reflection of lack of prestige or legacy legitimacy.  Political emphasis on promoting the financial sector was a significant part of the story.  And the Bank of England’s own analysis of the emerging macro risks didn’t exactly cover the institution in glory.

But, perhaps more importantly, there are other case studies.  The Reserve Bank of Australia had been around for decades when APRA was split out of it. It looks to have been a pretty successful split, and it isn’t at all obvious now that the RBA enjoys any greater authority or respect in its areas of responsibility than APRA does in its.   And, given the feedback on the Reserve Bank of New Zealand’s regulatory stewardship, I don’t suppose anyone would want to mount a serious argument here to leave the functions together because the Reserve Bank’s reputation and authority stands so high.

As it happens, Tucker isn’t too keen on New Zealand’s contribution to public sector management, including the notion (from the New Public Management literature of the 1980s) that one function per agency helps to enhance accountability.

In the UK, I suspect that NPM was a subtle (and baleful) influence on the 1997 decision to transfer prudential supervision away from the Bank of England.  That mattered beyond Britain’s shores. Given London’s position as a global financial centre and given that various other countries, including China and Korea, followed the UK, at least in some cases probably encouraged by the IMF, the UK contrived to put the world onto a false, even delusional, path,  Administrative fashions come unstuck eventually, and this one did spectacularly.

Methinks he doth protest too much  (even as he goes on to note that there are hazards in having the functions together).

He highlights one issue which I hadn’t given much thought to, arguing that if the central bank is to be responsible for both monetary policy and prudential supervision it needs to have the same degree of autonomy in each function.  He argues that if the central bank has less authority in supervisory areas than in monetary policy, it could provide a wedge through which politicians could exert pressure on the Bank over monetary policy.  I’m not so sure that is right or that, realistically, it is that important an issue especially if (as he insists) each function has its own statutory committee, and its own direct accountability.

But if there is something in what Tucker says, it would reinforce my doubts about keeping the functions together.  At present, in the New Zealand system the PTA is set every five years (and central bank budgets too), and beyond that there is no routine ministerial involvement in monetary policy.  On the regulatory side, plenty of powers are reserved to ministers (eg around failure management, AML, the rules of non-bank deposit takers, disclosure rules for banks) and as I’ve argued here before the Reserve Bank still has too much discretionary policymaking power over banks (LVR limits, with significant distributional consequences are a good example –  and one Tucker seems to have quite a lot of reservations about).  As I read him, he would favour delegating more policy power to the central bank in the supervisory/regulatory area.  Personally, I think there is a good case for giving the regulator less power, and for a clearer delineation between setting the rules of the game (politicians) and implementing them (independent agency).  And keeping the functions in separate institutions will make for stronger effective accountability –  a key theme of Tucker’s –  than two or three committees with the Governor and his Deputy sitting on all of them.  You can only fire – or not reappoint –  a Governor once.

One of reasons Tucker worries about differing degrees of independence is that it would not ‘be conducive to successful institution-building’, citing the way in which the Greenspn Fed looked down on supervisors as a “lower form of life”.   Again, I’m not sure I fully buy the argument –  it is more about the priorities and beliefs of the people at the top than about formal statutory remits –  but as both Geof Mortlock and I have argued in the New Zealand context, standalone agencies helps enable the creation of cultures of excellence in both institutions.   And even Tucker recognises that culture is one of the challenges to a multi-function central bank, even if both functions have equal statutory importance.

In many cases, these aren’t open and shut issues.  There are different models around the world, although on my reading in most advanced countries –  and especially most small ones –  structural separation is the route chosen.  It is far from obvious that the new British model is better than the old (only the next crisis is likely to test that), even if appropriately some issues have been clarified and powers refined out of the 2008/09 experience.  But in the New Zealand context, most of the arguments now line up pretty clearly in favour of structural separation, and the creation of a new standalone prudential regulatory agency, with powers, personnel, and governance/accountability structures specifically fit for purposes, rather than shoehorned into an institution designed primarily for a monetary policy role.


Split the Reserve Bank in two

In the last few months, I’ve run a couple of posts making the case for splitting the prudential regulatory/supervisory functions of the Reserve Bank out into a standalone prudential regulatory agency.  The main post was here, with some follow-up comments here.  The case for structural reform has been further strengthened, in my view, by the results of the recent New Zealand Initiative survey on regulated entities, in which it is clear that most respondents have little or no respect or regard for the Reserve Bank in its supervisory roles (as distinct from the inevitable disagreements with a regulator that should be expected/encouraged).   There are good arguments in principle for structural separation, and there is no sign (say) that despite those in-principle arguments the Reserve Bank has been doing a superlative job anyway.

As I noted in the earlier post, in most OECD countries (outside the euro-area, where central banks no longer have a monetary policy job to do), banking regulation and supervision is done by a body other than the central bank.

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.

Perhaps of most direct relevance to us in Australia’s place in that list.

Some others have also made the case for structural separation, including my former colleague Geof Mortlock.  Geof has a new substantive column out today forcefully making the case for change.   Geof and I have been disagreeing about things for 35 years since we started at the Bank in adjoining offices a couple of weeks apart.  He spent most of his Reserve Bank career in the regulatory side of the Bank and for the last decade or so has been a consultant on banking risk/regulatory issues, including a stint at the Australian Prudential Regulatory Authority.      Judging by the occasional emails we exchange and occasional comments here, I suspect we still don’t agree about very much –  quite probably including the substance and extent of financial system regulation and supervision.

But I agree with almost everything in his column today. I encourage you to read it, and I hope that Treasury officials working on Reserve Bank reforms and the Minister of Finance (and his associates) not only read it, but heed it.  It is an overdue change, and if the chance for reform isn’t grasped now the issue is likely to drift for another decade or two, with weak governance, weak accountability, and a regulatory body that is unlikely to command the respect it should earn whether from regulated entities, overseas supervisors or (most importantly) the New Zealand public.

Here is Geof’s list of the main reasons for change

  • It would reduce the concentration of excessive power in one government agency. Currently, the Reserve Bank has a very wide range of powers compared to most central banks in the OECD. It has responsibility for monetary policy, foreign exchange reserves management, currency intervention, operating significant parts of the payment system and securities settlement system, prudential regulation of banks, insurers and NBDTs, regulation of money laundering, regulation of the payment system, financial stability oversight, macro-prudential regulation and currency management. I will stop there. The sentence is already too long!  So is the range of functions under one agency. This concentrates excessive power in the Reserve Bank. It also creates potential and actual conflicts of interest, as I argue later in this article. A narrower span of functions would reduce this concentration of power and avoid conflicts of interest.
  • Removing regulatory functions from the Reserve Bank would enable the supervisory agency to focus on the job at hand without being distracted by the other central bank tasks, particularly monetary policy. ………the Reserve Bank has tended over the years to accord much greater emphasis, attention, management oversight, resourcing and public reporting to the monetary policy function than to its regulatory responsibilities. The Reserve Bank Board, likewise, has generally paid much greater attention to the monetary policy function than to financial sector regulation. (That said, the Board has performed very poorly in all of its monitoring roles. Sadly, it has been little more than a compliant rubber stamp and cheer leader for senior management).
  • Separation of the regulatory functions would also enable the Reserve Bank to focus on its core role of monetary policy and related functions, undistracted by the many regulatory issues which it currently oversees. This would likely be conducive to a more focused and effective central bank. It would help the central bank to lift its game in monetary policy – i.e. to keep inflation broadly around the mid-point of the inflation target range; something that it has consistently failed to achieve in recent years.
  • Separation of the regulatory functions would enable a senior management team to be appointed with the skills, knowledge and experience to perform the role effectively – i.e. people with deep knowledge of, and practical experience in, banking, insurance and financial regulatory issues. The current senior management team – and its predecessors – generally lack the skills, knowledge and experience required for the role.  …..
  • It would enable the regulatory agency to build the depth of knowledge and skills in its staff to perform the functions required of them. Currently, although the Reserve Bank has able people in the supervisory area, it lacks the depth and breadth of knowledge and industry experience to do the job as effectively as it should. ……

He adds a couple of other considerations that resonated with me

  • Separation of the supervisory function from the Reserve Bank would also remove potential conflicts of interest between the Bank’s functions. For example, there is a conflict of interest between the Reserve Bank’s role as owner and operator of core parts of the payment and settlement systems [notably the NZClear securities settlement system], and its supervisory responsibilities in these areas. It is rather like the referee of a rugby game also being an active player on the field. Even worse, this referee gets to write the rules of the game!
  • It would ensure that macro-prudential supervision policy is directed at the promotion of financial system stability rather than being used as a de facto monetary policy instrument or for other nefarious purposes that do not necessarily anchor to financial stability. Reflecting this, I very much doubt that, had the responsibility for macro-prudential policy been allocated to a separate prudential regulator, and not the Reserve Bank, the macro-prudential policy tools would have been used as aggressively and relatively clumsily as has been the case under the Bank.

I’m hopeful more than convinced of the argument in that final sentence.

Of course, structural separation is no panacea.  A new agency would need to be built from scratch, even if it took over the existing Reserve Bank staff.  It isn’t as if the field of suitable candidates to lead such an agency is thick on the ground, and building the sort of expertise and culture that the job requires will be the work of several years.  But, on the one hand, we face that challenge anyway: the Governor can’t simply ignore, or pay only lip-service to, the shocking feedback in the NZ Initiative survey.  And, on the other hand, if we don’t make a start –  and put in place structural preconditions that increase the chances of better institutions in the longer-term – things are unlikely to ever reach the standard they should.

It remains disconcerting that the second stage of the Reserve Bank Act review is being led jointly by the Reserve Bank and the Treasury, in a climate in which the Minister of Finance has shown little interest in these sorts of issues.  The situation is crying out for leadership from the government, and not allowing the existing Reserve Bank management to persuade the Minister to settle for something as little different as possible from the inadequate status quo.

(Geof’s comment on the severe weaknesses of the Reserve Bank Board echo my own over the years.  Neither their Annual Reports nor the minutes of their meetings record any dissatisfaction with management ever – even though their primary role is holding the Bank to account, and the Bank is made up of fallible human beings.    I wrote a few weeks ago about the “Charter” (really a code of conduct) the Board has devised for itself.  The “charter” talks of the Board’s right to advise the Governor, and asserts a right to be heard

The Board may advise the Governor on any matter relating to the performance of the Bank’s functions and the exercise of its powers. The Governor is not required to act on the Board’s advice, but is required to have regard to it.

Where advice relates to matters of significance, the Board may give that advice to the Governor in writing, having first discussed the matter with the Governor in a Board meeting.

The Board will maintain a record of any formal Board advice given to the Governor.

There was no record in the minutes over the last couple of years of any material oral advice (despite (a) legal requirements to maintain records of public affairs, and (b) some difficult issues, including –  for example –  the Toplis affair).  So I lodged an OIA request seeking copies of any written advice.

There was none of course. In fact, the Board chair went so far as to claim that this was a mark of the effectiveness of the Board.   I think he must have left off an “in”.    Geof’s term –  and I think I’ve used it before too –  was cheerleaders.  But hopeless at almost anything else, and useless to the citizenry. )

The Governor on banking and deposit insurance

There was another interview the other day with new Reserve Bank Governor Adrian Orr.  This one, on interest.co.nz, focused on issues somewhat connected to the Reserve Bank’s responsibility for financial sector prudential regulation/supervision, and associated failure management responsibilities.

In the interview Orr touched again on an idea he has already alluded to in one of his interviews: the idea of getting a clearer, more quantified, sense from Parliament as to what it is looking for from the Reserve Bank in its conduct of regulatory policy.

It is an appealing idea in principle.  For monetary policy, Parliament has specified a goal of price stability, and in the Policy Targets Agreement the (elected) Minister of Finance gives that operational form (a focus on 2 per cent annual inflation, within a range of 1 to 3 per cent).   There is nothing similar for the extensive regulatory powers the Bank has.

In respect of banks, section 68 of the Act sets out the goals

68 Exercise of powers under this Part

The powers conferred on the Governor-General, the Minister, and the Bank by this Part shall be exercised for the purposes of—

(a)  promoting the maintenance of a sound and efficient financial system; or

(b)  avoiding significant damage to the financial system that could result from the failure of a registered bank.

Which is fine as far as it goes –  and what isn’t there (eg a depositor protection mandate) is often as important as what is.   But it isn’t very specific, and provides no guidance as to how to interpret the idea of an “efficient” financial system (as a result, it has been debated internally for decades), no sense of how sound the system should be (or even what a “sound system”, as distinct from sound institutions, might be.   And the same overarching provision (sec 68) has seen the Reserve Bank’s approach to bank regulation and supervision change very substantially over the years, with little or no involvement from Parliament.

There is a reasonable argument –  made quite forcefully in former Bank of England Deputy Governor Paul Tucker’s new book on such matters – that if in a particular aspect society’s preferences aren’t reasonably stable, and able to be written down reasonably well, then policymaking powers in that area should not be delegated to an independent agency (let alone what is formally a one-man agency).  With the second stage of the review of the Reserve Bank Act underway, Orr can obviously see a threat to the Bank’s powers, and thus he suggests an attempt be made to have Parliament articulate its preferences, and views on possible trade-offs, more directly.  If they could do so, having unelected decisionmakers then working to deliver on that mandate might be less democratically objectionable, and the Reserve Bank might have a greater degree of legitimacy in these areas than it does now.

And so the Governor told his interviewer

“For inflation targeting we’ve got a clear target [being] 1% to 3% on average. For the prudential regulation, – how do we articulate that target? In other words what is the risk appetite of the people of New Zealand as represented by Members of Parliament for banking regulation? Do you screw it down to one corner where nothing can happen – it’s very sounds but totally inefficient, or do you have trade-offs allowing firms to come and go and consumers to be aware etc? So that is going to be a really good, useful articulation that will come out of that,” says Orr.

At first blush it sounds promising, and I’m certainly not going to discourage an effort to try to uncover such an articulation of preferences.  But I am a little sceptical that anything very stable or useful will emerge from the process.  I’d prefer that all rule-making powers were removed back to the Minister of Finance (or indeed Parliament), leaving the role of the Reserve Bank as (a) technical advisers, and (b) implementers.

It might be fine to express a view that banking system regulation should be designed on a view that there should be no major bank failure on average more than once in a hundred years   – actually about the rate in New Zealand history –  or, indeed, five hundred years.    That might (and has in the past internally) be some help in how one calibrates capital requirements for banks.  It will, however, be almost no help in deciding whether LVR restrictions are a legitimate use of coercive, redistributive, government powers.  Or whether we care much about small institutions.  Or, indeed, whether the Reserve Bank should have the power to approve (or not)  the appointment of senior staff in banks.   And even if society could express a stable preference for a regime designed to deliver no more than one failure per 100 years, it provides very little basis for that other vital strand of the governance of independent agencies –  serious accountability.    Good luck could readily deliver a 50 year run of no failures without reflecting any great actual credit on the central bankers in charge at the time (who might have been doing fine, or doing a lousy job).  And if the one in a hundred year shock happens next year, it will still be very difficult to say with any certainty that the central bankers were doing the job they were asked to do –  they may well have been, and just got unlucky, and the public is likely to want scapegoats.    Elected politicians serve that role better than unelected technocrats.

But if there is anything more to the idea the Governor is toying with, it would be good to get some material into the public domain in due course, and have it scrutinised or debated.

In his latest interview, the Governor also touched again on the calls for a royal commission into conduct in the financial sector, as underway at present in Australia.  This time he is a lot more moderate, explicitly recognising that it isn’t his call.

Against the backdrop of the unacceptable conduct coming to light in Australia’s Royal Commission on financial services, Orr doesn’t believe New Zealand needs its own Royal Commission. However, he says the impact of the Australian one is certainly being felt in NZ.

“There will be not a single bank in New Zealand that is not, at the moment, really checking every cupboard for skeletons here in New Zealand. That is without doubt. This has really put the wind up the banks to say ‘hey, what is the alternative to sound regulation, it’s a Royal Commission’. We’re meeting collectively with the CEOs, we’re meeting individually with the chairs, and we always do on a regular basis,” Orr says.

“Is a Royal Commission necessary? At the moment in my personal opinion no, but I’m not the one who would call one anyway.”

Orr says while the Australian Prudential Regulation Authority is “being held up as some [sort of] global best practice,” and works alongside the Australian Securities and Investments Commission and the Reserve Bank of Australia with all having “heavy boots on the ground,” they’re still having “this cultural challenge.” Thus more hands-on regulation than the Reserve Bank’s light touch regulatory oversight of banks isn’t necessarily the best way forward.

But it is an odd mix of responses.  On the one hand, Orr seems to come across as something of a champion or defender of the banks in New Zealand.  That is no part of his role.  He is the prudential (soundness) regulator, in the public interest –  recall section 68 of the Act, quoted earlier – and his role (the Reserve Bank’s role) has almost nothing to do with conduct standards.

And he seems to be attempting distraction on other issues by conflating prudential/systemic issues with conduct issues.  Thus, when various people (including the IMF) have argued that New Zealand should adopt a prudential regulatory regime more akin to APRA’s (which, in effect, operates here to a considerable extent anyway, because APRA is focused on the entire Australian banking groups), Orr doesn’t engage in the substance of that debate, but attempts to muddy the water by making the point that a more intensive prudential regime in Australia hasn’t prevented some of the conduct issues coming to light in the Royal Commission.  Indeed, but why would one imagine it should?   They are two quite different issues.  In the same way, an investigation into whether the local supermarket was meeting minimum wage or holiday pay provisions for its staff wouldn’t expect to shed any light on food-handling issues in the same supermarket.

Part of the legitimacy of independent central banks involves them being seen to speak in an authoritative and trustworthy way.

But the comment from the Governor that led me to read the account of the interview was on the vexed subject of deposit insurance.   The article had this as (part of) its headline

RBNZ Governor says differences between deposit insurance & minimum deposit not frozen in OBR scenario are ‘technicalities’

That sounded like an intriguing claim.  You’ll recall that the Reserve Bank has long staunchly opposed deposit insurance (eg articles/speeches referenced here), even though people like The Treasury, the IMF, and various other commentators (including me and my former RB colleague Geof Mortlock) favour it.  The new Governor doesn’t seem to share the Bank’s long-running opposition.

Asked whether the Reserve Bank should get an explicit statutory objective to protect bank depositors and/or insurance policyholders, Orr says deposit protection, or deposit insurance, is “something that’s going to be here in the future.” NZ’s currently an outlier among OCED countries in not having explicit deposit insurance.

“I think that’s something that’s going to be here in the future. We need to work our way through what it means

I’m surprised that change of stance didn’t get more coverage.  Of course, whether or not we have deposit insurance isn’t a decision for the Reserve Bank; it is a matter for the government and Parliament.  Nonetheless, if the Reserve Bank Governor is going to withdraw the bank’s opposition, that removes a significant bureaucratic roadblock.  Well done, Governor.    (To be clear, I favour deposit insurance not as a first-best outcome, but as a second-best that makes it more likely that future governments will allow troubled financial institutions to fail, rather than bail out all the creditors.)

But it was the Governor’s next comments on the issue that were more troubling, and which suggest he hasn’t yet got sufficiently to grips with the issue before opening his mouth.

I think people have been talking across each other a lot,” Orr says.

“The bank here has got a policy called Open Bank Resolution. And that is the idea that if a bank is too large to fail, we have to keep it open. But we have to recapitalise. So the current owners or investors who have largely done their dough, how do you recapitalise it and how do you have the door open the next day?”

“As part of that open bank resolution, we’ve already said there can be a de minimis around depositors money that they will have access to. We just need to speak in better English to say ‘you know you are going to have some cash there, you are going to be able to get your sandwiches, meet your bills, do all of that on the Monday. Because if it didn’t happen that way, then that one bank failure creates all banks to fail, there’s [bank] runs everywhere’,” adds Orr.

When it was put to him that depositors having access to a de minimis sum if open bank resolution was implemented on their bank isn’t the same as explicit deposit insurance, Orr suggested the difference is merely technical.

“We could have a discussion through that legislation to say ‘economically it’s the same, could we call it the same, or is it part of a failure management?’ I believe it’s the same end outcome, the technicalities behind it are just technicalities. We need to be able to say to the public ‘if we’re shutting the bank down, what do you have access to, what is the guaranteed de minimis or minimum, or protection,’ and then we need to work out how is that going to be funded.”

There is a lot of mixed-up stuff in there.

For a start, the question of how we manage the failure of a bank in New Zealand has nothing whatever to do with the idea of foreign taxpayers bailing out New Zealand depositors.  I’m not aware that anyone supposed that was very likely.  Indeed, all our planning –  including the requirement for most deposit-taking banks to incorporate locally –  has been based on the idea that New Zealand is on its own (although for the Australian banking groups, whatever happens in the event of failure is likely to be negotiated by politicians from the two countries).   Instead the general issue here is

  • should a large bank simply be allowed to close if it fails, and handled through normal liquidation procedures (few would say yes to that).
  • if not, how best can the bank be kept open,
  • it could be bailed out by the government (benefiting all creditors, including foreign wholesale ones),
  • or the OBR tool could be used, in which all creditors’ claims would be immediately “haircut”, so that the losses fall on shareholders and creditors not on taxpayers but  the bank’s doors remain open.

Within the OBR scheme there has always been the idea of a de minimis amount which might not be haircut at all.  It isn’t an issue about liquidity –  as the Governor suggests –  because in the reopened bank everyone has access to some of their money.  It is an explicitly distributional issue.   For example, a welfare beneficiary might have only $100 in their account (living almost from day to day),  such accounts in total won’t have much money in them, so it might be easier (involve many fewer creditors, and less immediate resort to eg foodbanks) and in some sense fairer just to give people with such small balances immediate access to all their money and not have them share in any losses (or have to bother about ongoing dealings with those handling the failure).  It has mostly been seen as a matter of administrative convenience, but also of realpolitik (reduce the number of voters affected by losses in a failure).   And if these very small creditors are fully paid out, it does involve a transfer of wealth from all other creditors, but the amounts involved, even cumulatively, are pretty small.

In recent years, there has been talk of this de minimis amount creeping up.    There have even been suggestions of something as large as $10000 –  in other words, if you have less than $10000 in your (failed) bank, you wouldn’t face any losses.    It must be this sort of thing the Governor has in mind when he talks of the difference between deposit insurance and the de minimis being little more than “technicalities”.

But he is still wrong:

  • first, the de minimis would only apply where OBR was used, and OBR is only one option.  Even if looks like an attractive option, in some circumstances, for a large bank, it might not be a necessary or appropriate response to the failure of a small bank.
  • second, the de minimis is being paid out of other creditors’ money (it is essentially a (small) depositor preference scheme).   That might be tolerable for very small balances –  other creditors have an interest in lowering administrative costs of managing the OBR –  but is most unlikely to be defensible, or acceptable, for larger de minimis amounts,   Perhaps the Governor has in mind, the government chipping in directly to cover the larger de minimis amounts, but relative to a proper priced deposit insurance regime that seems far inferior, and different by degree, not just by “technicalities”.
  • third, no de minimis amount I’ve ever heard mentioned comes close to the sorts of payout (coverage) limits in typical deposit insurance schemes abroad.  As the author of the interest.co.nz piece points out  “Under Australia’s deposit insurance scheme, deposits are protected up to a limit of A$250,000 for each account-holder at any bank, building society or credit union that’s authorised by the Australian Prudential Regulation Authority”.    Attempting to rely on the de minimis –  as people like the Governor sometimes do in advance of the failure –  is just a recipe for increasing the likelihood of a full bailout at point of failure, as the amount envisaged just won’t match public expectations/demands (as revealed in other countries).

To repeat, it is good that the new Governor appears to be shifting ground on deposit insurance.  But let’s not settle for half-baked responses, using a vehicle never designed to deal with the issue of deposit insurance.  Legislate and put in place a proper deposit insurance scheme, and levy depositors to pay for the insurance.

Do that and, as I’ve argued previously, the chances of being able to use OBR –  to impose losses on large and wholesale creditors, including foreign ones – will be materially increased.  Without sorting out deposit insurance properly, most likely any future government faced with a failure of a large bank will just fall back on the tried, true, and costly solution of a full state bailout.



A sadly diminished central bank

Under the Reserve Bank Act as it stands at present, before a Governor is formally appointed the Minister of Finance is required to reach agreement on a Policy Targets Agreement (on monetary policy) with that person.  It is a strange system –  again one no other country has chosen to follow in law.  A Governor-designate may, for example, not know a great deal about monetary policy before taking up the job.  And it also appears to give a great deal of policy-setting power to an unelected official, treating the Governor-designate as almost an equal with the elected Minister of Finance.   Since the Governor-designate will generally be ambitious for the role –  and as even potential Governors give some deference to, for example, electoral mandates – in fact the Minister of Finance has the greater say.

The system is shortly to be replaced.  Here is what the Minister of Finance had to say in his announcement on the Reserve Bank reforms in late March.

Currently, the PTA is an agreement between the Minister of Finance and the Governor. Looking forward, as the MPC will be collectively responsible for making monetary policy decisions, it would be inappropriate for the Governor to be the sole member of the MPC to agree the operational objectives for monetary policy. As a result, we are changing to a model where the Minister of Finance sets the operational objectives for monetary policy. These objectives will be set after nonbinding advice from the Reserve Bank and the Treasury (as the Minister’s advisor) is released publicly.

The approach the Government has agreed to for the setting of operational objectives going forward was recommended by the Independent Expert Advisory Panel. This approach imposes discipline on the decisions of the Minister, given the fact that the Minister’s decision will need to take account of publicly disclosed advice from the Reserve Bank and the Treasury. Further accountability measures, such as requiring the Minister to justify decisions before the House, will be considered in the detailed design of this policy proposal.

It is also intended that the setting of monetary policy objectives going forward will involve greater transparency and public input. Decisions on monetary policy objectives are important, and therefore public debate and understanding should be required.

There are still a few unanswered questions, details to be fleshed out, but that looks a largely sensible approach.  I especially welcome the emphasis on

a) the routine pro-active disclosure of official (Treasury and Reserve Bank) advice on the setting of the operational objectives for monetary policy, and

(b) greater ex ante transparency, public input, and public debate.   Setting the operational objectives for monetary policy is the key bit of policy around macroeconomic stabilisation, and is far too important to be done secretly by the Minister and a few internal advisers.  In almost other area of multi-year policy, proposed frameworks would be open for much more public consultation, scrutiny and debate.  I’ve written previously about the much more open approach adopted to the five-yearly refresh of monetary policy targets in Canada.

So, well done Minister.

But despite the admirable promises about the future, in the most recent PTA (that signed with Adrian Orr in late March, a day before he took office), the process seems to have borne no resemblance to what the Minister promises for the future.

There was no public consultation (indeed, the Treasury papers that have been released talk of some consultation with some market economists in 2016 –  under a different government with a different view on monetary policy and the Reserve Bank).

The Treasury advice to the Minister has been pro-actively released (I wrote about it here), but it was disturbingly thin in key areas (issues around the effective lower bound for nominal interest rates, and the next recession).

And what of the Reserve Bank?  One might expect that the Reserve Bank itself would have the greatest concentration of official expertise on monetary policy and related issues –  not just drafting issues, but the key economic issues, including some of those monetary management issues that are just over the horizon).  One certainly wouldn’t want only Reserve Bank perspectives taken into account –  after all, one key part of the PTA involves the Minister, acting in the public interest, disciplining and holding to account the Reserve Bank –  but it would be astonishing if they didn’t have useful perspectives to add.   Perspectives that really should be seen by both the Minister of Finance and by the Governor-designate.  The Minister’s statement about future arrangements would suggest that, at least in principle, he’d agree.

When the Policy Targets Agreement was released I noted that I had lodged an Official Information Act request for the Reserve Bank’s analysis and advice on PTA issues, but that I didn’t really expect much, because I expected to be obstructed and delayed.

There was a bit of delay, in that the Bank took almost the full 20 working days to respond when –  as will shortly be clear –  they could have (and by law should have) responded almost immediately.

This was what I asked for

Copies of any papers relating to the new Policy Targets Agreement signed earlier this week.  I am interested in any advice to the Minister or his office, and any advice provided to the then Governor-designate, as well as any substantive internal advice or analysis papers prepared or obtained in the period since the current government was formed.

and this was the response

The Reserve Bank didn’t provide advice about the Policy Targets Agreement (PTA) to Adrian Orr prior to his start as Governor, and advice to the Minister of Finance was provided by the Treasury rather than the Reserve Bank.

That is a categorical statement: no advice (written or oral) to the Minister of Finance, and no advice (written or oral) to the Governor-designate.

In a follow-up email exchange, I also clarified with them that there were no “substantive internal advice or analysis papers prepared or obtained in the period since the current government was formed” either.

And there was also nothing of this sort in the Briefing for the Incoming Minister released late last year either.

It is almost literally incredible –  ie impossible to believe.  Public servants of my acquaintance have suggested that the Bank might just be lying, but I don’t believe that.  Or perhaps I crafted my request too narrowly?  Perhaps they had done substantive analytical pieces before the election rather than after it, but given the differences in emphasis between the two main parties it doesn’t seem likely that one would really be a substitute for the other.  And they probably will have provided comments to Treasury on drafts of its advice to the Minister, but nothing in that advice is a distinctively Reserve Bank contribution.

It seems rather a sad commentary on what the organisation seems to have become over recent years.  There has been much talk about collective monetary policy decisionmaking –  and ministerial commitments to legislate –  and yet the new Governor apparently neither sought nor received any advice from his (new) senior colleagues on the drafting of the Policy Targets Agreement, the key macroeconomic stabilisation policy document.  The Reserve Bank has substantial experience with the conduct of monetary policy here,  substantial exposure to what is done in other countries, and a significant research capability funded by taxpayers (presumably, at least in part, to shed light on such issues).   The Minister of Finance says he wants future PTAs (or their equivalent) to benefit from (published) advice from both the Reserve Bank and the Treasury, and yet he sought –  or at least received –  none this time from the Reserve Bank.  And yet the Bank itself, if its OIA response is to be believed, had done no substantive analysis or internal advice on PTA issues in the months between the government  – with, for example, its new emphasis on employment – taking office and the signing of a new PTA.

It seems like some sad mix of abdication of responsibility, and the sidelining of the institution that is supposed to be centre of official professional expertise in the area.

It is a far cry from, for example, the approach taken fifteen years earlier.  In April 2002 Don Brash resigned as Governor, and Rod Carr was appointed to act, holding the fort until a new permanent appointment could be made.  That process in turn spanned a general election.  At the time, Reserve Bank senior management took the view that it would prudent and useful for us to invest quite heavily in preparing background papers which could assist the Minister of Finance, The Treasury, the Board, and whoever was being considered for appointment as Governor to (a) get to grips with the issue, and (b) see where our reading of the evidence and arguments had led us to.  The resulting 100 page document is here.    And that wasn’t the limit of our involvement.  We provided advice to Alan Bollard (before he took office) for his discussions with the Minister of Finance, and participated directly in at least one (I say “at least” because I attended one  myself) of his meetings with the Minister on detailed issues around the negotiation of the Policy Targets Agreement.   It wasn’t a climate in which Reserve Bank staff and management perspectives were necessarily overly welcome –  the Bank was to some extent seen as almost an ideological “enemy” (see, as one cause, Don Brash’s 2001 speech I wrote about recently) and there was a great deal of opposition in the Beehive to the idea of anyone internal getting the job as Governor.     But it didn’t stop the Bank preparing and supplying what was (to my mind) reasonably good quality analysis and advice.

As I’ve said previously, the Reserve Bank certainly shouldn’t have a monopoly on advice/analysis in this area –  and much of its analysis on various issues in recent years has been less good than it should –  but the apparent complete lack of any serious analysis or advice to the Minister or the Governor-designate reflects pretty poorly on all involved –  Minister, “acting Governor”, Governor-designate.   It tells of a sadly diminished central bank.

Designing monetary policy committees, revisited

(This post is likely to interest only those with a relatively detailed interest in the reform of the Reserve Bank.)

A month or so ago the Minister of Finance announced the outline of his planned legislative reforms of the monetary policy provisions (objectives and decisionmaking) of the Reserve Bank of New Zealand Act.  According to the material released then

What are the next steps for progressing the outcomes of Phase 1 of the Review?
Officials will advise the Minister of Finance on detailed implementation issues associated with the high-level Phase 1 decisions by late May.

so presumably Treasury is beavering away at present, with the Reserve Bank chipping in to try to retain as much effective control with the Governor and his management team as possible.  Unless, that is, the new Governor is taking a quite different –  and more open and legitimacy-focused –  approach than the Deputy and Assistant Governor he inherited from Graeme Wheeler.   Legitimacy is a key focus in a major new book (Unelected Poweron the institutional design of central banks –  and other autonomous government policy/regulatory agencies – published a week or so ago, and written by Paul Tucker former Deputy Governor of the Bank of England.

I’ve written various posts on aspects of the detailed design issues.  And in a post last week, I dealt with a recent conference presentation on these and related issues by two former central bank officials, one of whom was David Archer, former Assistant Governor (and successively head of financial markets and head of economics) of the Reserve Bank, and now head of the department for central bank studies at the Bank for International Settlements (a “club” for central banks).

I’ve been learning from –  and often disagreeing with – David for almost 35 years now, since he was briefly my boss in my first year out of university, when I was tossed a paper he was writing on reforming the operational aspects of monetary policy and asked for my comments.  He was my boss in a couple of other stints, and then for most of his last few years at the Reserve Bank, he was head of economics and I was head of financial markets.  Frustrating as he could sometimes be –  and I’m sure the sentiment was reciprocated at times – I reckon that in many respects he’d have made a pretty good Governor, at least of a monetary policy focused central bank.  These days he has the advantage of moving among a bunch of very able experts, and perhaps the disadvantage that those people are mostly insiders (formally or not), and his employer is an organisation that doesn’t need to worry much about legitimacy.  Readers may think I’m given to idealism, but on a pragmatism-idealism scale, I’m further to the pragmatic/political end of the spectrum and David towards the idealistic/technocratic end.

As I hope was apparent in post last week, there is a great deal David and I agree on in the context of designing laws, and associated rules, for monetary policy.

  • moving away from a single decisionmaker model (an innovation in the 1989 Act that no one chose to follow, and which has become increasingly less appropriate),
  • that public confidence in the legitimacy of the institution is crucial if operational independence is to be sustained,

Thus far, most people would agree. But we go further:

  • groupthink is a serious risk in any institution, and in any Monetary Policy Committee, and groupthink can seriously undermine the advantages of establishing a committee,
  • free-riding is also a risk in any such committee, and thus
  • a Monetary Policy Committee should have a clear majority of outside members,
  • and those members should be individually accountable for their advice and their vote,
  • a diversity of views/perspectives should be sought, and encouraged (consistent with the high degree of uncertainty and the risks of groupthink in any institution),
  • a role for parliamentary scrutiny (in my case) or approval (in David’s) for people nominated to serve on an MPC,
  • proper and substantive minutes of MPC meetings should be published, with no more than a short lag.  Such minutes should capture and convey the differing perspectives that individual members bring to the discussion (whether about specific OCR decisions, or the approach the committee is taking to monetary policy).  A parallel exists in the form of the range of (majority and minority) opinions judges of higher courts often deliver in deciding cases.
  • individual MPC members should be free to give speeches or interviews articulating their perspective on monetary policy issues, and not be bound to present only a majority institutional view,
  • appointment terms should be staggered, and of a significant length.   David favours prohibiting reappointment, although I’m more hesitant about going that far (because very long term weakens the effective accountability we both seek).
  • periodic external reviews of monetary policy have an important role to play, and should be an established feature of the system (rather than, say, a response to specific episodes of discontent).

Since my post last week, David and I have been exchanging notes on a couple of the issues where our views diverge.  (There are probably others –  while I’d not be averse to a single non-New Zealand member of an MPC, David would  – on past form –  be more open to a larger foreign participation.  For me, one element of legitimacy is about –  in Paul Tucker’s phrase –  perceptions of “values compatibility”.  The New Zealand public need to be confident that an autonomous central bank is working for them, and that is more likely –  at the margin – when the decisionmakers are themselves drawn from that community).  David has given me permission to quote from our exchange.

In my earlier post, I quoted from the Archer/Levin slides

The MPC should formulate a systematic and transparent strategy that guides its specific policy decisions over the coming year or so.

and observed

Easy enough to write down, but hard to make it mean anything particularly specific.

In response he noted (emphasis and link added)

As in my comments on Rennie, and as in Andy’s presentation, I see 3 layers for policy. Call them framework, strategy and tactics. They correspond roughly with what goes into a PTA; the policy reaction function that goes into the forecasting model (alternatively, a Taylor rule or alternative rule that captures the systematic aspects of policy in pursuit of the target(s)); and the stuff around nowcasting and forecasting. Andy and John Taylor and others argue that the Fed should be articulating its strategy, and disclosing that, though Andy is more open on the form in which the strategy is articulated that John appears to be. You and I argue that the RBNZ should disclose its model, also so that the systematic parts of the Bank’s thinking are on display. We’re all talking about central banks being more open about the systematic elements that are under the their control, to improve discipline and legitimacy.

So I actually think we’re in a similar place. We might disagree on whether a Taylor Rule type of PRF [policy reaction function] “dumbs down” the policy process too much – in my view, the ability of the Taylor Rule (or variants thereof) to capture the essence of policy needs is remarkable and telling, as is the regularity with which departures from TRs have turned out to be mistakes. And we share the view that central banks should be required to explain why they think this time is different, which is helped by having a publicly disclosed benchmark.

We both agreed that forecasting is of little value.

Part of the context here is about proposals in the US to require, by law, the Federal Reserve to publish the reasons why its interest rate decisions deviate from the recommendations of, say, the Taylor rule (a fairly simple, but at times surprisingly useful, guide to how central banks (should/do) run monetary policy (using just a neutral interest rate, an output (or employment) gap, and the gap between the inflation rate and target).  David is more sympathetic to something along those lines than I am, and sees the primary role of an MPC as to formulate and articulate a strategy to guide monetary policy.

In response I wrote

I’m inclined to agree that the Taylor rule seemed to do a remarkably good job for a period, although am less sure of its value in the last 5-10 years, because one of the key questions that central banks have had to grapple with (implicitly or explicitly) is what is happening to the natural interest rate itself –  and Taylor can’t offer useful insights on that.  As you note, I would favour the RB publishing its forecasting model, including the reaction function (as part of much greater sense of input-transparency all round), altho I’m more sceptical about the ability of the reaction function to really represent all the contingencies a committee of policymakers (esp an individualistic one) is likely to have in mind.  I’d probably put more weight on the potential for good minutes –  of the sort you suggest –  combined with a requirement for MPC members to publish their individual estimates of key system parameters (neutral interest rate, NAIRU –  akin to the final observation in the Fed dot-plot) to provide a steer as to thinking, and something later to use for some sort of accountability.

In other words, I’m all in favour of an MPC publishing lots of its inputs (eg the background staff papers it receives) and a lot about individual members’ priors.  Like David, I favour the publication of good minutes.   But I’m sceptical that an MPC can usefully go very much beyond what is captured in a PTA –  the bit the Minister of Finance controls.   There is just too much uncertainty about how the economy works at any particular point in time –  more so in the last decade with a great deal of uncertainty about “the” neutral interest rate – for statements of MPC strategy to add very much value.

Our other area of disagreement seems to be over the type of people who should be appointed to serve on a statutory Monetary Policy Committee.

In his announcement of the proposed New Zealand reforms, the Minister of Finance indicated his view on that issue as follows:

External members will have knowledge and experience in relevant policy areas (such as economics, finance, banking, or public policy). However, members will not be limited to monetary policy experts. External members will need to be free from conflicts of interest and will not be on the MPC to represent a particular sector.

It is worth noting that there is no particular reason to expect that most of the internal members will be monetary policy experts either.  At present, for example, the Governor is chief executive for a broadranging organisation, and may not have had a strong background in monetary policy (neither Brash, Bollard nor Wheeler did), and the current deputy governor is a career public servant with an economics background mostly in labour and fiscal issues.

I wasn’t unhappy with Grant Robertson’s description of the sort of people he expected would be appointed.  But in the Archer/Levin slides, they argued

…..the MPC should comprise a diverse group of experts who are individually accountable for their policy decisions.

To which I responded briefly.

I’m not totally persuaded by the “experts” line myself –  one needs lots of expert input/advice to policy, but when it comes to decisionmaking, soundness is at least as important as cleverness.

To which David responded (we both agreed that the value of outsiders shouldn’t be in bringing a better class of business anecdote to the table –  the role the external advisers play at present)

….the big issues in policy-making, the ones that impact on welfare, concern choices of framework and choices of strategy. Right now, as you also argue, the greatest attention by far should be on whether policy design is right. Do we have the right tools? Can we get interest rates to move enough in response to demand perturbations, without banging into lower bounds? What do we think about the appropriate speed of response? If we had a price level “attractor”, would that help induce stronger responses to negative perturbations that risk acquiring a deflationary dynamic? When might asset prices or other indicators of collective manias sensibly affect policy making? Questions about the variability of the exchange rate come into play in open economies. These are the things that can make a real difference. Tactics don’t. So if we’re staffing a policy committee, we should staff it to be capable of handling such questions, and bring a diversity of approach to the thinking on them. From my observation, it’s in relation to these questions where Group Think has its greatest hold. People find it easy to disagree on timing and tactics, but find it very hard to challenge accepted frameworks.

Hence I come down in favour of a diversity of people with the expertise and inclination to handle evaluations of frameworks and strategy, rather than something aimed to reflect the composition of society or of economic activity. And I acknowledge a cost to that approach: political legitimacy is less readily supported, because the policy committee members are not obviously “like us”.

It is an ambitious vision.  I wasn’t persuaded though

…..where we disagree is whether one looks to the MPC members primarily as expert analysts and decisionmakers/communicators in one, or as customers/purchasers for expert analysis, and then decisionmakers/communicators.  I can’t think of many (any?) bodies in our society that function in the former way.  …..  I guess I”m inclined to think that I want MPC members (including the Governor) who will create a climate that encourages debate, and research, and engagement –  inside and outside the Bank –  on all the sorts of issues you raise, and more, rather than being those experts themselves.  It doesn’t mean I’m opposed to have some genuine experts on the committee, but it might be undesirable (even if enough were available) for them all to be experts. For a start, those people won’t necessarily have the (eg) communications skills a public agency needs, or the institutional political skills.  And realistically, not one of the Governors in my career (here and abroad, …..) has been what I would call a monetary policy expert.   Arguably, none of the deputy governors have been either.  Perhaps that should be changed, but there are pretty slim pickings, and frankly what worried me more about Graeme wasn’t his lack of expert background as his lack of openness to debate/challenge scrutiny.  Realistically also, even if we had resident academics who were strong in these areas, many might be better used –  and themselves prefer –  to be based in the academy, generating research and then interacting with policy people, than devoting large chunks of their time to “tactics” and related stuff.
You also note that “People find it easy to disagree on timing and tactics, but find it very hard to challenge accepted frameworks.”.   Maybe, altho your great chart from the Sept 08 FOMC [reproduced in last week’s post] argues against that (at a time when it counted).
On my telling, an MPC should be a balanced panel of people, dominated by outside non-executives, but drawing on high level technical expertise (staff and outside resources).  Since I favour separating monetary policy and regulatory functions into separate institutions, I would favour seeking a monetary policy expert as Governor (and chief executive).   To me, the parallel is with something like the Cabinet –  drawing on expert advice, sometimes ignoring it completely, without themselves being the experts.   That seems more like the way in which we typically run institutions in our society (a telecoms company board will typically benefit from having some people who really know tech/telecoms but will rarely be exclusively comprised of such people).
David responded, having emphasised his view that frameworks and strategies, rather than specific OCR decisions, are mainly what we want an MPC for.

How does one evaluate alternative frameworks and strategies? With extensive modelling exercises, and empirical evaluation of results of different frameworks and strategies at work in practice in comparable countries. Evaluating, making sense of, and extracting the lessons from such research is thus the main task. The expertise required should be sufficient to evaluate research effectively, but not necessarily to design and conduct that research. What the candidate MPC member needs is sufficient training in economics to understand the research they are being presented with. There’s a specialised vocabulary involved. Different research methods take quite some time to understand, especially in terms of the implicit assumptions involved in the choice of method. Perhaps most importantly, even very experienced lay people struggle to grasp the general equilibrium mind set, which is crucial to comprehending how the macroeconomy responds to various impulses over the time frames relevant to the design of frameworks and strategies.

…. Experts should not be equated with PhDs with great track records for research and publication (though they shouldn’t rule the person out).

I’m not persuaded.  There is certainly a need for plenty of background research, and the synthesising and application of that research to a New Zealand context. But I don’t think decisionmakers need to be literate in the issues in the sort of depth David suggests, and I think there is a real risk that – even if enough such people could be found in New Zealand –  such a panel of people might prove more interested in the esoterica of some of the debates (and the important issues that really matter, like the near-zero lower bound) than about actually making good OCR decisions that deliver inflation consistently at or near whatever target the Minister of Finance has set.  This is a point Paul Tucker makes in his book: reputation is a key element of public sector accountability, but for it to work, the appointed policymakers have to care about the stuff the public is looking for from th institution.   People with a stronger interest in the international conference circuit (I’m caricaturing, but it is a risk) than in short-medium term New Zealand macro outcomes, won’t end up with very much effective domestic accountability.

Tucker also makes a point I’ve made here repeatedly.   Requiring technical expertise to be brought to bear before decisions are made does not mean that the technical experts should be the decisionmakers.   We need to bring a lot of technical expertise to bear around monetary policy (tactical decisions and framework design) but in my view much of that expertise should reside on the staff of the Reserve Bank, and it should be one of the prime roles of the Governor to (a) foster such expertise, and (b) ensure it is exposed to external challenge and scrutiny (and alternative external perspectives) and (c) to ensure the results, and alternative interpretations, are translated into language decisionmakers –  on the MPC –  can make sense of, and can question and challenge (and where those decisionmakers have the incentive to do so).  I’m sure there is a place for some monetary policy experts on an MPC –  including among the externals – but the MPC should no more be dominated by such people than (say) major decisions on war and peace should be made by generals (no matter how valuable their technical advice might be).    Legitimacy is rarely achieved simply by technical expertise.

These are important issues to be thought through in the design of the new MPC for New Zealand, and in the process of making the first wave of appointments (which will establish much of how the MPC works).  In practice, in a New Zealand context (given limited pools of candidates) I’m not sure how far apart David Archer and I would end up being, but I hope Treasury and the Minister are giving some thought to the sorts of issues raised here.