KiwiBuild: the Reserve Bank and crowding out

Last week, in association with the Monetary Policy Statement, the Reserve Bank published a short separate paper outlining how it was treating KiwiBuild for forecasting and monetary policy purposes.   The bottom line was

The Bank has assumed that half to three quarters of what KiwiBuild contributes to residential investment will be offset by crowding out of other private investment over the forecast horizon.

It isn’t that different an assumption than they have been making since the current government first took office.   This was what they wrote in the November 2017 Monetary Policy Statement

The Government has announced an intention to build 100,000 houses in the next decade…..our working assumption is that around half of the proposed increase will be offset by a reduction in private sector activity.

But, of course, then they refused to show us their workings or give us any supporting analysis.

I made brief reference to the new paper in my post last week on the MPS.  My main point then was to commend the Bank for publishing the separate paper, but in passing I noted.

(As it happens I remain rather sceptical of the assumption that KiwiBuild is going to be a significant net addition to total residential investment over the next decade.  Why would it, when the main issues in the housing market are land prices and, to a lesser extent, construction costs, and it isn’t obvious how KiwiBuild deals with either of them?  If it proves to be a net addition, it will probably be because it is a subsidy scheme for the favoured –  lucky – few.)

Today I went to spend a bit of time elaborating on that argument, and unpicking some of economic arguments in the Bank’s paper.

(Note that although the Bank’s paper has been reported as making difficulties for the government – and perhaps it has – in fact some of it is written as if it were a publication from the government.  It (repeatedly) talks of KiwiBuild houses as affordable, with no quote marks around that description/claim let alone any analysis of what affordability might really mean.  And there is the heartwarming talk of how it designed to “increase home ownership among New Zealanders”.)

The most puzzling aspect of the paper is that the Bank focuses wholly (but only partially) on one possible channel for crowding out and totally ignores another.

Their focus is on capacity constraints in the construction sector.   The claim is that there just isn’t enough labour, and that if the Crown insists on building 10000 additional houses each year it just won’t be possible, as there won’t be the workers.   That doesn’t seem a particularly compelling argument to me, at least over a multi-year horizon.

Over the past year, the national accounts records constructions (residential, non-residential, and other) of almost $40 billion in New Zealand.  Add on top of that (this is all hypothetical) say $2-2.5 billion of KiwiBuild spending a year (the government provision was $2 billion, and the Bank is assuming  –  after crowding out two-thirds –  a net total addition of $2.5 billion over three years) and it would represent an increase from the current level of not much more than 5 per cent.   And, sure, the construction workforce in New Zealand is quite large at present (240000 employed, in the HLFS) –  thus, the Bank argues it can’t really increase further –  but it looks to have been about the same size in Ireland at the peak of their construction boom, when their population was 10-15 per cent less than ours is now.    People change jobs, people postpone retirement, people put off going to Australia (as examples) if the price is right, if the good opportunities are there.  And, although the Bank’s analysis doesn’t mention it,  Australian residential construction activity is now tailing off quite sharply so – again, if the price is right –  you might expect some Australian builders, or expat New Zealanders, to try their luck back here.

I mentioned price a couple of times in that paragraph.    The Reserve Bank’s document doesn’t do so at all (aside from a couple of references to price caps on KiwiBuild houses).  Prices are signals and rationing devices.  You’d have thought the Bank’s economists would think to mention them.  In fact, prices (changes therein) are typically how crowding out works (eg in a fully-employed economy an increase in government spending will tend to boost demand, but will drive up interest rates and the exchange rate –  prices –  crowding out other activity and leaving the overall level of economic activity little changed.    But the fact that the multiplier might be zero doesn’t mean a central bank could just ignore a government that talked of a big increase in spending in a fully-employed economy.  Part of the crowding-out process arises from the monetary policy response (otherwise, it would happen through inflation).

And so the oddity of the Bank’s crowding-out analysis is that it seems to (a) focus on resource availability, and yet (b) simply assumes that the crowding out occurs without any associated price signals or inflation pressures.  Markets tend not to work that way.

At least in the abstract you would have thought the Bank would have wanted to treat the entire KiwiBuild programme as an exogenous boost to demand (whether or not they think it will actually happen their standard operating procedure is –  prudently so –  to assume that government policy is as stated), and then trace through the mechanisms whereby any crowding out occurs.  In this case, for example, one might perhaps expect to see higher wages, higher construction costs (a direct component in the CPI), and perhaps even a higher OCR (than otherwise) as part of the freeing-up/crowding-out process.   The bottom line still might have been the equivalent of half to three quarters of other investment crowded out. But how you get there matters.  If it is a resource constraint story, you can’t simply assume resource constraints have no price consequences.  But, as they’ve told the story, the Reserve Bank seems to have.

Of course, “capacity constraints” is a politically convenient story.  It links to government rhetoric on skills, for example, and even (fallaciously) to the government’s enthusiasm for immigration.  And it channels an implicit story –  never backed with evidence –  that there is some unexploited wedge out there in which, given current laws and regulation, construction material costs, and bureaucratic practices, new houses (including land) can be built more cheaply than current house (including land) prices.  It is only “capacity” –  or just possibly finance –  that holds us back.  I doubt any serious analyst really believes such a story.  There is also an implied story about homelessness –  as if there would be 300000 not housed at all (or grossly inadequately housed) if the government didn’t initiate 100000 new dwellings, “affordable” or otherwise.  Again, that just isn’t plausible.

So, although I do want to run a “crowding out” story, it is a quite different one than the Reserve Bank is spruiking.  On my story, there could be as many builders and associated tradesmen and labourers as you like –  resources flowing easily, with high elasticities, into building as required, with barely any change in prices –  and over any reasonable horizon (say, five to ten years) a credible government announcement that it will build 100000 more houses will, to a first approximation, reduce the construction of other houses by 100000 over that period.    It almost has to be that way because:

  • announcing that as a government you are going to build lots of houses doesn’t change land use law or land availability.  It is what it is –  whether in Auckland or elsewhere.  Everyone recognises that (artificially regulated) land scarcity is a huge component in the high cost of New Zealand houses.   Other government policy measures may yet act on the land use issues, but this is a debate about KiwiBuild, in the existing regulatory system,
  • announcing that you are going to build lots of houses isn’t likely to materially alter the price of building materials in New Zealand, and
  • it isn’t going to materially alter regulatory approval timeframes and related things that (for example) affect financing costs.

In other words the marginal supply price of a new residential property –  like for like in its features –  doesn’t change.    Fix those things and there will be more effective demand for houses from the existing (and projected) population: building activity could really step for quite a while (and some of those capacity constraint and resource pricing issues could be relevant for a few years).    But if you don’t change any of those things –  and KiwiBuild doesn’t materially change any of them –  you’ll end up with no more houses, unless (and only to the extent) that the government-sponsored construction doesn’t cover true costs, and effectively offers a subsidised entry to the market for the favoured few.  Even then, the effect will mostly be to drive out more private construction, but there might still – at least for a time –  be a net increase in the housing stock.

Rational owners of developable land (whether on the fringes or where there is scope for intensification) and potential developers will either know all this consciously, or discover it as they explore the economics of projects they have in mind. KiwiBuild isn’t like (say) a large scale government motorway expansion scheme, when the government has a monopoly on motorway supply.  If the government is determined to build more houses under its badge, there would then (prospectively) be more competition and the expected profits margins and the ability of the private developer to get the returns he or she hoped for will be undermined.  There aren’t super-profits in this business, and if projects no longer look as profitable, many just won’t proceed.   It isn’t as if the government can gear up housebuilding faster than they can either wind back their projects, or look to get their projects branded KiwiBuild, or their land and resources used for KiwiBuild.

To be sure, all this is highly-stylised.  Champions of KiwiBuild will tell me that the programme will build a specific type of house that the market isn’t building.  And perhaps that is even true, but there is plenty of substitutability within the housing market.  And my focus is primarily on the entire life of the planned KiwiBuild programme, whereas the Reserve Bank is (rightly) focused on the next two to three years, the period relevant to today’s monetary policy and related economic forecasts.   So I’m not suggesting one should automatically assume full crowding out without any further thought but rather that (a) capacity constraints are unlikely to be the main consideration (and in any case usually involve price/wage adjustments to make them happen) and (b) full crowding out is probably a reasonable starting point for analysts, who should then justify any deviations they believe it is warranted to assume.

Perhaps the designers and champions of KiwiBuild really believed it would boost home-ownership (as the Reserve Bank claims) or boost overall housing supply. It has always had more of the feel of something with a strong sense of “we need to be seen doing something” and “doesn’t the memory of nice M J Savage bring warm fuzzies memories/feelings to mind”.  Charitably, the official policy position of the Labour Party suggested they were actually going to fix the land market – in which case KiwiBuild would just have been an unnecessary (in economic terms) inefficiency.  Sadly, a few weeks short of halfway through the government’s term very little or nothing has been done on things that might make a real difference –  actually render decent housing affordable again –  while KiwiBuild has become a politically troublesome distraction.

See, not so hard after all

Back in November 2017, just after the government took office, the Reserve Bank in its Monetary Policy Statement identified various assumptions they had made about the impact of various of the new government’s policies.  Some of these assumptions made quite a difference to the outlook, but no analysis or reasoning was presented to give us any confidence in the assumptions they were (reasonably or unreasonably) making. One of those new policies was KiwiBuild.

Seeing as the Bank is a powerful public agency, it seemed only reasonable to request copies of any analysis undertaken as part of arriving at the assumptions policymakers were using.   The Bank refused and many many months later the Ombudsman backed them up (if ever there was a case for an overhaul of the Official Information Act, this was a good example).  The Ombudsman did point out that he had to rule as at the date the request had been made.  So, a year having passed, I again requested this material.  The Bank again refused (and I haven’t yet gotten round to appealing to the Ombudsman).     Quarter after quarter the Monetary Policy Statements talk about KiwiBuild, but we’ve never seen any supporting analysis.   A state secret apparently.

Until yesterday that is.  In the latest Monetary Policy Statement there was the usual discussion of KiwiBuild –  potentially a big influence on one of the most highly-cylical parts of the whole economy –  but there was also a footnote pointing readers to an obscure corner of the Bank’s website, and a special background note on KiwiBuild, and the assumptions the Bank is making.  All released simultaneous with the statement itself.   See, it just wasn’t that hard.  And has the sky fallen?

(As it happens I remain rather sceptical of the assumption that KiwiBuild is going to be a significant net addition to total residential investment over the next decade.  Why would it, when the main issues in the housing market are land prices and, to a lesser extent, construction costs, and it isn’t obvious how KiwiBuild deals with either of them?  If it proves to be a net addition, it will probably be because it is a subsidy scheme for the favoured –  lucky – few.)

As for the overall tone of the monetary policy conclusions to the statement, count me sceptical.  At one level it is almost always true that the next OCR move could be up or down –  and in that sense most forecasting (especially that a couple of years ahead) is futile: useless and pointless.   But for the Governor to suggest that the risks now are really even balanced, even at some relatively near-term horizon, seems to suggest he is  falling into the same trap that beguiled the Bank for much of the last decade; the belief that somewhere, just around the corner, inflation pressures are finally going to build sufficiently that they will need to raise the OCR.   We’ve come through a cyclical recovery, the reconstruction after a series of highly-destructive earthquakes, strong terms of trade, and a huge unexpected population surge, and none of it has been enough to really support higher interest rates. The OCR now is lower than it was at the end of the last recession, and still core inflation struggles to get anywhere 2 per cent.    There is no lift in imported inflation, no significant new surges in domestic demand in view, and as the Bank notes business investment is pretty subdued.  Instead actual GDP growth has been easing, population growth is easing, employment growth is easing, confidence is pretty subdued, the heat in the housing market (for now at least) is easing.  Oh, and several of the major components of the world economy –  China and the euro-area  –  are weakening, and the Australian economy (important to New Zealand through a host of channels) also appears to be easing, centred in one of the most cyclically-variable parts of the economy, construction.   It was surprising to see no richness or depth to any of the international discussion –  and to see the Bank buying into the highly dubious line that any slowing in China is mostly about the “trade war”.   Few other observers seem to see it that way.

From a starting point with inflation still below target midpoint after all these years, it would seem much more reasonable to suppose that if there is an OCR adjustment in the next year or so, it is (much) more likely to be a cut than an increase.      Time will tell, including about how long the 1.5 per cent lift in the exchange rate will last.

Commendably, the Bank is now talking openly about many other economies have limited capacity to respond to a future serious downturn.  That is welcome acknowledgement, but it would count for more if the Bank were taking seriously the real (if slightly less binding) constraints New Zealand will also face in the next future serious downturn.

A couple of other things in the document caught my eye.  One was this chart

NAIRU 2019

The Bank seems to be trying to tell us that it really has no idea whether the unemployment was above or below the NAIRU at any time in the last 17 years.  I don’t suppose in practice they operate that way, but when they present a chart like this it is a bit hard to take seriously the other bits of their economic analysis.

The other specific was some rather upbeat comments on productivity performance in recent years, which has led the Bank to the view that they now to expect no acceleration in productivity growth in the years ahead.  The Governor always seems to err on the (politically convenient) upbeat side.  I’m not sure quite how the Bank derives their productivity measure –  I’m guessing as some sort of per person employed measure –  but as a reminder to readers here is the chart of real GDP per hour worked, the standard measure of labour productivity.  To deal, to some extent, with the noise in the individual series, I use both measures of quarterly GDP and both (HLFS and QES) measures of hours.

real GDP phw dec 18

There has been no labour productivity growth for the last three or four years, and little for the last six or seven.  I wouldn’t be surprised if the Bank is right to expect no acceleration (on current policies), but if we keep on with near-zero labour productivity growth it is a rather bleak prospect for New Zealanders.

A great deal of the press conference was taken up with questions –  generally not very sympathetic –  about the Governor’s proposals to increase substantially capital requirements for banks.   In the course of the press conference he and Geoff Bascand made some reasonable points –  including about the merits of putting the big 4 banks and the smaller banks on a more equal footing in calculating requirements – and at least fronted up on the other questions.  It is just a shame this was being done reactively now, rather than pro-actively when the proposals were first released in December.

I remain rather sceptical of the Bank’s case –  in which everything is a win-win, in which the economy is safer, more prosperous, and even with lower interest rates.  If you doubt that I’m characterising their bold claims correctly, this is the stylised diagram that leads the consultative document.

something for allIt is a free lunch they are claiming to offer.  I suspect few will be convinced.

In the course of the press conference, the Governor asserted that the Bank’s proposals will, if implemented, mean that future capital ratio requirements would be “well within the range of norms” seen in other countries.  I found that a surprising claim, and there is nothing –  not a word – in the consultative document to back it up.  If true, it would be material in thinking about the appropriateness of the Bank’s proposals.  But where is the evidence (granting that this is something that can’t be answered in a ten second Google search)?  I’ve lodged an Official Information Act request for the analysis the Governor is using to support his claim.  It would, surely, be in his interests to have such analysis out there.

Also at the press conference, there was the hardy perennial claim that inflation expectations are “well-anchored” at 2 per cent, and everyone believes that monetary policy is just fine.  As my hardy perennial response, here are inflation breakevens from the government bond (indexed and conventional) market.  The last observation is today’s data.

IIB breakevens feb 19

People with money at stake don’t seem to believe you Governor.  Last time things got this low a series of OCR cuts only helped, at least partially, rectify the position.

And, finally, who does the Bank suppose gets any value at all from the cartoon version of the statement?  For example

cartoon

Is the Monetary Policy Statement now a set text in intermediate school?  If the kids are especially naughty do they have to read it twice?   Even your average MP, sitting on the Finance and Expenditure Committee and supposedly holding the Bank to account, has to be able to cope with a little more than that.  I’m not expecting much of the new statutory MPC, but perhaps they could prevail on the Governor to drop the cartoons and simply write in reasonably accessible English?

Later this morning we get the Remit (PTA replacement) and Charter for the new Monetary Policy Committee.  I’m sure I’ll have some thoughts about them tomorrow.

Two charts and a speech

A post of two unrelated graphs this morning.

Just before Christmas I wrote a post prompted by an FT story about new OECD work that attempted to standardise estimates of hours worked to improve cross-country comparative productivity (GDP per hour worked) estimates.   Before writing the post, I’d confirmed with Statistics New Zealand that they had been consulted and that there were no material implications re New Zealand data.    Reading numbers, rather roughly, off a chart I’d attempted to illustrate the implied new OECD rankings.

But the OECD has now included the new hours worked estimated in their own official published data, and (thanks to a tweet from the chair of the Productivity Commission) I noticed this chart yesterday.

OECD labour productivity 2017

As I noted in the earlier post, this revision lifts several countries (Austria, Switzerland, and Sweden) into the upper bracket of OECD countries.  It also improves the position of the UK (in yesterday’s post I noted that they were now about 30 per cent of us, but on these revised and improved data the lead is just over 40 per cent).

But it is our position relative to the emerging OECD economies that really interests me.    Not only are Slovakia and Slovenia ahead of us –  they’ve been there or thereabouts on the old measures since about 2014 –  but now so are Lithuania and Turkey.  Go back 20 years and both  – on the old measures, but presumably on the new ones too –  were miles behind us.  Based on their productivity growth performance this decade, the Czech Republic and –  a few years later –  Poland will be beating us before long.

In a way “beating us” isn’t the right word.    It isn’t a competition in the sense that their gains mean we are worse off.  We should celebrate their economic gains.

But it is the right word if we use the experience of other countries to benchmark our own performance.    In modern New Zealand history, not one of those countries in the previous paragraph has ever been richer or productive than New Zealand.  Until now.  30 years ago all but Turkey were just beginning to throw off decades of Communist rule –  with all the misallocations of resources and skewed incentives and degraded institutions that went with that dreadful system.    Lithuania wasn’t just part of the Soviet sphere of influence, it was –  by conquest –  part of the Soviet Union itself.

And 30 years ago we were a stable democratic country, with the rule of law, long-established market institutions (even if they’d been a bit attenuated in the protectionist decades) just about –  although we didn’t know it then – to enjoy decades of a significant trend improvement in our terms of trade.     And yet these are the outcomes we’ve managed, that our policy frameworks applied to available resources have produced.

And for those who’ve liked to believe that large-scale non-citizen immigration, and a larger population, were a material part of what might improve New Zealand’s productivity prospects, here is the percentage change in the population of the former eastern-bloc OECD countries and (at the other end of the spectrum) of the high immigration OECD countries.

Population growth (%) 1990 to 2017
Latvia -27
Lithuania -23.4
Estonia -18
Hungary -5.5
Poland 1
Czech Republic 2.5
Slovakia 2.6
Slovenia 3.5
Canada 32.7
New Zealand 39.3
Australia 44.3
Israel 86.1

I wouldn’t recommend the experience of the Baltics (low birth rates and high emigration).  I don’t envy them a geographic position right now to Russia either.    But the absence of much immigration, and little or no population growth doesn’t seem to have held any of those former eastern-bloc countries back from a pretty impressive resurgence.  They all have a long way to go to match the best-of-class among the OECD countries, but so does New Zealand…..and we’ve been making no progress at all towards that sort of goal.

The Reserve Bank’s Monetary Policy Statement is due out this afternoon.  Yesterday the Bank released its latest Survey of Expectations.  There wasn’t a great deal of interest in the data, but this was the series that caught my eye.

mon cond year ahead 19

The Bank has been running this question for almost 20 years now, asking respondents (on a seven point scale) their expectation of “monetary conditions” a year from now.  They also ask about perceptions of current conditions.  Perceptions of current conditions are quite loose in the latest survey, but what is striking is that almost always when respondents think current conditions are loose they expect a substantial tightening in the next year or so.   That was what the data showed in 1999, 2001, 2003, 2010, and 2013.  It wasn’t what showed up in 2015/16: then relatively easy conditions (probably then mainly a proxy for relatively low interest rates) were expected to be followed by even easier conditions.   A succession of OCR cuts followed.  As of the latest survey, a net 69 per cent of respondents think conditions are easier than neutral (not quite a record), but by the end of the year a record (see chart) 73 per cent of respondents expect things to be easier than neutral.

This result doesn’t yet show up in the OCR expectations themselves –  which are edging downwards but a year out the mean expectation is still above 1.75 per cent (the median is bang on) –  but the expected easing in “monetary conditions” looks a bit more consistent with market pricing, in suggesting the OCR cuts are becoming more likely.

(At the margin, the OCR expectations in the survey would have been a touch lower if I had actually submitted mine.  I filled in the form, printed out a copy for my records, and then must have failed to push the button to submit it.    The lowest official OCR expectation for December 2019 is 1.5 per cent, but the table in front of me says I wrote down 1.25 per cent.  We’ll see.)

And a final suggestion for journalists at the Reserve Bank’s press conference this afternoon.  The other day a reader sent me an invitation they’d received for a function you could pay to attend at which the Governor was going to be speaking next month.

This year it is Dr Adrian Orr, the Governor of the Reserve Bank who will also speak about the bank’s views of the economy in an candid off the record way.

Perhaps the organisers mis-spoke, but I’d have expected the Bank to review carefully how the Governor’s involvement in any such event was described.    When market-sensitive matters are involved –  and Governor’s/Bank’s view on the economy clearly qualifies –  it is highly inappropriate for any Bank officials (even the Governor) to be speaking “candidly” in an off-the-record environment.  Anything other than the most anodyne comment should be done in the Monetary Policy Statement (or associated press conference or testimony to Parliament) or in on-the-record speeches, to which everyone has access at the same time and the same way.   It is even worse when access to the Governor, for potentially market-sensitive material, is sold-off, even if there is a decent charity cause behind it.

I’ve written about this sort of thing previously

I notice that NBR’s Shoeshine column this week also touched on that earlier INFINZ event, describing it as an “expletive-laden speech” on all manner of topics, and observing “unfortunately, this speech was never put on the web (very strange for a Reserve Bank governor’s speech)”.    Not so strange if it were genuinely just rehearsing old ground, but the various accounts suggest it wasn’t.

Asking the Governor about the approach he thinks appropriate to his speeches  – about his commitment to openness and transparency – would aid the cause of accountability.

Bank capital: (not) consulting with APRA

After I’d posted yesterday, a reader made this comment about an article which apparently appeared in the Australian Financial Review yesterday

I see the AFR reporting today that APRA say they were “consulted” about the RBNZ release last Friday which was the document’s release date.

That account seemed consistent with a comment I’d seen in The Australian the previous day in which APRA indicated that they would be consulting with the Reserve Bank on its proposals, but with no indication that there had been any prior consultation.  If so, that seems extraordinary.

My reader went on to ask

Is there any protocol for consultation between APRA and RBNZ on these types of regulatory issues? It seems surprising to me that the RBNZ could propose something so radical without a genuine prior discussion with the regulator of the banks who dominate the NZ financial system.

I can only endorse that second sentence.  If anything, it seems like an understatement.

There are reciprocal provisions in the New Zealand and Australian legislation (the New Zealand provision is here), but they are mostly about doing whatever possible to avoid damage to the other country’s financial system (especially in crisis resolution).  There is also an RBNZ/APRA MOU, but it is mostly about ongoing supervision of trans-Tasman banks.   There is this brief, rather minimalistic, section

Regulatory Policy Development
25. The Authorities expect to respond to requests for information on their respective national regulatory systems and inform each other about major changes, including those that have a significant bearing on the activities of Cross-border Establishments.

But not every expectation of reasonable and appropriate behaviour should need to be written down.

Searching the Reserve Bank’s consultative document for references to APRA, it seemed telling that the Bank referred a couple of times to the possibility of aligning with APRA standards around the idea (questionable) of introducing a leverage ratio, but has no discussion at all about the merits (or otherwise) of introducing new capital requirements so far in excess of those APRA imposes (requirements called “radical” by one of the ratings agencies).

And yet the risks the two countries’ banking systems are exposed to seem very similar, and much the same banking groups are involved.   And when the senior management of our Reserve Bank is pretty new to these sorts of issues, and when the Bank consciously chose to dis-establish its own risk modelling capability several years ago, it is hard not to think that the Reserve Bank would have benefited from serious consultations with APRA (at various levels of the respective organisations) even as the Governor retained the right to come to his own decision.   There is a suggestion that the Governor has a bit of chip on his shoulder about Australia and Australian banks.  Whether that is true or not, if the indications of lack of prior consultation are correct, it isn’t good enough.  But I suppose it parallels the apparent lack of any systematic advance consultation –  technical papers, seminars etc –  with people outside the Bank in New Zealand either.     It might be interesting for someone to ask them who they actually did consult with (other than (apparently) Professors Admati and Hellwig).  Even within government, how much prior consultation was there with The Treasury or the Minister of Finance?

The New Zealand legislation may, misguidedly and for the time being, give the Governor the barely-trammelled power to make these decisions, but it is important to recognise that the Reserve Bank (the Governor) neither bears the costs of these decisions (whether they work out well or not) nor gets any benefits from them.  Great power –  in a single person’s hands – and yet not much incentive to get things right.  That is a worrying combination.

After yesterday’s post, another reader sent me this line from Adam Smith

The statesman who should attempt to direct private people in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it.

The Wealth of Nations, , Book IV, Chapter II

The full quote is mostly about a slightly different point, but as my reader noted the final couple of lines seemed particularly apposite.

 

Funding the Reserve Bank: focus on your statutory mandate

The Reserve Bank has been joining the ranks of the public sector agencies bidding for more money –  not just doing so in the conventional manner, behind closed doors in private discussions with relevant ministers, but in public.

There were some initial comments a few weeks ago, which I didn’t notice at the time, using this totally spurious argument

we are a net contributor to Crown revenue rather than a cost, and we’ve asked if we can hang on to a little more of what we make in order to fund extra work,” the Reserve Bank spokesman said.

The Reserve Bank generates a lot of money (mainly) by issuing zero interest bank notes (a statutory monopoly) and investing the proceeds in interest-bearing assets.  It takes little skill to collect this (what is in effect a) tax.     That income should have no bearing, formal or rhetorical, on how much of our resources the Reserve Bank is permitted to spend on other stuff –  mostly more bureaucrats to do regulation, analysis, and (see below) political positioning, of the sort many other cash-constrained bureaucracies in Wellington do.   Those activities do not generate even an iota of revenue for the Crown.

They were back with the begging bowl this week at the annual financial review undertaken by Parliament’s Finance and Expenditure Committee.  I saw two accounts –  one from Newsroom, and one from interest.co.nz.      There were a couple of strange claims, including the Governor appearing to suggest that the CBL failure might have occurred because the Reserve Bank didn’t have enough staff.  I don’t regard that as a totally implausible story  –  then again, the system is not supposed to prevent all failures, and at least some concerns relate to what the Bank did do (suppression orders) rather than what it didn’t do.  But if staffing was a concern, and the Bank thought it didn’t have the resources to do the job Parliament had given it, surely the previous year’s Annual Reports would have said so.  And I’m pretty sure they didn’t.

Orr is also reported as claiming that

….now was the time to resource-up and ready the bank for a crisis.

“The time when under-resourcing most shows up is generally during a time of crisis and we aren’t in one of those times,” Orr said.

I doubt that is so. In a crisis it is all hands to the pump, and institutions pull through.  If there is under-resourcing (and that is an open question) it is more likely to affect progressing work programmes in more-normal times.

Perhaps it is why, 8.5 months into his governorship, we still haven’t had a substantive speech from the Governor on either monetary policy or financial stability/regulation?  But that can’t really be the explanation either –  after all, we’ve always only had one Governor, and his predecessors somehow managed.

The Reserve Bank’s finances are not very tightly managed (externally, by the minister or Parliament).  Under the current Act there is provision for (but not a necessity for) a five-yearly funding agreement, outlining how much the Bank can spend.   It isn’t a great model, for various reasons, even if it was a step forward on the total lack of formal controls that existed prior to the 1989 Act.

But my experience was that almost every year, the Reserve Bank’s actual spending undershot what was provided for in the Funding Agreement.  I knew they had had the odd tighter year this decade, but other than that it isn’t something I follow closely.  But here is interest.co.nz’s account of what the Bank said in its latest Annual Report released in October.

The Reserve Bank’s annual report, issued last month, showed it had undershot spending allowed through its funding agreement by $26.7 million over three years and paid a $430 million annual dividend. By June 30 the Reserve Bank had spent $173.1 million of a possible $199.8 million allowed by its 2015-2020 Funding Agreement, signed with the previous National-led government. Net operating expenses in the June 2018 year were $4.1 million below the funding agreement, despite rising $8 million year-on-year to $76 million.

“The $26.7 million cumulative underspending is expected to partially reverse in the last two years of the funding agreement, as capitalised expenditure on systems improvements is amortised to operating expenses, and the issuance of new banknotes continues. The Bank expects to be within the five-year aggregate expenditure provided for in the funding agreement,” the annual report said.

Bottom line?  They’ve been underspending again, and even though that is “expected to partially reverse” over the next two years, the forecast reversal is only partial and, once again, they expect to underspending the Funding Agreement allowance.  And, under the current statutory model there are no adverse consequences for the Bank if it were to have spent a little more than the Funding Agreement number anyway.  But the issue is moot –  they seem to have managed in a way that will actually underspend (again).

Which leaves another of Orr’s comments ringing a bit hollow

Orr in the select committee again pointed out the limitations of the five-yearly model, saying a “phenomenal” number of “unanticipated” events had happened in the last five years, and the same would be the case in the next five years.

And probably every five years since 1990, and yet the Bank still almost always underspends.

Having said that, this may be one of the areas in which there is some convergence of views between me and the Governor.  The five-year funding agreement model is crazy and should be scrapped.   No corporate – no government agency for that matter –  sets operating expenditure budgets five years in advance, and it is simply silly to expect to do so for the Reserve Bank.  It is fine to do rough medium-term plans to help ensure that foreseeable expenditure pressures are identified well in advance, but that is different from a binding five-year budget.

Where we may well diverge again is that I think the Reserve Bank’s policy, regulatory and related activities should be funded –  as most government agencies are – by means of detailed annual appropriations by Parliament (and will be forthrightly making that case when the current review of the Reserve Bank Act gets round to looking at funding issues).  I wrote about the issue in a post earlier in the year.   Here were some of my points:

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

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

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

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

But if the Governor really thinks he doesn’t have enough resources to do aspects of the job Parliament has given, perhaps he could look rather hard at how he prioritises.  In his FEC appearance the other day, he claimed to have been doing so, but in my observation his sense of priorities appears personal, idiosyncratic and even political, not at all well-aligned with the Bank’s statutory mandate.

Recall that the Governor has only been in office for just over eight months, but already we’ve had things like:

  • speeches on climate change, helping out his buddies in the government and in the liberal wing of the business community,
  • the “Reserve Bank as tree god” exercise, which surely didn’t just flow off the end of the Governor’s pen in an idle hour one Saturday afternoon. It will have consumed real resources, at an opportunity cost,
  • cartoon versions of the Monetary Policy Statements and Financial Stability Reviews,  and
  • swamping those individually modest items by several orders of magnitude there was the conduct inquiry of which I noted upon its release

Despite highlighting several times in the report that this was really none of their business (of course they phrased it more bureaucratically: “neither regulator has a direct legislative mandate for regulating the conduct of providers of core banking services”), they’d spent an estimated $2 million of public money to mount their bully pulpit, lecture the banks, lobby for more powers for themselves.  

It simply wasn’t their job, but it suited the Governor’s ambitions to sweep in and spend large amounts of public money –  for modest-sized agencies –  on a personal campaign, to discover what?

The waste goes on.  There is an advert out at the moment for a Manager, Performance and Corporate Relations.  There appears to be some real work associated with the role (some of the bureaucratic hoop-jumping all government agencies have to do) but part of the role is this

Leading a mid-sized team of specialists, the person appointed will provide leadership to organisation-wide initiatives such as the Bank’s Climate Change Strategy and Te Ao Maori framework.

There can be no possible need for whatever a “Te Ao Maori framework” actually turns out to be.   The Reserve Bank isn’t some social agency dealing with troubled individual families, where quite possibly individual cultural backgrounds matter.  It doesn’t really deal with ordinary people much at all –  that is not a criticism, it doesn’t need to.    It runs monetary policy –  which affects and benefits people quite regardless of ethnicity-  and it regulates banks (and other financial institutions) again –  one would hope –  regardless of the ethnicity of individual managers or shareholders.  Fortunately, the “principles of the Treaty of Waitangi” are not part of the Reserve Bank Act.     I don’t suppose the Bank will be spending a vast amount of money in this area, but every little bit reallocated to financial regulation would surely help, at least if you believe the Governor and his Deputy.  It has the feel of the Governor pursuing another personal political agenda at the expense of the taxpayer.

And then there is “the Bank’s Climate Change Strategy”.    I’ve touched on this before, but as a reminder the Reserve Bank is an office-bound organisation, with precisely two offices (main one and a small one –  probably unnecessary –  in Auckland).  For practical reasons (to do with specialist vaults) the Bank –  unlike most central government agencies –  owns a building in central Wellington, and if they own any vehicles at all it might be just one car.  They are a wholesaler of one physical product –  bank notes –  but they import that product from overseas producers, for whom the Reserve Bank is no more than a modest-sized customer (thus with little market power).  But they do, I suppose, travel to lots of overseas meetings (but last I looked, international air travel still isn’t captured in the agreed international carbon reporting framework or our own current government’s incipient net-zero goal).

There is just no obvious reason –  at least not one that isn’t ultra vires –  for the Reserve Bank to be spending public money on a “climate change strategy” at all.  It is a feel-good piece of political positioning, perhaps helping the Governor is his turf fights around the Reserve Bank Act, and assisting him in a cause that he clearly feels strongly about personally –  even if there is little sign of him thinking about it deeply.

I’ve written prevously about the sheer vacuity of much of this, especially in the New Zealand context –  our banking system hardly being heavily exposed to, say, oil producers.  There was a vapid box in the FSR a few weeks ago, and as I noted of it

The text burbles on about possible risks, but it all adds up to very little.     There are numerous risks banks and borrowers face every decade, every century.  Relative prices change, trade protection changes, external markets change, exchange rates change, technology changes, economies cycle, land use law changes.  Oh, and the climate changes.

If one looks at the structure of New Zealand bank (or insurer balance sheets) it just isn’t credible that climate change poses a significant risk to the soundness of the New Zealand financial system (that pesky law again).   Some individuals are likely to face losses from actual and prospective sea-level rises, but banks (and insurers) typically have diversified national portfolios.   People can’t have mortgage debt without insurance, and so the insurers are likely to be constraining people first.   Much the same surely goes for the rural sector?   Sure, adding agriculture into the ETS at the sort of carbon price some zealots have called for would be pretty detrimental to the economics of a dairy debt portfolio, but then freeing up the urban land market probably wouldn’t be great for residential mortgage portfolios, and we don’t see double-page spreads from the Reserve Bank on that issue, or the Governor trying to play himself into some more central role in that area.     It smacks of politics –  signalling the Governor’s green credentials –  more than anything legitimately tied to financial system soundness.

As it happens, the Bank yesterday released its “Climate Change Strategy“, a 10 point statement which seems almost equally devoid of content relevant to the statutory responsibilities of the Bank.  Instead, the Governor is offering political support to the government (that is the gist of the first paragraph) and bidding to be a player.  Here are two of their 10 points.

8.No single institution working alone can achieve meaningful progress on a global challenge such as climate change. Furthermore, it is not for financial policymakers to drive the transition to a low-carbon economy, nor is it the role of the Bank to advocate one policy response over another. That is the role of government.

9. However, appropriate action on a national or global level can only be achieved if individuals and entities are able to take action on a micro level. For this to occur, two conditions need to be met. First, there has to be proactive and effective leadership to drive our collective understanding of climate risks and to establish robust strategies to respond to those risks. Second, there has to be effective and timely dissemination of those assessments and strategies. Appropriate information will be vital in enabling entities and individuals to price and manage risks, facilitating the transition to a low-carbon economy, and ultimately contributing to both the soundness and efficiency of the financial system.

You might agree, disagree, or simply yawn, but when did this become an issue for a central bank, with important, powerful, but quite limited, statutory responsibilities?  And a central bank crying poor, claiming it doesn’t have enough money for its day jobs.   It is more like a creed than something one might reasonably expect from a central bank.

As part of the Bank’s statement we learn that

The Bank has also been welcomed as member of the Network of Central Banks and Supervisors for Greening the Financial System (NGFS). The Network was set up in December 2017 at the Paris ‘One Planet Summit’ to strengthen the global response required to meet the goals of the Paris agreement.

Head of Department Financial System Policy and Analysis Toby Fiennes says the Reserve Bank is very proud to have been accepted as a member of the NGFS.

“Playing our part globally, and as a leader in the Pacific region, is important both in terms of reinforcing New Zealand’s reputation as a ‘good global citizen’, and in providing us access to the latest thinking around the globe,” Mr Fiennes says.

(Among this small group of (excessively funded?) central banks and regulators is the central banking arm of the Chinese Communist Party. )

I guess it is the sort of feel-good, but empty, rhetoric one now expects from public servants.  And I guess when you see yourself as a tree god, the fit with an organisation devoted to “greening the financial system” must be almost complete?   But it is all empty.  “Playing our part globally” seems likely to involve little more than another round of international meetings to attend –  all those extra emissions – at the taxpayers’ expense, to advance Orr’s personal agenda at a time when he suggests the institution has insufficient money to do the job the taxpayer instructed them to do.  On an issue where there are no material financial system implications at all.

I’m open to the idea that the Bank might in fact need more financial resources, given the various jobs that (wisely or not) Parliament has instructed them to do.   There are other agencies and causes that might have a stronger case  and (on the other hand) some that should simply be wound up altogether.  But the Bank’s case would be that much more compelling if there weren’t repeated signs that the Governor was using the institution and public resources to advance personal, often quite political, agendas that reach beyond his statutory responsibilities.  He should be ensuring –  and the Board insisting –  that resources are rigorously prioritised to focus on the statutory mandate.

Encouraging transparency and accountability

I’m travelling today and tomorrow, so just something brief now, and perhaps nothing tomorrow.

The government announced a couple of days ago that

From January, all Government ministers will have to release details of their internal and external meetings.

Minister for State Services (Open Government) Chris Hipkins said Cabinet had agreed to the release of summary information from their ministerial diaries from January 2019 onwards, with the first publication in February 2019.

To be specific

For each meeting in scope, the summary would list: date, time (start and finish), brief description, location, who the meeting was with, and the portfolio. The monthly summary will be published on the Beehive website within 15 business days following the end of each month.

It is a significant step forward, and will (or should) strengthen scrutiny and accountability of ministers.  There are some exceptions, and potential scope for the rules to be bent, but it goes beyond the publications practice for ministers in the UK and in New South Wales.   Together with the decision to pro-actively release Cabinet papers, it is another step towards delivering on the commitment to greater openness and transparency in government.

The (largely taxpayer-funded) lobby group Transparency International –  the ones who nonetheless host senior public servants giving secret speeches – has put out a statement welcoming the move.

“We are pleased that the Government acknowledges the need for transparency from its Ministers. Transparency is the antidote for corruption, every action they take makes New Zealand a better home for her citizens and reinforces New Zealand’s leadership in the global fight against corruption,” stated TINZ Chief Executive Officer Julie Haggie.

They suggest this should only be a first step

“We hope it is not long before all Parliamentarians are required to release their diaries and this requirement is codified in law so that it cannot be undone in the future by politicians fearful of transparency,” [chair Suzanne] Snively adds.

Not to disagree with that, but in many respects we have less to fear –  in our sort of political system –  from backbench members of Parliament than from senior officials (and even judges) exercising in some cases huge amounts of discretionary power.  Sometimes that is the ability to regulate directly, but even if they don’t have that particular power then the enforcement (or otherwise) of laws and rules made elsewhere opens up the potential for inappropriate influence, or even corruption.

The specific case I’m most interested in is the Governor of the Reserve Bank.  He will shortly lose his exclusive power to set and adjust the OCR himself, although he will still be hugely influential in monetary policy (and people will be keen to bend his ear or get the inside word).  But even once the new legislation is passed the Governor will retain his, largely untrammelled, powers as individual decisionmaker in regulating banks, and in enforcing (or not) a wide range of regulatory provisions affecting banks, non-banks, and insurers.  There is a great deal of money at stake in many of these decisions.

I’m not suggesting that anything very untoward goes on –  although successive Governors have each been involved in some questionable episodes.  But we (a) need to keep it that way, and (b) gain confidence in the way an institution is being run partly by means of transparency.   And what is good enough for elected Ministers of the Crown (who face scrutiny in Parliament every day) is surely a standard that should also be met by powerful unelected, largely unaccountable, officials.   I’d encourage the Governor to take the lead and announce that he will adopt the same standard, and if he doesn’t do so the Board and the Minister should prevail on him to reconsider.  If such transparency is good enough for ministers, it should be a standard expectation for the top tier of public officials.

Hope springs eternal, but I’m not very optimistic that the Governor will see such transparency as a positive virtue.  Readers will recall that the Ombudsman recently ruled in the Governor’s favour, allowing the Bank to withhold internal analysis and advice prepared for a Monetary Policy Statement at which the then (acting) Governor announced what the Bank was assuming about the impact of some major policy initiatives of the new government (including the now mired in controversy Kiwibuild), with no supporting detail or analysis.   Among the Ombudsman’s justifications was that, although his decision wasn’t made until almost a year after the request, his decision had to relate to the date on which my request had been made (ie very shortly after the relevant MPS).  To test this standard, I then re-lodged the request, so that a new decisions would have to be made about this analysis and information but on the basis that it is now a year old.

Absolutely not to my surprise, the Bank again rejected the request.  They do this even though, across the road, very similar sorts of background notes and briefing papers prepared for the Minister of Finance by Treasury staff as part of the Budget process are routinely, and pro-actively, released.

The Bank does condescend to observe that

In considering how long it is reasonable to withhold information of this nature, the Reserve Bank recognises that as time passes then release is less likely to have an inhibiting effect.

but concludes that a lag of more like five to ten years might be appropriate.  It would be laughable if it weren’t so serious.  According to the Bank, citizens are not entitled to see background papers on such matters ( and in the end the Bank’s analysis of Kiwibuild probably didn’t change the OCR decision materially) even a year after they were written (using taxpayer resources).  It makes a mockery of the principles of the Official Information Act, further undermining the already limited accountability of an already over-mighty public official.

Ministers have set an encouraging lead. The Treasury sets a good example around papers feeding into the Budget process. It is surely time for the Governor –  encouraged by the Board, soon to be more directly answerable to the Minister through a directly-appointed chair – to get with 21st century standards of transparency and accountability.

 

 

Central bank minutes released: a small victory for transparency

Regular readers will recall that the Reserve Bank has long been deeply resistant to releasing any information relating to OCR decisions or Monetary Policy Statements, other than what they themselves chose to release, whether in the published documents or in subsequent interviews.  That has never been very satisfactory, but the Bank has attempted to carve out for itself a special place, more or less above the provisions of the Official Information Act.

One of the things they’ve consistently refused to release is minutes of the Governing Committee, the body set up by the previous Governor, in which the Governor takes his final OCR decision (and other major decisions, including ones around LVRs).  They had long taken the same stance to the minutes of the predecessor Official Cash Rate Advisory Group, even when the requests related to decisions some time in the past. Often enough, it seemed that there were no written minutes at all (which was probably in breach of the Public Records Act).

I had largely given up on making any progress on this issue (and, anyway, the new statutory Monetary Policy Committee, which will have its own charter on such matters, is coming next year). But for some reason, which I now forget, I had lodged one more request six months ago seeking

1. the minutes of any meetings of the Governing Committee relating to the May MPS,
including minutes of the meeting where the OCR decision was taken;

When the Bank refused to release anything (not even date of meeting, list of attendees, headings –  even if all the substantive content was redacted) I complained to the Ombudsman, noting that (among other things) the Bank quite often released minutes of Board meetings (even with some content withheld).

The Bank regularly releases minutes of the meetings of its own Board (in response to OIA requests), with individual deletions as appropriate.  It seems inconceivable, for example, that the date, time, place of the meeting, the list of attendees, the confirmation of past minutes, and the final decisions of any meetings (themselves reflected in a later published document) could pass a “free and frank”: withholding test, even if (again) it is plausible that if there is any substantial account of the nature of contentious discussion at the meeting that specific element of the material might.

And then I forgot all about the request until a short time ago when an email from the Reserve Bank turned up.

We refer to your complaint to the Office of the Ombudsman (ref: 480453) relating to your request for: “minutes of any meetings of the Governing Committee relating to the May MPS, including minutes of the meeting where the OCR decision was taken.

The Reserve Bank has reconsidered its initial position and is now releasing with redactions, a copy of the only document within the scope of your request – the Governing Committee minutes in May. The document is attached to this correspondence.

And it has only take six months, which is progress.  Credit to the Ombudsman.

For anyone interested, the minutes themselves are here

Governing Cttee minutes May 2018 OCR

One day perhaps we might even have released –  with a suitable lag – the background papers the Governor (and his new MPC) receive, and upon which they base their decision

I’m not sure there is any new information in the particular minutes released, but having released Governing Committee minutes in this form –  against a request made almost immediately after the relevant OCR decision was released – a small but helpful precedent has been established.   Some material is still withheld on the highly questionable ground of avoiding damage to the substantial economic interests of New Zealand.  One day, the Ombudsman is going to have to provide some substantive guidance on that provision, but for now both he and the Bank seem keen to avoid the Ombudsman having to draw the appropriate line between national economic interests and those of a particular public agency.