Monetary policy, the Governor etc

In a post a couple of weeks ago I highlighted the extent to which monetary conditions appeared to have been tightening over the last few months, even as the OCR has been kept steady at 1.75 per cent.  Specifically, retail interest rates (lending and deposits) have increased, and the exchange rate has risen.  In addition, but less amenable to easy statistical representation, credit conditions have tightened, through some mix of Australian and New Zealand regulatory interventions and banks’ own reassessments of their willingness to lend.    Over this period there has been no acceleration in economic growth and inflation (whether goods or labour) hasn’t been increasing.  If anything, core measures of inflation –  already persistently below target –  have been falling away.

Yesterday the Reserve Bank released the results of the latest Survey of (business and economists’) Expectations.    The Reserve Bank has recently changed the survey, dropping a number of useful questions altogether, and missing the opportunity to plug some key gaps (eg there are no surveys in New Zealand of expected net migration).  They’ve also added some useful new questions, but for the time being are refusing to release the results of those questions –  including those around OCR expectations, house price expectations, and longer-term inflation expectations.

But one set of questions I was a little surprised that they left unchanged were those around monetary conditions.  I like the questions but it is a long time since I’ve seen anyone else write about the results.   Respondents are asked to indicate what their perception of current monetary conditions is (on a seven point scale, where four is neutral).  And then they are asked the same sort of question about expectations for the end of the following quarter and a year hence.

Broadly speaking, respondents tend to describe monetary conditions –  or at least changes in them –  as one might expect.   Here is the perception of current monetary conditions, dating back to the start of 1999 when the OCR was introduced.

mon condtions current

The peak in the series was right at the peak of the last OCR cycle, where the OCR was raised to 8.25 per cent.   Since then, although the Governor likes to describe monetary policy as extraordinarily accommodative, respondents have never thought that monetary conditions have been (or are) anywhere as easy as they were tight in 2007/08.  (When I completed the latest survey, I described current conditions as just a bit tighter than neutral.)

Note that latest observation.  Respondents reckon that monetary conditions have tightened.   The increase doesn’t look that large, and does come after a fall in the previous quarter.    But, the larger increases tend to occur either when the OCR is actually being raised, or when the Reserve Bank is talking hawkishly about the probable need for further OCR increases (thus, you can see the two big increases in 2014, when the Bank was in the midst of what it was talking of as 200 basis points of OCR increases).

But perhaps more interesting is that respondents also expect conditions to be quite a bit tighter by the end of the year, and again by the middle of next year –  and all that with no Reserve Bank encouragement at all.    And –  I would argue –  none from the underlying economic data either.

mon conditions ahead.png

The scale of the increase in the last few quarters is comparable in magnitude to the increase in 2013/14 when the Reserve Bank was talking up, and delivering, significant OCR increases.

Quite why respondents –  completing the survey in late July –  are expecting so much tighter is a bit of a puzzle.  But if it isn’t down to the Reserve Bank itself, or to the underlying economic/inflation data, perhaps it is reflecting trends respondents are observing –  the rising retail interest rates, high exchange rate and tightening credit conditions –  and that they are assuming that those things won’t reverse themselves, and may even intensify.

Personally, I think the case for somewhat easier monetary conditions is relatively clear at present: weak inflation, unemployment still above NAIRU, weak wage inflation, and a housing market that seems weaker than the toxic mix of land use restrictions and continued rapid population growth would warrant.  (To be clear, I’m not making a positive case for higher house prices inflation – though more housebuilding would be welcome –  just noting that the housing market is where, if overall conditions were about right (for the economy as a whole), we should be seeing continuing high inflation.)

Against that backdrop, I think it would be highly desirable for the Reserve Bank to make the point explicitly on Thursday that the economy has not needed, and does not now appear to need, tighter monetary conditions, and that some easing would be welcome and appropriate.    As I noted in the earlier post, I’m not sure it would really be appropriate for the Governor to cut the OCR –  given that (a) he hasn’t foreshadowed such a move, and (b) that this is his last OCR decision.    In a well-governed central bank –  such as almost every other advanced country has –  a change of Governor is less important: however influential the Governor’s views are, in the end he or she has only one vote in a largish committee.  All the other voters will still be there the next time an interest rate decision is made.

The problems here are compounded by the (a) the forthcoming election, so that no one knows what regime (what PTA) monetary policy will be being made under in future, (b) by the fact that we only have an acting Governor –  an illegal appointment at that – for the next six months, and people in acting roles are often loath to do anything they don’t strictly have to, and (c) by the lack of transparency in the Reserve Bank’s systems and processes.  When, say, Janet Yellen or Phil Lowe took up their roles as head of the respective central banks we knew a lot about how they thought about monetary policy.  Same goes for Mark Carney –  even though what we knew about him was from another country.    There is almost nothing on record as to how Grant Spencer these days thinks about monetary policy.  Even if he is to operate –  illegally –  under a (purported) PTA that is the same as at present, the PTA captures only a small amount of what is important to know: what matters as least as much is how the individual thinks about and reacts to incoming data.  With no speeches, no published minutes, no published record of the advice he has given the Governor on the OCR we know very little at all.

It is a model that badly needs fixing.  We simply shouldn’t be in a position where one person holds so much power, and hence their departure leaves such a vacuum (especially when, as will inevitably happen from time to time, such changes occur around election time).    We know that the Opposition parties are promising change –  roughly speaking in the right direction, although the details need a lot of work –  but what the National Party has in mind remains a mystery.   Treasury is refusing to release any of the versions of Iain Rennie’s report on central bank governance, claiming that the matter is under active consideration by the Minister of Finance.  That is a dodgy argument anyway –  since Rennie’s report to The Treasury is not the same as Treasury’s advice to the Minister (something I haven’t requested) –  but since they’ve had the final report for months now,  it shouldn’t be unreasonable to expect some steer from the Minister as to what his response might be.  As I’ve noted before, with the process of choosing a new Governor underway, at present neither candidates nor the Board have any real idea what a key aspect of the job might be.

The problems around “one man governance” aren’t restricted to monetary policy.   The Deputy Governor, Grant Spencer, gave a thoughtful speech the other day on “Banking Regulation: Where to from here?”.  But in a sense, the problem was in the title.  The Governor personally makes the policy decisions, and the Governor is leaving office next month.  Spencer will be minding the store –  illegally –  for a few months, and then retires early next year.  As we’ve seen in the past, the particular person who holds the role of Governor can make a big difference to the character and specific direction of regulatory policy –  LVR restrictions, for example, were (for good or ill) a legacy of Graeme Wheeler personally (and the earlier hands-off disclosure driven model, a legacy of Don Brash personally).  So in many respects it makes no more sense for Grant Spencer to be giving speeches on “where to from here” for bank regulation than it does for Steven Joyce to give such a speech on where to from here with tax policy.  In Joyce’s case, at least it is a campaign speech –  he hopes to still be in place next year, whereas Wheeler and Spencer will both be gone.  Neither they nor we know what their successors’ inclinations might be.

Again, that isn’t good enough.  We’ve personalised control of a major area of policy, when the general practice, here and abroad, is that when technocratic agencies exercise regulatory power they do so through boards that provide considerable continuity through time.  Individuals come and go, but they do so one at a time, and in a way that doesn’t dramatically change the balance of the board in the short-term.  That provides stability and predictability for both the institution itself, for those we are regulated (or indirectly but materially affected by regulation) and for those –  citizens –  with a stake in the agency.     We are well overdue for significant governance reforms to the Reserve Bank legislation.  And to say that is not to criticise the individuals –  Wheeler, or Spencer – who have to operate with the law as it stands it present, inadequate as it is.   The responsibility for the inadequate legislation  –  the iunadequacies of which have been brought into sharper relief in the last few years –  rests with ministers and with Parliament.

In closing, I do hope that when journalists get to question the Governor, and when later in the day FEC members get the same opportunity, they will not overlook the egregious and inexusable behaviour –  not sanctioned by any legislation –  by the Governor, his deputies, Geoff Bascand and Grant Spencer, and his assistant John McDermott –  in attempting to silence Stephen Toplis when they disagreed with some mix of the tone or content of his commentaries on them.     The intolerance of dissent, and the abuse of office, on display then aren’t things that can simply be let go silently by.   I’m as appalled as anyone by the lack of contrition Metiria Turei has displayed over her acknowledged past benefit fraud.  But bad as that is, abuse of high office by senior incumbents is, in many respects, a rather more serious threat.  Our elites seem to have become all too ready to do hardly even the bare minimum to call out, and expose, unacceptable behaviour by the powerful.  Here, we’ve seen no contrition, we’ve seen a Treasury advising the Minister to ignore the behavour, and a Minister of Finance –  legally responsible for the Governor –  happy to walk by on the other side, saying it is nothing to do with him.

(It was nonetheless interesting to read the BNZ’s preview pieces for this week’s MPS.  Perhaps they were just chastened by the data having not gone their way, or perhaps the heavy-handed pressure from the Governor really did work, because the tone (and spirit) of these latest commentaries is very different from what we saw –  and what so riled the Governor  –  in May.   Personally, I thought –  and think –  that the Governor’s May monetary policy stance was more appropriate than the BNZ’s, but that isn’t the point.  Our system is supposed to thrive on vigorous debate, and one isn’t supposed to lose the right to challenge the powerful just because in this case the Governor happens to regulate the organisation employing the critic.)




Intervening without understanding: the RB and the housing market

I spoke last night to the Nelson Property Investors’ Association.  They’d asked me to talk about the Reserve Bank and the waves of new direct controls on housing finance that the Bank has put in place (or is positioning itself to put in place).  Those controls have upended a liberalised and decentralised market that had been in place and functioning well, providing good access to credit without drama, for almost 30 years.  Instead, we have now superimposed one man’s judgement.

It was a topic I was happy to talk about.  It is certainly timely.  In part that is because the current Governor’s term ends next month, and the person who gets the job next year as his permament replacement will materially influence the future direction of housing finance controls (although ideally governance reforms will materially reduce one person’s influence).  But also because the Reserve Bank currently has a consultation document out, as part of a process to get the imprimatur of the Minister of Finance for possible use of debt-to-income regulatory limits.    Submissions on the debt to income ratios proposal close next week and although I will be making a submission, last night’s address didn’t specifically focus on that proposal.

Much of my address was material I’ve covered before here.  Nonetheless, in pulling it all together into a single (more or less) coherent story, I realised afresh just how poor the processes, background analysis, and the policies themselves have been.    As it happens, at the meeting last night a representative of the NZ Property Investors’ Federation also spoke briefly, and his remarks were a reminder that poor quality policy certainly isn’t unique to the Reserve Bank.   The difference perhaps is that we choose the politicians, and when governments do daft or dangerous things, we get to vote on tossing them out again.  No such luck with the Reserve Bank.   And, from my perspective, I write about things I know something about, and I’m pretty sure that the Reserve Bank was once considerably better than this.  And could be again.

I began by looking back

When I was young and exploring job opportunities, I spent a day at the Reserve Bank. The then deputy chief economist was explaining the attractions of working at the Bank – things other than just the heavily-subsidised house mortgages. But the one line I remember was when he stressed the involvement the Reserve Bank had in the housing market, and issues around mortgage financing.

That wasn’t too surprising when one thinks about it. It was December 1982. We were coming towards the end of 40 years of pretty pervasive regulatory controls over so many aspects of the financial sector, including housing finance. The Reserve Bank was then a strong advocate in official circles for financial system deregulation, and allowing the market to take over the allocation of credit. It was – I thought then, and think now – on the side of the angels.

But in my first 20 or so years at the Reserve Bank housing was, at best, a very minor point of what we did. Within months, almost all the direct controls were stripped away. Institutions lent for housing if (a) they could fund themselves, and (b) if they could find (hopefully) creditworthy customers. It was their issue, not ours. Credit, generally, became more readily available. Interest rates trended back down, and banks typically became more willing to lend for longer terms. For an ordinary working person looking to buy a house, a very long repayment period will often make a lot of sense – just as a high initial LVR loan had always done.

And Parliament was careful to provide that whatever prudential powers the Reserve Bank did have were to be used not just to secure the soundness of the financial system, but also to promote the efficiency of that system.

But the bulk of the address focused on the weaknesses in what the Reserve Bank has been doing, in how it has made its case, and in the subsequent accounting for the impact of those controls:

  • how they’ve never adequately engaged with the range of international experiences in 2008/09, fixating on the US and Irish experience when (a) Ireland was in the euro, so lost a lot of policy flexibility, and (b) the US has a long history of heavy government involvement in the housing finance market.  Plenty of other advanced countries, including New Zealand and Australia, had big increases in house prices and housing credit, and no housing-driven financial crisis,
  • how they continue to ignore the implications of their own successive waves of stress tests, which continue to show that even with very severe shocks the banking system appears to be resilient,
  • they hardly ever engage on, and have produced no research on, the efficiency implications of direct controls, including on how they controls apply to banks and not non-banks, how they apply to housing lending but not other sorts of credit (even when past research suggests housing loans are rarely a key factor in systemic crises), and how the controls end up favouring riskier housing lending (new builds) over safer lending (on existing properties).  Similarly, they’ve never engaged on the extent to which controls will impede the information discovery process implicit in different banks managing risks in different ways,
  • there has been no evidence produced to explain why, in the Governor’s judgement, banks can be “trusted” to run their own credit policies in all other areas of their balance sheets, but just not in housing finance,
  • they’ve produced nothing on the distributional implications of their policies –  which tend to favour established low-leverage participants, at the expense of those looking to get into the market.  These concerns only increase now that policies once sold as temporary are becoming increasingly longlived.
  • despite assertions that the controls have reduced system risks, they’ve produced no analysis or research to make that case.    Simply arguing that the volume of high LVR housing loans is lower (no doubt true), simply isn’t a satisfactory basis for such claims.

But, in a way, what concerns me at least as much as all this is that the Reserve Bank simply does not have a remotely adequate model of house prices.   If they produced such a model (in words, or equations) we could carefully scrutinise it.  If it was robust, we might even be inclined to defer to policy proposals based on that model.    As it is, there is almost nothing –  in public (and if they had such a model, they’d have every incentive to publicise it).

Consistent with this, the Bank’s house price, and implicit house price to income ratio, forecasts have been consistently and repeatedly wrong.     They seem to put far too much weight on interest rates –  while rarely acknowledging that interest rates are high (or low) for a reason, usually one to do with the expected growth potential of the economy.   In much of New Zealand, reall house prices how are no higher, or even lower, than they were a decade ago when the OCR was at 8.25 per cent.

The Bank also seems to have an implicit model in which what has gone wrong is that building has lagged behind short-term unexpected changes in demand.  No doubt it has to some extent, but the much the bigger issue –  as most experts (and, I think, both main political parties) would now agree is land prices, themselves a product of land use regulatory restrictions (and associated infrastructure problems).   These are no multi-decade phenomena, and show no sign of being resolved any time soon.    When land is made artificially scarce by regulatory interventions in place for decades, which have not successfully been reversed anywhere else, what basis does the Bank have for (a) thinking that the house price issue is to any considerably extent an “overly liberal finance” problem, and (b) for supposing that a deep sustained correction  –  a halving of house prices –  is a serious possibility?   On their published material, none at all.

Instead of a good rich model, and a nuanced understanding of the housing market, all we are given is the extreme reduced-form, of “what goes up, must come down again”.  Well, perhaps one day, but regulated prices can stay well out of line with unregulated fundamentals for a very long time –  see second hand cars in NZ in the 1950s onwards, or New York taxi medallions. 

The absence of a richer basis of research and analysis to back these multi-year interventions should be deeply troubling.  It simply isn’t how public policy should be made.  It risks looking as though policy is based on one man’s whims.

I wrapped up this way

So we’ve ended up with highly invasive direct controls which mean that, for the first time in decades, ordinary borrowers need to worry about what the government might regulate next, instead of being free simply to deal with their bank on the intrinsic merits of their own project, or their own servicing capacity. Years on, there are no published criteria indicating when these temporary measures might be lifted – if anything, we seemed to be headed deeper into a morass of financing controls. And all this has been done based on no good evidence whatever – whether about crises, about housing, or about the housing finance market, which had seemed to most involved to be working just fine. It is bad enough when they don’t publish analysis. What is scarier is that the really don’t seem to know. It is so far from being an acceptable standard that probably no one could have envisaged this happening even 10 years ago.

How did this sad state of affairs come to be?

Good systems of governance avoid putting very much power in one person’s hands. But by law, the Governor could do all this on a whim. We don’t run other state agencies or our court system that way.

We had a Board of the Reserve Bank that did nothing when the Governor they appointed started running off the rails.

We have banks that are scared to speak out, or take on the regulator.

We have a Parliament that isn’t willing to do its job – holding to account the man, and institution, to whom they gave so much power.

Events matter too. Those crisis-ridden months of 2008/09 rightly prompted a “never let it happen here” mentality. But it was a knee-jerk reaction, with no analysis looking carefully at why it hadn’t happened here. It seemed to provide an open field for enterprising interveners.

And then there were the NZ specific events: the huge and unexpected population surge, all amid governments (and oppositions) willing to do almost nothing to fix the underlying dysfunction in the housing and urban land supply market. “Someone needs to do something” was the mood. Well, the Reserve Bank was “someone” and LVR controls were “something”. Never mind that they might have nothing to do with the underlying housing problem, and respond to financial stability problems that RB numbers suggest just don’t exist.

Sadly, we’ve upped the returns to lobbying, and to keeping sweet with the regulator – incentives only accentuated by episodes like the Toplis affair. Evidence is that the Bank doesn’t welcome debate, or challenge, or scrutiny, and could well try to take it out of your hide. That means even less serious scrutiny of the Bank than we might once have hoped for.

And so one thing piled on top of another, and a single person at the head of a once well-regarded body gets let loose to pursue his (questionably legal) whims, and mess up our well-functioning housing finance market, all while pontificating idly (without thoughtful background research or analysis) on a steadily worsening housing crisis. I’m sure he has good intentions – about saving us all from ourselves – but no mandate, no analysis or evidence, no accountability. Just whim.

Shortly, the one man will be off. And we – citizens, savers, actual and potential borrowers – will be left to live with the consequences. We can only hope that whoever takes up the role of Governor next year, does so with a quiet determination to begin unpicking the mess, allowing the market in finance to work properly – as it had been doing in recent decades – and building an institution known for the excellence of its analysis, operations and policy. Perhaps the new improved Bank may even be able to offer some compelling insights on the regulatory disaster that our housing market – in common with those in many other similar countries – has become.

But I’m not hopeful about any of this. Politicians seem not to care. And powerful officials typically rather like the degree of power they enjoy. Why take the risk, they might well say, of removing controls. Why not just trust us, we know what we are doing.

There were a couple of questions that helped shed light on my story.

One asked how different things would look if we’d simply stuck with the deregulated finance market and not put on any of the LVR controls.

My response was “not much”, at least on the house price front.  As the Reserve Bank itself will openly state, they don’t think LVR restrictions make much sustained difference to house prices.  You might get six months “relief”, perhaps even twelve months, but before long the structural fundamentals  –  population pressures on the land-supply constrained market –  reassert themselves.   Perhaps in total house prices are still a couple of per cent lower than they might otherwise have been, but no one can tell with any confidence.  What we can be reasonably confident of is that different people own the houses: fewer new entrants, and more owned by establishment players. So much for the democratisation of finance that the 1980s reforms made possible.

Of course, there would probably be a larger stock of higher LVR loans –  and banks would be holding more capital against those loans.    But since we don’t adequately understand what banks have chosen to do instead of the high LVR loans they are barred from, we don’t even know have different the risk profile of their balance sheets would look, let alone whether they were more at risk of some future crisis.   (I would also note that had the Reserve Bank done nothing, the less direct guidance to the Australian banks from APRA would no doubt have influenced lending patterns here).

And the second was along the lines of what I might have done in Graeme Wheeler’s place.  My short answer was “nothing”.   There is no evidence that the housing “crisis” is, to any material extent, a phenomenon of inappropriately loose finance, and there is no evidence that banks here have systematically been making poor judgements about the allocation of (housing) credit.  I’d have been reassured by the stress tests –  in fact, I still recall going to an internal seminar, perhaps in 2014, when the results of the stress tests were first presented.  I, among others, didn’t want to believe them, but despite all the pushback and probing, the results appear to have been robust.  Keep doing the stress tests, and when those results look worrying that is the time to consider further action.

None of that is a story of indifference to the problems of a dysfunctional housing supply and urban land market.  But problems need to be correctly diagnosed, and appropriate remedies applied.  Appropriate remedies to the housing market failures rest squarely with central and local government, not with the Reserve Bank.    Research resources are scarce, but there might even have been a case for the Reserve Bank to have invested in becoming something of a centre of excellence in housing, housing finance, and the economics of land use.  In some respects, it isn’t core Reserve Bank business, but it is hard to argue that it would be inappropriate for the central bank to develop and maintain structured expertise in a market that represents that main form of collateral for the banking system.    We don’t want our Reserve Bank, or the Governor, politicised, but a high-performing central bank, with an established reputation for objective excellence, could nonetheless have made a valued contribution to a better debate, and better policy responses, to the lamentable situation that is New Zealand housing.    Perhaps, with a different Governor, they still could.

Anyway, the full text of my address is here.    We are entitled to expect better from such a powerful public agency.



Uncle Philip comes to visit

I wasn’t really planning a post today.  I’m in the middle of preparing a speech/presentation on the Reserve Bank and the housing market (working title “Intervening without understanding”).     But the Reserve Bank yesterday released some (a) comments on their forecasting review process and some aspects of monetary policy, prepared by a former BIS economist, and (b) the Bank’s spin on those comments.  Various people got in touch to say that they were looking forward to my reaction.

When an old uncle or family friend is in town and comes for dinner, the visitor will usually compliment the cook, praise the kids’ efforts on the piano, the sportsfield, or in dinner table conversation, and pass over in silence any tensions or problems –  even burnt meals –  he or she happens to observe.    Mostly, it is the way society works.  No one takes the specific words too seriously –  they are social conventions as much as anything.  One certainly wouldn’t want to cite them as evidence of anything much else than an ongoing, mutually beneficial relationship.

Philip Turner is a British economist who has recently retired from a reasonably senior position at the Bank for International Settlements.  The BIS is a club for central banks, and a body that has been champing at the bit for much of the last decade, encouraging central banks to get on and raise interest rates again.    Turner himself spent his working life in international organisations –  before the BIS he spent years at the OECD, where he developed a relationship with Graeme Wheeler (who was The Treasury’s representative at the OECD for six years or so).  He has never actually been a central banker, or involved in national policymaking.

Back in 2014, Graeme asked Turner to review the Reserve Bank’s formal structural model of the economy (NZSIM).   I didn’t have much to do with him on his visit then, but my impression (perhaps wrongly) was of someone now more avuncular than incisive (albeit with the odd interesting angle).   Having left the BIS last year, the Governor invited him back to New Zealand earlier this year, during which he sat through, and offered some thoughts on, the three-day series of forecast review meetings the Bank undertakes in the lead-up to each Monetary Policy Statement.  

There is nothing particularly unusual about that.  Perhaps twice a year the Bank has someone in who does something similar –  often a visiting academic or foreign central banker who was going to be in Wellington anyway.  It is an interesting experience for the visitor –  I will always remember the time Glenn Stevens (subsequently the RBA Governor) participated, and came out declaring that he now realised we were much less mechanistic than we seemed –  and usually there is the warm fuzzy feeling of mutual regard.  The visitors – friends of the Reserve Bank to start with –  get closer to the monetary policy process than is typically permitted in other central banks, and they are usually suitably appreciative.   Their reports, typically passed on to the Board, typically convey the sense of how good the process is, but sometimes there are even quite useful specific suggestions.    I’m not aware that such reports have ever previously been made public –  and I suspect that had someone asked for them under the Official Information Act, the Bank would have been as obstructive as ever.   Perhaps Turner’s report was particularly generous, perhaps the Governor was feeling particularly beleagured –  eg after the Toplis censorship attempts – but for whatever reason they have both released his report, and attempted to spin it well beyond what it warrants.

Actually, for those not familiar with the Reserve Bank’s internal process, the report may be of mild interest.   The description of the three days of meetings Turner sat through rang true –  and was interesting to me because it suggested things are still much as they were when I was last involved 2.5 years ago.  It will complement some of the other material the Bank itself has released on its processes.

In its press release, the Reserve Bank claims that Turner “commended the Reserve Bank’s forecasting and monetary policy decision-making processes”.  In fact, he did nothing of the sort.   He had no involvement in observing the preparation of the draft forecasts (the background work undertaken by the staff economists), he was not apparently invited to observe the Governing Committee discussions where the Governor makes his final OCR decision, and he engaged in no attempt to assess the Bank’s track record in forecasting or policy.  That isn’t a criticism of Turner.  He wasn’t asked to do those things.  Instead, he will have been handed a binder of background papers, and sat through perhaps 8 to 10 hours of meetings where those papers are discussed and issues around them identified.

That said, there is no doubt he is effusively positive about that process.

This process, which takes advantage of the small size of the central bank, avoids a problem that affects many other institutions. This is that unpopular or unorthodox opinions can get filtered out by successive levels in the hierarchy, as it is only more senior staff who make the presentations to Governors……

The open working-level culture is a credit to the RBNZ. Junior staff are given their voice. Views or arguments expressed by colleagues are challenged in a constructive and professional way. This is essential if the policy blind spots of a few individuals are to be avoided.

In my (rather long) experience there was an element of truth to all this.  The Bank is unusual in having very junior staff presenting directly to Governors.  That is generally good for them, and sometimes works well.  Then again, the Bank is a small organisation.  But it often involves people with quite limited experience or perspectives who can be quickly at sea when taken just slightly off their own safe ground or the established “model”.   It is an operational model that has some strengths, in staff development, but strongly prioritises (by default –  it is usually what 22 year old economists can do) fluent updates on the status quo.

There was also typically plenty of opportunity for people to chip in with unthreatening questions or clarifications.

But as for unpopular or unorthodox views being welcomed and heard……..

Perhaps things have changed a lot for the better in the last 2.5 years,  but it hadn’t been my impression of the Bank’s processes for quite some considerable time.   I largely stay clear of Reserve Bank people these days  (for their sake as much as anything) but nothing I hear through others suggests that the institutional culture has improved.  And how likely is it when the Governor is so outraged by external critical comments that he enlists each of his top managers to try to shut Stephen Toplis up, and when that fails he tries heavy-handed approaches to the CEO of the BNZ, a body the Governor himself regulates?  Whatever Turner’s (no-doubt genuine impressions) of the meetings he sat through, I suspect he saw what he wanted to see.      He formed a good impression of the Bank decades ago, his friend Graeme is now the boss and invites him over for a spot of post-retirement consulting, and when everything is presented as rosy, everyone is happy.

As a reminder, the Governor is so scared of diversity of view that he refuses to release –  even years after the event –  background papers, the balance of the advice he receives on particular OCR decisions, or the minutes of Governing Committee meetings.  But apparently Uncle Philip says all is good, and that should really be enough for us.

Turner saw what he thought he saw in the meetings he sat through.  Then again, he will have little or no familiarity with the New Zealand data, issues, or context.

And on that count what was perhaps more surprising was the rather strongly-worded declarations he offered on monetary policy (substance not decisionmaking process) in New Zealand in recent years.    One might suppose that such conclusions –  not just offered in passing over a drink, but now as an officially-authorised publication of the Reserve Bank – might require engaging with the data, with the details of the Bank’s mandate, with alternative perspectives, and so on.  But there is no evidence of any of that.

What specifically bothers me?  Well, for a start there is no mention of the fact that the Reserve Bank of New Zealand is unique in having run two quickly-aborted tightening cycles since the end of the 2008/09 recessions.  Then again, as I noted earlier, the BIS has long looked rather askance at low global interest rates, and has been keen –  with no mandate whatever –  to have advanced country interest rates raised again.  So was the Governor –  who keeps talking about how extraordinarily stimulatory monetary policy is.  But as an experiment, raising interest rates didn’t work out that well here.  And, at bottom, however good the process looked, the substance of the forecasts was repeatedly wrong.

Turner also gets into selective quotation of the Policy Targets Agrement.  He argues that

Clause 4(b) adds further that “the Bank shall implement monetary policy in a sustainable, consistent and transparent manner, have regard to the efficiency and soundness of the financial system, and seek to avoid unnecessary instability in output, interest rates and the exchange rate”. I have italicised these words because they describe a mandate that is realistic about what monetary policy can achieve. This mandate would not have been fulfilled in recent years, given the large shocks to international prices, by trying to keep the year-on-year inflation rate in New Zealand at close to 2 percent. To have achieved this, interest rates would have had to move by more than they have in recent years, and this would have created the unnecessary instability in output and the exchange rate that the RBNZ is enjoined to avoid.

Of course, no one has ever argued that headline CPI inflation should be kept at 2 per cent each and every year, so to that extent he is addressing a straw man.   Perhaps, charitably, he means keeping core inflation near target, something the Bank has failed to do for years.    But even then Turner omits a key phrase: the Bank is asked to avoid ‘unnecessary instability”, but only “in pursuing its price stability objective”.  The inflation target is paramount, and “unnecessary” variability here is clearly intended to  be distinguished from the necessary variability required to achieve the inflation target.    It isn’t an independent goal in its own right.

In fact, the whole of Turner’s quotation is pretty extraordinary once one remembers that this was the same Bank that marched the OCR  up the hill in 2014, only to have to smartly march it back down again in 2015 and 2016.  If that wasn’t “unnecessary variability” it is hard to know what would have been.  And quite what leads Turner to think that a stronger economy, getting inflation back to target, would have led to “unnecessary variability” in output –  when per capita growth (and even total GDP growth) has been anaemic by the standards of past cycles – is beyond me.  But no doubt Graeme and his acolytes told Philip so.

In his conclusion, Turner observes

The main conclusion is that the monetary policy process at the Reserve Bank of New Zealand works well. This is hardly a surprise given the RBNZ’s distinction as a pioneer in much of modern central banking (e.g. the inflation-targeting framework, the careful attention given to an accountability regime for the central bank that actually works) and given its high standing today among its central banking peers.

As I said, he seems to have formed a favourable impression of the Reserve Bank 25 years ago, and at this late stage isn’t minded to reassess.    If the Reserve Bank of New Zealand is still highly regarded among its “central banking peers” –  which frankly I doubt –  it can only mostly be because of that historical memory, of the pioneering days when –  for better and worse –  the Reserve Bank was genuinely innovative in monetary policy institutional design and banking regulation reform.  Frankly, I doubt many overseas central bankers pay much attention to New Zealand economic data, or to the publications and speeches of our central bank.  Why would they?  And no doubt Graeme is fluent enough when he turns up at BIS meetings.      Perhaps the biggest clue to what is wrong with that paragraph is the idea that we have “an accountability regime that actually works”.  No one close to it thinks so (however good it looked on paper 25 years ago).

Turner’s final paragraph is as follows

A final remark, in conclusion. Results over the past few years speak for themselves. The RBNZ has helped steer its economy through several large external shocks. Because it has done so without becoming trapped at a zero policy rate and without multiplying the size of its balance sheet by buying domestic assets, it has retained more room to pursue, if needed, a more expansionary monetary policy than is available at present to many central banks of other advanced economies.

This is simply almost incomprehensibly bad.     Inflation has been well below target, even in a climate of no productivity growth and lingering high unemployment.  If New Zealand isn’t “trapped” by the zero bound, it is entirely because we’ve persistently had neutral interest rates so much higher than those almost anywhere else –  which is neither to the credit nor the blame of the Reserve Bank –  and so were able (belatedly) to cut interest rates more than almost anyone else.  Because neutral interest rates are still, apparently, materially higher than those elsewhere, the Reserve Bank does have a bit more policy leeway than most other central banks when the next recession hits.  But, contra Turner, it is no cause for complacency –  no advanced country has enough room now –  and no credit to the Reserve Bank.

It is a shame the Reserve Bank is reduced to publishing, and touting, a report like this in its own defence.  When good old Uncle Philip, a fan of yours for years, swings by, it must be mutally affirming to chat and exchange warm reassuring thoughts.  But as evidence for the defence his rather thin thoughts, reflecting the favourable prejudices of years gone by, and institutional biases against doing much about inflation deviating from target, isn’t exactly compelling evidence for the defence.    Sadly, getting too close to Graeme Wheeler as Governor seems to diminish anyone’s reputation.  It is a shame Turner has allowed himself to join that exclusive club.




Keep an eye on the earth, not the stars

So far this year, there has been only a single on-the-record speech from the Reserve Bank Governor, and none at all [UPDATE: actually one] from his Deputy Chief Executive (and incoming –  although unlawful – acting Governor) Grant Spencer.   But there have been quite a few speeches from the next tier or two down –  in some cases probably as part of Wheeler-backed bids for the governorship.   Geoff Bascand –  currently, in effect, chief operating officer –  is probably the only really serious internal contender, and I still intend a post on the  speech he gave last week on matters  –  New Zealand’s external indebtedness – well outside the range of his day job.

But yesterday there was another speech from Assistant Governor and Head of Economics, John McDermott, delivered to an Auckland corporate/fx audience.  The speech was put out under the rather groan-inducing heading Looking at the Stars.   In formal economic models, the equilibrium values of variables are often denoted with an *.    Thus, r* –  or “r star”  –  is the equilibrium, or neutral, interest rate.  McDermott’s speech was an attempt to explain how the Bank uses some of these equilibrium variables  (“the” output gap, “the” neutral interest rate, and “the” equilibrium exchange rate) in setting monetary policy.

I had various picky concerns about the speech, but I won’t bore you with those.

The speech was pretty consistent with the sort of speeches McDermott has given over the years.   In his role, he is (among other things) the Governor’s chief adviser on the New Zealand economy and monetary policy.  He’s had the job for 10 years now, and yet there is still a pervasive tone of the textbook about his speeches.   Models –  disciplined ways of thinking through issues –  have a role to play, probably in all areas of policy.  But in his speeches McDermott never seems to have found a way of successfully conveying a nuanced understanding of the economy and policy issues, in a way that doesn’t leave too much of the formal architecture on display.    It is quite a contrast to successful senior policymakers in central banks in other countries.

At times, it is as if he doesn’t feel comfortable without the formal apparatus, even when he knows the rather severe limitations of those tools and techniques.  Here is an example of what I mean.  In the conclusion to his speech, McDermott states that

To set monetary policy we need to know [emphasis added] where the key macroeconomic factors (such as interest rates, output, and the exchange rate) are tracking relative to their equilibrium levels, denoted by our ‘stars’. These stars are unobservable and complex to estimate, so we use a range of techniques to help form our view of their values over time. Like the night sky, our stars keep moving.

Earlier in his speech he had noted that these equilibrium values “are the anchors around which we aim to stabilise the economy”.

Such in a world –  in which the Reserve Bank, and others, knew where these equilibrium levels are, and how they are changing – might well be great.    (Although even then a single instrument –  the OCR –  just can’t manage three other variables, in addition to inflation.)     But it isn’t the world we live in.

In fact, McDermott more or less acknowledges that.  Take the output gap  –  the difference between actual GDP and estimates of potential GDP –  as an example.    There have been huge revisions to the Bank’s estimates of the output gap over time (I’ve illustrated this previously, but it isn’t contentious –  everyone recognises the point), and McDermott himself states in the speech that “we have a range of uncertainty with respect to the output gap; around 2 per cent of potential output.”.    In a series which the Bank estimates has only flucuated in a range of -3 to +3 in the last 25 years or so, those margins of error are large enough that only rarely can the Bank even be confident which sign the output gap has.    If knowing potential output and the output gap is as essential to monetary policy making as McDermott claims in this speech, we might as well give up completely.  They don’t know, and neither does anyone else with any great confidence.

The conceptual framework might well be useful –  you are more likely to need to tighten if the economy is running above capacity –  but real-time empirical representations of this sort often aren’t very much use at all.  In fact, one of the more obvious gaps in the speech is there are no observations, or charts, illustrating how the Bank’s view of these equilibrium values goes on changing.   It isn’t so much that 2017’s neutral interest rate might be different from 2007’s, but that the 2017 estimates of the 2007 neutral interest rate may be very different to what the Bank thought the 2007 neutral rate was when it was making policy in 2007.    For some research purposes –  making sense of economic history etc- that doesn’t matter, in fact it is how knowledge advances.  But actual policymakers have to operate in the knowledge that they are highly likely to be wrong in their contemporaneous estimates of these equilibrium relationships.    And there is simply nothing of that in this speech.

If the errors was just randomly distributed it might matter less.  But some of them are rather more systematic.  Neutral interest rates are a good example.   Most people now accept that neutral interest rates are lower than they were, but most –  including most policymakers –  have been slow to adjust those estimates.    That is a natural human tendency, but it also means that any policymaker who puts a great deal of weight on their current estimates of neutral interest rates will think any particular level of market interest rates is further from the “true” neutral rate than will actually turn out to have been the case.  Monetary policy will then have been run too tight.    One could mount a reasonable argument that that is a material part of the story of what has gone on at our Reserve Bank.   Recall that the Governor keeps asserting that monetary conditions are extremely stimulatory –  suggesting he has in mind quite a strong view about what “the” neutral interest rate is.    Recall too McDermott’s comment that the Bank seeks to use these equilibrium relationships as “anchors around which we aim to stabilise the economy”.  There has been a strong sense over the years of the Reserve Bank constantly wanting to get the OCR back much closer to its estimate of the neutral rate.

Actual policymaking isn’t always that bad.   How could it be when on the one hand they think the economy is running at full capacity (one equilibrium concept they tell us they rely on), while the OCR is a whole 175 basis points below neutral (the other main equilibrium concept they tell us they rely on knowing).   But it hasn’t been very good either.  And the policy communications –  examples like this speech –  are pretty consistently poor.

Sometimes I even worry about basic levels of apparent competence.   McDermott includes this chart in his speech

Figure 1: Nominal Neutral OCR and Actual OCR


Source: RBNZ estimates


This is their current estimate of how the neutral OCR has tracked over the history of the series (the OCR was only introduced in 1999).    They have a suite of tools and models that produce a range of estimates –  the grey band –  and the blue line is the mean of those estimates.    In the text, McDermott says the Bank is now using 3.5 per cent as the neutral OCR in their modelling and forecasting, which is about where the blue line is at present.

There is some economic discussion around the chart

Over time, the neutral interest rate has been slowly falling; a trend that has been seen in many countries around the world. Economic theory tells us that changes in neutral real interest rates reflect changes in real economic factors such as population growth, productivity growth, preferences for savings, and world conditions. A combination of these factors appears to have been contributing to the fall in neutral, both in New Zealand and abroad.

Which all sounds fine, and sounds consistent.   But then you remember that the neutral interest rate the Reserve Bank is using is the OCR, and the OCR is an interest rate that isn’t paid by any borrower, or received  by any saver, in the wider economy.    For those one has to look at data on, say, term deposit rates or floating mortgage rates.

Start with the chart above.   The Bank says its estimate of the neutral OCR is now 3.5 per cent.  But go back a decade –  July 2007 was just before the financial crisis stresses really started to infest funding markets globally –  and the blue line looks as though it would be almost bang on 5 per cent.    If I recall rightly, at the time we thought the neutral OCR was much higher than that –  perhaps as high as 6.5 per cent –  but as things stand now the Reserve Bank is telling us it thinks the neutral OCR has fallen by 1.5 percentage points over the last decade.

That might sound like a lot.   In fact, it is nothing at all.  Here’s why.  In July 2007, the OCR was 8.25 per cent.   At the same time, the Reserve Bank’s measure of six month term deposit rates was 7.98 per cent, and the Bank’s measure of new floating first mortgage rates was 10.35 per cent.  Term deposit rates were 27 basis points below the OCR, and first mortgage rates were 210 basis points above the OCR.

Right now, the OCR is 1.75 per cent and has been all year.  Last month (latest data), the term deposit rate indicator was 3.31 per cent (156 basis points above the OCR) and the indicative new first mortgage rate was 5.84 per cent (409 basis points above the OCR).

In other words, the margins between the rates people are actually paying/receiving and the OCR have blown out enormously –  in fact by around 190 basis points.    Implicitly, the Reserve Bank has revised upwards its estimates of neutral retail interest rates.

Those spreads between the OCR and retail rates can and do move around, so I’m not suggesting you focus on the difference between the 150 point cut in the neutral OCR, and the 190 point increase in spreads between the OCR and retail rates.   The real point is that, despite the fine words in the chief economist’s speech about reasons why neutral interest rates here and abroad have probably fallen –  perhaps quite considerably –  the Reserve Bank has made practically no adjustment of substance at all.  As they’ve always said, it is retail interest rates –  not the OCR –  that affects spending and investment choices.

I can’t believe McDermott doesn’t know all this –  we used to have charts presented with each set of forecasts illustrating how the spreads had changed since before the crisis –  but if that is right, what is the explanation for how the speech is written?    And is this the sort of presentation that has the Governor still asserting that monetary policy is highly stimulatory, even as inflation continues to track “broadly sideways”?

In a way, these things shouldn’t matter.  A prudent central bank would simply treat current interest rates as a starting point, and look for actual data –  new developments –  suggesting a case for change.  But at our central bank it does seem to matter to some extent, because we have key policymakers out asserting that they “know” what the equlibrium values are, and can/should use them to make monetary policy.   What say instead the Reserve Bank had assumed a 150 basis point fall in neutral mortgage rate?  That would translate to a neutral OCR of around 2 per cent at present.  It seems at least as plausible as the Bank’s own number –  with inflation persistently below target, an output gap they think is near zero, and unemployment persistently above the NAIRU.  Then presumably we would be hearing quite different rhetoric from the Governor about just how stimulatory, or otherwise, monetary policy is.

Changing tack, the other thing that is striking about the speech is the reminder of just how little focus the Reserve Bank puts on the labour market.   Labour is by far the biggest input to the economy, and also the market in which the rigidities and slow price adjustments –  a key concern for monetary policy – are most prevalent.  And yet it hardly rates a mention in McDermott’s speech.   Many other central banks –  and forecasters –  find the concept of the NAIRU (the non-accelerating inflation rate of unemployment), and the gap between actual unemployment and the NAIRU, as a useful (even central) part of their forecasting and analysis framework.  That is partly because the unemployment itself is a directly observed and, in principle, is a direct measure of excess capacity (more so, certainly, than the output gap).   But it is also because policy is supposed to be about people, and ability of people to get a job when they want a job is one of the key markers of a successfully functioning economy.   We have active discretionary monetary policy because the judgement has been made that without it the inevitable shocks that hit the economy would leave countries too prone to prolonged periods of unnecessary unemployment (Greece is the extreme contemporaneous example).   Voters don’t greatly care about unemployed machines, but they do care about unemployed people.

Contrast the Reserve Bank of New Zealand’s approach to that of the Reserve Bank of Australia –  with a very similar inflation target.   Yesterday, the RBA Governor was out with a thoughtful nuanced speech on labour market issues, in which he observed that “the unemployment rate is still around 1/2 a percentage point above estimates of full employment in Australia”.   He referenced a clear and useful recent Bulletin article on “Estimating the NAIRU and the unemployment gap”  which opens with this clear and simple statement

Labour underutilisation is an important consideration for monetary policy. Spare capacity in the labour market affects wage growth and thus inflation (Graph 1). Reducing it is also an end in itself, given the Bank’s legislated mandate to pursue full employment. The NAIRU – or non-accelerating inflation rate of unemployment – is a benchmark for assessing the degree of spare capacity and inflationary pressures in the labour market. When the observed unemployment rate is below the NAIRU, conditions in the labour market are tight and there will be upward pressure on wage growth and inflation. When the observed unemployment rate is above the NAIRU, there is spare capacity in the labour market and downward pressure on wage growth and inflation. The difference between the unemployment rate and the NAIRU – or the ‘unemployment gap’ – is therefore an important input into the forecasts for wage growth and inflation.

You’ll see nothing of the sort from the Reserve Bank of New Zealand.      It is as if they fear that somehow talking about ordinary people, and the overall balance in the labour market, will somehow be betraying their mission.    But their mission is about people’s lives, jobs, and opportunitites.

I’m not suggesting that at present the RBA is running policy any better than the RBNZ is –  in both countries there looks to me a case for thinking about possible further rate cuts –  but the RBA certainly communicates much better, and in a way that suggests both a grounded story about what is happening in Australia and the world, and an identification with the interests of ordinary Australians.

That is part of the reason why, somewhat reluctantly, I’ve come to the view that the Labour Party is right to campaign on amending the Reserve Bank Act to add a focus on unemployment to the goals of monetary policy.   It should be implicit in the current way the Act is currently written, but in practice it seems to have become something the Bank is uncomfortable with, rather than something central to their reason for being.  Phil Lowe and Janet Yellen  –  or their respective decisionmaking boards –  aren’t some rampant wet inflationistas, and yet they manage to talk openly and sensibly about these issues, and find it a useful framework for analysis and communication, in a way that seems beyond our Reserve Bank.    We’ve got to the point where far-reaching is needed at the Bank –  in its legislation, its ethos, and in its senior people.

I’ve always been a bit hesitant about suggestions that the Reserve Bank operates primarily in the interests of one group of New Zealanders over another –  that hesitancy shouldn’t be surprise; after all, I sat round the monetary policy decisionmaking table for a couple of decades and we all want to believe that we serve the public interest.  But, with the benefit of a bit more detachment, I increasingly worry that the Bank –  unconsciously rather than deliberately – reflects more the perspectives and interests of what the Australians talk of as “the big end of town”, than of ordinary New Zealanders.

There are just a couple of illustration of what bothers me.  After each MPS the Reserve Bank runs (or at least did when I was there) a series of presentations around the country to explain its thinking.  In some ways they worked quite well –  we spread out across the country (usually the three main centres plus one provincial centre a quarter) the morning after the MPS.  I enjoyed participating.   But all these functions were hosted by the banks, and the invited attendees were the banks’ business, corporate and financial customers –  in smaller provincial areas, they were often hosted in a bank’s business customer lounge.   Never once did we do those talks to union-organised gatherings of interested employees, to church or community groups, to students, to meetings of beneficiaries or the like.  Don’t get me wrong –  the Bank does, or did, accept some invitations in the course of the year to talk to other groups, but the big events are about corporate audiences.

It struck me again yesterday when I picked up John McDermott’s speech. It was delivered to HiFX (presumably staff and invited clients), a “a UK-based foreign exchange broker and payments provider that has been owned by Euronet Worldwide since 2014”.  Out of interest, I looked back through the other on-the-record speeches McDermott has done during Graeme Wheeler’s term of office.  They were to audiences at:

  • Federated Farmers
  • FINSIA (a financial sector training group)
  • NZICA CFOs and Financial Controllers
  • Goldman Sachs Australia
  • Macroeconomic Policy Meetings, Melbourne
  • Bay of Plenty Employers and Manufacturers
  • Wellington Chamber of Commerce
  • Waikato Chamber of Commerce/Institute of Directors

Each a perfectly worthy audience in its own right no doubt.  But there is something of a pattern –  it is an employers and financial sector focus, rather than (m)any groups broadly representative of the citizenry.    When the people you talk to are mostly rather comfortable, it must to an extent influence the way in which you as an organisation end up thinking.    Few if any of those audiences would be much bothered if the unemployment rate had been above the NAIRU for, say, eight years and counting.

McDermott told us about how he was looking at “the stars”.  In fact he knows almost nothing particularly useful about them –  and if there is a criticism it isn’t that he doesn’t know the unknowable, but that he keeps asserting against all the evidence that he can.  Perhaps he and his colleagues would be better off keeping a cold hard eye on the ground, on the things we know rather better –  a (core) inflation rate still well below target, wage inflation still very subdued, and an unemployment rate still persistently high.   And talk to us in language that suggests a care about the interests of ordinary New Zealanders.



Vision, measurement, and (lack of) achievement

You might get the impression that I can be rather critical.  No doubt I can.  But one the thing the last couple of years has confirmed to me is that there is a still a sunny upbeat, naively optimistic, streak lurking within.    In particular, I keep being surprised by just how bad things really are at the Reserve Bank, and that despite having spent 32 (mostly quite enjoyable) years on the payroll.

A few weeks ago I wrote about the Reserve Bank’s (statutorily obligatory, but largely pointless –  given that the Governor is just about to leave, and the Governor makes all the decisions) Statement of Intent for the next three years.

Quite early in the document, in a section headed “Strategic direction”, I had come across this

The Reserve Bank’s purpose is to promote a sound and dynamic monetary and financial system. It seeks to achieve its vision – of being the best small central bank

As I noted then

It was a line one used to hear from the Governor from time to time when I worked at the Bank (somewhere I think I still have a copy of a paper that attempted to elaborate the vision), but it hasn’t been seen much outside the Bank, and if I’d given the matter any thought at all I guess I’d have assumed the goal had been quietly dropped.   Apparently not.

As an aspiration, it is one that has always puzzled me.

It is good to aim high I suppose, but isn’t it really for the owners to decide how high they want the Reserve Bank to aim? Then it is the manager’s responsibility to deliver.  I’ve not seen the Minister ask the Reserve Bank to be the “best small central bank”.    That isn’t just an idle point, because the ability to be the best will depend, at least in part, on the resources society chooses to make available to the Reserve Bank.  There are some gold-plated, extremely well-resourced, central banks around, particularly in countries that are richer than New Zealand.   I suspect New Zealand probably skimps a little on spending on quite a few core government functions including the Reserve Bank (but I’m probably somewhat biased, having spent my life as a bureaucrat), but that is a choice.    If we asked of the Reserve Bank what we ask of it now, but made available twice as many resources, we should expect better results.   As it is, there are limitations to what we should expect from 240 FTEs, covering a really wide range of responsibilities (the Swedish central bank, for example, appears to have about 40 per cent more staff, for a materially narrower range of responsibilities).

Given that the Governor has now restated the vision of having the Reserve Bank as the best small central bank, I assume he must have some benchmark comparators in mind, and assume they must have done some work to assess how they compare.  Since I assume any such documents would be readily to hand, I’ve lodged a request for them.

Specifically I asked as follows

I refer to the observation on p10 of the Bank’s new Statement of Intent, in which it is stated that the Bank’s vision is to be “the best small central bank”. I would be grateful if you could provide me with copies of any and all benchmarking exercises conducted since the vision was adopted (the start of the current Governor’s term?) indicating how the Reserve Bank is doing relative to other small central banks.

I’m not quite sure what I expected, but it wasn’t what I finally received this morning.

The Reserve Bank is declining your request under section 18(e) of the Official Information Act, because the document alleged to contain the information does not exist or cannot be found. Specifically to this ground, the Bank is declining your request as it has not conducted any benchmarking exercises since the vision was adopted indicating how the Bank is doing relative to other small central banks.

Not a thing.   No comparative tables.  Not a single paper for the Senior Management Committee or the Governing Committee.  Not a single paper for the Board, the body paid to hold the Governor to account, and to scrutinise and report on the Bank’s performance.

I’m still flabbergasted.  This is, so staff and the now the public are told, the Bank’s “vision”.  It was a distinctive emphasis introduced by the current Governor shortly after he took office, still being repeated front and centre in a key accountability document as the Governor gets ready to leave office.  And yet, he and they have apparently done nothing at all to assess where they stood at the start, and what if any progress they might have made since.   I’m sure that any junior manager at the Reserve Bank who articulated an ambitious vision for his or her own team would rightly have got pushback along the lines of “how will know you’ve achieved it?” and “who are you benchmarking yourself against”, or “what data collections processes will you put in place to enable us to assess whether you are making progress”.

Ambition is good.  Vision is good –  “where there is no vision, the people perish”.     But hand-wavy “visions” with little or nothing behind them, that apparently drive no decisions, and where there are no benchmarks, and no way of assessing progress, are worth almost nothing at all.   Within an agency, they just fuel staff cynicism.  Beyond the four walls of the institution concerned, they border on the deliberately dishonest – the sort of cheap and empty rhetoric (small beer in this case) that is corroding confidence is institutions and leaders across the Western world.     The pervasiveness of this sort of cheap rhetoric is presumably reflected in the fact that both the Minister of Finance and the Reserve Bank’s Board reviewed drafts of the Statement of Intent.  Did none of them ask: “Governor, this vision of being the ‘best small central bank’, where do you stand now, what progress have you been making, and how will we –  those charged with holding you to account – know?”?

Visions have their place.  But from independent government bureaucracies, I’d settle for consistently excellent delivery on the tasks Parliament has given them.  For too long now, we’ve not had that from the Reserve Bank, or from those charged with holding them to account on our behalf.  But when they met last week, applications for Governor’s job having closed, was the Reserve Bank Board even aware of the deficiencies?  And, even if so, did they care?

Options for a new Governor

Applications for the job of Governor of the Reserve Bank closed this morning.

As I’ve noted before it is a very odd business:

  • applicants don’t really know what job they are applying for (since Labour and Greens are promising material changes in the monetary policy decisionmaking model, and in the Bank’s statutory objectives, and the Rennie review may yet foreshadow changes by the current government),
  • the Board, charged with evaluating and recommending a candidate to the incoming Minister of Finance, also has no real idea what the job is.  The emphases of a Labour/New Zealand First government (say) would probably be rather different than those of a National-ACT government.

And yet, with still 2.5 months until the election, the Board will shortly settle down with their recruitment consultants to winnow down the list of applicants.  And this is a Board entirely appointed by the current government, and although the individual Board members may each be quite capable they are likely to be a different bunch of people, with different inclinations and preferences, than a Board appointed by a Labour-led government would have been.    Of course, elections have consequences –  governments get to appoint sympathetic people to the (too) numerous goverment bodies –  but it isn’t obvious why, if this year’s election leads to a change of government, the last election should so strongly influence the sort of person likely to be presented to the incoming Minister of Finance as the nomineee for Governor.

Board members have neither legitimacy nor expertise.  They aren’t elected, don’t front up to select committees or the media, don’t even maintain proper records (as required by law), and can’t be tossed out by voters if they do a poor job.   In other countries, almost every country I’m aware of, the Governor of the central bank is appointed by the Minister of Finance (or some other elected person –  eg the President in the US).  And in most countries, the Governor of the central bank has much less power than our Governor has.

In our system in particular, the Governor is a really consequential appointment.  The Governor is the sole legal decisionmaker on monetary policy and most aspects of banking regulation (as well as numerous other less important things the Bank is responsible for).  He –  and it most probably will be a he – alone gets to decide how aggressively the Bank should respond to economic downturns, or how closely it adheres to the Policy Targets.  He gets to decide how well-positioned New Zealand is for the next recession. He gets to decide whether banks are even allowed to lend to you by residential mortgage.  He could, if he chose, stake billions of taxpayers’ money on interventions in the foreign exchange markets, and if the bet goes wrong we –  not he –  lives with the consequences.    There is a gaping democratic deficit –  too much power in one person’s hands –  but is made worse by the fact that elected politicians (whom we can hold to account) can’t appoint someone in whom they have confidence to exercise these powers.  They must take a name handed to them by a bunch of company directors and the like appointed by the previous government.  The Minister can knock back any particular Board nominee, but in the end the Minister can only appoint someone that Board nominates.  And he can’t even easily replace the Board at short notice.

So who are these enormously influential members of the Board?   One member’s term expires in a week or so, and apparently he won’t be replaced until after the election.  That leaves six of them.

The chair is now Neil Quigley, vice-chancellor of Waikato University.   These days, Neil is an academic administrator, but earlier in his career he had a research background in banking regulation, financial history etc.

The vice-chair is Kerrin Vautier, a microeconomist by background, who has also been a company director and is a lay member of the High Court (under the Commerce Act).

The other four include two private sector company directors (one of whom is a director of an insurance company, even though the Reserve Bank regulates insurance companies), one lawyer, and one member whose roles seem to be mainly government appointments and not-for-profit positions.

I don’t want to be too critical of them as individuals.  I know, and have worked with, three of them at various times, and they are each able people.  But none of the six individually – or the group collectively – really seem to have the skills for making such a crucial public appointment.   They are not subject experts and have no expert advisers –  and yet they must presumably evaluate applicants’ monetary policy or regulatory inclinations/expertise – nor do they bear the downside if they make a poor recommendation.  They also have no experience in high profile public roles.   Ministers of Finance also typically aren’t experts, but (a) they have an entire Treasury to assist, and (b) they do bear the downside, since the public (reasonably enough) tend to hold elected politicians to account for the failures of public agencies.

The process is so flawed that I’ve argue before, and repeat the point today, that the Opposition parties really should indicate that, if elected, they will change the law to allow the Governor to be appointed simply by the Cabinet on the recommendation of the Minister of Finance, as is done in most other countries (perhaps with advisory quasi-confirmation hearings by a parliamentary committee).  Not only would it make our system more democratically legitimate and internationally comparable, it would also put the Board in a better position to monitor and hold to account whoever is appointed as Governor.  They’d have no incentive to simply back their own appointee, but could simply do the monitoring job  –  on whoever the Minister appointed –  as agent for the Minister and the public.

But for now, the system is as it is, and has its own momentum.  As the Board prepares for its next meeting on 20 July, they really need to start by thinking hard about:

  • what the nature of the job really is, and
  • about the outgoing Governor’s stewardship of the role during the last five years (especially bearing in mind that many of the current Board were responsible for Wheeler’s appointment).

It isn’t obvious the Board has really been doing the second with much energy at all.  I’ve written previously about their Annual Reports, which never seem to have found any cause for concern about anything, functioning more as additional legs in the Bank’s own public communications efforts.   The year just ended is the first in which the new chair, Neil Quigley, has led the Board.   Perhaps this year’s report will be a bit different and a bit more open but it is difficult to be very optimistic.    This is, after all, the same Board who defended the Governor over the OCR leak debacle, expressed no concern even after the event at the ill-fated 2014 tightening cycle, and so far have been totally silent about Graeme Wheeler’s highly inappropriate sustained attempts, including use of his senior managers, to attempt to censor a private sector critic.

When the advert for the Governor’s role first appeared, I wrote a bit about some of the surprising features of what they were asking for in their advert.  If there are governance system changes in the period ahead the Governor’s role may change, but at present it seems that there are three broad aspects to the role:

  • chief executive of an organisation with a large (but typically low risk) balance sheet, and a staff with significant policy, analysis and operational responsibilities,
  • the sole legal decisionmaker on all aspects of monetary policy, most aspects of banking regulation, and personally responsible for the Bank’s policy advice and actions in other areas,
  • a key crisis manager, and
  • the public face of an organisation whose choices at times bear heavily on the short-term performance of the New Zealand economy.

Under current law, those are features of the role at any time.   But in the current situation, there is the additional challenge of rebuilding the Bank’s capability and reputation after the Wheeler years.   Monetary policy hasn’t been well-handled.  Banking regulation appears to frustrate the banks (more than the inevitable tension between regulator and regulated).  No one now seriously looks to the Reserve Bank for “thought leadership” in the areas of its responsibility.  And, for all that the Bank likes to claim to be very open and engaged, it is perhaps akin to (say) a Singapore-government style of openness, that chooses tame interlocutors and just ignores alternative perspectives or, say, journalists who might ask hard questions.   There is a great deal of rebuilding to be done, and a good Governor over the next few years –  particularly with the prospect of legislative change –  needs to have qualities that will enable him or her not just to steward an organisation in good heart, but to lead organisational change and revitalisation.

With so much policymaking power personalised in the Governor’s hands, it is difficult to see how the right appointee won’t need to have a significant amount of directly relevant professional expertise.   Of course, monetary policy is very different from banking and insurance regulation, and quite possibly no serious candidate is particularly strong in both fields.   And on the financial sector side, it is important to recognise that this is a regulatory role –  some of my friends differ on this, but the Reserve Bank (despite the name) isn’t primarily a bank, even though it needs to understand banking to regulate it effectively.

Each of the three Governors under the current law has had an economics background. None was necessarily strong in the key technical dimensions (and of the three, only Don Brash had any prior experience in the public eye).     Ideally, we would find someone better aligned to the role (as, say, the last three Governors of the Reserve Bank of Australia have been), but there may not be such a candidate.    Really successful organisations are usually able to promote from within –  again the Australian experience –  but unfortunately the Reserve Bank here has been quite weak on developing people with the relevant senior experience (Grant Spencer has been both chief economist and head of financial stability, but he is retiring).

But if the appointee needs to have some significant professional expertise in the Bank’s areas of responsibility –  it might be different if the Governor was primarily CEO and just one voting member among five or seven on relevant committees –  technical expertise is far from all that matters.  As I noted in the earlier post, I was surprised the Board made no mention of character and judgement –  qualities that can take someone a long way, especially when times get tough and the Governor is under pressure.    Earlier in the year I wrote

For me, I’d settle for someone with the character, energy and judgement, backed up a solid underpinning of professional expertise, to revitalise the institution, rebuild confidence in it, and provide a steady hand on the policy levers, backed by high quality analysis and an openness to alternative perspectives, through both the mundane periods and the (hopefully rare) crises.  And all that combined with a fit sense of the limitations of what monetary policy and banking regulation/supervision can and should do

That still seems right.

Who might it be?   Back in February, shortly after Graeme Wheeler announced that he would be leaving, I noted

the lists of people talked about as potential candidates as Governor, be it Geoff Bascand or Adrian Orr (probably the names at the top of most lists) or others –  Rod Carr, John McDermott, Murray Sherwin, David Archer, Arthur Grimes, New Zealanders running economic advisory firms, New Zealanders who are past or present bank CEOs here or abroad etc

They still seem the most likely sort of people.  For reasons I’ve outlined before I don’t think it would be at all appropriate, let alone politically feasible, to appoint a foreigner as Governor, wielding all the power that position holds at present.     One foreign member of (say) a five or seven person Monetary Policy Committee or Financial Policy Committee might make sense at times.  But under our current law the Governor wields at least as much power as a typical Cabinet minister, and we require our Cabinet ministers to be New Zealanders.

When people occasionally ask me who I think will get the job, I usually note that Geoff Bascand must have the inside running.   He is a competent economist (albeit not mainly in macro or financial areas), knows his way around the bureaucracy, and has outside chief executive experience.   He has a number of downsides, including lack of any financial sector (or related regulatory experience), but appears to have been actively promoted by the current Governor (which perhaps should be a negative, but may not be).  The Board gets to see him every month.  A competent internal deputy is always likely to have the inside running.

I’ve heard that there is talk around Wellington that one of the CEOs of the Australian banks might be in line for the job, and Ian Narev’s name (head of CBA, parent of ASB) has been specifically mentioned.    At present, three of the group CEOs of the Australia banks are New Zealanders (one was apparently even a bank economist early in his career).   One can’t rule out the possibility completely, but none of these guys has any experience with monetary policy, nor any of being a regulator.  And they are used to running vast organisations, not ones of 250 staff.  You have to wonder whether a left-wing government –  perhaps especially one including Winston Peters –  would really be comfortable handing control of our monetary and banking system to the very wealthy CEO of an Australian bank (Narev for example took home A$12.3 million last year).   And, of course, if one were a shareholder of an Australian bank mightn’t the fact that the chief executive was looking to get out, applying for another job, be information that you might regard as material, warranting disclosure?   It seems a more plausible option if, say, the Minister could just directly appoint someone in whom they had confidence, rather than going through a drawn-out application process.

Of the people on that list, David Archer probably now isn’t widely known in New Zealand.  He holds a senior position at the Bank for International Settlements (club for central banks) but was formerly Assistant Governor and Head of Economics, and prior to that Head of Financial Markets, at the Reserve Bank.  He and Alan Bollard didn’t really get on, and David went overseas in 2004.    David would bring drive, energy, curiosity, openness, and high intellect.   On the other hand, he has been out of New Zealand for a long time now, and that does have hard-to-pin-down disadvantages.   He also doesn’t have any real experience with financial regulation –  in fact, in times past was a champion of a fairly minimalist approach (and whatever the merits of those arguments, they bear no relation to current NZ law).  He also has –  or had –  a style that works very well with some (the intellectually self-confident, perhaps even combative) but not necessarily with others.

Rod Carr remains an interesting possibility.   He was Deputy Governor for five years, and missed out on becoming Governor when Don Brash left.  He has direct banking experience (albeit 20 years ago).  He has also been a Reserve Bank Board member for the last five years, but was apparently ousted as chair by the other Board members last year.  Perhaps he will apply for Governor.  But in the various Board minutes that have been released to me in recent months, there is no sign that Carr absented himself from discussions around the process leading towards advertising for and selecting a new Governor.  Had he been planning to apply, to have absented himself (and documented that absence) would have seemed appropriate conduct.

Time will tell.  My main point is that it is a terrible way to select a person for the most powerful unelected role in New Zealand:

  • the wrong sort of people dominate the process (in principle)
  • in practice, the current Board has done a poor job, and doesn’t look well-placed to find a good replacement Governor, and
  • the timing is weird

At very least, the Board should have left applications open until the election result is clear.  That much was in the Board’s own hands.  Political leaders should have taken back to themselves the power to make (directly) such a vital appointment, as is done in other countries.  There is still time.

(And, of course, far-reaching governance reform is overdue. Ideally, the Minister would be looking for someone to oversee and implement a transition to a new model.)

It is now the school holidays.  Posts over the next couple of weeks will be quite sparse.


Who did Iain Rennie consult?

I’ve written a couple of times about the review former State Services Commissioner Iain Rennie has been conducting, at the request of the Minister of Finance, into two aspects of the governance of the Reserve Bank:

  • whether something like the existing internal committee in which the Governor makes his OCR decisions should be formalised in legislation, and
  • whether the Reserve Bank should remain the “owner” of the various pieces of legislation (RB Act, as well as the insurance and non-bank legislation) it operates under.

An earlier OIA request from a journalist saw The Treasury refuse to release the terms of reference for the report, but they did release the terms of engagement.  I wrote about that here.    We learned from that release that the report had been delivered to Treasury in mid-April.    We also learned that

In completing the work, the author will engage with an agreed set of domestic and international experts.


The key deliverable is a report, which will be peer reviewed by a panel of international experts.

I was interested to know who these experts were, and lodged an OIA request with Treasury.  No doubt, they could readily have responded in a day or so, but after four weeks they did finally respond yesterday.

Anyway, this was the list of “agreed domestic and international experts”.


and this was the list of reviewers


It is a curious list in many ways.    Setting aside the SSC people, of whom I know nothing but who are presumably knowledgeable on issues of governance of New Zealand public sector institutions, not a single one of the central bank experts (first list) has any experience of, or exposure to New Zealand (let alone actually being a New Zealander).

And Rennie, with Treasury’s agreement, appears to have consulted only current serving central bankers.   No doubt several will have had useful perspectives to offer on their own central banks’ experiences.  But the world of central bankers is a fairly clubby (or collegial) one, and you would have to think it unlikely that Rennie would have heard anything from these people that would cast doubt on how the arrangements their New Zealand peers operated under were working.   And among those current central bankers only one (Poloz, the Canadian Governor) has any stature in his own right; the others appear to be “corporate bureaucrats”, able no doubt to pass on information about how things work in their own central banks, but not self-evidently qualifying as “international experts” on central bank governance etc.

One might have supposed that any number of other people (even from abroad) could have provided valuable perspectives and insights.  For example, retired Governors and former members of decisionmaking committees, who are freer to speak their mind.   Lars Svensson, the leading academic and former monetary policy board member, wrote a review of our Reserve Bank in 2001 for our then-government.   Having had extensive experience as an insider since then, and retaining an interest in New Zealand, he would have seemed like a natural person for Rennie to have consulted.    In fact, there is not one academic on the list.   Not, for example, Alan Blinder, former vice-chair of the Fed and author of academic work on decisionmaking by committee.   There are no private economists on the list.  Not, for example, Willem Buiter now chief economist of Citibank and a former academic and member of the Bank of England’s Monetary Policy Committee.  And no one from abroad with, say, a Treasury perspective, or the perspective of a Minister.  Bernie Fraser, for example, had been both Governor of the Reserve Bank of Australia, and Secretary to the (Australian) Treasury.

And not a single person from New Zealand made the expert list?  Not Arthur Grimes, who was heavily involved in the design of the current system and later chair of the Reserve Bank Board.  Not Don Brash, who was Governor under the current system for 12 years.  Not thoughtful former Board members such as (for example) Hugh Fletcher.  Not people who had been involved from a Treasury perspective (especially in the years since Rennie himself left Treasury).  And, of course, no one who has written on the issues domestically.

You might, incidentally, be wondering why people from the Bank of Canada and the Bank of Israel top the list of experts.  That is likely to be because Canada is the only other advanced country central bank with the Governor as (formally) single decisionmaker (Canada has quite old central banking legislation, and the Bank of Canada has much narrower responsibilities than our Reserve Bank).  And until relatively recently, Israel also had the Governor as a single decisionmaker, before the legislation was overhauled and a mixed committee (internals and externals) took over the monetary policy decisionmaking role.  The Israeli experience should be interesting, but again you have to wonder why Rennie didn’t consult Stan Fischer, former Governor of the Bank of Israel, and now vice-chair of the Federal Reserve.

What of the international peer reviewers?  There were three, and each will have been likely to have added something in commenting on Rennie’s draft.    But, again, there is a distinctly “let’s keep this inside the club” feel to it all.   Goodhart, for example, is a respected academic economist, and former staff member and Monetary Policy Committee member at the Bank of England.    But he is now rather elderly, and has had a very strong relationship with the Reserve Bank of New Zealand over the years –   including as guest speaker at the (rather extravagant) 50th anniversary celebrations of the Bank, and then someone used as an expert witness  by the Bank at the parliamentary select committee when the current Reserve Bank Act –  governance and all – was being legislated (rather controversially) in 1989.

Donald Kohn is pretty highly-respected in international central banking circles.  So much so that Treasury omit to note in their description that, having retired from a career at the Federal Reserve, he is now a member of the Bank of England Financial Policy Committee, so still entirely within the central banking club.  He has visited the Reserve Bank and, from memory, wrote up his experiences pretty positively.

The final reviewer is David Archer, former Assistant Governor and Head of Economics at the Reserve Bank (and sometimes mentioned on lists of potential future Governors). He now holds a senior position at the Bank for International Settlements, a body owned by central banks (including ours) which describes itself thus

The mission of the BIS is to serve central banks in their pursuit of monetary and financial stability, to foster international cooperation in those areas and to act as a bank for central banks.

I worked with David closely over a long period, and he was usually pretty willing to speak his mind.  He certainly knew the Reserve Bank well –  at least in the days before financial regulation became so important, and before the Reserve Bank moved more back into the mainstream of central government as a major regulatory institution –  but you have to wonder quite how free he will have felt to offer views the Reserve Bank might be uncomfortable with – the Governor visits the BIS pretty frequently –  especially as those views will themselves presumably be discoverable in time.

So the offshore people consulted, or used as reviewers, seem as though they will have been a rather partial perspective on the issues at hand. No doubt, all provided some useful information and perspectives, but you can’t help thinking there could have been a lot more there if Rennie had sought it.  Then again, as State Services Commissioner his reputation was hardly that of someone keen on open government.  What is perhaps more troubling is that The Treasury was okay with all this.

Despite this published list, you have to wonder who else Rennie in fact consulted.  Why I do suppose there was anyone else?  Because, somewhat by chance, I also yesterday got a response from the Reserve Bank to an Official Information Act request for minutes of the Reserve Bank Board.

In the minutes of the Board meeting held on 30 March this appears

Rennie board

There follows almost three pages recording the details of the Board’s discussion with Rennie (and his supporting Treasury staff). every single word withheld (on somewhat questionable grounds).    Nothing else ever gets three pages of text in the Board minutes –  in fact, the process for appointing a new Governor is still not being minuted at all, even in this latest set of releases.

I don’t have any particular problem with Rennie consulting with the Bank’s Board.  They are likely to have some useful experiential perspectives to offer, but if the discussion covered almost three pages of minutes and –  according to Treasury –  no one else in New Zealand with any familiarity with central banking issues was consulted, it does all have the feel of an insiders’ job.  Perhaps that is what Steven Joyce wanted.  It isn’t what the situation requires.    Meanwhile, one can only hope that the report itself, along with the terms of reference, will be released before too long.

New Zealand isn’t the only country looking at these issues.  The Norwegian government just this week released an independent report they had commissioned looking at the future governance and mandate of their own central bank.  The summary report is very easy to read, and includes specific draft amendments to the law to give effect to the report’s recommendations.  Among those recommendations is a streamlined system of governance, with proposals for a monetary policy committee (40 per cent of whose members would be externals appointed by the government), and for a separate Board to which the Governor would be responsible in his role as chief executive of the Bank.    We can only hope that the completed Rennie report will be as clear and crisp.