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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

a.  the stability of the currency of Australia;

b.  the maintenance of full employment in Australia; and

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

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

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

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

Section 2A. Monetary policy objectives

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

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

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

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

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

So I’d suggest wording along these lines

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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