Central bank research

For some reason the other day I was prompted to have a look at how many research papers the Reserve Bank had published in recent years. This chart resulted.

RB DPs

Only one in the last two years, and that one paper – published last February – had five authors, four of whom worked for other institutions (overseas). It was really quite staggering. It wasn’t, after all, as if there had been no interesting issues, policy puzzles or the like over the last two years. It wasn’t as if universities had suddenly stepped up to the mark and were producing a superfluity of research on New Zealand macro and banking/financial regulation issues. It wasn’t even as if the Bank had suddenly been put on tight rations by a fiscally austere government – in fact, the latest Funding Agreement threw money and the Bank and staff numbers have blown out. Rather, or so it appears, management just stopped publishing research.

These research Discussion Papers are usually quite geeky pieces of work, formal research that is subjected to some external review before publication, and often written with the intention of being of a standard that might be submitted to an academic journal. The Reserve Bank had put quite an emphasis on this sort of research (mostly on macroeconomic matters) for probably 50 years, as one part of the sort of analytical work that underpins its policy, operations, and communications.

Of course, what ends up in published research papers like this isn’t all the thinking, analysis, or even research that the Bank has been doing – ever, not just now. Apart from anything else, they have a variety of other publications, including the Analytical Notes series that was started up a decade ago to fill a gap (for example, less-formal research, often with shorter turnaround times), and even the Reserve Bank Bulletin which had had a mix of types of articles, but itself appears to have been in steep decline. There are speeches from senior managers, but as I’ve pointed out previously these days these are few and rarely insightful (not much research, here or abroad, informs them). There will be other analysis and research that simply never sees the light of day – the Bank not being known for its transparency – but what appears in public is likely to be an indicator of what does (or doesn’t) lie beneath the surface. The Bank still has some staff who appear to have formal research skills – indeed a year ago they recruited one of New Zealand’s best economists apparently to work on preparations for the next review of the monetary policy Remit – but what we see is thin pickings indeed. Most of most able researchers of the last decade have left, and as far as I can see there is no one working in the research function with any long or deep experience of the New Zealand economy and financial system.

Recall that the previous Governor espoused a goal that the Bank should be not just adequate but the “best small central bank” in the world, while the current one often reminds people of his mantra “Great team, best central bank”, suggesting a vision not even constrained by the (small) size of New Zealand.

Does any of this matter? I could probably mount an argument that much of what the Bank is charged by Parliament with doing could, in principle, be done with little or no formal research (of the type that appears in Discussion Papers). In principle, a keen appetite for the products of overseas research, a climate that encouraged debate and diversity of ideas, active engagement with other central banks, and a steady flow of less-formal analysis wouldn’t necessarily lead to particularly bad outcomes. And having been around in the days when the Bank was doing some world-leading stuff (notably inflation targeting, but also some of the bank regulatory policies) it is fair to note that little or none of that drew on (or was reflected in) formal RBNZ Discussion Papers.

But it isn’t really the standard that we should expect these days, nor is there any sign that people in other countries do. It is not that a single research paper is likely to decisively change any particular policy setting (perhaps not even 5 or 10 would) and many of the papers might go nowhere much at all. But a flow of formal published research is one of the marks of an institution that thinks, that has an intellectually vibrant culture, that is open to new ideas etc etc. And on some policy calls, we really have a right to expect that the Bank – with huge amounts of policy discretion, and quite limited accountability – is doing world-standard research of its own, and/or commissioning it from others, and making that research available for challenge, scrutiny etc. One might think here of appproaches to bank capital policy, where the current Governor took a bold non-consensus decision, but where the institution has no published record of any substantive serious research. Sometimes these things might just be about trying to find frameworks that make some sense – never all of it – of what has been going on, or bringing formal evidence to bear on (for example) what the LSAP has accomplished.

But, these days, there is little sign of any of it from our central bank – and as a straw in the wind, it is at one with a record of few (and rarely good) speeches, inaccessible MPC members (themselves ruled out from doing research), and policy documents that rarely seem to reflect robust analysis.

Of course, one can expect formal research outputs to fluctuate a bit from year to year. Topics come and go, immediate management priorities come and go, particularly able and productive researchers come and go. But one paper (and that mostly co-authored) in two turbulent years isn’t a sign of an institution that any longer takes seriously generating research output, or the sort of climate that makes an institution attractive to really able people.

What about other countries? I went counting.

Much discussion in New Zealand compares us to other Anglo countries, and in central banking terms, Australia, Canada and the UK have had similar (inflation-targeting) macro policy frameworks.

anglo DPs

Of course, each of these are much bigger countries than New Zealand (and on that basis one might think the RBA rather light on its published research) but (a) there aren’t huge economies of scale in central banking (our economic puzzles can be just as intractable as those of much larger countries), and (b) both the RBA and the Bank of Canada have a narrower range of policy responsibilities than the Reserve Bank of New Zealand.

So how does the RBNZ compare with the central banks of other small advanced countries?

DPs adv countries

Central banks of very small countries (in this case, Iceland and Slovenia) have tended not to publish much formal research – although still more than the RBNZ in the last couple of years – and one might wonder at the budgetary priorities of the central bank of Lithuania (just under three million people and without a monetary policy of its own), but even before this decade the flow of formal research from our central bank looks to have been at low end of what one might expect given (a) our population, (b) the wider range of issues the RB is responsible for, and (c) the idiosyncratic nature of some aspects of our economy. There is no single right or wrong volume of formal research, but next-to-no published research simply looks like a dereliction of duty. (One might have hoped that a Board chaired by a university vice-chancellor – one with a reputation of getting research metrics looking good – might have raised questions, but…….this is the mostly-useless Reserve Bank Board.)

Again, does it matter? In my more cynical moments over the years I used to observe that perhaps the main difference inventing inflation targeting made was that we subsequently got invited to a better class of international conference. It might not sound much, but it is a straw in the wind for something that really does matter – the connectedness of the institution, the exposure to ideas, the ability to get leading people to take an interest and visit etc etc. We used to have that. Not all the conferences were useful, not all the visitors were useful, and so on, but becoming known as a central bank that (a) rules out from its MPC anyone with ongoing expertise in monetary policy, (b) publishes hardly any serious research, and (c) where senior management, if they speak at all (recall that the chief economist gave not a single published speech), make only the lightest-weight speeches isn’t a recipe for keeping engaged with the world, or the flow of ideas or research. When you are all already small, remote, idiosyncratic, and not as rich as Croesus (we can’t just throw money at potential visitors) it is a poor lookout.

These outcomes must have been the result of deliberate decisions. They need not be forever. Capability can be rebuilt, although doing so in an enduring way takes time and leadership. Who Orr appoints to the current key vacancies is likely to reveal quite a bit as to whether the Governor has any interest in creating a research-informed Reserve Bank, across the range of key policy areas he is responsible for. If not – and most likely not – it will be another sign of a deeply troubled institution, taking a similar path of decline to too many other New Zealand institutions in recent years. Responsibility for that rests not just with individual officials, but with a government (and Minister of Finance in particular) who seems not to care.

A sad ending

Yesterday morning’s news was an NBR headline – story accessible only to those with a subscription – in which the Reserve Bank appeared to have confirmed to this single media outlet that Deputy Governor, Geoff Bascand (a statutory appointee, and member of the Monetary Policy Committee) had left his job early, after speaking without authorisation to a third party about the Bank’s management restructuring. Later in the day, we got more accessible versions of this astonishing development (including this interest.co.nz account).

Bascand had been a public servant for a period spanning 40 years, starting in The Treasury in the 80s, and including stints as head of the Labour Market Policy Group (at the old Department of Labour), Government Statistician, and (since 2013) as Reserve Bank Deputy Governor. His public sector career had had its ups and downs, and he never quite reached the very top levels, but what a way to end it. In many ways, he was a classic public servant – most people seemed to like him, quite a few respected him, he wasn’t (it seemed) flamboyant or reckless. He went along. He wasn’t an intellectual leader, but he got things done. He didn’t seem to stand on titles etc – I was quite impressed that he was willing to take the step back from a CEO role at SNZ to (initially) the third-ranked position at the Reserve Bank (even as I assumed at the time that he saw it as a stepping stone back into the policy-institution mainstream, perhaps with aspirations to be Governor or Secretary to the Treasury). And in 2017 he was quite (unusually) open (to media) that he’d applied for the Governor’s role, knowing (presumably) that even as incumbent (but new) deputy chief executive he probably had no better than a 50/50 chance. In the first three years of the Monetary Policy Committee, he had been by far the least-unimpressive of the members, and gave speeches that were sometimes almost worthy of a member of a powerful independent policymaking committee in an advanced country.

I first met Geoff 35 years ago, but had only had off and on contact with him until he came to the Bank. We then sat on many of the same committees, but I left the Bank a couple of years later, and my main dealings with Geoff were actually over the last 8 years when we were both trustees of the troubled Reserve Bank staff pension scheme and spent too many hours locked in long meetings. We had our differences there – sometimes quite stark, sometimes on quite important issues – but in recent years in particular we seemed to have got on well, and even together crafted a resolution to one of the lesser issues the scheme was dealing with. I say this mostly as context. I don’t wish Geoff any ill at all.

When it was announced a few months ago that Bascand was leaving the Bank at the start of 2022, it wasn’t entirely clear what was going on. One plausible story was that at his age (60ish), unlikely now to ever become Governor, he’d simply opted for a slower pace of life – golf, grandkids, and some directorships/consultancies etc. Another was that he had become so frustrated with the Orr approach that he simply wanted out. The two weren’t incompatible necessarily, but if you are part of a project you are totally at one with, it isn’t usual to simply walk away – in good health, and not that old. But the new governance structure for the Bank was coming in mid-2022, and he might also have thought someone needed to be willing to commit several years to bedding in the new model. There was always the possibility Orr wanted him out, but as holder of a statutory office appointed by the Minister there was no direct way of effecting that, despite the reputation Orr had long had for churn among his senior staff. The speed with which Bascand’s replacement was announced – with no advertisement etc process – did tend to reinforce suspicions.

The concerns about top-level departures started to step up in November when it was announced that the Bank’s Chief Economist was leaving after less than three years in the job – having been appointed by Orr, it was quickly apparent he was being restructured out by Orr (Orr having restructured out the previous Chief Economist). Questions started to be raised, including at Parliament’s Finance and Expenditure Committee. With inflation rising sharply, and unease (justified and not) about the Bank’s handling of monetary policy through the Covid period, the Governor’s position was becoming somewhat exposed.

But there was more to come. The management restructuring was ongoing and now claimed the two senior managers responsible for banking regulation and supervision, who had been direct reports of Geoff Bascand’s (as deputy governor and head of financial stability). We still don’t know the details of the restructuring – the Bank is playing OIA obstruction – but both Andy Wood and Toby Fiennes decided to leave, their own previous jobs presumably having disappeared (Fiennes already having been effectively demoted in an earlier Orr restructuring). That might prove quite uncomfortable for the Governor, with annual select committee hearing coming up on 15 December (this time the annual Financial Review, focused on the year to 30 June, but allowing a very wide range of issues to be raised).

And so, it seems (Orr did not deny it when questioned on it at FEC), the Bank decided to keep this news secret (from staff and the public) until after the FEC hearing was over.

And yet the news got out, with a story from Business Desk’s Jenny Ruth late the previous afternoon (and a statement from the Bank confirming the departures). Orr faced repeated questions at FEC the following day (I wrote about it here), and some of the answers from him and his team proved to be quite misleading. There was a lot of bluster, and the Governor did not emerge well.

There were a couple of straws in the wind – no more – that week that suggested that the Bascand situation was less than happy. Watch the FEC hearing (accessible on the FEC Facebook page) and you will see that Bascand was there – Orr even mentions it at one point – but in the back seats with the large group the Bank brought along. That was odd. Bascand was at this point still the incumbent Deputy Governor, and the hearing was formally focused on the 2020/21 financial year. It wasn’t that there wasn’t room at the top table – Orr was joined there by the incoming Deputy Governor and one of the his many more-obscure Assistant Governors. Not having Bascand up front – and several MPs have made generous comments about Bascand – looked not quite right.

And then on the Friday of that week, Bascand simply did not turn up for a long and important meeting of the superannuation scheme trustees, a meeting that had been scheduled explicitly to draw on his expertise and experience before his scheduled departure in the first week of January. His replacement had already been appointed (from 5 Jan) and invited to attend the meeting as a silent observer. Initially not suspecting anything – other than idly wondering what financial stability drama there might be on 17 December – I asked the chair if Geoff had then nominated the replacement as his (legal) alternate, which would enable that person to participate fully. It would have been a natural thing to have done if something had come up and Geoff was simply too busy. But all we got was a rather flustered “no”.

But none of that took one anywhere, at least until yesterday’s story.

The story did not tell us what Bascand had told to whom, only that he had had unauthorised discussions with an outsider, had confessed and apologised, and had left the Bank on 17 December, several weeks before his scheduled (early Jan) departure date.

So it is hardly a stretch to suppose that he was the ultimate source of the 14 December story about the further senior management departures – since it (a) involved people who had directly worked for him for several years, and (b) came out late on 14 December, and while he was still there (FEC) on the early morning of the 15th he was gone by the 17th. Most probably Bascand didn’t directly communicate with the journalist who broke the story – although even had he done so, the journalist would have needed independent confirmation to help provide cover to her source – but may well have told someone with the explicit intention that the news get to a journalist with a reputation for taking RB issues seriously. (It is quite clear, on the other hand, that these unauthorised discussions weren’t, say, a passing mention to his wife – the consequences, confirmed by the Bank yesterday, tell us it was much more serious than that.)

There can’t have been many people at the Bank who knew (on say 13 Dec) that Wood and Fiennes were going. The Governor, the incoming deputy (who would soon be responsible for financial stability), perhaps the Assistant Governor responsible for HR, perhaps the respective PAs, Wood and Fiennes themselves, and Bascand. Bascand either because he was still incumbent Deputy Governor or because either or both of Wood and Fiennes would most likely have talked to Bascand – their boss for several years, but not now the person driving decisionmaking – before making their final decisions. Only disgruntled people had an incentive to leak, which would have quickly narrowed the field, and Bascand apparently confessed, apologised, and agreed to go early. It could reasonably have been seen as a sacking offence but (a) no doubt the Bank wanted to keep this quiet, and (b) getting rid of a statutory officeholder isn’t quite like dismissing an ordinary staff member.

Why would Bascand have done it? Presumably the motive was pure and simple to put Orr on the spot at FEC, perhaps driven by frustration at how his loyal and capable senior staff had been treated. But it was still a strange step for someone like Bascand – the mostly fairly buttoned-down bureaucrat – to have taken. After all, although the FEC hearing became more of a spectacle, and more uncomfortable for Orr, it wasn’t as if this was really whistleblowing – the FEC hearing itself was never going to be decisive (of anything), and the Bank would have announced the departures a day or two later anyway. If – as I think there are – there are serious questions to be asked about Orr’s stewardship, a couple of days wasn’t going to make much difference in the scheme of things. Perhaps Geoff was just at the end of his tether?

If this is the story – and while it seems likely we can’t be certain – did he suppose he’d not be found out? Perhaps, but why take the risk? Perhaps he thought there weren’t really any downsides for him? But if so, he was wrong. Leaving two weeks early a job you’d resigned from anyway isn’t the cost. But yesterday’s story is. I guess that story wasn’t guaranteed to leak out, but….Wellington is a small place, and who knows what story staff were told as to why Geoff wasn’t around for his scheduled last few days.

It is simply a really bad look. Even real whistleblowers – of information about (a) misbehaviour that (b) would never otherwise come out – rarely prosper (even though society needs such people). But this wasn’t whistleblowing – Orr was within his rights to restructure, and the news was going to come out anyway – and just looks rather petulant and undisciplined. And whatever you think of Orr’s stewardship of the Bank, a senior figure behaving this way – breaching his obligations (moral and otherwise) is unlikely to endear himself to people (government or private sector) considering Geoff for future directorships and consultancies. If he had real concerns about Orr’s stewardship – and he should have – a detailed letter to the Minister of Finance, after he had left the Bank, might have been in order. Perhaps even a serious interview with a major media outlet a few months down the track (Orr is up for reappointment early next year), although in cosy Wellington even that would have raised eyebrows. But not leaking to the media – with a high probability of being found out – simply for some short-term additional embarrassment for the boss. (And it is not as if Geoff in the past has not expressed firm views on anyone speaking out in a way that might embarrass him or those he supports.)

I was glad the news of those further senior management departures got out in time for FEC, was glad to see National and ACT MPs asking hard questions of Orr – and hope they now follow up further – but what Bascand (who had obligations to the Bank) appears to have done was quite inappropriate and unacceptable, and it is good that that news has belatedly come out. It is a sad way to end a long public service career.

But what a mess an important and powerful public agency is clearly in. So many key people going or gone, so little analytical, operational or policy excellence, so little banking or regulatory experience at the top of a major banking regulatory agency, and so on. Meanwhile, the Board chair who presided while all this went on has been given another term, and all indications are that none of this much bothers the person with the ultimate responsibility, the Minister of Finance. It should. We need to end, and reverse, the degradation of major New Zealand public institutions.

UPDATE: Continuing to mull over this business, I’m still a bit inclined to wonder if there is more to the story. Is there a possibility that Bascand took the fall, covering for someone else (for whom the consequences of discovery might have been greater)? I guess we’ll never know, and perhaps it is just that I don’t want to believe that someone like Geoff could have acted this way, even tired, even frustrated. There is something particularly treacherous about a deputy deliberately undercutting his boss in a way implied by the story told in this post. But probably only a couple of people know the truth of the matter, and they won’t be saying.

The Reserve Bank appears underwhelming

First thing this morning the Reserve Bank fronted up at Parliament’s Finance and Expenditure Committee for their Annual Review hearing.

The Governor kicked off with some introductory remarks that were celebratory (the focus of the hearing was notionally on the last financial year) but superficial. In some cases barely even honest. He was “very proud” of all the Bank had achieved, talked up monetary policy as having been “highly effective in preventing deflation”, claimed (wrongly) to have been one of the first central banks to have raised policy interest rates again, and ended with a paean to “diversity and inclusion” talking of having “many plans” and “much action” on that front. There was no mention, for example, of the $5 billion of taxpayers’ money they had lost, or of the continuing churn at the top of the organisation.

Last evening they had had to announce that two more senior managers were leaving, ousted in yet another of Orr’s restructurings. Orr didn’t deny the claim made by National’s Simon Bridges (and various journalists) that the Bank had hoped to keep these departures secret until after the hearing, and had only announced them late yesterday afternoon after the news had seeped out. It can be hard to keep track of all the departures – in several cases Orr can’t even blame his predecessors as at least two of the senior management departures have been of people who Orr had first promoted before changing tack and pushing them out. I’ll take the departure next year of the Bank’s long-serving CFO (who would be over 65) as a genuine retirement, but mostly the departures seem to have been Orr-initiated, such that of the large senior management group in place when he took office only 3.5 years ago, only two will soon be left.

And the departures aren’t simply in peripheral or support positions. Orr has now ousted two chief economists in succession, and we have no idea who will be filling that vacancy on the MPC, at a time when things are scarcely all quiet on the monetary policy front. On the financial stability side – largest part of the Bank and the growing bit – the gaps are even more obvious. The Deputy Governor (who ran that side of the Bank) is leaving, and now the two senior managers (heads of supervision and head of prudential policy/analysis) are leaving – the latter having already accepted a demotion a couple of years ago. Each of these guys has strengths and weaknesses (although I thought Andy Wood was good value), but all will be gone very shortly – and with them huge amounts of experience. In their place, we have a new Deputy Governor who has no background in banking, supervision or financial regulation, and two vacancies. So far at least, Orr has shown no ability to (or interest in doing so?) attract top-notch talent to the Bank at senior levels. And from 1 July next year, the Bank’s new Board is becoming the key decision-making body on prudential matters including policy. The Minister makes those appointments and so far no one whom one might think of as offering exceptional intellectual or practical leadership in these areas had been appointed. The Bank looks incredibly weak on that side of its business, and one wonders what their capable and experienced APRA counterparts make of it all.

But to return to this morning’s hearing, when Simon Bridges suggested that the volume of churn might almost be described as “reckless”, Orr’s only response was to suggest “or planned”. As Bridges noted the Bank was losing a lot of senior and experienced people, likely to be replaced with more junior less experienced people, perhaps “people who agree with you”. Bridges went on to comment on the number of people who had already got in touch with him to express concern at what was going on at the Bank. Orr offered no comment in response.

David Seymour also chipped in on this issue asking about turnover at senior levels. The Bank’s response seemed to be a mix of cute answers (people who had confirmed they were leaving shortly were nonetheless still there and so hadn’t left), obfuscation (emphasising how many more staff in total the Bank had – as if that too should not be a concern), and a bit of outright denial. Seymour asked Orr if he was “absolutely confident” that there was nothing about his (Orr’s) leadership that had led to conflicts resulting in departures”. Orr’s reply: “Absolutely”. I don’t suppose he was ever going to own up – the main who really hates being challenged or disagreed with – but it wasn’t a confidence-inspiring performance. And who is responsible for the Governor? Well, that would be the current ineffectual Board – whose chair has been carried over to the new and (legally) more powerful Board, and of course the Minister of Finance.

The Green Party’s Chloe Swarbrick also asked a couple of useful questions, and was simply fobbed off by Orr. Was there anything about the policy response over the last couple of years, she asked, that the Governor might have done differently with the benefit of hindsight? It was, she was told, a hypothetical that he wasn’t going to answer, but he then went on to say that he was “very confident” that “exactly the right decisions had been made”. With the benefit of hindsight, does any normal reflective human being make such bold claims? Well, Orr certainly does ($5bn of losses, as just one example, notwithstanding). Swarbrick went on to ask if there would be value in a review of Covid fiscal and monetary policy (a good idea, and a suggestion I’d also made to Treasury at a consultation session last week). Orr claimed that such reviews were ongoing and very transparent. If so, there is no evidence of it, and when someone reviews themself such reviews are often not received with total conviction.

David Seymour followed up, noting that the Governor had said earlier that house prices were above a “sustainable” level, employment was above the maximum sustainable level, and inflation was high and/or rising. Might it not be thought that the degree of monetary stimulus had been a bit overcooked?

Orr’s blustering response was that it was better than an alternative of extremely high unemployment and deflation, repeating his line that the Bank had been one of the first in the world to raise rates. Seymour pushed back and suggested some possibility of a middle ground – that, with hindsight, a bit less monetary stimulus might have been warranted, but Orr simply refused to engage.

There were no questions about the LSAP scheme ($5bn of losses notwithstanding) but National’s Andrew Bayly again asked about the Funding for Lending scheme. Crisis conditions have long passed, the OCR is working fine, and being raised, and yet the Bank keeps on for another year with the emergency facility that all else equal holds interest rates DOWN. The Assistant Governor burbled on about the need to provide certainty to banks – as if anything else about the economic (or virus) environment is certain. It is simply bizarre that emergency facilities are still providing stimulus, even as core inflation heads for top of the target range.

Not all the questions from non-Labour members was really to the point. As Orr noted, the MPC has to take the fiscal stance as given and adjust the OCR as required (having said that, National could point out that on occasion Orr has been an open cheerleader for bigger fiscal deficits), and National seems unable to decide whether it dislikes high inflation or a higher OCR more. Personally, I’m with the Governor on that one: high inflation needs to be brought back into check, and monetary policy is the most effective instrument. In fact, it was good to hear Assistant Governor Hawkesby explicitly note that inflation expectations had risen and that monetary policy was oriented towards getting inflation back to around the midpoint of the target range.

But two final questions are worth noting. A government member asked a patsy about the Bank’s climate change crusade, prompting National Andrew Bayly to note that the Federal Reserve of New York had recently published research suggested that climate change posed little threat to financial stability (he could have cited recent Bundesbank stress tests as well). Bayly asked if the Bank had done any modelling of its own. Orr’s response was an unequivocal “yes”. That was interesting because a quick check of the Bank’s climate change page showed that still the only “research” they listed was a single paper from 2018 which (“preliminary analysis”) also concluded that there wasn’t likely to be much to the climate change financial stability risk issue. You might have supposed that the Bank would be keen to get out in the public domain any research they’d done supporting the Governor’s ideological priors and political preferences. I have today lodged an OIA request for the modelling work the Governor was referring to this morning. On past form, we might see something six months from now.

And then Chloe Swarbrick got in one last question. You’ll recall that the Governor had told the Committee that in the Bank’s view house prices were currently higher than “sustainable”. All else equal, Swarbrick asked, how much would house prices need to drop to be considered “sustainable”. Orr’s response was “I don’t have that number” (he had what looked like a dozen staff present in support). It seemed an eminently reasonable question. The Bank has the biggest team of macroeconomists in the country, it has in-house research capability and has claimed – not once but many times – that prices are “unsustainable”. The way places like the Bank work is that there will be a range of model estimates informing the judgement that current prices are unsustainable. It wasn’t that Orr didn’t have a number (or, more likely, a range) it was that he simply refused to answer, and did not suggest he would follow up and get back to the member.

A year ago, one might have said (I would have) that it really wasn’t an issue for the Bank. But the Minister changed the Bank’s Remit, and Orr and the MPC have embraced the change. You may, like me, think that they way they approach “sustainable” is meaningless and often misleading (their concept has nothing at all to do with longer-term fundamental supply characteristics) but…….they are the ones openly opining that prices are “unsustainable”. How much then, even as a range? Orr’s refusal to reply really made a mockery of parliamentary scrutiny.

Overall, it was good to see the Bank and the Governor facing some serious questions. 55 minutes for the whole thing, including government patsys, really wasn’t enough in the circumstances, but what we saw was a weak and unpersuasive central bank. The Reserve Bank is a key economic agency in New Zealand, exercising a great deal of discretionary power, and we (and Parliament) should expect a solid team of really capable and experienced senior people, articulating credible and thoughtful nuanced responses to serious questions and challenges. It wasn’t at all what we saw today. But of course, there is little follow through, and no serious questioning on these issues of either the Bank’s Board or the Minister of Finance. Instead we just see the continued degradation of yet another of New Zealand key public sector institutions. I suppose unserious governments – there is little sign they care much about institutions or medium-term economic performance, let alone getting house prices down – invite increasingly unserious bureaucracies, of which today’s Reserve Bank is one. Perhaps Orr will surprise and he’ll soon announce the appointment of a phalanx really strong capable independent-minded senior managers, who last (perhaps outlast him) but nothing about his tenure to date (or the continued churn) should give us – or Parliament- much confidence.

LSAP losses

The Minister of Finance and The Treasury appeared before Parliament’s Finance and Expenditure Committee yesterday. It was encouraging to see National MPs asking questions about the Reserve Bank’s Large Scale Asset Purchase programme, which was undertaken with the agreement of both the Minister and The Treasury and which has now run up staggering losses for the taxpayer.

A standard way of estimating those losses is the mark-to-market valuation of the Bank’s very large LSAP bond portfolio. As of the latest published Reserve Bank balance sheet, for 31 October, those losses were about $5.7 billion. When the 30 November balance sheet is out, probably next week, the total losses will be lower (bond rates fell over November), but with a very large open bond position still on the books taxpayers are exposed to large fluctuations in the value of the position (up or down), with no good basis for supposing that the expected returns are likely to compensate for the risk involved. If there was a case for putting on a large open bond position early last year – I doubt it, but take that as a given for now – there is no case for one now, in a fully-employed economy with rising inflation, and with the conventional instruments of monetary policy – which expose taxpayers to no financial risk – working normally and effectively.

A post from a few weeks ago set out the issues.

I didn’t watch the whole 2 hours (link to the video above) but from exchanges with various people I think I have seen all the questions and answers relevant to the LSAP issues.

First, at about 43 minutes in, National’s Andrew Bayly asked the Minister of Finance (a) why, when Crown indemnity was approved the Minister did not then require a plan for unwinding the position (the Bank is currently talking about having a plan early next year, almost two years on), and (b) why there was no limit to the indemnity.

I’m not sure either question was that well-targeted, and the Minister had no real trouble responding. As he noted, the LSAP programme had been initiated in the middle of a crisis, time was short etc. And although there isn’t a limit on the indemnity itself there is a limit of how many bonds can be bought, and the government determines which bonds are on issue which amounts to much the same thing. That said, both responses take as more or less given that the idea of an LSAP had never occurred to anyone on any corner of the Terrace/Bowen St triangle until late March 2020. We know the Bank had been (rather idly) talking about the option for several years, including saying they’d prefer not to use it, but it seems they had not done the hard ground work, and neither had The Treasury nor the Minister insisted on it, well in advance. There is no sign any cost-benefit analysis for something like the LSAP was ever done, no analysis of likely Sharpe ratios, no analysis of potential peak taxpayer losses and so on. The Bank should be held accountable for that, but…the Minister is primarily responsible for holding them to account, and The Treasury is the Minister’s principal adviser (and the Secretary is a non-voting member of the MPC).

After the Minister left, Bayly returned to the LSAP (at about 68 minutes), supported by National’s new finance spokesman Simon Bridges. Bayly asked the Secretary to the Treasury whether an increase in the OCR would increase the liability for the Crown for the indemnity. The Secretary responded that the indemnity was net neutral from a whole of Crown perspective. What followed was a slightly confused discussion with Bridges ending up suggesting that the Secretary was “plainly wrong”. I don’t think the Secretary answered well, and she certainly didn’t answer in a way designed to help clarify the issues around the LSAP, but she is correct that the indemnity itself does not affect the overall consolidated Crown financial position (the claim the Bank currently has on its balance sheet is fully offset by an obligation the (narrowly defined) central government has on its balance sheet. It is quite likely that without the indemnity the MPC would have been very reluctant to have run a large-scale LSAP programme (the Bank’s own capital would not support the risk), but once the programme was established what determines the financial gains or losses is, in short, just the movement in market interest rates. The indemnity just reallocates any losses within the wider Crown accounts. In that particular exchange, The Treasury made none of this clear, and Secretary herself seemed a bit confused when the discussion got onto the different ways the bond position might eventually be unwound (there is little or no indemnity if the bonds are held to maturity, but that doesn’t mean there are no costs to the taxpayer). And thus (reverting to Bayly’s initial question) an increase in the OCR – particularly one now expected – doesn’t itself change the Reserve Bank’s claim under the indemnity

About 25 minutes further on, Bridges returned to the fray and a rather more enlightening conversation followed. Bridges asked whether the LSAP did not represent a significant increase in Crown financial risk. The Secretary agreed and both she and one of her colleagues explained – as I have here repeatedly – that what had gone on was that the Bank had bought back long-term fixed rate bonds, effectively swapping them for the issuance of settlement cash, on which the interest rate is the (variable) OCR. Unfortunately some of the discussion still got bogged down in matters of Crown accounting (the difference between the purchase price of the bonds and the face value, which is of no economic significance), and the Secretary was very reluctant to allow herself to be pushed into acknowledging that the position of the LSAP portfolio – implemented with her support – is deeply underwater. As a simple matter of analysis, she was never willing to distinguish between the mark-to-market loss to now, and the potential gains, losses, and risks on continuing to hold a large open position from here on. One is a given – now a sunk cost – and conflating the two (in the hope “something will turn up”) obscures any sense of accountability, including for the choices to keep running the position. She and her staff wouldn’t accept that sort of explanation from any other government agency running large financial risks.

Were the position to be liquidated today – as, at least in principle (crisis having passed, economy full-employed) it should be – a large loss for the taxpayer would be realised. At a narrow financial level it is as simple as that. If the position continues to be run – in the limit through to maturity, finally in 2041 – what will matter is where the OCR averages relative to what is currently priced into bond yields, but it won’t change the fact that the portfolio is starting behind – the OCR is already much higher than was expected at the time most of the bonds were bought. And if the portfolio is let continue to run, taxpayers are exposed to ongoing large risk for no expected return (there is no reason to suppose the Bank is better than the market at guessing where the OCR will need to go over the next 10-20 years).

(The current agreement between the Minister and the Bank requires that if the Bank looks to sell the LSAP bonds it do so only to the Treasury itself. Such a sale, of course, changes nothing of economic substance (purely intra-Crown transactions don’t) – the high level of settlement cash balances would still be there, earning whatever OCR the macro situation requires – but from a political perspective it would be convenient, as there would no longer be monthly updates on the Bank’s website as to the extent of the losses caused by the MPC’s rash choices (backed by The Treasury).

Treasury officials did chip in a couple of caveats. First, the Secretary noted that in assessing the overall LSAP programme one had to look also at the (any) macroeconomic benefits. In principle, of course that is correct, but (as I’ve argued previously) any such gains are unlikely to have been large:

  • the LSAP was designed to lower long-term bond rates, but these are a very small element in the New Zealand transmission mechanism,
  • it is hard to see much evidence here or abroad of sustained effects of LSAP-like programmes on long bond rates (eg movements beyond what changing expectations of future OCR adjustments themselves would simply),
  • the Bank always had the option of cutting the OCR further (on their own telling, to zero last year, and lower still since the end of last year), at no financial risk to the taxpayer, and
  • if there is a macro effect, perhaps it was modestly beneficial last year, but must be unhelpful now (recall that the literature suggests it is the stock of bonds that matters, not the flow of purchases, and we now have an overheated economy with above-target inflation.

And one of her deputies chipped in noting that there might have been some savings to The Treasury from having been able to issue so heavily at such low rates last year, the suggestion being that without the LSAP the Crown might not have been able to get away so many bonds so cheaply. There is probably something to that point, in an overall accounting, but (a) the effect is unlikely to have been large relative to the scale of the subsequent rise in bond yields, and (b) especially with hindsight a better model would have been for the Bank not to have been purchasing bonds and the Crown to have been issuing fewer.

The Select Committee discussion ended with the offer that National MPs could lodge a follow-up question for written response by the The Treasury. I hope they avail themselves of that offer.

The Treasury could be, and should be, much clearer and more upfront about the analytics of the LSAP issues, but it isn’t clear – given their involvement all along – that their incentives are in this case that well-aligned with the interests of the public in scrutiny, transparency, and accountability.

$5.7 billion

A few weeks ago I wrote a fairly discursive post on the losses the Reserve Bank had run up on its Large Scale Asset Purchase programme. I know some readers found the basic point a little hard to grasp (no doubt a reflection on my storytelling), so today I’m going to do a very stylised representation of what has gone on.

But first, as I noted in that post, as market interest rates rise losses mount. The Bank has now released its end-October balance sheet and this is the line item representing their claim on the Crown (the Minister of Finance indemnified the Bank for losses incurred).

lsap losses

So the losses have now reached $5.7 billion (roughly 1.6% of annual GDP). Market interest rates fluctuate each day, but as of yesterday’s rate current losses are likely to be very similar to those as at 31 October. Perhaps Covid has inured us to big numbers, but these are really large losses, which were quite avoidable.

Now I want to step you through a very stylised illustration of roughly what has gone on.

A severe shock hits (call it Covid, but it could be anything) and the government determines that it needs to run a large fiscal deficit. Say that (cash) deficit totals $70 billion. The government finances that deficit prudently by issuing (selling) long-term bonds, issuing $70 billion at par, and thus raising $70 billion in cash.

Once the government has borrowed and spent, its bank account balance (at the Reserve Bank) isn’t changed. And after recipients of the deficit spending and purchasers of the government bonds have all made their transactions, the aggregate balances held by banks in their settlement accounts at the Reserve Bank also haven’t changed.

But now assume the Reserve Bank enters the fray, deciding that it will launch a large scale bond purchase programme, in which it buys $50 billion of long-term government bonds (for simplicity, assume the same bonds the government just issued on market). The Bank pays for those bonds by issuing on-call liabilities (settlement cash balances), on which it pays the OCR interest rate.

What does the Crown’s overall debt exposure look like under those two stages?

Financing the fiscal deficit

Floating rate debt held by the private sector (settlement cash) $0

Long-term government bonds held by private sector $70bn

Add in the effect of the LSAP

Floating rate debt held by the private sector (settlement cash) $50bn

Long-term government bonds held by the private sector $20bn

The total amount owed by the Crown (government plus Reserve Bank) is $70 billion in both cases, but the risk to the Crown is substantially different.

The emergency having finished (by assumption in this stylised example), the Reserve Bank now has two choices. It can hold the bonds it purchased to maturity or it can sell them back to the market. One choices closes out the risky position they chose (rightly or wrongly) to run during the emergency, while the other leaves it running (for years).

Now assume that market interest rates rise sharply, across the curve (so long-term bond yields rise but so – perhaps gradually – does the OCR itself.

When market interest rates rise, the market value of a portfolio of long-term bonds falls. That is what has happened in New Zealand over the last year or so, reflected (in respect of the LSAP portfolio) in the chart at the start of this post.

If the bonds were sold back to the market, the Reserve Bank (and Crown as a whole) would realise less on the sale than they paid for the bonds. On present rates, a lot less. Selling the bonds back to the market would, however, restore the balance sheets as under the “Financing the fiscal deficit” scenario above. The private sector would hold no floating rate government debt (settlement cash) but lots of long-term bonds. All the risk would be with the private sector, although the Crown would have crystallised the large loss it let the Reserve Bank run up.

But what if, instead, the Reserve Bank just stuck the bonds in the bottom drawer and held them to maturity (last maturities not for 20 years)? The bonds would mature at par, and there might be little or no claim under the indemnity (depends on the initial purchase price relative to the face value). But, if things play out as current market prices envisage, the OCR would rise by quite a lot and (on average) stay much higher over the remaining life of the portfolio. Since the Bank is still holding the bonds, settlement cash would also stay high, and the Bank pays the full OCR on all settlement cash balances. Under that scenario, the Reserve Bank – having issued lots of floating rate debt, and having no matching floating rate asset – will be up for much higher interest costs.

Either way, the Crown (the taxpayer) has lost a great deal of money. If market rates play out as the yield curve currently predicts, either there will be a large payout under the indemnity, or the Reserve Bank’s future dividends to the Crown will be reduced. But the loss has already happened, it is just a matter of how it ends up being recorded/realised. $5.7 billion dollars of it. The Crown could probably have funded quite a few ICU beds for quite a few years with that sort of money…..but it has gone.

You’ll notice that I bolded some words in the previous paragraph. Even if the best estimate of future short-term rates is something like what the market currently prices, that is a very weak standard, and it is exceptionally unlike that actual short-term rates will follow exactly that path. They could be lower, but they could be higher (perhaps quite a bit higher or lower).

If the Reserve Bank sold the bonds it holds back to the market we (taxpayers) wouldn’t need to worry. The overall Crown would be back to having funded itself with long-term debt, and fluctuations in rates wouldn’t affect us (at least unless/until the bonds need rolling over years down the track).

But if the Reserve Bank keeps the bonds, we (taxpayers) keep the risk. Having had them drop $5.7 billion of our money so far, they keep the position open. From here, they could make us a bit of money, or they could lose a bit of money (well, actually “a lot” in either direction). But there is no obvious reason to have some bureaucrats speculating on bond markets – because that is what the LSAP portfolio now purely is – at our risk. It isn’t even as if these people – the MPC – have some demonstrated track record of generating attractive Sharpe ratios (returns relative to risk) for their punts. And if as individuals we do want to take punts, the market already has products for us.

Perhaps the key point here is that the $5.7 billion has already gone – that is what mark-to-market accounting measures – but the risk remains. From here we could lose another (say) $5.7 billion, or make a great deal of money, but there seems to be no effective accountability, for activities which – at this point, well beyond the crisis – is simply not a natural business of government. Monetary policy in a floating exchange rate system like ours normally involves next to no financial risk to the taxpayer.

Are there caveats to all this, or alternative approaches?

One possibility is that the government chooses to neutralise the risk the Reserve Bank continues to run. They could do that relatively easily, by issuing new bonds on market with the same maturity dates as those the Bank holds. All else equal that would eliminate the future floating rate exposure. They could probably do something similar (but hedging less effectively) with interest rate swaps. But it doesn’t seem terribly likely, or terribly sensible (including because it would simply further inflate balance sheets).

Since this is an entirely stylised exercise, I’ve been able to dwell in the simplified air of “sell” or hold”, as if “sell” was akin to selling a single excess car or house. But the Bank has more than $50 billion in bonds and it would not make sense to offload them all at once (doing so would be likely to push the price unnecessarily against the Bank/Crown). So when I say “sell” what I really have in mind is a steady pre-announced programme that would unwind the entire portfolio over 1-2 years. That means assuming quite a lot of risk in the menatime, but unfortunately that is the hole Orr and his colleagues dug for us.

Observant readers will have noticed that so far I’ve not mentioned at all any macroeconomic effects of the LSAP programme. The LSAP was launched with the intention of having stimulatory macroeconomic effects. I’ve always been sceptical there was much to the story, especially in the New Zealand context. The proceeds of the bond purchases were fully sterilised (that is what paying the OCR on all balances does), short-term rates were held low by (a) the OCR itself, and (b) some mix of RB statements and market expectations about the economic/inflation outlook, and long-term rates just don’t matter much to the transmission mechanism in New Zealand. But remember that the LSAP was explicitly sold as a substitute for the Bank last year not having been able (so it said) to take the OCR negative. It is now quite clear – even if it wasn’t at the time – that any such need had dissipated by this time last year. This year, inflation and unemployment have been overshooting and the OCR has begun to be raised. So even if you think – with the Bank – that the LSAP had a useful macroeconomic effect, any useful bits must have been concentrated in a few months last year. And it simply isn’t credible that any such gains were as large as the 1.6 per cent of GDP of our money that the Bank has….. lost. (Note that the literature on LSAPs suggests that any beneficial effects come from the stock of bonds hold not the flow of purchases, but the Reserve Bank continued its purchase programme well after it was clear the OCR itself could take any slack and now – when looking to tighten conditions – refuses to reduce risk to the taxpayer by making a start on reducing the Bank’s bond holdings.)

And all this from a weak and not very transparent, or accountable, institution. As per yesterday’s post, two of those responsible – MPC members – are moving on, and the Minister has to make various new appointments shortly. One of those most responsible – the MPC member responsible for monetary policy and financial markets – has just been given a big promotion. But none of them – internal, external, Governor or more specialist expert – has given any sort of adequate accounting for the public money they have lost.

(Where does the Minister himself fit into all this? I’m not particularly sympathetic to Robertson, who seems the epitome of a minister uninterested in holding anyone to account, but realistically on the dawn of a crisis, no Minister of Finance was likely to have turned down the Bank’s request for an indemnity, at least if The Treasury was onside with the Bank. No, the substantive blame here rests first and foremost with the Governor, the MPC, secondarily with the Bank’s Board and the Secretary to the Treasury, and only then with the Minister of Finance. But it is the Minister who is accountable to Parliament and the public, and who had failed to ensure that the Reserve Bank was fit for purpose (people, preparedness) going into a crisis like Covid.)

UPDATE: For those who have pointed out, or noticed, that I did not discuss here issues around actual settlement account balances over the last 20 months (or developments in the Crown account), they are discussed in the earlier post linked to above.

Housing

I hadn’t paid much attention to the renewed wave of restrictive regulation of the housing finance market being imposed by the Governor of the Reserve Bank this year, but a journalist rang yesterday to talk about the latest proposal which prompted me to download and read the “consultative document” the Bank released last Friday.

Why the quote marks? Because quite evidently this is not about consultation at all, simply trying to do the bare minimum to jump through the legal hoops to allow the Governor to do whatever he wants. The document was released on Friday 3 September. The consultation period is a mere two weeks, which is bad enough. But then they tell people who might be inclined to submit that ‘we expect to release our final decision in late September’ – at most nine working days after submissions close – with the new rules to come into effect from 1 October. And if you were still in any doubt there is that line they love to use: “we expect banks to comply with the spirit of the new restrictions immediately”.

WIth that sort of urgency and disregard for any serious bow in the direction of consultation and reflection, you’d have to assume the Bank had a compelling case for urgent action, such that (for example) a delay of even as much as a month would pose an unendurable threat to the soundness and efficiency of the financial system (still the statutory purposes these regulatory powers are supposed to be exercised for). And since the Bank is quite open about the fact that the new restrictions will impede the efficiency of the system, you’d expect an overwhelming case for a soundness threat, complete with a careful analysis indicating that these new controls – directly affecting huge numbers of ordinary people – were the best, least inefficient, response.

But there is nothing of the sort. Instead they are actually at pains to stress that the financial system is sound at present, so the worry is about what might happen if things went on as they are. But that can’t possibly be an issue that rides on a one month, it must be something about several more years.

But even then their case amounts to very little. For example, they point that if house prices were to fall 20 per cent from current levels some $4 billion of lending would be to borrowers who would then have negative equity, But that is hardly news. The typical first-home buyer has always – at least in liberal financial systems – borrowed at least 80 per cent of the value of the home they are purchasing. It is usually sensible and rational for them to do so (indeed 90 per cent would often be sensible and prudent). So a fall of 20 per cent in house prices would always put a lot of recent borrowers into a negative equity position. Note, however, that (a) $4 billion is not much over 1 per cent of total housing lending, and (b) it is $4 billion of loans, not $4 billion of negative equity. If I borrowed 82 per cent of the value of the house, the house fell in value 20 per cent, and I lost my job and had to sell up, the loss to the bank might be not much more than 2 per cent of the loan.

More generally, in the entire document there appears to be not a single mention of the capital position of banks operating in New Zealand, or the Reserve Bank’s capital requirements. You might recall that New Zealand banks have some of the highest effective capital ratios anywhere in the advanced world, and that the Bank is putting in place a steady increase in those capital requirements. Moreover, if you read the Bank’s document – at least as a lay reader – you might miss entirely the point that the capital rules, and the internal models banks use, require more dollars of capital for higher risk loans than for lower risk loans. It is how the system is supposed to work. There are big buffers, those buffers are getting bigger (as per cent of risk-weighted assets), and the dollar amount of capital required rises automatically if banks are doing more higher-risk lending.

Of course, the Bank says a significant fall in house prices is more likely now. But we’ve heard that sort of line from every Reserve Bank Governor at one time or another over 30 years now. As it happens – and for what little it is worth – I happen to think house prices may be more likely to fall than to rise further over the next 12-18 months (even put a number consistent with that in the Roy Morgan survey when their pollster rang a few days ago), but I don’t back my hunch by using arbitrary regulatory restrictions that – on their own telling – will force many first home buyers back out of the market.

And it might all be more compelling if the Bank showed any sign of understanding the housing market. Thus, we are told (more or less correctly) that immigration is currently low (really negative) and lots of houses are being built. But, amazingly after all these years, there appears to be no substantive discussion of the land-use regulations and the land market more generally. Perhaps there will be something of a temporary “glut” in dwelling numbers – at current prices – but unless far-reaching changes are made to land-use rules that won’t change the basic regulatory underpinning for land prices. We know the government’s RMA reforms aren’t likely to help – may even worsen the situation – including because if these were credible reforms, the effect would be showing through in land prices now. And we know from the PM and Minister of Finance – and possibly the National Party too – that they don’t even want to do reforms that would materially lower house/land prices.

It all just has the feel of more action for action’s sake. Perhaps the government isn’t too keen on first-home buyers being squeezed out, but at least when they are criticised for not fixing the dysfunctional over-regulated housing/land market they can wave their hands and talk about all the things they and their agencies do, however ineffectual. As even the Bank notes, LVR restrictions don’t make much difference to prices for long. And if there is a compelling financial stability case, it isn’t made in this document – which, again, offers nothing remotely resembling a cost-benefit analysis for respondents to address. This despite bold – totally unsubstantiated – claims in the paper that their new controls would be beneficial for “medium-term economic performance”.

Then again, why would they bother with serious analysis when the whole thing is a faux-consultation anyway.

At which point in this post, I’m going to turn on a dime and come to the defence of both the Bank and the government. A couple of weeks ago the Listener magazine ran an impassioned piece by Arthur Grimes arguing that the amendment to the Reserve Bank Act in 2018 was a – perhaps even “the” – main factor in what had gone crazily wrong with house prices in the last few years. Conveniently, the article is now available on the Herald website where it sits under the heading “Government has caused housing crisis to become a catastrophe”.

Grimes was closely involved in the design of the 1989 Reserve Bank Act, and for a couple of years in the early 1990s was the Bank’s chief economist (and my boss). He left the Bank for some mix of private sector, research, and academic employment, but also spent some years on the Reserve Bank’s board – the largely toothless monitoring body that spent decades mostly providing cover for whoever was Governor. These days he is a professor of “wellbeing and public policy” at Victoria University.

However, whatever his credentials, his argument simply does not stack up, and given some of the valuable work he has done in the past, on land prices, it is remarkable that he is even making it.

There is quite a bit in the first half of the article that I totally agree with. High house prices are a public policy disaster and one which hurts most severely those at the bottom of the economic ladder, the young, the poor, the outsiders (including, disproportionately, Maori and Pacific populations). But then we get a story that house prices have been the outcome of the interaction between high net migration and housebuilding. As Arthur notes, immigration has hardly been a factor in the last 18 months (actually it has been negative, even if the SNZ 12/16 model has not yet caught up) and there has been quite a lot of housebuilding going on.

And yet in the entire article there is nothing – not a word – about the continuing pervasive land use restrictions (and only passing mention about the past). If new land on the fringes of our cities – often with very limited value in alternative uses – cannot easily be brought into development (if owners of such land are not competing with each other to be able to do so) there is no reason to suppose that even a temporary surge in building activity will make much difference to a sustainable price for house+land. Instead, any boost to demand will still just flow into higher prices.

Remarkably, in discussing the events of the last year there is also no mention of fiscal policy – the boost to demand that stems from a shift from a balanced budget just prior to Covid to one that, on Treasury’s own numbers, is a very large structural deficit this year.

Instead, on the Grimes telling the problem is a reversion to “Muldoonism” – not, note, the fiscal deficits, but the amendment to the statutory goal for the Reserve Bank’s monetary policy enacted almost three years ago now. Recall the new wording

The Bank, acting through the MPC, has the function of formulating a monetary policy directed to the economic objectives of—

(a) achieving and maintaining stability in the general level of prices over the medium term; and

(b) supporting maximum sustainable employment.

The main change being the addition of b).

Grimes has been staunchly opposed to that amendment from the start, but his assertion that it makes much difference to anything has never really stood up to close scrutiny. It has long had more of a sense about it of being aggrieved that a formulation he had been closely associated with had been changed.

He has never (at least that I’ve seen) engaged with (a) the Governor’s claim (which rings true to me) that the changed mandate had made no difference to how the Bank had set monetary policy during the Covid period, (b) the more generalised proposition (that the Governor is drawing on) that in the face of demand shocks a pure price stability mandate (and the RB’s was never pure) and an employment objective (or constraint) prompt exactly the same sort of policy response, or (c) the extent to which the New Zealand statutory goals remains (i) cleaner than those of many other advanced countries and yet (ii) substantially similar (as the respective central banks describe what they are doing) to the models in, notably, the United States and Australia. Similarly, he never engages with the straight inflation forecasts the Bank was publishing this time last year: if they believed those numbers, the purest of simple inflation targeting central banks would have been doing just what the RB did (and arguably more, given that the forecasts remained at/below the bottom of the target range for a protracted period).

Grimes seems to be running a line that the LSAP was the problem

The central culprit has been monetary policy that has flooded the economy with liquidity. This liquidity in turn has found its way into the housing market.

But there is just no credible story or data that backs up those claims. Banks simply weren’t (and aren’t) constrained by “liquidity”. The LSAP was financially risky performative display, but it made no material difference to any macro outcomes that matter, including house prices.

There is quite a lot of this sort of stuff.

Grimes ends on a better note, lamenting the refusal of governments – past and present – to contemplate substantially lower house prices, let alone take the steps that would bring them about (his final line “And no politician seems to care enough to do anything about it” is one I totally endorse). But in trying to argue a case that a change to the Reserve Bank Act – that had no impact on anything discernible as it went through Parliament or in its first year on the books – somehow explains our house price outcomes (especially in a world where many similar price rises are occurring, and where there was no change in central bank legislation), seems unsupported, and ends up largely serving the interests of the government, by distracting attention from the thing – land use deregulation – that really would make a marked difference and which the government absolutely refuses to do anything much about.

Funding for lending and other myths

There is a huge number of stories around at present on various aspects of monetary policy and the (successive) governments-made housing market disaster (the two being, in fundamentals, quite unrelated). Were I in fine full health and energy I’d no doubt be writing about many of them. Instead, I’m going to focus here just on the controversy around the Reserve Bank’s so-called Funding for Lending programme, the details of which were announced last week.

It isn’t always inviting to defend the Reserve Bank, since they are often (as here) their own worst enemy, but on the essence of the FLP programme I’m mostly going to. That doesn’t mean I think it is a particularly good scheme – there is a perfectly straightforward way to lower interest rates (the OCR), which influences the exchange rate as well, that they simply refuse to use. And they have named the scheme in a way that actively misleads and invites misunderstanding from those who haven’t thought hard about monetary systems.

All the FLP programme really is is a scheme to lower interest rates a bit more without changing the OCR. That isn’t just my take; that is the official Reserve Bank view. Here is the graphic from the MPS last week as to how they think the thing works

FLP 2

Even that is a bit inaccurate since – as the Governor explicitly noted in his press conference the other day – the expectation that the Bank will be willing to offer funds (not a dollar has yet been transacted) has already done the job. Retail deposit interest rates have fallen relative to the OCR.

But you will note that nothing in that graphic talks about a channel in which additional funds are now available in ways that enable banks to lend in ways, at rates ($m), they couldn’t otherwise.

There are at least two good reasons for that.

The first is that banks are simply not funding constrained. In fact, they are awash with central bank provided funding/liquidity: total settlement cash balances that were about $7bn pre-Covid are now about $24bn. If lending is not occurring at present to the sort of borrowers that some politicians or commentators might prefer – and you have to wonder what such private transactions have to do with them – it isn’t because banks are facing some sort of funding constraint (actual or prospective – there is no uncertainty that adequate funding will be available, including because the Reserve Bank’s core funding requirements – on precise types of funding – have been markedly relaxed for the duration). The Governor made basically that point in his press conference the other day: if not much new business lending is happening at present that is most likely because there is considerable (much larger than usual) economic uncertainty – not anyone’s fault, not anything that can quickly be allayed. That uncertainty affects both prospective lenders and prospective borrowers. Market reports – and the RB credit conditions survey – indicate that banks have tightened their effective credit standards, which is surely what one would expect – probably even hope for, from prudent bankers – in such a climate. There will always be chancers, keen to borrow, but in such a climate banks should probably be particularly cautious about potential business borrowers without strong collateral who are particularly keen to borrow.

So at a system level (and we have no reason to suppose it is different at an individual bank level), settlement cash – which is what the Bank is willing to supply – simply isn’t a constraint on lending. (It wasn’t really even in the 2008/09 recession here, although then New Zealand banks and their parents had reasonable concerns about ongoing access to specific classes of desirable funding.)

As importantly, at an aggregate level any Funding for Lending programme lending does not replace other funding/deposits. In the normal course of bank business in a floating exchange rate economy, and for the system as a whole, deposits arise simultaneously with lending. All bank lending either results in a reduction in someone else’s loan or adds to deposits. That is true within the banking system as a whole, although not for any individual bank (if Bank A increases lending particularly aggressively most of the new deposits may end up at other banks in the system). Any Funding for Lending loans to banks add to their liabilities, but they (collectively) don’t need those liabilities to increase lending. What FFL loans will do, in direct balance sheet terms, is to increase bank borrowing from the Reserve Bank, and increase bank lending to the Reserve Bank (settlement cash balances). And that is it. All the other deposits will still be there.

Now this isn’t to suggest that the FFL scheme is futile. It is not. As the Reserve Bank notes, it is a way of lowering interest rates a bit more. And that is really all. It does that partly through signalling effects and partly (ultimately) because each individual knows it can compete a bit less aggressively in the term deposit market and still be sure (individually) of having ample funds. If all banks respond similarly, there won’t be systematic drains from any of them. And there won’t be much need for many actual FFL loans to occur at all. Time will tell whether the scheme is much used, but if it isn’t that is almost a bonus: it worked (lowering term deposit interest rates relative to the OCR) by the Bank’s willingness to provide, without needing actually to provide much at all.

From banks’ perspectives they’d probably prefer (at least in aggregate) not to use FFL much at all. After all, they borrow at the OCR and then the additional settlement cash (in aggregate) just earns them the OCR, and in the process they just blow up their balance sheets a bit more. But they probably like the option value of knowing the Bank is willing to lend at the OCR – which happens to be roughly where short-term interest rates are.

Which is a (perhaps longwinded) way of saying that the controversy over whether the Bank should have tied these loans to “productive lending” – a weird notion in itself, but that is a topic for another day – is strange and largely empty. I suppose the Bank could have insisted it would only lend under FFL to the extent banks increased their business lending, but had they done so there would have been a very real prospect that the mechanism would not have worked at all. As noted above, banks are not funding constrained and – as almost everyone seems to agree, with the possible exception of Andrew Bayly – to the extent business lending is not growing (it doesn’t usually in recessions), it has little or nothing to do with availability of funding. The scheme is designed to lower interest rates, and seems to have done that. Tying eligibility to particular types of lending – that just aren’t attractive at present, to most borrowers or lenders – would have markedly reduced the effectiveness of the tool, with no gains for the actual lending the politicians purport to champion. That, in turn, would have been a recipe for deepening and lengthening, a bit more than necessary, the recession. Some seem not to mind that, but one would have hoped that neither the government (which made employment an explicit focus for the Bank) nor a responsible Opposition would want that.

But to repeat, the Reserve Bank are supposed to be experts in this stuff, and yet they directly contributed to the problem by so egregiously mislabelling the scheme, in a way that led laypeople to think that somehow “funding” was the constraint on lending (or that up to $28 billion would be pouring into new lending, when in fact the simple availability of new settlement cash will probably no difference whatever to the stock of loans on bank balance sheets). Had they called it a supplementary short-term interest rate management tool it would have been more accurate – but I guess would have sounded less glamorous at the time.

Finally, note that unlike the LSAP programme, the FFL does not involve any material financial risk to the Crown or the Bank, so there was no need for a Crown indemnity. Any FFL loans are fully-collateralised on highly-rated securities, and the Bank’s haircut requirements are usually quite demanding, and all the loans are on floating rate terms (the OCR, as it potentially changes), matching the floating rate liability the Bank will also be assuming (the additional settlement cash balances).

Housing, the Reserve Bank, and interest rates

Last week it was reported that the Reserve Bank’s chief economist Yuong Ha had told assembled journalists (at a media briefing on the Bank’s proposed new tools – all while they refuse to use the core one they already have) that

“The worse situation we’d face right now is actually if we had house prices falling.

Ha isn’t just any official. He is one of the four internal members of the Reserve Bank’s Monetary Policy Committee. He was appointed as chief economist by the Governor, but serves on the statutory MPC with the endorsement of the Bank’s Board (themselves appointed by the Minister of Finance) and of the Minister of Finance himself. His department delivers the forecasting and analysis that typically guides the rest of the MPC in their deliberations. In principle at least, he wields quite some clout.

In practice, there is reason to doubt just how much influence he has. He was appointed 18 months ago (somewhat to the surprise of many observers, and perhaps with more emphasis on his service as an Orr-lackey, including around the generation of Orr’s tree-god rhetoric, than for any particular analytical or policy depth). And in that time he appears to have given not a single on-the-record speech – this in the Orr administration that claims to be more pro-active in its external communications and speaking – or paper. It is a striking contrast to, say, the Reserve Bank of Australia or the Bank of England. And it is not as if management has held back to allow the external members of the new MPC to shine: they’ve either been unwilling to, or been forbidden from, speaking at all. And all this through turbulent and uncertain economic times.

But the Bank obviously feels they have to wheel Ha out from time to time so he gets to do the odd interview and the like. Some of them have been quite odd, and all too often reading Ha’s remarks one gets the sense that he just hasn’t really adjusted to operating in the major leagues (he’d had almost no external profile or media experience prior to taking up this job), and that many of his comments probably leave his colleagues wincing just a bit. From a senior statutory officeholder the Bank – and more importantly the country – deserves better. If they were doing their jobs, the Board and the Minister would insist on it.

As just one example, earlier in the year – mid-March actually – we saw this in the Herald reporting comments in a panel discussion Ha had participated in, and casting doubt on just how much difference asset purchase programmes might make.

yuong ha

As it happens, I think he was right then. In fact, he was running the fairly standard line the Bank had run for some time. It is just that within a few days there was going to be volte face and suddenly the Bank would be claiming that large scale asset purchases were making huge amounts of useful difference.

There was also this little snippet I’d forgotten until I went looking for the quote above.

ha apr 20

Perhaps there really is/was a good reason for the Bank’s ongoing resistance to any serious transparency, but that certainly isn’t a compelling argument.

I’m not going to try to track down all the quotes I’ve seen this year – and no doubt some have been perfectly reasonable articulations of the (poor) policy Ha is a consenting party to.

But I suspect that the most charitable interpretation of last week’s comments is that it was just another such mis-step. That Ha had simply never taken a moment to reflect on how what he was about to say would sound – most particularly in the last days of an election campaign. Or lifted his perspective from some equation in which these dubious “wealth effects” might have shown up. There was a – highly arguable – narrow point that he might have made, but instead he ranged expansive appearing the welcome New Zealand’s iniquitous house prices as somehow “a good thing”. (And, contrary to at least one commenter I saw, I don’t suppose it had anything to do with the personal financial positions of Ha or any other members of the MPC – very comfortable as they all no doubt are.)

Here is the fuller quote from the interest.co.nz article

ha quote on housing

There is a quite confused mix of things going on in those comments. On the one hand suggesting that higher house prices are “a good thing” in terms of supporting demand at present (a monetary policy commentary) and then shifting into financial stability matters for which Ha has little or no responsibility. And it is here that he suggests that falling house prices at present – any falls apparently – would represent a worrying (“worse”) situation from a financial stability perspective. But the subsequent comments are then all over the place. Clearly journalists pushed back and suggested that modest falls in house prices are hardly likely to jeopardise the stability of the financial system – as indeed the repeated Reserve Bank stress tests show – and so then Ha is left floundering, falling back on “wealth effects” again, suggesting – at least by implication – that these could threaten the financial system. It was all just very badly done (on the assumption that his remarks are fairly reported in context). And he ended up simply feeding the narrative that somehow the New Zealand economy is a house-of-cards reliant on house prices staying high, or rising, indefinitely, and that the Reserve Bank is somehow party to this conspiracy against the nation’s young and poor. And comes across as backing the reluctance of our political party leaders to do anything that might lower house prices.

I don’t really believe it is the institutional view. If I’m not a great fan of the Governor I have heard him do much better on this issue (and have even used those remarks to defend the Bank on occasion). He’s pointed out the falling house prices only pose a serious systematic threat when (a) house prices have fallen a long way, and (b) when the unemployment rate goes very high and stays high for some considerable time. That is the consistent result of the Bank’s stress tests, including those done in the last three months. One could easily add that whether one approved or not of the Bank’s LVR restrictions – I didn’t and don’t – they did have the effect that few people buying a house since 2013 will have had a deposit less than 20 per cent, and prices have mostly risen quite a bit since then. That is really quite a large buffer (ie if house prices fall even 15 per cent – a bit more than they fell in the 2008/09 recession – very few people are going to have any modest negative equity.

And I’ve heard the Governor better articulate even the wealth effect (dubious) story, to be rather clearer that the Bank has no vested interest in high or rising house prices, but that one way monetary policy can work – all else equal – is by affecting asset prices. What, of course, no one at the Bank points out is that in 2008/09 real house prices fell by 15 per cent – and took five years to get back to previous peaks – even as the Bank cut the OCR by 575 basis points). There is nothing necessary about cuts to the OCR – in recessions – driving up house prices, as for example we also saw after 1987/88 and in the late 90s. Why is that so? Because recessions typically involve income loss, heightened uncertainty, and some tightening in lending standards. (What has made the last few months a bit different? Massive income replacement in the near-term, and the removal of the LVR restrictions – temporarily ending financial repression will tend to have the sorts of effects we’ve seen.)

For myself, I remain very sceptical of the idea of any material housing wealth effect at all. The Bank has been running this line for the last 15 or so years – really since the 00s boom got into full swing – but its case has never been very persuasive, and it remains a story one hears much more vocally from our central bank than from others operating in countries with high/rising house prices. My scepticism on this count is now of long standing, and has both a conceptual and empirical strand. At a conceptual level, higher house prices do not represent greater wealth for the population as a whole (that makes them quite different from, notably, higher stock market valuations, especially those resting on business innovations and rising profit opportunities etc). There is, of course, a distributional effect affecting some people (although not generally owner-occupiers, who have a natural position owning one house and wish to consume housing services for the rest of their lives). Those holding rental properties, who can reallocate their portfolio are certainly better off when prices rise (and worse off when they fall). But their gain is exactly offset by losses to the renters, and to those in a demographic wanting to shift into home ownership.

Ha himself was asked about part of this

Asked whether there was a point at which high house prices would actually have an inverse effect – IE leave people, especially renters, with less cash to spend on stimulating the economy, Ha said this was something the RBNZ was constantly monitoring.

But it doesn’t suggest they have done any serious work on this hardly-new issue.

That it isn’t new is documented, no doubt inter alia, in this article published in the Reserve Bank Bulletin as long ago as 2011 (of which I was editor and co-author). It was mostly an article about understanding consumption behaviour in aggregate, and the abstract read as follows (emphasis added)

Household spending is typically the largest component of economy activity. This article sets out some ways of thinking about what shapes household consumption decisions and looks at New Zealand’s experience over the last decade or so – a period marked by rapid growth in asset prices and debt, and by big swings in economic performance. Large unexpected, but sustained, shifts in incomes appear to have been the biggest influence on total household consumption. Fiscal policy also appears to have played a role. It is less clear that the large increases in asset prices played a substantial role in influencing total household spending.

Among the many points traversed was this chart

housing and C

If you think there is nothing very interesting to it, that is sort of the point. Private consumption – even consumption ex housing – as a share of GNI showed no consistent trends or even cycles over (then) 20 years, and nothing to even hint at any sort of material economywide wealth effect, even as real house prices had risen enormously.

And this chart is from a followup discussion note I did a year later, showing the sharp increase in housing “wealth” over the decades.

housing and c 2

Some individuals will have felt wealthier. Some will have been wealthy. But many others will have felt or been poorer. In aggregate – as you’d expect , since we don’t export houses to any considerable degree – not much sign of any material economywide effect. I’ve seen nothing to suggest things have been different in the wake of the rise in house prices of the last decade. It is very hard to unpick what is causing what in a business cycle – and so house prices are often rising when the economy is growing quite strongly, both influenced by similar third and fourth and fifth factors. But as I noted almost a decade ago

If one looked at NZ consumption and savings data for the last decade unaware that there had been a house price and credit boom, one would not immediately think there was anything unusual to explain.

More generally, the Reserve Bank needs to find better, and consistent across their people and across time, ways of communicating that it is not responsible for house prices and it does not, or should not, have a view on where house prices should go (up, down, sideways). As a bank regulator, the Bank has a responsibility to ensure that banks are adequately placed to cope with sharp falls in house prices, especially those accompanied by sharp sustained rises in unemployment (which one would not expect to be the case if land use was substantially liberalised). The Bank appears to have done that – perhaps overdone it with the new capital, requirements. Beyond that, house prices are just one of those thing they may need to factor into their forecasts (of which there are many), not something it should be opining about the merits of. And while I would never encourage them to weigh in, given the Governor’s politicised remarks on all manner of other policy issues, if they are going to weigh in you might hope it was on the side of more affordable house prices and better opportunities for the young and the poor.

Finally – and this post has gone on quite long enough – you’ll have noticed the story yesterday that Heartland Bank is now offering a mortgage product at (just) less than a 2 per cent interest rate. From a housing affordability perspective this should have been a cause for muted celebration. Instead, we get headlines about driving prices to even more unaffordable levels.

The (real) cost of housing really should now be at an all-time low. The cost of using a house (rent, actual or imputed) is the cost of using a long-lived assets. With very low interest rates, the alternative returns from other assets should be expected to be very low, driving real rents down. Lower interest rates also slightly lower the cost of bringing new houses to market – holding costs of land, financing costs during the construction phase etc. And the cost of building materials themselves shouldn’t be materially affected by interest rates (and lows in interest rates are often reached in very low-inflation environments). Ah, but I hear you say, what about land, which is after all in fixed supply. But even there two things weigh against a very substantial effect. First, sustained low interest rates are often associated with low productivity growth (few investment opportunities) and that may be a true of rural land as anything else. But second, and more important, it is only the unimproved value of the land under a house (actual or potential) that should be affected by interest rates, and – in a liberal land market – that unimproved land value will be a relatively small part of the overall price of a house+land. That, of course, is not the way it is in modern New Zealand, but that has nothing whatever to do with the Reserve Bank or monetary policy, but with successive waves of central and local governments that make land – abundant in New Zealand – artificially scarce for housing purposes.

And a few days out from an election we, of course, don’t hear a single significant political party either pointing this out, or promising to make a real and substantial difference.

Having the Governor’s back

When the Reserve Bank Act was passed back in 1989, decision-making power was taken away from the Bank’s Board and given to the Governor (even as, overall, the Bank gained a greater degree of autonomy). The Board was retained but in a quite different sort of role. Their new role was primarily to hold the Governor to account, on behalf of the Minister and the general public. Later reforms were made to try to strengthen (the appearance of?) that role: somewhat belatedly the Governor was to no longer chair the Board (although he remained a member of a board whose primary role was to hold him to account), and the Board was required by statute to publish an Annual Report. More recently still – in a well-overdue move – the current government amended the Act to provide that the Minister of Finance would in future appoint the Board chair, making it clearer who the Board was responsible to.

Over the years, the powers of the Bank and the range of activities it undertakes has also grown, and the policy discretion exercised by the Bank has grown well beyond what was orginally envisaged. And latterly most of the formal monetary policy powers have been handed over to a statutory Monetary Policy Committee, and the Board is now also responsible for holding them to account.

But through all these changes, one thing has been constant: the Board has never really acted to hold the Governor to account at all, and instead the Board – through numerous waves of different members and different chairs – seems to have acted as if its primary role was to have the Governor’s back, and reinforce the gubernatorial spin. (In previous posts I’ve argued that in some respects this was always likely, since (a) the Board had no independent resources (eg for external advice), (b) the Governor remained a member, (c) the secretary to the Board was for a long time a member of the Bank’s own senior management, and (d) there were no real incentives to rock the boat.)

There seems to have been a belated general acceptance that the Board is useless, and not readily able to be fixed, in its current role. In fact, the government has introduced legislation which will, if passed, scrap the current model and give the Board primary decisionmaking responsibility for most of the Bank’s non-monetary policy functions (it is a hodge-podge model, itself not likely to work that well, but that is a post for another day).

The Bank’s latest Annual Report was released last week. It didn’t get attention. The Board’s Annual Report got even less (pretty sure it was none). That is hardly surprising. The Board buries its report in the middle of management’s report, and the press release the Governor puts out never mentions that there is an independent report by an entity paid and mandated by Parliament to hold he and his colleagues to account.

As it is, had anyone read the Board’s Annual Report (start on page 6 here), they could only have come to the conclusion that the Board was determined to prove its utter uselessness and ineffectualness in any role other than covering for the Governor. It is spin and/or unquestioning acquiescence, from start to finish.

There is, for example, the nonsense inflation of the Bank’s importance:

We are pleased with the decisive actions that have been taken by the Bank to deal with the potential collapse in economic activity.

75 basis points off the OCR, and whatever lowering of near-term government bond rates the LSAP achieved, simply did not – on any serious reckoning – avert a “potential collapse in economic activity”, and could not conceivably have done so, when the shock to economic activity was primarily about things (fear of virus, policy response to virus) that monetary policy has no affect on.

Remarkably they also claim to be “pleased by the communication and transparency the Bank showed in delivering these innovative tools”.

All while making no mention of, for example, the Governor’s substantive interview last year (in the year under review) expressing a strong preference for a negative OCR as a first cab off the rank, or the public comments of one of his own senior managers in March this year playing down what anyone might reasonable expect from a bond purchase programme. Or the failure to release any research/analysis around the LSAP. Or the failure to release the detailed background papers – promised by the Governor in a speech in March – on the various unconventional instrument options. Or the weird pledge the MPC made in March not to alter the OCR for a year come what May.

And, of course, they make no mention of expressing any concern that despite (a) years of lead time, and (b) the Governor’s explicit preferences expressed last August, it only emerged quite belatedly that it was not until the end of January that the Bank took any steps to discover whether the banking system was operationally ready for a negative OCR (perhaps that is because, as they note, “well before Covid-19, we were briefed on the Bank’s preparations”, and presumably none of them asked the question either).

There is no suggestion of any unease around the policy/communications inconsistency from the MPC in the middle of last year (they could perhaps have explained it away as teething issues with the new MPC, but they seem resolutely determined to utter no cautions on anything at all sensitive).

The Board was quite as determined, it appears, to have the Governor’s back when it comes to financial stability as well. They are firmly behind the big increase in capital requirements and seem quite unbothered about concerns and questions raised, and (if anything) even less bothered about the abusive style adopted by the Governor on many occasions during the course of the consultation. Reflecting the Bank’s own lines, the Board both championed the much higher capital requirements – which had not come into effect and made little or no difference to capital levels by the end of last year – and repeat the Bank’s spin about how sound the system is/was in the face of the (large) Covid shock at the old capital levels. Taxpayers’ money is wasted on this.

Lest you thought that they never uttered a challenging word – to encourage or discourage – there is in fact one quiet dissent in the report, although presumably only allowed to get this far because the Governor himself was on board. We learn that

Policy work on the Deposit Takers Act is highly complex and significant for the Bank’s operations; the Board has expressed concern that the policy development process should be thorough and not rushed.

And that is it – and even then a comment on something not largely under the Bank’s control (Treasury and the Minister having a large say).

For the rest of the report, it is just gush. Perhaps the Board is less than enraptured with the Governor’s climate change ambitions – they just get passing mention – but they are all-in with the Maori strategy; this in an institution that operates at a wholesale, not primarily individual-member of the public facing, level:

The Board believes the incorporation of Te Ao Maori into the Bank’s work will help develop a central bank with a distinctive New Zealand approach and character.

Tree god myths and other pandering, but with not a shred of evidence for how any of this expenditure of public resources (from memory of my OIA it was $1m) will enhance macroeconomic or financial stability. But I guess when the Board chair is accused in his day job of fostering “systematic racism” (universities and all that being, in current form, a western development) he probably had to be seen to go along.

The gush continues to the end. We learn that the Governor and Deputy Governor have provided “outstanding leadership” – so much so an accountability body finds no fault at all – and the report ends having lost all touch with reality observing that the Bank is “realising the Bank’s vision to be a – Great Team, Best Central Bank.”

You might conceivably think the Bank does, on the whole, not a bad job. But there is no conceivable basis – in outputs or outcomes (or actually in inputs for that matter) – to think that the Reserve Bank is even close to being the “best central bank”. As I’ve noted previously, in a not-so-wealthy small economy it might not ever be realistic as an aim. But it could do a great deal better than it is on numerous fronts – and presumably if the decisionmakers did not agree they would not recently have decided to throw lots more taxpayers’ money at the Bank to help them do better.

Most likely, there will only be one more of these puff pieces, and by 2022 the new legislation is likely to pass and any pretence that the Board is an accountability body will pass out of law. When it finally does, of course, it will only reinforce how weak the accountability mechanisms are around this very powerful independent agency. I’m still of the view that New Zealand would benefit, slightly and at the margin, from establishing a small Macroeconomic and Finance Policy Monitoring agency, operating at arms-length from both The Treasury and the Reserve Bank.

The final thing of interest in the Bank’s own Annual Report is the higher salaries table. This is an excerpt from this year’s.

RB salaries

As I noted last year, Orr himself seemed to be getting more than the Minister had suggested when the appointment was made. And there seem to be a lot of senior colleagues – in a still not very large organisation – pulling in very high salaries. I’m not one of those who generally thinks top-tier public service salaries are too high in principle. These are probably something like fair salaries for excellence, but there is little sign of consistent excellence at the top of the Bank, particularly not from the Governor.

(Incidentally, government department chief executives earlier this year took a temporary 20 per cent pay cut in the wake of Covid. I’ve seen no hint that the Governor – exercising significant public policy powers, and better paid than most of them, and apparently thwarting a collapse in the economy – followed their lead. Perhaps some journalist might ask why.) UPDATE: Thanks to the reader who drew my attention to the footnote describing the Governor’s temporary pay cut.

The Board itself pulls in a couple of hundred thousand (in total) in fees – the largest chunk going to the chair who, one woud have thought, had a demanding day job. The Governor might be getting his money’s worth, but the public is not.

Writing off the Reserve Bank’s government bonds

From time to time I’ve been asked about the idea that the government bonds the Reserve Bank is now buying, and will most likely be holding for years to come, might be written off.   I thought I’d written an earlier post on the idea but I can’t find it –  perhaps it was just a few lines buried somewhere else – and the question keeps coming up.

The Reserve Bank’s own answer to the question –  I’ve seen it recently from both the Governor and the Chief Economist (the latter towards the end of this) – is to smile and suggest that, since they are the lender, it really isn’t up to them.    That, of course, is nonsense.  It is quite within the power of a lender to write-off their claim on a borrower, and that doesn’t require the borrower first to default or to petition for relief.   To revert back to some old posts, that is how ancient debt jubilees worked.

I guess that, in answering the way the do, the Bank is simply trying to avoid getting entangled in controversies that they don’t need.  I have some sympathy for them on that, and so just possibly it might be a tactically astute approach.  A better approach would be for them – as the specialists in such things, unlike the Minister of Finance – to call out the idea of that particular debt being written off for what it is: macroeconomically irrelevant.

In reality, of course, if the debt held by the Reserve Bank were to be written off, it would only be done with the concurrence of the government of the day.    Apart from anything else, if the Governor (or the Board, when the new Reserve Bank legislation is enacted) were to write off the Bank’s claims on the government, it would render the Bank deeply insolvent (very substantial negative equity).  You can’t have management of a government agency just deciding – wholly voluntarily – to render the agency deeply insolvent.

And that is even though the Reserve Bank is quite a bit different than most public sector entities, in that life would go –  operations would continue largely unaffected –  if the Reserve Bank had a balance sheet with a $20 billion (or $60 billion) hole in it.   The Bank isn’t a company, its directors don’t face standard penalties and threats, and –  critically – nothing about substantial negative equity would adversely affect the Bank’s ability to meet its obligations as they fall due.   The Reserve Bank meets its obligations by issuing more of its own liabilities (notes or, more usually, settlement cash balances).  People won’t stop using New Zealand dollars, and banks won’t stop banking at the Reserve Bank, just because there is a huge negative equity position.

(This isn’t just some hypothetical.  Several central banks have operated for long periods with negative equity; indeed I worked for one of them that had so many problems it couldn’t even generate a balance sheet for years at a time.  It also isn’t materially affected by arguments that seignorage revenue –  from the issuance of zero interest banknotes –  means that “true” central bank equity is often higher than it looks (much less so when all interest rates are near zero, and not at all if other interest rates are negative).)

The big reason why writing off the claims the Reserve Bank has on the government through the bonds it holds wouldn’t matter much, if at all, for macroeconomic purposes is that the Reserve Bank is –  in substance – simply a branch of the government.  Any financial value in the organisation accrues ultimately to the taxpayer, and the taxpayer in turn is ultimately responsible for the net liabilities of the Bank.  Governments can –  and sometimes do – default, but having the obligation on the balance sheet of a (wholly government-owned and parliamentarily-created) central bank doesn’t materially change the nature of the exposure.  If anything, governments have tended to be MORE committed to honouring the liabilities of their central bank –  their core monetary agency, where trust really matters –  than in their direct liabilities (thus, in New Zealand  –  as in the US or UK – central and local governments have –  long ago –  defaulted, but the Reserve Bank has never done so).

It is worth remembering what has actually gone on in the last few months.  There are several relevant strands:

  • the government has run a huge fiscal deficit, (meeting the gap between spending and revenue by drawing from its account at the Reserve Bank, in turn resulting in a big increase in banks’ settlement account balances at the Reserve Bank, as bank customers receive the net fiscal outlays),
  • the government has issued copious quantities of new bonds on market (the proceeds from the settlement of those purchases are credited to the Crown account at the Reserve Bank, paid for by debiting –  reducing –  banks’ settlement account balances at the Reserve Bank,
  • the Reserve Bank has purchased copious quantities of bonds on market (paying for them by crediting banks’ settlement accounts at the Reserve Bank).

In practice, the Reserve Bank does not buy bonds in quite the same proportions that the government is issuing them.  But to a first approximation –  and as I’ve written about previously – it does not make much macroeconomic difference whether the Reserve Bank is buying the bonds on market or buying them from the government directly.   In fact, it would not make much difference from a macroeconomic perspective if the Reserve Bank had simply given the government an overdraft equal to the value of the bonds it was otherwise going to purchase.     There are two caveats to that:

  • first, under either model the Reserve Bank has the genuine power to choose, and
  • second, that the fiscal deficit itself is not altered by the particular mechanism whereby the funds get to the Crown account.

But that seems a safe conclusion for now under our current institutional arrangements and culture.

From a private sector perspective, the net effect of the various transactions I listed earlier has been that:

  • private firms and households have been net recipients of government fiscal outlays, (which, in turn, boosts the non-bank private sector’s claims on banks)
  • banks have much larger holdings of (variable rate) settlement cash balances at the Reserve Bank.

Those settlement cash balances are the (relevant) net new whole-of-government debt.

By contrast, quite how the core government and the Reserve Bank rearrange claims between themselves just doesn’t matter very much (macroeconomically) at all.

Suppose the Minister of Finance and the Governor did get together and agree no payment needs to be made in respect of the bonds that Bank holds at maturity.  What does it change?   It doesn’t change is the appropriate stance of monetary policy –  determined by the outlook for the economy and inflation.  It doesn’t change the nature and extent of the Reserve Bank’s other liabilities –  which still have to be met when they mature.   And it doesn’t change anything about the underlying whole-of-government fiscal position.

I guess what people are worried about is that the government might feel it had to raise  taxes –  or cut spending –  more than otherwise “just” to pay off those bonds held by the Reserve Bank.  But remember that the Reserve Bank is just another part of government.  What would actually happen in that scenario is that settlement account balances held by banks at the Reserve Bank would fall (as, say, net taxes flowed into the government account at the Reserve Bank) –  and those are the new claims the private sector currently has on the government.    In other words, the higher taxes or lower spending still extinguish net debt to the private sector.   And if the government didn’t want to raise taxes/cut spending, it could simply issue more bonds on market.  In the process they would (a) repay the bonds held by the Reserve Bank, and (b) reduce settlement cash balances at the Reserve Bank, but (c) increase the net bonds held by the private sector.    Total private claims on whole of government aren’t changed.

(Now it is possible that at the point where the bonds mature, the Reserve Bank still thought that for monetary policy reasons settlement cash balances needed to be as large as ever.  If so, then of course they could purchase some more bonds on-market, or do some conventional open market operations. Neither set of transactions will change the overall claims of the private sector on the government sector –  net fiscal deficits are what do that.)

And what if the bonds were just written off?   As I noted earlier, write off the bonds and the Reserve Bank has a deeply negative equity position.   I don’t really think that is a sustainable long-term position.  It is a bad look in an advanced economy. It is a bad look if we still want to have an operationally independent central bank.  And we can’t rule out the possibility that, for example, risk departments in major international financial institutions might be hesitant about continuing to have the Reserve Bank of New Zealand as a counterparty, including for derivatives transactions, if it had a balance sheet with a large negative position –  even though, as outlined above, the Bank could unquestionably continue to pay its bills.  So at some point of other, the Bank would have to be recapitalised. But again that has little or no implications for the rest of the economy –  or the future tax burden.   The government subscribes for shares…and settles them by issuing to the Bank…more bonds.  The government, of course, pays interest to the Bank –  whether on bonds or overdrafts –  but, to a first approximation, Bank profits all flow back to the Crown.

This post has ended up being quite a lot longer than I really intended, as I’ve tried to cover off lots of bases and possible follow up questions.  Perhaps the key thing to remember is that what creates  the likelihood of higher taxes and lower spending (than otherwise) in future is unexpected/unscheduled fiscal deficits now.

Those deficits might be inevitable, even desirable (as many, perhaps most, might think of those this year as being), but it is they that matter, not  what are in effect the internal transactions between the core government and its wholly-owned Reserve Bank.   That is true even in some MMT world, provided one takes seriously their avowed commitment to keeping inflation in check over time.  You could fund the entire government on interest-free Reserve Bank overdrafts and the consequence would be explosive growth in banks’ settlement cash balances at the Reserve Bank.  But real resources are still limited (see yesterday’s post).  Over time, if you are serious about keeping inflation in check, you still have to either pay a market interest rate on those balances, or engage in heavy financial repression of other sorts, imposing additional imposts on the private sector just by less visible means.

Perhaps the other point worth remembering is the relevance of focusing on appropriately broad measures of true whole-of-government indebtedness, not ones dreamed up from time to time for political marketing purposes.