Two BIMs and a bureaucrat

As I noted last week, government departments’ (and agencies’) briefings to incoming ministers have mostly become a bit of a joke: mostly devoid of any substance, typically specifically tailored to the preferences of the particular incoming government (ie written/finalised after the shape of the new government is clear), and mostly not much more than process pieces.  If one is interested in the actual substantive advice –  the sort of things the Lange government intended to make available when they began publishing BIMs in the mid 1980s –  citizens need to fall back on the Official Information Act, with all its limitations.

There are exceptions –  I wrote the other day about some substance in the Reserve Bank’s BIM.   And even on the little that is released, sometimes tantalising hints sneak through.  The intelligence services, for example, left unredacted a suggestion that governments might need to be concerned about the influence activities in New Zealand of foreign governments –  something neither the current Prime Minister nor her predecessor have been willing to take seriously or address openly.

Of the other economic functions, neither the Treasury nor the Immigration BIMs say much.  But sometimes there is quite a bit even in a few words.  Take immigration for example.    It was only a few years ago that MBIE was telling Ministers of Immigration (and the public) that immigration was a “critical economic enabler” –  a potential catalyst to transform New Zealand’s dismal productivity performance.   There isn’t much in this year’s Immigration portfolio BIM –  mostly process again –  but my eye lit on this paragraph

New Zealand’s immigration system enables migrants to visit, work, study, invest, and live in New Zealand. Economically, it contributes to filling skill shortages, encouraging investment, enabling and supporting innovation and growing export markets. Immigration has contributed to New Zealand’s strong overall GDP growth in recent years largely through its contribution to population growth. However, the evidence suggests that the contribution of immigration to per capita growth and productivity is likely to be relatively modest.

The theory –  dodgy bits like “filling skill shortages” and the more plausible bits –  is there in the first half of the paragraph.  But by the end of the paragraph, even MBIE has to concede that there isn’t likely to be much boost to per capita income or productivity at all –  the effects are “likely to be relatively modest”.  It is hard to avoid that sort of conclusion –  looking specifically at the New Zealand experience –  when (to take MBIE’s list from the second sentence) “skill shortages” have been a story told in New Zealand for 150 years, business investment has been weak by OECD standards for decades, firms haven’t regarded it as particularly attractive to invest heavily in innovation (again by world standards), and the export share of GDP is now at its lowest since 1976.  Still, it is good to see reality slowing dawning on MBIE.  On my telling, they are still too optimistic, but even on their telling when such a large scale policy intervention seems to produce such modest economic results it might be time for a rethink.

And what about the BIMs prepared by Treasury?   There isn’t much in the main Finance document (lots of process stuff, and plenty of talk of diversity and wellbeing and none on productivity).  There is an appendix specifically aimed to address what Treasury understand to be the new Minister’s priorities, but not much about Treasury’s own view of what needs to be done, or the pressing problems.    If anything, reading Gabs Makhlouf’s covering letter to Grant Robertson one might conclude that Treasury didn’t think there was much to worry about at all.

You are taking up your role at a time when New Zealand’s economy is in a relatively strong position.  There is solid forecast growth, complemented by fiscal surpluses and a strong debt position.  And while international markets still present a number of risks and uncertainties, overall the global economy –  as reflected in the IMF’s recent outlook –  presents opportunities for New Zealand to seize, in particular with Asia’s ongoing growth.

Presumably the Secretary didn’t think it worth emphasising five years of no productivity growth, seventy years of pretty weak productivity growth, shrinking exports as a share of GDP, sky-high house/land prices, pretty weak business investment and so on.  Or even the fact that notwithstanding “Asia’s ongoing growth” –  a story now for more than forty years –  nothing has looked like turning around New Zealand’s continuing gradual economic decline.    And perhaps when you are a temporary immigrant yourself –  as Makhlouf presumably is –  the cumulative (net) loss of a million New Zealanders isn’t something that concerns you?

In their BIM Treasury proudly asserts that “We are the Government’s lead economic and financial adviser”.  Perhaps they hold that formal office, but it is hard to be optimistic about the content of what they might be offering the government.

But Treasury also had some other BIMs for other portfolios they have responsibilities for.  The one I noticed was the Infrastructure one.    Buried in the middle of that document was this observation

Auckland’s ability to absorb growth has been reached. Environmental, housing and transport indicators all reflect a city under increasing pressure. Traditionally, Auckland has been more productive than other regions of New Zealand but, on a per capita basis, this productivity premium has been shrinking over time. Auckland is not performing as well as expected for its size and in comparison to other primary cities around the world.  There are opportunities to increase this productivity but only if supply constraints, especially transport and housing, are resolved.

That key middle sentence –  no hint of which appears in the main Treasury BIM –  could easily have been lifted from one of my various posts on similar lines.    They could have illustrated the point with a chart like this.

akld failure


Appearing in the standalone Infrastructure BIM, Treasury appear to want to blame these poor outcomes largely on infrastructure gaps –  a conclusion which I think is flawed –  but I’m encouraged to see a recognition of the problem in official advice to the Minister of Finance.   It is all a far cry from the rather lightweight celebratory speech Gabs Makhlouf was giving about Auckland’s economy only 18 months ago, which I summed up this way

[it] might all sound fine,  until one starts to look for the evidence.  And there simply isn’t any.  Perhaps 25 years ago it was a plausible hypothesis for how things might work out if only we adopted the sort of policies that have been pursued. But after 25 years surely the Secretary to the Treasury can’t get away with simply repeating the rhetoric, offering no evidence, confronting no contrary indicators, all simply with the caveat that in “the long run” things will be fine and prosperous.  How many more generations does Makhouf think we should wait to see his preferred policies producing this “more prosperous New Zealand in the long run”?

If the Secretary to the Treasury was going to address the economic issues around Auckland, one might have hoped there would be at least passing reference to:

  • New Zealand’s continuing relative economic decline, despite the rapid growth in our largest city,
  • Auckland’s 15 year long relative decline (in GDP per capita), relative to the rest of New Zealand,
  • The contrast between that experience, and the typical experience abroad in which big city GDP per capita has been rising relative to that in the rest of the respective countries,
  • The failure of exports to increase as a share of GDP for 25 years,
  • The fact that few or any major export industries I’m aware of our centred in Auckland (the exception is probably the subsidized export education sector) –  and by “centred” I don’t mean where the corporate head office is, but where the centre of relevant economic activity is.

There is nothing of economic substance on immigration in the main Treasury BIM this year, but perhaps over the next few years Treasury could start thinking harder about whether it really makes sense to be using policy to bring ever more people to one of the most remote corners on earth, even as personal connections and supply chains seem to be becoming ever more important, at least in industries that aren’t simply based on natural resources.

The one other thing that did catch my eye in the Treasury BIM was this paragraph

The Treasury Board. This external advisory group supports the Treasury’s Secretary and ELT to ensure that its organisational strategy, capability and performance make the best possible contribution to the achievement of its goals. Current members of the Board are the Secretary to the Treasury (Gabriel Makhlouf), the Chief Operating Officer (Fiona Ross), Sir Ralph Norris, Whaimutu Dewes, Cathy Quinn, Mark Verbiest, Harlene Hayne and John Fraser (Secretary to the Australian Treasury).

Now, to be fair, the “Treasury Board” has no statutory existence, and no statutory powers.  It isn’t even clear why it exists at all –  Boards are typically supposed to represent shareholders, and as regards Treasury, the Minister of Finance, Parliament, and the SSC are supposed to do that on our behalf.  But given that there is an advisory Board, what is a senior public servant from another country  –  the Secretary to the Australian federal Treasury –  doing on it?      New Zealand and Australia might be two of the closer countries in the world, but we don’t always have the same interests, and at times those interests –  and perspectives – clash rather sharply.    I gather John Fraser is quite highly regarded, but who does he owe allegiance to, and whose interests is he advancing in his work on the New Zealand “Treasury Board”?  I might not worry if he were a retired former Treasury Secretary from Australia, but he is a serving official of the Australian government.  It seems extraordinary, and quite inappropriate.   Did he, for example, have any involvement in the recent, superficially questionable, appointment of a former senior Queensland public servant to a top position in our Treasury?    Again, close working relationships between the two Treasurys –  each as servants of their own governments –  might be reasonably expected, and perhaps mutually beneficial.   But providing a senior official of another government with inside access to the senior-level workings of one of our premier government departments seems questionable at best.  GIven Makhlouf’s past enthusiasm for China, perhaps the appeasers at the New Zealand China Council will soon be suggesting he appoint someone from China’s Ministry of Finance could join Fraser on the “Board”?

And finally, some kudos for a bureaucrat.  As various people have noted, Graeme Wheeler went for five years as Governor –  as the most powerful unelected person in New Zealand –  without ever exposing himself to a searching interview, or making himself available for an interview on either main TV channel’s weekend current affairs shows.  His appointment might be highly legally questionable, he might be only minding the store for a few months, but yesterday Grant Spencer went one better than Wheeler and sat down for interview on Q&A with Corin Dann.    I thought he did well, but what really counted was just showing up, and being open to questions.

Since much of the interview was about Spencer’s speech last week, which I’ve already written about, there was much in it that I disagreed with.  But I’m not going over that ground again.  Perhaps the one new thing that caught my attention was when Spencer claimed that the Bank is independent for monetary policy, but not around things like LVRs.   That is simply factually untrue.  The Act makes it very clear that any decisions to impose or lift LVR restrictions are solely a matter for the Governor (also a point that the Prime Minister, the Minister of Finance and their predecessors have recognised).   Spencer went on to say that if the then government had not wanted the Bank to impose LVR restrictions they wouldn’t have done so.     That might be fine, but I hope they never apply that standard to monetary policy decisions.  And if LVR decisions really are more political and redistributive in nature, perhaps as part of the forthcoming review, the Reserve Bank Act should be changed so that the Reserve Bank offers technical professional advice, but the Minister of Finance makes the decision?.  We can, after all, toss out elected governments.




Revisiting Westpac and the Reserve Bank

Last week I wrote a post about the Reserve Bank’s announcement that it had increased Westpac New Zealand Limited’s minimum capital requirements –  by quite significant amounts – “after it failed to comply with regulatory obligations relating to its status as an internal models bank”.

Two things in particular annoyed me last week:

  • the complete lack of any serious explanation, from either the Reserve Bank or Westpac, as to what had gone on and why, how and by whom the errors were uncovered, what remedial steps had been taken (in both institutions), how we could be sure similar problems didn’t exist in other banks, and
  • the absence from both statements (Reserve Bank and Westpac) of any reference to Westpac’s directors, even though under our system of bank regulation and supervision, the directors have primary responsibility for attesting to the accuracy of disclosure statements, and face potential civil and criminal penalties for (strict liability) offences for publishing false information.

One can understand why Westpac would not want to say anything more, even if (for example) they thought the Reserve Bank had overreacted: don’t upset the regulator is one of the watchwords of the banks, because even if your concern might be justified on one point, the Reserve Bank has many other ways to get back at you on other issues (where, eg, approvals are needed) if you make life difficult.

The Reserve Bank’s stance is more disconcerting.  It is, after all, a government regulatory agency, responsible to the public for the exercise of its statutory powers, and for the management of its own operations.    And yet, as so often with monetary policy, they seem to think it is up to them to decide how much they will graciously tell us, rather than to be accountable and answer the questions that people have.  I gather they are refusing to explain themselves further at all.  If, as it says it is, the government is serious about increasing the transparency of the Reserve Bank, this is just another example of why reform –  and a new culture –  is needed.

When I wrote last week, there were several things I didn’t notice.

First, I noticed the lack of any sign of contrition in the Westpac statement, but didn’t go on to draw the obvious conclusion that lack of any sign of contrition –  even feigned for the public – might suggest that they felt they were being rather unjustly dealt with in this matter.    Had they been caught out doing seriously bad stuff, you’d have expected them to, if anything, overdo the public contrition (mea culpa, mea culpa, mea maxima culpa and all that).

Second, the Reserve Bank’s statement was clearly designed to have us believe that there had been systematic problems for nine years now, ever since Westpac was first accredited to use internal models.  Why do I say that?  This is what they said.

The report found that Westpac:

  • currently operates 17 (out of 35) unapproved capital models;
  • has used 21 (out of 32) additional unapproved capital models since it was accredited as an internal models bank in 2008;

But someone pointed out to me Westpac’s initial disclosure of the problems in its September 2016 disclosure statement.   In that statement (page 9) Westpac disclosed a couple of trivial errors dating back to 2008 (in sum, lifting risk-weighted assets by $44 million on a balance sheet of $86 billion).  And what about the model approvals errors?  Well, this is what the directors’ disclosure says:

“The Bank has identified that it has been operating versions of the following capital models without obtaining the Reserve Bank’s prior approval as required under the revised version of the Reserve Bank’s Capital Adequacy Framework (Internal Models Based Approach)(BS2B) that came into effect on 1 July 2014”

If it is correct that prior to July 2014 internal models banks did not require Reserve Bank approvals for specific models (and I have now have vague recollections of internal discussions on exactly this point in 2013/14, and an earlier version of BS2B does not have the requirement) that would put a rather different light on Westpac’s errors than was implied in the Reserve Bank statement.    Transition problems associated with a pretty new requirement look rather different than a failure that had run for nine years since the inception of the Basle II regime.

The original conception of allowing banks to use internal models to calculate risk-weighted assets (for capital adequacy purposes) had not been to have the Reserve Bank micromanaging the process, but rather reaching an overall judgement about the ability of banks to responsibly use such models, while imposing supervisory overlays where the Reserve Bank thought the models were producing insufficiently cautious results (as we did from day one in respect of housing mortgage exposures).  Over the years, the Reserve Bank grew less confident in the internal models approach, culminating (apparently) in the 2014 requirement that all models have prior Reserve Bank approval.

As the situation stands now

Registered banks may only use approved internal models for the calculation of their regulatory capital adequacy requirement. Banks must advise the Reserve Bank of all proposed changes to their estimates and models before implementing them.

There are specific requirements laid down about the information banks have to submit to the Reserve Bank when seeking such approvals. I’ve been told that the Reserve Bank can then take up to 18 months to work through the process of approving any change (there are, after all, 32 models for Westpac alone, and four internal-models banks).

The Reserve Bank also requires that

A bank that has been accredited to use the IRB approach must maintain a compendium of approved models with the Reserve Bank. This compendium has to be agreed to by the Reserve Bank and only models listed in that compendium may be used for regulatory capital purposes. The compendium is to be reviewed and relevant sections are to be updated at least once a year. The compendium must be updated as soon as practicable after a model change has been approved by the Reserve Bank. The compendium lists basic model-related information such as version number, approval date, risk drivers, key parameters, as well as information from the most recent annual validation report on RWA, EAD, validation date and model outlook, and any other model-related information required by the Reserve Bank.

All of which sounds sensible enough, but it raises some obvious questions.  If this was a new requirement in 2014 (but in fact whenever the requirement was introduced), surely the Reserve Bank would have insisted on a compendium from each bank of the models that bank was using at the time, and then would have put in place a process to (a) monitor any changes it was approving, and (b) ensure, whether by directors’ attestation or whatever, that any changes to the models banks were using actually had prior Reserve Bank approval.  But did any of this happen?

Since we don’t have anything in the way of a good explanation from either Westpac or the Reserve Bank we can only guess at what must have happened.  I’m pretty sure Westpac didn’t consciously set out to deceive the Reserve Bank –  the banks are gun-shy, terrified of breaching conditions of registration –  and the Reserve Bank’s own statement seems to accept that story.

Perhaps there is a clue in this line from the Reserve Bank statement as to what the independent investigation found.  Westpac New Zealand

failed to put in place the systems and controls an internal models bank is required to have under its conditions of registration.

Most or all of the risk modelling work is likely to have been being done in Sydney (by the parent bank) and not by Westpac New Zealand at all.   Quite possibly, people on this side of the Tasman only ever see the bottom line numbers, and pay no attention to the modelling or (small?) changes in it.    Perhaps Sydney went on refining risk models, including updating the models for changes in data composition (as the composition of individual loan portfolios changes), and just didn’t know that they were now (unlike the first few years as an IRB bank) required to notify and get Reserve Bank approval for each and every change?   If so, it is still a system failure –  and potentially of concern for the way it highlights how things could go more seriously wrong –  and shouldn’t have been allowed to happen, but it doesn’t seem like the most serious failing in the world.  Did the Reserve Bank see Westpac’s model compendium in 2015, and if so did they confirm with the Westpac risk people in Sydney (presumably who they are primarily dealing with) that the models in the compendium, and only those models, were being used?  If so, why it did it take another year to uncover the problems.  And if not, why not?

Without a proper explanation, we don’t know if this is the story.   But depositors and creditors should be owed an explanation by Westpac, and the public are owed one by our regulator, the Reserve Bank.

The third thing I didn’t pay much attention to last week was the statement that Westpac now had a total capital ratio (share of risk-weighted assets) of 16.1 per cent.  It seemed surprisingly high, but it was higher than the (temporarily increased) regulatory minima, and than the level Westpac had undertaken to maintain, so I passed over it quickly, and I shouldn’t have.

Here are Westpac New Zealand’s capital ratios (common equity tier one, and total capital) for the last couple of years.  The data are taken from disclosure statements and, for September 2017, from Westpac’s press release last week.

wpac capital ratios

I couldn’t find any reference anywhere to Westpac New Zealand Limited having issued any capital instruments on market in the September 2017 quarter.    But the Westpac New Zealand branch did issue $US1.25 billion of perpetual subordinated contingent convertible notes in September.  Those instruments would qualify as Tier One capital (though, of course, not as common equity).  Since we don’t yet have the September disclosure statement, we can’t be sure what went on, but it looks as though the proceeds of that issue might have been used to subscribe to (eg) a private placement of similar securities by Westpac New Zealand to its parent.  Whatever the story,  it seems unlikely that the sudden increase in Westpac New Zealand’s capital ratio had nothing to do with the fight they were then no doubt in with the Reserve Bank about the appropriate response to the model-approvals issue.

Again, we deserve a better explanation from the Reserve Bank (and Westpac) as to what actually went on.  For example, did the Reserve Bank insist that Westpac take on more capital, even beyond the temporarily increased regulatory minima, and then let Westpac raise the additional capital before letting the public (and depositors/creditors) in on what was going on?  Perhaps not, but the alternative –  in which Westpac New Zealand just happened to decide to raise more capital just before the regulatory sanction was announced  –  seems a bit implausible.  The news coverage would have been at least subtly different if last week’s announcement of the model approvals errors had been accompanied by the statement that Westpac New Zealand would need now to take steps to increase its level of capital (as distinct from just glossing over a fait accompli).

Which also brings us back to the unanswered questions?   We don’t know how much difference the use of unapproved models actually made to Westpac’s risk-weighted assets –  in fact, we don’t even know if the Reserve Bank knows.   And we don’t know if the Reserve Bank insisted on this new capital –  although it seems likely given that they noted that

In addition, the Reserve Bank has accepted an undertaking by Westpac to maintain its total capital ratio above 15.1 percent until all existing issues have been resolved.

when 15.1 per cent is well above even the temporarily higher regulatory minima for Westpac.

But if so, is the penalty proportionate to the offence?  It is impossible to tell, on the information the Reserve Bank has so far made available, and that isn’t a good state of affairs –  no basis for holding this (weakly-accountable) regulator to account.

And, to return to one of the questions I posed last week, why wouldn’t prosecution of the directors have been a more appropriate penalty, and one better-aligned with the design of the regulatory framework?  I’m not suggesting anyone should have gone to prison, but if what actually went on here was a governance design failure, surely it is an obvious case for trying out the penalty regime designed to ensure that directors do their job (of, among other things, ensuring that management do their job)?  A fine on each director –  for what are, after all, strict liability offences –  looks as though it could have been a more appropriate penalty.    But if such prosecutions had been contested, that might have forced the Reserve Bank to disclose more, including about their own system failures, than perhaps they would have been comfortable with?   Bureaucrats protect themselves, and their bureau.

As I said last week, I hope journalists use the opportunity of the Financial Stability Report press conference next week to pose some of these questions to the “acting Governor” and Geoff Bascand, the new Head of Financial Stability.  They can’t force the Reserve Bank to answer questions, but if the Bank continues to stonewall, in the face of repeated questions from multiple journalists, in a news conference that is live-streamed, it won’t be a good look for the Reserve Bank (or for Geoff Bascand personally, if he is still in the race to become the next Governor).



More questions than answers

When a Reserve Bank press release turned up yesterday afternoon, announcing that the Reserve Bank had temporarily increased the minimum capital requirements for Westpac’s New Zealand subsidiary, after breaches had been discovered in Westpac’s compliance with its conditions of registration, my initial reaction was a slightly flippant one.  It must, I thought, be nice for the Reserve Bank to be able to impose penalties when banks don’t do as they should, but it is a shame that there is no effective penalty operating in reverse.   When the Reserve Bank misses its inflation target, imposes new controls with threadbare justification, flouts the principles of the Official Information Act, allows OCR decisions to leak, or attempts to silence a leading critic what happens?  Well, nothing really.

But as I reflected on the Reserve Bank’s statement and the Westpac New Zealand, both reproduced here, I became increasingly uneasy.

This is what we know from the Reserve Bank

Westpac New Zealand Limited (Westpac) has had its minimum regulatory capital requirements increased after it failed to comply with regulatory obligations relating to its status as an internal models bank.

Internal models banks are accredited by the Reserve Bank to use approved risk models to calculate how much regulatory capital they need to hold. Westpac used a number of models that had not been approved by the Reserve Bank, and materially failed to meet requirements around model governance, processes and documentation.

The Reserve Bank required Westpac to commission an independent report into its compliance with internal models regulatory requirements. The report found that Westpac:
·currently operates 17 (out of 35) unapproved capital models;
·has used 21 (out of 32) additional unapproved capital models since it was accredited as an internal models bank in 2008; and
·failed to put in place the systems and controls an internal models bank is required to have under its conditions of registration.

The Reserve Bank has decided that Westpac’s conditions of registration should be amended to increase its minimum capital levels until the shortcomings and
non-compliance identified in the independent report have been remedied.  …..

In addition, the Reserve Bank has accepted an undertaking by Westpac to maintain its total capital ratio above 15.1 percent until all existing issues have been resolved.  The Reserve Bank has given Westpac 18 months to satisfy the Reserve Bank that it has sufficiently addressed those issues or it risks losing accreditation to operate as an internal models bank.

There is nothing additional in the Westpac statement, but they don’t appear to dispute either the Reserve Bank’s findings or its response.

There are a few things to clear away.  First, the temporary increase in the minimum capital requirements for Westpac New Zealand does not constitute a financial penalty at all.    Arguably that might be true even if it increased the actual amount of capital Westpac had to hold (Modigliani-Miller and all that), but this measure does not do that.    The Reserve Bank statement tells us that as 30 September, Westpac’s total capital ratio was 16.1 per cent.

That doesn’t mean it is no penalty at all.   I’m sure there has been a great deal of very uncomfortable anguishing in recent months both among Westpac New Zealand directors and senior management, and at head office (and the main board) in Sydney.  APRA is likely to have taken a very dim view of this sort of mismanagement by an Australian bank’s subsidiary.  And, of course, a lot of scarce staff time is now going to have be devoted to sorting these issues out over the next 18 months.  That resource has an opportunity cost –  other things those people could have been used for, which might have boosted the bank’s earnings.

But what I found more striking was how little either the Reserve Bank or Westpac statements said about breaches of conditions of registration which appear to go to the heart of our system of prudential supervision.

There is, for example, nothing at all in the Westpac statement about how these errors happened (use of numerous unathorised models, dating back to 2008), and not much contrition either.  The closest they come is this

WNZL is disappointed not to have met the RBNZ’s requirements in this area.

And our system of banking supervision is supposed to, at least in principle and in law, rely very heavily on attestations from each individual director that the bank they are directors of is fully in compliance with the conditions of registration (which includes provisions around calculation of minimum capital requirements and associated models).  But there is no apology from the directors, and no sign that any director has lost his or her job.   Potential heavy civil and criminal penalties –  including potential imprisonment –  are supposed to sufficiently focus the attention of directors that depositors and other creditors can rely on the information banks publish.  Westpac’s clearly haven’t been able to rely on their disclosure statements for almost a decade.  And yet there is no specific mention of the directors in the Reserve Bank’s statement either.

There is also nothing in either statement (Reserve Bank or Westpac) about the quantitative significance of the errors.   The Reserve Bank tells us that they accept that Westpac did not deliberately set out to reduce its regulatory capital, but intent and effect are two different things.    These problems appear to have been known about for more than a year –  Westpac tells us they first reported them in their September 2016 Disclosure Statement.  But was the effect, over the years since 2008, to reduce the amount of capital Westpac had to hold relative to what it would have been if they’d been using Reserve Bank approved models?  Or does no one –  at the Reserve Bank or Westpac –  yet know?   When the issues are sorted out will Westpac New Zealand be required to restate its capital ratios for the whole period since 2008?

The Reserve Bank’s own processes also seem lax at best.    And this comes closer to home for me, since I sat for a long time on the Bank’s internal Financial System Oversight committee.  The precise mandate of that committee was never fully clear –  in a sense, it was to provide advice on whatever issues the Governor wanted advice on –  and we didn’t typically do individual bank issues at this level of detail.  But that Committee provided advice to the then Governor to go forward with Basle II and, in particular (back in 2008), to allow the big banks to use internal-models based approaches to calculating regulatory capital requirements.    I don’t recall if anyone ever asked how we –  the Reserve Bank –  could be confident, on an ongoing basis, that an internal-models bank was actually using approved models.  But had anyone done so, I’m pretty sure the answer would have been along the lines of “director attestations” and the stiff potential civil and criminal penalties directors could face for what are, after all, strict liability offences (directors don’t have to be shown to have intended to mislead –  it is enough that their statements were subsequently found to be false.)

For a long time the concern was that any questions we (the Bank) asked of bank management would weaken the incentive on directors to get things right –  they might, after all, claim they had relied on us.   But that mentality had been changing in the last decade –  eg the Reserve Bank started collecting private information that creditors don’t have access to.     But where were the questions around Westpac’s models?  After all, it wasn’t a single model where someone overloooked getting Reserve Bank sign-off, but roughly half of all the models, stretching back years.

If there is nothing in the Reserve Bank statement about steps the Bank may have taken to improve its own monitoring and recordkeeping (given that they had to grant approval, how did they not know that so many models were being used and had had no approval?), there is also nothing about any steps they may have taken to assure themselves that there are not similar problems in any of the other IRB banks.   Have they even asked the question?  Surely, one would think, but mightn’t we expect to be told?

As I noted, there was no mention of the directors in the Reserve Bank statement.  But did the Reserve Bank consider taking prosecutions against Westpac’s directors, who signed false disclosure statements over the years from 2008 to 2016?  If not, why not?  If the directors believed (as presumably they did) that the statements they were signed were correct, did they have reasonable grounds for that belief?  What procedures or inquiries had they instituted over eight years that (a) they had confidence in, and (b) still proved wrong?  The Reserve Bank insists on independent directors: those on the Westpac NZ board look quite impressive, but what were they doing all those years?

If the Reserve Bank has lost confidence in a system of rather condign punishment of directors, perhaps it should tell us so, and seek legislative changes.  But if it really still believes that director attestations have a central role in the framework, surely this is as good an episode, and time, to make an example of someone as there is ever likely to be?  After all, it was about a core aspect of the regulatory framework (capital requirements), and comes at times when there are no jitters around the health of the financial system.  If there is no penalty for directors, no doubt directors of other banks will take note.

And then there is the question of the other (apparent) breaches of the conditions of registration. I don’t make a habit of reading Disclosure Statements (and don’t bank with Westpac anyway –  although, come to think of it, the Reserve Bank Superannuation scheme, that the “acting Governor” is a trustee of, does).  But I had a quick look at the latest Westpac statement.  On page 2, there is half page of disclosures of things Westpac NZ is not compliant with.  Several appear to be dealt with by yesterday’s announcement, but another five don’t.   Perhaps they are all pretty small matters –  they look that way to this lay reader – but banks are supposed to be fully compliant.   It is the law.

From the Reserve Bank’s side, the press statement went out in the name of Deputy Governor (and new Head of Financial Stability) Geoff Bascand.  But he has been in the role for less than two months now.  By contrast, “acting Governor” Grant Spencer was head of financial stability from 2007 to 2017, spanning the entire period of the use of internal models, and one of his direct reports, the head of prudential supervision, has also been in his role that entire time.    One would hope that the Reserve Bank’s Board is now asking some pretty serious questions about just what went on, about how the Reserve Bank has handled these issues over the last decade, and about how much confidence New Zealanders can have in an avowedly hands-off system.

Most probably, the empirical significance of this protracted breach of the rules will prove to have been small.  For that small mercy, we should of course be grateful.  But it is also small comfort because the fact that such breaches could go on for so long –  and the statements aren’t even clear how they came to light – leaves one wondering about what other gaps we (or the Reserve Bank, or Westpac or other IRB banks) might not yet know about.  Often enough, such problems only come to light when it is too late.   In many other central banks and regulatory agencies, if they hear about this episiode, there will be tut-tutting along the lines of “well, that is what you get when you don’t have on-site supervision of banks”.  Personally I wouldn’t want to see New Zealand go that way, but my confidence in our approach has taken a blow in the last 24 hours.

The Reserve Bank has a review of capital requirements underway at present.  I hope final decisions are not going to be made before a new Governor is in place.   There is plenty of unease around the use of internal-models for calculating capital requirements –  especially for rather vanilla banks such as those operating here.  Personally, I’d be comfortable moving away from that system, back to a standardised model for calculating capital (which would, among other things, put Kiwibank –  somewhat put upon by the Reserve Bank – and TSB on the same footing as the large banks).  But, for now, the law is the law, and needs to be seen to be enforced.  A breach of this sort, with little serious direct penalty, risks undermining confidence in our system.

And, of course, there is the small matter of openness.  Not every aspect of the Reserve Bank’s dealing with an individual bank can be published, but there are a lot of questions –  including about the Reserve Bank itself –  to which we really should be entitled to more answers than the Bank has yet given us.

I hope some journalists are willing to pursue the matter further.  Questions could be directed to David McLean, the well-regarded Westpac NZ CEO, to the Board members past and present (especially the independents), perhaps to the parent bank in Sydney, and –  of course –  to Grant Spencer and Geoff Bascand –  if not before then at their next (financial stability) press conference, which is now only a couple of weeks away.




The Reserve Bank second XI takes the field

The second XI at the Reserve Bank fronted up to present today’s Monetary Policy Statement.    There was the unlawfully appointed “acting Governor” Grant Spencer –  who is now signing himself as “Governor”, not even as acting Governor –  the chief economist, John McDermott, and the new head of financial stability (and openly acknowledged applicant for Governor) Geoff Bascand.    At best, they are holding the fort until the new Governor is appointed, and a new Policy Targets Agreement put in place, but despite that Spencer still felt confident enough to assert that “monetary policy will remain accommodative for a considerable period”.     How would he know?  He won’t be there.

One could feel a little sorry for the Bank.  After all, not only is the second XI holding the fort, but a new government took office only a week or so ago.    Between Labour’s manifesto commitments and the agreements with New Zealand First and the Greens, there are a lot of new policy measures coming.  But there is not a lot of detail on most of them.    The Bank’s typical approach in the past has been not to incorporate things into the economic projections until they become law (at, in the case of fiscal policy, in a Budget).   They’ve departed from that approach on this occasion, and have incorporated estimates of the macro effects of four new policies:

  • fiscal policy,
  • minimum wage policy,
  • Kiwibuild, and
  • changes to visa requirements affecting students and work visas.

I suspect they’d have been better to have waited.  On fiscal policy, for example, there are no publically available numbers yet –  just last week the Prime Minister told us to wait for the HYEFU.    On immigration, there has been nothing from the new government on the timing of any changes.  And on Kiwibuild, there is no sign of any analysis behind the assumption the Bank has made that around half of Kiwibuild activity will displace private sector building that would otherwise have taken place.  And so on.

And then there are the numerous other policy promises the Bank hasn’t accounted for.  In the Speech from the Throne yesterday there was a clear commitment to “remove the Auckland urban growth boundary and free up density controls” in this term of government.  If so, surely that would be expected to affect house prices and perhaps building activity?   Binding carbon budgets are also likely to have macro effects.

I’m not suggesting the Bank can produce good estimates for any of these effects.  Rather, they’d have been better to have stayed on the sidelines for a bit longer, since they were under no pressure at all to change the OCR today, rather than incorporate rough and ready estimates of a handful of forthcoming changes, with little sign that they have really stood back and thought about how the economy is unfolding.

And the conclusions they’ve come to do seem rather questionable.  The “acting Governor” kicked off his press conference talking of the “very positive” economic outlook.  I’m not sure how many other people will agree with him. As the Bank themselves note, they’ve been surprised on the downside by recent GDP outcomes, and housing market activity has been fading.  Even dairy prices have been edging back down, and oil prices have been rising.  (And, of course, there has been no productivity growth for years.)

The Bank forecasts an acceleration of economic growth –  even as population growth slows –  on the back of additional fiscal stimulus and additional building activity under the Kiwibuild programme.    Like other commentators, I’m rather sceptical that we will see anything quite that strong.  But even on their own numbers, productivity growth over the next few years is now projected to be weaker than the Bank was projecting in August.       And if Kiwibuild really is going to add so much to housing supply, in conjunction with slower population growth than the Bank was expecting, how plausible is it real house prices will simply be flat as far the eye can see (or the forecasts go)?  Not very, I’d have thought.

In the end, the numbers don’t matter very much.  Spencer will be gone at the end of March, and we’ll have a new Governor and a new PTA.  A new Governor will make his or her own assessment, and own OCR decisions.  But part of what that person will need to do is take a look at lifting the quality of the Bank’s economic analysis.

For all the talk of initiatives promised by the new government, the Monetary Policy Statement itself was striking for containing not a word –  not one –  mentioning that the monetary policy regime itself is under review.  Of course the “acting Governor” can’t pre-empt changes the detail of which aren’t known, but the Act does require the Bank to discuss in MPSs how monetary policy might be conducted over the following five years: a horizon over which we’ll have a different PTA, a different Governor, an amended statutory mandate, and a statutory committee to make decisions.

My main interest was in the contents of the press conference, where journalists raised both the issue of the proposed new mandate and the proposed changes to the statutory decisionmaking model.    In both cases, I suspect the second XI said too much.

Asked about the proposed mandate changes, Spencer began noting that he couldn’t say too much as the review was just getting started.  He then went on to assert that “moving to a dual mandate was unlikely to have a major impact on how policy is run”, explaining that in many ways flexible inflation targeting is akin to a “dual mandate” (something that, in principle, I agree with).     But then, somewhat surprisingly, he claimed that the proposed change could lead the Bank to become more flexible, potentially allowing greater volatility in inflation to promote greater stability in employment.  I guess it depends on the details of the changes, which none of us yet knows, but it was the first I’d heard of anyone calling for more volatility in inflation.  Over the last decade, those who think the Bank hasn’t put sufficient weight on the labour market indicators (like me) would have been quite happy to have seen core inflation at the target midpoint on average.  The previous Governor committed to that, but didn’t deliver.

On which note, it was a little surprising to hear the Chief Economist talk about how the Bank had improved its forecasts, and got its inflation forecasts right over the last couple of years.  That would then explain why core inflation has remained persistently below the target midpoint???  And has not got even a jot closer in the last couple of years?

Spencer noted that at present the Bank regarded the labour market as ‘pretty balanced’, such that a dual mandate wouldn’t make much difference right now.   But it turns out that they really don’t know.

They were asked a question about the government’s goal of getting the unemployment rate below 4 per cent, and –  fairly enough –  drew a distinction between structural policies that might lower the NAIRU and anything monetary policy could do.  When pushed, they argued that on current structural policies, an unemployment rate lower than 4 per cent would be inflationary, and suggested that estimates of the NAIRU range from 4 to 5 per cent at present.

But then all three of the second XI went on.  Spencer noted that the estimates are ‘very uncertain” and that in anticipation of a “dual mandate” the Bank was now doing some work to come up with some estimates of the NAIRU, suggesting that they haven’t had a precise estimate until now [although there were always assumptions embedded in the model].    Then the chief economist –  who at almost every press conference tries to discourage the use  of a NAIRU concept –  chipped in claiming that any NAIRU was “very very variable” and “changes all the time”, without offering a shred of evidence for that proposition.

And then the head of financial stability chipped in, opining that estimates of NAIRUs around the world have been declining (not apparently seeing any connection between this thought and (a) the NZ experience, and (b) his colleague’s observation a few moments earlier that the numbers were pretty meaningless anyway.

Out of curiousity I had a look at the OECD’s published NAIRU estimates.  This is the NAIRU for the median OECD monetary areas (ie countries with their own monetary policy plus the euro-area as a whole).

nairu oecd

The estimate for 2017 is 5.3 per cent.  That for 2007 was 5.5 per cent.     There just isn’t much short-run variability in the structural estimates of the long-run sustainable unemployment rate. That is true for other advanced countries.  It is almost certainly true for New Zealand.    It reflects poorly on the Reserve Bank how little they’ve done in this area, and it one reason why a change in the wording of the statutory mandate is appropriate.  The unemployment rate is a major measure of excess capacity, pretty closely studied by most central banks but not, until now it appears, by our own.

(Of course, had they wanted to be a little controversial, they could have noted that proposed structural policy changes –  notably the increased minimum wages they explicitly allowed for –  will tend to raise (not lower) the NAIRU to some extent.)

If they were at sea on the unemployment rate issue, what really staggered me was the way Spencer (and Bascand) used the press conference to campaign for minimal changes to the statutory governance and decisionmaking model for monetary policy.      They didn’t need to say more than “decisionmaking structures are ultimately a matter for Parliament, and we will be providing some technical input and advice to the Treasury-led process the Minister of FInance announced earlier in the week”.

But instead, they took the opportunity to campaign for as little change as possible.  Spencer noted that they agreed the Act should be changed to provide for a committee, but noted that they already had a committee, they thought it worked well, and they would like to reflect that in the Act.   Others might challenge whether the advisory committee, or the Governor, has done such a good job in the last five years (or today) but set that to one side for the moment.

They loftily conceded that there were possible advantages to having externals on a committee –  the potential for greater diversity of view. But they were concerned that in a small country it could be very difficult to find outsiders with unconflicted expertise to make the system work.  There was nothing to back this –  no explanation, for example, as to how places like Norway and Sweden manage, or how we manage to fill the numerous other government boards in New Zealand.

But what they really hate –  and I knew this, but was still surprised to hear them proclaim it so openly, just as a proper review is getting underway –  is the idea that any differences of view might be known to the public.   They could, we were told, tolerate a system of ‘collective responsibility’ –  in which all debates are in-house and then everyone presents a monolithic front externally –  but were strongly opposed to any sort “individualistic committee” in which individual views might become known.    These systems –  of the sort prevailing in the UK, the United States, Sweden, and the euro-area –  have, they claimed, the potential to become a “circus” with too much media focus on monetary policy, and a concern about “heightened volaility” in financial markets.   Spencer went so far as to suggest that an individualistic approach could undermine the reputation and credibility of the institution.

A slightly flippant observer might suggest that the second XI and their former boss have done that all by themselves –  between the actual conduct of policy, and attempts (in which they all participated) to silence one of their chief critics.  A more serious observer might ask for some evidence from the international experience, to suggest that the more individualistic approach has damaged the standing of the Fed, the BOE, or the Riksbank.  Are these less well-regarded organisations than the Reserve Bank of New Zealand?    I’d have thought it would be hard to find such evidence.

Bascand –  one of the declared candidates for Governor –  then chipped in to note that what management was concerned about was to ensure that the focus of discussion was on the issues “the Bank” had identified, not on individuals or their particular views. Loftily –  earnestly no doubt – he declared that they wanted the focus to be on substance.  No doubt, as defined by management.   It reinforces the point I’ve made often that Bascand is the candidate for the status quo.  Bureaucrats setting out to protect their bureau.  Predictable behaviour – even if usually more subtle than this –  and what the public need protecting from.

There are successful central banks that adopt the collegial approach –  the RBA is one, albeit one with a rather old-fashioned committee decisionmaking model –  but there is nothing to suggest, in the international experience, that that model produces better outcomes, or a more credible central bank, than the individualistic approach.  Indeed, many observers would regard Lars Svensson’s open disagreement with his colleagues on the Riksbank decisionmaking committee as a useful part of the process that finally led the rest of the committee, including the Governor, to abandon their previous excessively hawkish approach a few years ago.

The second XI’s approach is that of “the priesthood of the temple” –  we will tell you, the great unwashed, only what it suits us to tell you, in the form we want to present it.  It is simply out of step with notions of open government, or with a serious recognition that monetary policy is an area of great uncertainty and understanding is most likely to be advanced by the open challenge and contest of ideas.

Fortunately, the new government shows signs of seeing things differently.   There is a minister for open government (admittedly, lowly ranked), a commitment to improving transparency under the Official Information Act.  And in the Speech from the Throne yesterday there was an explicit commitment –  not referenced by the Second XI, still trying to relitigate – that

“The Bank’s decision-making processes will be changed so that a committee, including external appointees, will be responsible for setting the Official Cash Rate, improving transparency.”

Note the use of “will”.   The Bank management’s preference for a “collective model” would do nothing at all to improve transparency.

It is all a reminder of how uncertain things still are, and how important the membership of the Independent Expert Advisory Panel the Minister of Finance has pledged to appoint as part of review of the Act might be (including whether the panel is really “expert” or –  as rumour suggests – a politician might chair it).   And also how important it is that Bank management do not have a leading say in the advice that goes to the Minister.  Management is paid to implement Parliament’s choices, not to devise models that cement in the dominance (and secrecy) of management.

It is also a reminder of just how important the appointment of the new Governor is, and why it remains hard to be confident about just how committed the government is to serious change when they’ve left that appointment in the hands of the Reserve Bank Board –  all appointed by the previous government, all on record endorsing the way things have gone for the last five years, and with a strong track record of serving the interests of management rather than those of (a) the public and (b) good public policy.

The Robertson reviews of the RB Act

When you’ve favoured a reform for the best part of 20 years, and made the case for it –  inside the bureaucracy and out –  for several years, then, even though it was a reform whose time was coming eventually, there is something deeply satisfying about hearing the Minister of Finance confirm that legislative change will happen.    That was my situation yesterday when Grant Robertson released the terms of reference for the review of the Reserve Bank Act, including specific steps that will before long end the single decisionmaker approach to managing monetary policy.   Various Opposition parties had called for change (the Greens for the longest), market economists had favoured change,  The Treasury had tried to interest the previous government in change five or six years ago, before Graeme Wheeler was appointed.  But now the Minister of Finance has confirmed the government’s intention to introduce legislation next year.   The amended legislation won’t be in place before the new Governor takes office, but presumably the policy will be clear enough by then that the new Governor will know what to expect, and what is expected of him or her.  Reform was overdue, but at least it now looks as though it will happen.

There were several aspects to yesterday’s announcement from the Minister of Finance:

  • the new “Policy Targets Agreement”,
  • the two stage process for an overhaul of the Reserve Bank Act, and
  • inaction on the appointment of the new Governor.

In what looks like not much more than a photo opportunity, Grant Robertson got Grant Spencer, current “acting Governor” of the Reserve Bank over to his office and together they signed a “Policy Targets Agreement” that was, in substance, identical to the one Steven Joyce and Grant Spencer had signed in June.

There was no legal need for a new Policy Targets Agreement (even if either of these two documents had legal force, which they don’t), and no incoming Minister of Finance has ever before requested a new PTA (the Minister has to ask, and can’t insist) that is exactly the same as the unexpired one that was already in place.   When National came to power in 2008, they did ask for a new PTA.   The core of the document –  the obligations on the Governor –  weren’t altered, but they did replace clause 1(b), which describes the government’s economic policy and how the pursuit of price stability fits in.  Under Labour that had read

The objective of the Government’s economic policy is to promote sustainable and balanced economic development in order to create full employment, higher real incomes and a more equitable distribution of incomes. Price stability plays an important part in supporting the achievement of wider economic and social objectives.

National replaced that with

The Government’s economic objective is to promote a growing, open and competitive economy as the best means of delivering permanently higher incomes and living standards for New Zealanders. Price stability plays an important part in supporting this objective.

If the new Minister of Finance really thought a new PTA was required to mark his accession to office, surely he could have at least replaced the National government’s policy description with one of his own –  even simply going back to Michael Cullen’s formulation, which actually mentioned full employment.

Apart from the photo op, I’m not sure what yesterday’s re-signing was supposed to achieve.  The Minister presented it as providing certainty to markets, but it does nothing of the sort: we are in the same position now we were a couple of days ago, Robertson had already told us he wouldn’t make substantive changes until the new Governor was appointed and we still have no idea who that person will be, or what the precise mandate for monetary policy only a few months hence will look like.  Nor, presumably, does the Reserve Bank.

And by signing the document, Robertson seems to have bought into Steven Joyce’s “pretty legal” (but almost certainly nothing of the sort) approach to the appointment of an “acting Governor”.    As I’ve noted previously, the Reserve Bank Act does not provide for an acting Governor except when a Governor’s term is unexpectedly interrupted (death, dismissal, resignation or whatever), and –  consistent with this –  there is no provision in the Act for a new Policy Targets Agreement with an acting Governor (since a lawful acting Governor will only be holding the fort during the uncompleted term of a permanent Governor who would already have had a proper and binding PTA in place).    Spencer’s appointment appears to have been unlawful, and Robertson has now made himself complicit in this fast and loose approach to the law.   Consistent with the fast and loose approach, he allowed Spencer to sign yesterday’s Policy Targets Agreement as “Governor”, not as “acting Governor”.  He cannot be Governor, since under the Act any Governor has –  for good reasons around operational independence – to have been appointed for an initial term of five years.  And he isn’t acting Governor, since there is no lawful provision for him to be so in these circumstances.  At best, he is “acting Governor” –  someone purporting to hold that title.

The heart of yesterday’s announcement, however, was the two stage process for reviewing and amending the Reserve Bank Act.

Phase 1:

The review will:
• recommend changes to the Act to provide for requiring monetary policy decision-makers to give due consideration to maximising employment alongside the price stability framework; and

• recommend changes to the Act to provide for a decision-making model for monetary policy decisions, in particular the introduction of a committee approach, including the participation of external experts.

• consider whether changes are required to the role of the Reserve Bank Board as a consequence of the changes to the decision making model.

A Bill to progress the policy elements of the review, including on the details necessary to introduce a potential committee for monetary policy decisions, will be introduced as soon as possible in 2018. This will give greater certainty on the direction of reform in advance of the appointment of the next Reserve Bank Governor, currently scheduled in March 2018.

Phase 1 of the review will be led by the Treasury, on behalf of the Minister of Finance. The Treasury will work closely with the Reserve Bank who will provide expert and technical advice. An Independent Expert Advisory Panel will be appointed by the Minister of Finance to provide input and support to both phases of the Review.

Phase 2:
In line with the Government’s coalition agreement to review and reform the Reserve Bank Act, the Reserve Bank and the Treasury will jointly produce a list of areas where further investigations of the Reserve Bank’s activities are desirable. This list will be produced in consultation with the Independent Expert Advisory Panel.

This list, and the next steps for the review, will be communicated early in 2018. This phase of the review will incorporate the review of the macro-prudential framework that was already scheduled for 2018.

It is clearly intended as a pragmatic approach.  With a new Governor to take office in March, they want to get on with the specific changes Labour campaigned on  so that they come into effect as soon as possible after the new Governor is in office (realistically, it is still hard to envisage the new Monetary Policy Commitee making OCR decisions and publishing Monetary Policy Statements until very late next year –  perhaps the November 2018 MPS – at the earliest.)  It also appears to aim to separate the things on which the government mostly just wants advice on how best to implement changes they’ve promised, from other issues that may need looking at but where the parties in government have not taken a strong position.

But it still leaves me a little uneasy, on a couple of counts.

First, while it would be easy enough, after due consideration, to make limited changes to the Act to give effect to the desire to make explicit a focus on employment/low unemployment without many spillovers into the rest of the Act (I listed here a handful of clauses I think they could amend to do that),  I’m less sure that is true of the monetary policy decisionmaking provisions.    As the terms of reference note, if monetary policy decisions are, in future, to be made by a statutory committee, it raises questions about the role of the Bank’s Board –  whose whole role at present is built around the single decisionmaker (the Governor has personal responsibility for all Bank decisions not just monetary policy ones).

But how can you sensibly make decisions about the future role of the Board without knowing what changes (if any) you might want to make to the Bank’s other functions?  If, in the end, you leave all the other powers in the hands of the Governor personally, something like the current Board structure might still make sense, with some minor changes as regard monetary policy decisions.  But if you concluded that a statutory committee was also appropriate for financial stability issues, and that even the corporate functions should be governed in more conventional ways (Board decides, chief executive implements), there might be no place at all for a Board of the sort (ex post monitoring and review agency) we have now.    Decisions about the governance of an institution need to start by taking account of all the responsibilities of the institution, not just one prominent set of powers.

Second, it may be difficult to maintain momentum for more comprehensive reform once the government’s own immediate priorities have been dealt with.    On paper, it doesn’t look like a problem, but resources are scarce, legislating takes time and energy, implementing new arrangements for monetary policy takes time and energy, and it would be easy for momentum on the second stage to lapse (whether at the bureaucratic level, or getting space on the government’s legislative agenda).    That risk is compounded by an important distinction between phases one and two.    In phase one, the Treasury is clearly taking the lead, on behalf the Minister.  In phase two, we are told, “the Reserve Bank and the Treasury”  (the order is theirs) will “jointly” produce a “list of areas where further investigations of the Reserve Bank’s activities are desirable”.    A joint list raises the possibility of the Bank holding a blocking veto –  not formally, but in practice –  and where the Bank is more interested in (a) blocking other far-reaching changes that might constrain management’s freedoms, and (b) advancing whatever list of minor reforms it might have in mind itself.

Perhaps in the end much will depend on the Minister himself, and on the Independent Expert Advisory Panel he plans to appoint.  But the Minister of Finance will be a very busy man, and up to now he has shown little interest in reforms of the Reserve Bank legislation beyond the first stage ones.

What of the panel?  We’ll know more when we see what sort of people are appointed to it, and how much time they are being asked to give to the issue.

In a set of Q&As released with yesterday’s announcement the Minister indicated of the panel that “they will be individuals with independence and stature in the field of monetary policy, including governance roles”.   That is probably fine for phase one (which is monetary policy focused), but the bulk of the Bank’s legislation, and much of its responsibility, has nothing to do with monetary policy at all.  So if the panel is going to play a substantive role in the planned phase 2, I’d urge the Minister to consider casting his net a bit wider.

As to who might serve on it, there aren’t that many with what look like the right mix of skill, experience, and independence.  It is sobering to reflect that when the (still secret) Rennie review on related issues was done earlier in the year, not a single domestic expert was consulted.  I imagine they will want to draw mainly on people who actually live here.  But if possible, I would urge Treasury and the Minister to consider inviting Lars Svensson to be part of the panel –  as someone who has undertaken a previous review for an earlier Labour government, someone who supports an explicit employment focus, and someone with practical experience as a monetary policy decisionmaker.    David Archer – a New Zealander (and former RB senior manager) who now heads the BIS central banking studies department – might also be worth drawing on.

The third dimension of yesterday’s announcement was the Minister of Finance’s comments about the process for appointing a new Governor.    There I think he is making a mistake.

In his Q&As, the Minister noted that “the process for appointing a new Governor is in the hands of the Board”.

Newsroom reports that, when asked, Robertson noted that

“I’ve met with the chair of the board and he has assured me that process is underway and well under way and going well. I sought an assurance from him that any candidates he was interviewing would be ones who would be able to implement a change to policy along the lines we’re going, he expressed his confidence about that but in the end the process itself lies in his hands.”

Appointing a new Governor of the Reserve Bank is –  or should be –  the most consequential appointment Robertson will make in the next three years.  For a time that person will, single-handedly, wield short-term macro-stabilisation policy (which is what monetary policy is) and –  perhaps indefinitely –  will wield all the regulatory powers of the Bank.  Even if committees end up being established for both main functions, the Governor will have –  and probably should have –  a big influence on how, and how well, macro and financial regulatory policy is conducted over the next five years.

There has been a pretty widespread sense that the Reserve Bank in recent years has not been operating at the sort of level of performance –  on various dimensions –  citizens and other stakeholders should expect.  That isn’t just about substantive decisions, but about supporting analysis, communications, operating style etc.  And yet the Reserve Bank Board –  and chairman Quigley –  have backed the past Governor all the way (whether on minor but egregious issues like the attempts to silence Stephen Toplis, or on the conduct of monetary and regulatory policy).   But the new government claims to want something different.   The issue isn’t whether a potential candidate can, as a technical matter, manage the sort of phase 1 changes the Minister plans.  I’m sure any competent manager could.  The more important issues are around alignment and vision.  Is the Minister content to leave the process to the Board –  all appointed by the previous government – and take a chance on them coming up with someone who represents more than just the status quo?   At this point, it appears so.  Apparently, the selection process will not be reopened, even though the advertising closed months ago and the role of the Bank (and Governor) is to be changed.

It is quite an (ongoing) abdication by the new Minister. In (almost all) other countries, the Governor of the Reserve Bank is appointed directly by political leaders (Minister of Finance, head of government or whoever).   Those leaders no doubt take soundings in various quarters, but the power –  and the responsibility –  rests with the politician.   Here, Grant Robertson just rolls the dice –  relying on a bunch of private sector directors appointed by his predecessors –  without (it seems, from the tone of his comment above) a high degree of confidence in the outcome.  Perhaps he’ll like who the Board comes up with. But if he doesn’t, so much time will have passed that he’ll be stuck. He can reject a Board nomination, but they’ll just come back with the next person on their own list, evaluated according to their own sense of priorities etc.  It isn’t the way appointments to very powerful positions –  the most powerful unelected person in the country for the time being –  should be done.

And two, very brief, final points:

  • now that the government has changed, and the Minister who asked for the Rennie review of Reserve Bank governance issues has gone, surely there can be no good grounds for continuing to withhold Rennie’s report and associated papers?  It is not as if it is playing any role in the current Minister’s thinking.

    Newsroom also asked Robertson if he had seen a review of the bank undertaken by former State Services Commissioner Iain Rennie that was requested by former Finance Minister Steven Joyce.   He said he was yet to see it, but had asked Treasury about it.

  • we are told to expect a new Policy Targets Agreement when the new Governor is appointed.   Presumably, true to past practice, the first the public will know about it is when the document –  guide to macro-management for the next five years –  is released.    It would good if the Minister of Finance would commit now to proper transparency, including pro-active release (once the document is signed) of  relevant documents.  It would be better still if he would think about adopting the considerably more open, and rigorous, Canadian model.

    Less than a year since completing the last review of its inflation-targeting mandate, the Bank of Canada is starting to prepare for the next one in 2021.

    Consultations kick off in Ottawa on Sept. 14 with an invitation-only workshop of economists that will be webcast on the central bank’s website. It’s an early public start to the process, and comes amid a growing sense that a deeper look at the inflation target is needed after almost a decade of poor economic performance.

A more open approach to these issues – as practised in Canada for years – has much to commend it (even if I didn’t always think so when I was a bureaucrat.)

Can any good thing come from the BIS?

The Bank for International Settlements was supposed to be wound up after World War Two.  That was agreed at the Bretton Woods conference in 1944, partly because the International Monetary Fund was being established, and partly because the BIS –  based in Basle, just over the border from Germany – was perceived to have got altogether too cosy with, and protective of the interests of, the other side.

But the BIS –  originally set up to handle reparations settlements and related issues –  survived.  These days it provides a variety of useful services to central banks around the world, provides a venue for various central bank meetings, and employs some interesting people and publishes some stimulating research.    The BIS was once largely a North Atlantic affair, but these days even the Reserve Bank of New Zealand is a shareholder.

Prior to the financial crisis and 2008/09 financial crisis, the then head of the BIS Monetary and Economic Department, Bill White, was one of the few prominent establishment voices foreshadowing serious problems ahead.  Inflation targeting, he argued, was one of the causes of the looming problems.  Few national central bankers were at all receptive to his views (not all of which, by any means, were correct).

These days, the head of the Monetary and Economic Department is Claudio Borio, a long-serving BIS economist who, individually and with co-authors, has published a series of papers on matters financial and macroeconomic that have also tended to challenge  the current “establishment view”.   Over the last few years he –  and the BIS –  have been sceptical of case for official interest rates being as low as they’ve actually been, arguing that economic outcomes might even have been better if interest rates had been higher, and that monetary policy should be driven more by considerations around ‘financial cycles” than by (the outlook for) inflation.    There is a lot of work resting behind these arguments, and even if I don’t end up agreeing with many of the conclusions, Borio’s articles and speeches are well worth reading for anyone interested in the issues (a recent accessible example is here, which I might back and write about substantively at some point)

The prompt for this post was a column that appeared in the (UK) Daily Telegraph a few days ago, in which their economics columnist Ambrose Evans-Pritchard sought to tie together the BIS/Borio views –  which would have argued for a much tougher approach to monetary policy in recent years (at least on conventional definitions) –  with the New Zealand Labour Party’s (and the new government’s) desire to amend our Reserve Bank Act.   The article, which various readers sent me, appears under the somewhat flamboyant heading “Apostasy in New Zealand spells end of global central bank era”  (the article is behind a paywall, but if you register you can get one article per week free).

It begins

The cult of inflation targeting began in New Zealand in the late Eighties. We may date its demise to a remarkable ideological pivot in the same country thirty years later, and with it the end of central bank ascendancy across the world.

Which would not, I’d have thought, be how Grant Robertson (or his senior colleagues in the new government) would have thought about what they appear to be proposing for New Zealand.  They aren’t proposing to change the inflation target range itself (or even, so far as we’ve heard, move away from the explicit midpoint added in 2012), but argue that in adding a requirement (details to be advised) that the Reserve Bank pay explicit attention to the maintaining something near “full employment” (long-run sustainable rate of unemployment), they are simply converging on the international mainstream.  In particular, they cite Australia and the United States.

And if pushed about what difference such a focus might have made had it been in the Reserve Bank Act in the past, Grant Robertson has suggested that the Reserve Bank would have been less likely to have tightened (as much) in 2014 –  the shortlived, ill-fated, tightening cycle that proved unwarranted by inflation developments.  In other words, if anything  (and no one can be sure that different words, but same Governor, would have made a difference), it would have been towards having interest rates a little lower, a little sooner, than otherwise.   In other words, the diametrical opposite of the approach that Claudio Borio, the BIS, (and Ambrose Evans-Pritchard) would have favoured.  If anything, I suspect that the BIS view may have influenced Graeme Wheeler’s enthusiasm for raising the OCR in 2014 –  with constant references to “normalising” policy.

Evans-Pritchard concludes his article

“[Western central banks] can excuse themselves for runaway asset prices, vaguely talking about the deformities of China’s Leninist capitalism, or the Confucian ethic, or some unfounded exogenous shock from Mars.  It has let them cling to inflation targeting shibboleths for far too long. Premier Ardern is the canary in the mineshaft.  It was the same New Zealand Labour Party back in the Eighties that pioneered so much of what we think of as globalisation [I’m really not sure where he gets that idea from], before it was gamed by the elites and began to go off the rails.  The Party now wants to reassert the primacy of the democratic nation state, and to call time on the excesses –  starting with a ban on home purchases by foreigners.  The global axis is shifting.”

The BIS –  or Evans-Pritchard –  might (or might not) be right about the politics or the economics globally.  But nothing we’ve seen or heard from the new Minister of Finance –  or his colleagues –  suggest that they have anything in mind for New Zealand monetary policy, or the mandate of the Reserve Bank of New Zealand, that steps outside the international mainstream at all.  That might disappoint some –  who actively prefer higher interest rates without first securing the productivity growth and investment demand which would sustain higher real interest rates –  but what those people wish for is nothing like what Labour’s words suggest we in New Zealand are likely to be delivered.

Of course, the first big decision about monetary policy for the new government is who should be the next Governor.   Individuals matter at least as much, arguably more, than the details of formal mandates.   In almost all other countries, political leaders themselves get to appoint directly the head of the nation’s central bank.  Obama appointed Janet Yellen, Scott Morrison (Australia’s Treasurer) appointed Phil Lowe, George Osborne appointed Mark Carney, euro-area heads of government appointed Mario Draghi, and so on.  It is the way democratic societies typically work –  actually, non-democratic ones come to that.  But not New Zealand.

Here, unless he changes the Act, the Minister’s hands are tied. He will have to appoint as Governor someone nominated by Reserve Bank Board.  All the Board members were appointed by the previous government, the advert for the job was framed under the previous government, all the Board members have endorsed the conduct of monetary policy (and the performance of the Bank more generally) in recent years, none has much experience in central banking, financial regulation, and none has any public accountability.  And yet they will decide who will, single-handedly (for the time being) wield the levers of macroeconomic policy.  It is a gaping democratic deficit –  even if you don’t think actual policy should be run even a little differently in future.   The Government could easily change those provisions, and bring New Zealand into line with standard international practice. It requires a simple amendment to the Reserve Bank Act, deleting six words.

Strong candidates for Governor aren’t exactly thick on the ground. But if the Minister were to make a change, or even to make suggestions to the Board, one of the people he shouldn’t go past actually works at the BIS.   David Archer currently holds a senior position at the BIS, but until 2004 had spent a decade as first Head of Financial Markets, and then as Head of Economics (including carrying the title of Assistant Governor) at the Reserve Bank.  He fell out with Alan Bollard and made his escape.

I worked closely with (and for) David across a couple of decades.  Up that close you see both the strengths and weaknesses.  David has a reputation as something of an “inflation hawk”.  That was perhaps most obvious over 2003/04, when he was right –  interest rates were too low for too long, and as a result core inflation got away on us (see the chart in yesterday’s post).   But such reputations (“hawk” or “dove”) usually don’t mean very much –  smart people will sometimes differ on how to read any data, and at different times the same person will end up on the different side of those debates.  David’s greatest strength in my view is a high degree of intellectual curiosity, a demand for rigour, but an openness to debate, to challenge, to exploration of alternative views and ideas. It certainly isn’t the only quality one needs in a Governor, but it is an important one –  perhaps especially in a single-decisionmaker system, but also as the Reserve Bank recovers from the Wheeler years.  He is the sort of person who attracts capable people –  again something the Bank will need in the coming years.

There are drawbacks, or gaps, as there are with all the possible candidates.   David hasn’t had much involvement in bank regulation or supervision –  now a big part of what the Bank does –  and was (rigorously) sceptical of the Reserve Bank getting actively involved in discretionary supervision and regulation.   I’m not sure how his views on these issues may have evolved over the years, but what could be counted on would be a rigorous and systematic approach to the application of the law, and to recommendations on any possible changes to the law.  And, of course, he has now been away from New Zealand for 13 years –  that brings the upside of extensive international contacts, but the downside of reduced familiarity with New Zealand (and the way the Bank’s own role in the public sector has evolved).    That people here still recognise his potential value was seen in Treasury’s choice of him as one of the external reviewers of the recent (as yet unseen) Rennie review –  Treasury is currently fighting to keep Archer’s comments secret.

David wouldn’t be a candidate for the status quo.  If the Minister of Finance is really content with the status quo, he might as well just stick with the Board-led process, likely to end up appointing Deputy Governor Geoff Bascand.  But whether around decisionmaking structures, transparency and accountability, and monetary policy goals themselves, all the public indications have been that the government is looking for change, and a lift in the overall performance of the Bank.   If so, Basle might well, on this occasion, be one of the possible alternative places to look for someone to take on this very influential, powerful, role.


OIA: unexpected bouquets and brickbats

I have been critical over the years of the Reserve Bank’s approach to Official Information Act requests.  I made mention of it, in passing, just this morning.   The long-established practice had been to withhold absolutely anything they could conceivably get away with, and to delay as long as possible anything they really had to release.   The presumptions of the Act (well, specific provisions actually), of course, operate in the opposite direction.

In the last couple of weeks I had lodged requests for a couple of pieces I had written while I was still working at the Bank in 2014.   One was the text of a speech, on New Zealand economic history and the evolution of economic policy, to a group of Chinese Communist Party up-and-coming officials, delivered as part an Australia New Zealand School of Government programme (in which they got to hear from John Key, Gerry Brownlee, Iain Rennie, no doubt a few others, and me).     The other was a discussion note I had written on how best to think of New Zealand’s economic exposure to China.    The second request was lodged only late on Monday.    I could not envisage any good (lawful) reason for them to withhold the material, but that often hasn’t stopped the Reserve Bank in the past.  If they released the material at all, I was anticipating a 20 working day wait.

But this afternoon, I received both documents in full.  I was shocked.  I took the opportunity to send a note to the Bank thanking them for the prompt response.  And as I have often been critical here of aspects of the Bank’s handling of various things, including OIA requests, I thought I should take the opportunity to record my appreciation openly.    Who knows what prompted the change, but it is an encouraging sign.  Perhaps the “acting Governor” (a sound caretaker, unlawful as his appointment may be) is making a positive difference?

On the other hand, I’ve usually been pretty openly positive about The Treasury’s approach to OIA requests.  One isn’t always happy with their decisions, but there is a strong sense that they generally do all they can to be as open as possible.    There is the look and feel of an agency that seeks to comply with the spirit of the Act, as well as the letter.

But not when it comes to the Rennie review.   Some time ago, they refused a journalist’s request for the terms of reference for the review.   They also refused to release some of the papers associated with the Rennie review (including drafts of the report) that I had requested some time ago .   In July they told me they wouldn’t release papers because of “advice still under consideration” (even though that is not a statutory ground, and Rennie is neither a minister nor an official, and even though I had not then requested a copy of the final report which had been delivered in April).

But time has moved on, and so early last week I lodged a fresh request.  This time I asked for:

I am requesting copies of :

  • the draft supplied to Treasury on 5 April 2017
  • the report delivered to Treasury on 18 April 2017
  • the version of the report sent out for peer review
  • the completed report incorporating any comments provided by the peer reviewers.
  • copies of comments supplied on the draft paper by peer reviewers
  • file notes of meetings Rennie or assisting Treasury staff had with non-Treasury people in the course of undertaking the review (including the Board of the Reserve Bank).

I am also requesting copies of any advice to the Minister of Finance or his office on the Rennie review, and matters covered in it, since 18 April 2017.

And this afternoon I got a response from The Treasury, refusing to release any of this material.

Their justification?

This is necessary to maintain the current constitutional conventions protecting the confidentiality of advice tendered by Ministers and officials.

That is, in principle, a valid statutory ground (unless public interest considerations trump it).  But…..Iain Rennie is not an official or a Minister, but was rather a contractor to The Treasury.

But what about the advice to the Minister himself (or his office)?  Well, according to Treasury,  “Mr Rennie’s report has not been tendered to the Minister of Finance, nor has any other Treasury advice on this issue since the report was commissioned.”

So, the report which was requested by the Minister of Finance himself (he told a journalist so in April which is how news of the review became public), which was finalised more than six months ago, has not been sent to the Minister of Finance at all, and nor has any advice from Treasury been sent.  Since oral briefings are covered by the Official Information Act, we must then assume that a notoriously hands-on minister has no idea what is in a report he requested, and which was finished six months ago.   Perhaps, but it seems unlikely.

Treasury tries to claim in its letter “that this work was commissioned to inform Treasury’s post-election advice”.  But that certainly wasn’t the impression the Minister of Finance was giving in April, when this was presented as his own initiative.   But even if that story is true, it still isn’t grounds for withholding a six months old consultant’s report paid for with public money.  It is official information, and releasing the report is not the same –  at all –  as releasing Treasury’s views on it.

There were three external reviewers of the draft report.  Comments were sought from:

  • Charles Goodhart, an academic and former Bank of England official and MPC member,
  • Don Kohn, former vice-chair of the Fed, and currently a member of the Bank of England’s Financial Policy Committee, and
  • David Archer, former Assistant Governor of the Reserve Bank and now a senior official at the Bank for International Settlements.

The comments of the first two are withheld on the standard ground “to maintain the current constitutional conventions protecting the confidentiality of advice tendered by Ministers and officials”, but neither Goodhart nor Kohn is either an official (of New Zealand or –  in Goodhart’s case of anywhere) or a Minister, and these are comments on a draft report I’m seeking, not something ever likely to get as far as the Minister of Finance.

Archer’s comments are withheld on different grounds:

  • “the making available of that information would be likely to prejudice the entrusting of information to the Government of New Zealand on the basis of confidence by the Government of any other country or any agency of such a Governoment or by an international organisation”

But there is no indication that Archer was commenting on behalf of an international organisation, but rather was offering personal views (rather than confidential “information”).   It isn’t, say, confidential information about the business of, say, the BIS.

  • “to protect information which is subject to an obligation of confidence where the making available of the information would likely prejudice the supply of similar information or information from the same source and it is in the public interest that such information should continue to be supplied”.

There is no evidence that (a) Archer’s comments, made presumably in a personal capacity, were subject to an “obligation of confidence”, or (b) that publishing his comments on a draft report would make him less likely to provide such comments (not clearly “information” in any case) on future Treasury consultants’ reports on Reserve Bank issues.      And nor is there any reason why this clause should apply any more to Archer’s comments than to those of Goodhart and Kohn –  for which it has not been invoked.

It is all (a) incredibly obstructive and (b) not remotely convincing.  I will be appealing The Treasury’s decision to the Ombudsman.  Perhaps some journalist might consider asking Steven Joyce if it is really true that he has no idea what is in the Rennie report that he asked for eight months ago, which was completed six months ago, and which is held by his own department.  Even if that is true, it is not good grounds under the Act for withholding a consultant’s report, let alone drafts of it.

So, well done Reserve Bank.  And it is a shame about The Treasury.