A public inquiry isn’t necessary

A few weeks ago in a post about what a new government might do about the Reserve Bank, I noted with some concern that the National Party had been very quiet on the issue.

I noted then that the process for reappointing (or not) Orr was likely to be getting underway very soon, and that if the Opposition thought it was inappropriate for him to be reappointed they needed to be raising concerns now (helping create a climate in which it would be more difficult for the government to push ahead) and not wait until (as required by law) the Minister has to consult other parties on the person he proposes to appoint as Governor (by when there would be considerable momentum behind any particular name).

So it was interesting and encouraging to see a press release yesterday from Luxon which appeared to raise serious concerns about Orr’s stewardship of monetary policy., apparently prompted at least in part by the Wheeler-Wilkinson (WW) note out yesterday morning, which has had considerably coverage. The centrepiece was a call for an independent public inquiry

tied to the issue of whether or not Orr is reappointed thus

Count me sceptical.

There have been a couple of earlier strands to calls for inquiries. The Green Party has for some time been calling for the Finance and Expenditure Committee to inquire into the conduct of both fiscal and monetary policy over the pandemic period. They have had support in that call from both ACT and National but the Labour majority (no doubt on instructions from above) simply refuses. It seems to me a natural topic for a serious select committee to look into, and even allowing for the partisan priors of all participants, it isn’t impossible such a review could shed some light.

The second, and more recent, strand is that inquiry into the RBA that the incoming Labor government in Australia has established (terms of reference here). But this inquiry isn’t really relevant to the issue here, and while pandemic responses aren’t out of scope the focus of the inquiry seems likely to be on policy frameworks more broadly and the governance model. On the latter, the current New Zealand government has only recently legislated for new models, for monetary policy specifically and the Bank more generally. As I’ve highlighted in various posts on this blog, there are a lot of problems with the new arrangements, but this government is hardly likely to revisit its own creations so quickly. That (I hope) will be a matter for a new government one day.

Note also that the RBA review, with reviewers already appointed, has to report by March next year. The question of the (re)appointment of a Governor here has to proceed on a much faster track than that, since Orr’s term expires in late March. As I noted in my earlier post, I expect that the question of the (re)appointment will be on the Board’s agenda very shortly, with a goal (Minister, Board, Bank – and probably markets) of having everything more or less settled by Christmas. Consistent with that, I saw this in Bernard Hickey’s newsletter this morning

Finance Minister Grant Robertson immediately refused yesterday to agree to a review and said he was in discussions with the Reserve Bank’s board about the re-appointment process. 

Robertson has ruled out a review, but even if he hadn’t I don’t think it would be a particularly good use of public money to have one. Apart from anything else, it is hard to think of anyone in New Zealand who knows the territory who is not conflicted or who has not already declared their hand (often in quite strong terms).

In other comments, the Minister has pointed out that the Bank’s Board is responsible for reporting and reviewing the Bank’s performance. Of course, there he is just playing distraction since he appointed both the old and new boards (and their chairs) and knows that the Board is on record (minutes released under the OIA) as having done no serious scrutiny or evaluation of the Bank’s monetary policy performance. Nor is there any sign that the Minister has ever asked for more. And, most recently, he has appointed a new Board that is manifestly underqualified for the statutory roles of holding the Governor and MPC to account, or recommending the appointment of a future Governor. Other OIAs show that the Minister just reappointed two of the MPC members – in the midst of a really troubling period for monetary policy – with no serious attempt to evaluate their performance at all.

In addition, The Treasury is now formally charged with a role monitoring the Bank’s performance. It is hard to be optimistic that will deliver much (the institutions are typically too close) but there is no sign Robertson has any serious interest in enhanced scrutiny or analysis. (In addition, of course, Treasury is more than a little compromised by their closeness to the Bank – including the Secretary as non-voting MPC member – and the advice they provided at the time, including recommending the Minister enable the LSAP programme.)

Finally, it is true that the Reserve Bank is working on its own evaluation of its handling of policy over recent years. We can expect this to largely be a self-serving self-congratulatory piece being done by staff (not even by the MPC) but even so when they eventually publish it it will still provide a basis for discussion and critique. The Bank tells us it has taken some independent overseas advice, but if that sounds reassuring it probably shouldn’t: they haven’t told us who they have sought advice from, and it is hardly a novel insight to suggest that the choice of overseas person is quite likely to be influenced by what the Governor already knows of that person’s views. One can always find a sympathetic commenter.

The real reason I don’t think an independent inquiry is warranted is that we already know pretty much all there is usefully to know. Defenders of the Bank/Governor will interpret the set of data one way, and others will contest a range of alternative interpretations. It is, and should be, a process of contest and debate. And the issues relevant to the question of whether Orr should be reappointed by not even close to limited to those around the pandemic response (in fact, I would argue that these later points should not be given too much weight at all). We know about things like:

  • Orr’s bullying style,
  • his lack of receptiveness to scrutiny, challenge, and criticism (most evident in the bank capital review process),
  • the high rate of turnover of staff, particularly senior staff,
  • the top-heavy management structure he has put in place, in which very few have much evident subject expertise (eg the deputy chief executive responsible for macroeconomics, monetary policy and markets, who has no background in economics at all),
  • the really big increase in the size of the Bank (with no material change in responsibilities), in many cases in non-core areas (notably the very large communications staff),
  • the distracted focus and politicisation of the Bank as Orr has pursued his climate change, indigenous network, tree god, and similar interests, for which he has no statutory responsibilities,
  • the absence of serious speeches from the Governor shedding light on his thinking or analytical frameworks around areas of his core responsibility,
  • the degrading of the Bank’s research and analysis capabilities (despite the massive increase in total staff) that has seen very few serious research papers published in recent years,
  • the insular monolith the Governor has helped create in the MPC, where outsiders with relevant ongoing expertise are banned from being appointed to the Committee, and challenge and dissent (let alone public accountability) appears to be actively discouraged.

All these speak of someone not fit for the job, someone who isn’t even that interested in developing a world-class small central bank or doing the core functions of the Bank excellently.   We don’t need an inquiry for any of that.

What of the pandemic response?    Perhaps there is case that could be made that any time core inflation gets so far outside the target range, the Governor and most of the MPC should lose their jobs almost automatically.   Such a regime might be better than one in which leading central bankers (globally) rarely pay much (if any) personal price for their mistakes, no matter what cost they impose on the public in the process.  $8 billion plus in losses on the LSAP speculative punt (with not even any evidence of a robust risk analysis before launching the scheme) isn’t nothing, and neither is the recession likely to be required for getting core inflation back down again.  They are serious failures.  Honourable people responsible might well choose to resign, or not seek reappointment.  They took the job, and the pay and prestige, and accept that there is a price to be paid when things go badly, if only to encourage others.

But what makes me hesitant is that these choices were not made in a vacuum.  Others, with incentives to get things right, had views at much the same time as the Orr-led Reserve Bank was making its call, and the middle-ground of expert opinion at the time was not, I assert, wildly different to the policy choices Orr and the MPC (and their peers abroad) were making.  I take seriously the idea that when central banks are targeting inflation, their forecasts matter hugely (given the lags, perhaps almost as importantly as outcomes).   At the times the Reserve Bank was making key choices, their forecasts –  which I will treat as their honest best effort –  either showed (core) inflation undershooting the target range (the case for most of 2020), or staying in the range based on policies similar to those they adopted.

I would accept that there was a good case for not reappointing Orr (and the MPC) if:

  • New Zealand’s Reserve Bank was the only one to have made the same mistake (thus, they ignored relevant perspectives from peers), and/or
  • the Reserve Bank’s forecasts and policy actions at the time they were made were seriously out of step (in what proved to be the wrong direction) with those of most serious observers, forecasters, commentators, and/or market prices

But as far as I can see that was not the case, on either count.   Sure, there were always people critical of some or other aspect of what the Bank was doing (I was an early critic/sceptic of the LSAP policy, although did not anticipate how large the losses they would run might be), and (of yesterday’s authors) Bryce Wilkinson was among them.  But often, at least I would argue, those who disagreed with some or other aspect of what the Bank was doing may have been right for the wrong reasons, and right analysis counts in making judgements about key policymakers.

People will, reasonably enough, point out that there are several advanced countries that have not seen the extent of the rise in core inflation New Zealand (and most others) have.  Thus, they suggest, there was wisdom our Reserve Bank could have followed and did not.  I’m not convinced.  The countries that have not seen much of a rise in inflation seem mostly to have been those that were already at the effective lower bound in early 2020.  They did not materially ease monetary policy because they could not.  It is unknowable at this point what they would have done if they’d had the capacity (and New Zealand and Australia and the US did have that capacity –  starting with policy rates still materially above zero).

It isn’t a common position for me to be defending the Bank, and in many respects I don’t (to me, there is a strong case for not reappointing Orr on things it is quite appropriate to directly hold him to account for –  his choices, his information).   But there is an element of the last 2.5 years that may have been simply unknowable with any great conviction or certainty.   Sadly, no one I’m aware of was (18 months ago) forecasting that New Zealand would soon see record low unemployment (similar outcomes in many other countries).  With hindsight, perhaps they should have, but it was an idiosyncratic shock –  pandemics, lockdowns, virus and policy uncertainty –  for which we (and central banks) had no real precedents.    I’m still happy to argue that the LSAP should have been stopped in the second half of 2020 when it was clear the world wasn’t ending, but….at the time the Bank still had very low inflation forecasts (and if others differed, no one I’m aware of differed to a huge extent).  I’m quite content to argue that the Bank –  and peers abroad –  should have started raising the OCR earlier and more aggressively last year but……given the lags it isn’t likely that any credible tightening started mid last year, even done at some pace, would have made a lot of difference to the inflation we have seen in the latest June quarter numbers (but would have brought it down sooner and faster). But again, who was openly calling for tightenings last May or June (for myself, the May MPC was the first time in almost a decade I’d been more “hawkish” than the Bank, but I wasn’t then calling for immediate OCR increases). 

Perhaps societies need scapegoats, but it isn’t self-evidently obvious that a reasonable human set of central bankers at the RBNZ would have been likely to have done better than Orr did in that particular set of circumstances.  The Bank is wrong to allow the suggestion to continue that they moved earlier by international standards (they were nearer the median of OECD central banks), but they were a bit earlier than the Anglo central banks we often default to comparing against.

Perhaps I’m just playing devil’s advocate here, but I don’t think so.  There is a real point about the limitations of human knowledge, and of what we might realistically expect from a typical (not exceptional –  you’ll rarely find them) central banker.    And a quickfire inquiry wouldn’t really help resolve that one.

It is encouraging that National is beginning to get down off the fence again (after Luxon initially shut down Bridges saying National had no confidence in Orr late last year).    But they probably need more confidence in their convictions (assuming they have found some) and be willing to back a case that the Governor should not be reappointed, and the external MPC members should be replaced as their terms expire.   Much of what Orr has done, and failed to do, has been done with the apparent approval, or even endorsement of the Minister of Finance (who thus shares some responsibility).  But in the end, Robertson has the choice to jettison Orr if he becomes a liability for the government.  An honourable Governor would probably walk away, expressing his regrets for the outcomes he has presided over.  So far, (per past select committee appearances and yesterday’s statement) Orr appears to regret nothing about policy, even with hindsight, and if he has regrets at all it is the empty and meaningless regret that Covid itself has intruded.

I regret that the Committee – and society at large – has been confronted with the COVID-19 pandemic, and other recent events that have caused food and energy price spikes. 

We should regret that Robertson appointed a Governor who has done so poorly, who has cost New Zealanders so much, and regret that Robertson has gone along with the Governor in barring the appointment of an open and excellent MPC, following that up with the appointment of a weak and inadequate board.

What might be done about the Reserve Bank

(And other economics agencies of government, but the Reserve Bank should be the highest priority given the extent of the decline and the substantive importance/powers of the institution.)

On Friday my post focused on the (severe) limitations of the members of the new Reserve Bank Board. Together, they look as though they would be a well-qualified (perhaps a touch over-qualified) group for the board of trustees at a high-decile high school……but this is the central bank and prudential regulator.

I had a couple of responses suggesting that, if anything, I was pulling my punches, understating the severity of the situation, when it came to the Reserve Bank. One person, who preferred to remain nameless (having high level associations with entities the Bank regulates), indicated that I was free to use their comments provided it was without attribution. These were the comments:

The situation is parlous: inept, multi-focussed but wrong focus, terrible judgement, appalling hires, complete absence of appropriate governance, woeful expertise, [backside]-covering of the regulator rather than interaction. I have zero confidence in their leadership, judgement, processes, balance of hires, and particularly governance governance which has been enabling of dross.  

I guess the Governor could, in response, point to the recent NZ Initiative survey (of the regulated) suggesting the Bank’s standing among that community had improved in recent year (it was never clear to me why, other than the decision to move one key individual who had had significant responsibility for prudential policy).

So views will differ, and if – based mostly on what we all see – my views are a bit less harsh than those of some, it seems clear to me that there is a significant problem, and that with the new Board appointments the situation is worsening. The entire new governance and decisionmaking structure – overhauled over several years – is now in place with an MPC where serious expertise is explicitly a disqualifying factor for appointment as an external member (the people who are supposed to represent a check on management), and a Board where in practice serious subject matter expertise (financial stability and regulation or macro) also seems to have been treated by the minister as a disqualifying factor. And all this with a senior management team that is inexperienced (3 of the 4 internal members) or in the case of the Governor mediocre on a good day and more interested in other things (“patently inadequate” for the job was the stronger description of my commenter). Oh, and a Minister of Finance who doesn’t seem to have much interest in building excellent institutions or achieving excellent policy outcomes, who falls short of the standard citizens should be entitled to expect.

What we don’t know is how the National Party Opposition see things. They are their partner now lead in the polls and seem to have a pretty good chance of forming a government after the next election. Since Simon Bridges late last year, just after becoming the Finance spokesperson, said that National would not back reappointing Orr and was shut down within hours by his new leader, we’ve heard nothing much at all from National. You get the sense that the Governor is not exactly their cup of tea, but what (if anything) do they propose to do and say. They (and the other parties) were required to be consulted on the Board appointments. But whether they were happy, or pushed back vigorously, we have heard not a word from the new Finance spokesperson. Silence risks counting as (perhaps resigned) assent.

The Governor’s current five-year term expires in late March next year (ie less than 9 months from now). The process for filling the slot is likely to be getting underway very soon, and it would surprise me if the government (and the Bank) did not want to have everything resolved before Christmas. Under the Act, the Minister can turn down any candidate the Board nominates, but the Minister cannot impose his or her own candidate – ultimately whoever is appointed must be nominated by the Board. There is, of course, nothing to stop the Minister telling the Board in advance that he would not accept a nomination of a particular person or class of persons. In practical terms, there is also nothing to stop the Minister telling the Board who he might like them to nominate – although with a capable and independent Board that approach would risk backfiring.

Most RB-watchers treat the reappointment of Orr as pretty much a foregone conclusion (assuming the Governor has not found greener pastures in which to labour). At present, I agree. But that is partly because of the silence where one might have hoped there was an effective political Opposition. If National is content to resign itself to another five years of Orr – using his platform as head of a technocratic non-partisan institution to champion personal left-wing causes, operating with his bullying and divisive style, presiding over a sharp downgrading of the Bank’s research and analysis capability, losing billions of dollars for the taxpayer and then (together with the surge in core inflation) brushing it all off with a “I have no regrets” – they should just keep right on as they are.

But if they aren’t content, they should be saying so, forcefully and often, now. If Labour really insists on reappointing Orr, there is not much formally that can be done to stop it – a brand-new board, selected in part by Orr, is simply not going to decline to recommend reappointment. The only chance of him not being reappointed (assuming he still wants the job) is for Labour (Robertson) to decide it isn’t worth it for Labour to continue to back Orr. We should hope for Governors who are broadly acceptable across the spectrum (not necessarily the ideal candidate for the other side, but broadly tolerable nonetheless) – after all, they wield a great deal of power, can’t easily be dismissed, and Labour itself inserted the new clause in the law requiring the Minister to consult other political parties in Parliament before appointing a person as Governor. “Consult” does not mean “obtain consent or support”, but in a context like this it should mean “take seriously very strong opposition, especially from a range of parties, or perhaps from the largest other party”. It was, after all, Labour that just introduced the provision. But waiting until December to privately express concern is a pathway towards just being ignored – by then the reappointment process would have a lot of momentum behind it already. Now is the time to start speaking out, carefully but forcefully. If they care.

In the New Zealand system, most official appointees have fixed terms and cannot simply be dismissed and replaced immediately by a new government. Mostly, that is a good thing. The position of Governor of the Reserve Bank is one of those positions. So, it seems, are appointees to the MPC and the Board.

Each of these individuals or classes of people can be replaced at any time, but only “for (just) cause”, and what counts as “just cause” is defined in the Act. In the case of the Governor

The provisions around removal the Governor from office seem more tightly drawn than they were under the previous legislation (which may have something to do with the formal responsibility for many things the Bank does having been shifted to the Board).

Much as I am critical of a lot of what has happened at the Bank during Orr’s tenure, none of it (individually or collectively) adds up to enough to represent a credible basis for removing him. Are $8bn of LSAP losses dreadful and without excuse? Sure, but it was the Minister of Finance who agreed to the policy and the risks. Is it bad that inflation is at about 7 per cent? Sure. Could the Bank have prevented core inflation getting above 4 per cent? Most probably, and I think there should be searching criticism of the Bank’s failure, and lack of transparency/accountability. But it just isn’t enough to sack a Governor mid-term, especially when (a) so many other countries are seeing something similar, and (b) the median market economist/commentator wasn’t much better when it mattered (last year). One might reasonably lament the decline in the analytical and research output, some poor appointments and massive losses of senior staff. One might lament the diversion of focus onto non-central banking things like the tree gods and climate change. But no one is ever going to sack an incumbent Governor mid-term over such failings (and the Minister often seems to have welcomed the diffusion of effort), bearing in mind the risk of being judicially reviewed, and the attendant lengthy period of (market) uncertainty. It just won’t happen (and probably shouldn’t).

Which is why, if National were to be seriously bothered about Orr they need to be speaking out now and focusing on the looming reappointment.

Fortunately, even if reappointment is the key, there are other levers for promoting change. The Monetary Policy Committee’s Remit can be altered (and, no doubt, the forthcoming financial policy one), including to take out the woolly and irrelevant (to monetary policy) references to sustainable and low carbon economies. National is proposing to delete the employment limb of the target (on this, I agree with the Governor, that the amendment adding it hasn’t made more than cosmetic difference, and nor would reversing it). Ministerial letters of expectations aren’t binding, but they are one more lever, and a new government could make clear from the start that it expects the Bank to focus on its core responsibilities, expects a lift in the quality and range of research outputs etc. The Minister could also amend the rules around the MPC to, for example, require individual votes and reasons for those votes to be disclosed, and to create an expectation that individual MPC members could be expected to make speeches, give interviews, front FEC, and generally be accountable for their view. Small legislative changes to move the responsibility for MPC appointments purely to the Minister (not mediated by the Board) would also be a step in the right direction, weakening what is now a heavy degree of gubernatorial control over monetary policy and the committee.

And then there are the appointees themselves. By the time a possible National government takes office, Orr may be just 6-8 months into a second five year term. But quite a few of the new Board members have been appointed for terms that expire in mid-2025. A new government should begin looking early for high quality people, with strong subject expertise, to replace them. And what of the MPC? There are three external members. One has a term that expires next April, and will have either been reappointed or replaced by the current government. But one member – Peter Harris, who has had close Labour Party associations – has an extended term expiring next October. That should be a date that disqualifies a permanent appointment being made prior to the election (it still puzzles me why Labour chose that date – he could easily have been extended for 2 years rather than 18 months). And the final member has a term expiring in April 2025. It should be made clear to all involved that there will no longer be a bar on appointing people of demonstrated ongoing excellence and capability in macroeconomics and monetary policy, and that the Minister would have a strong preference to appoint at least one such person at the earliest opportunity.

And then there is the budget. The Bank is an unusual government agency, in that it is not funded by annual appropriations (in the way many important – with aspects of independence – agencies are) but through a five-yearly funding agreement, governing how much of its own earnings can be used as operational spending. There are a number of flaws in this procedure but it is what it is, for now at least.

The Bank was given a massive increase in funding in the agreement approved in 2020. But one of the interesting (broadly incentive-compatible) aspects of the arrangement is that permitted spending is specficied in nominal terms for five years. Above target or unexpectedly high inflation makes nasty inroads on the Bank’s real capacity to spend. As wages and salaries rise faster than originally allowed for, that bite is likely to be coming on soon. Moreover, although the agreement wasn’t signed until late Feb 2020, by the time a possible new government takes office (say next November) the Bank will be very conscious that the next round of negotiations will be looming before too long. The final year covered by the current funding agreement is 2024/25, but if you were the Bank (management and Board) you would be wanting some clear signals from the Crown fairly early as to how much the Bank might have available to spend in the following five years. An early signal (say by the time of the 2024 government Budget) from an incoming Minister of Finance that s/he was minded to materially reduce real Reserve Bank spending in the future funding agreement would affect choices the Bank was making from them. National seems to be struggling to identify expenditure savings, and while the Reserve Bank is not that big in the scheme of things, it is much bigger and more expensive that it was five years ago, and ripe for trimming down. The basic functions of the Bank haven’t changed, but the size of Orr’s empire has blown out. It should be pulled back. Ideally, the legislation should be amended to allow the Minister to better specify what money is spent on, but it should be made clear to the Governor and the Board that the Minister expects a ruthless focus on core functions (not, eg, a proliferation of comms or climate change people). The office of Governor might be much less appealing to someone like Orr if he was compelled to manage in that way. That, on this scenario, would not be a bad thing.

And all this without even touching on those mind-numbing documents like the Statement of Intent. The Minister can require a new Statement of Intent at any time, and the Bank must take seriously (“consider”) the Minister’s comments on a draft.

All this is by way of saying that while, if National cares about the Bank, it should focus now on building a climate where it is not worthwhile for Labour to stick by Orr (or where if they do it just looks like a poor and partisan appointment), there are plenty of avenues open to a new Minister to put pressure on to constrain the Governor’s behaviour, his dominance of the MPC process, his empire, his focus, his style and so on. But a new Minister has to want change, and be prepared to follow through consistently.

Finally on the Bank, it is fair to note that it is one thing to argue that Orr should not be reappointed, but quite another to identify an excellent potential replacement. There are no immediately obvious potential nominees of the stature required to begin credibly rebuilding the institution (Bank and MPC). That itself is a poor reflection on the way the Bank has been run for at least the last decade (contrast say the RBA or the Bank of Canada), and perhaps symptomatic of wider weaknesses now at the upper levels of the New Zealand public sector more generally. But just because there is no obvious single name now, isn’t a reason to stick with such a poor incumbent (and if there isn’t an obvious replacement, I can think of several who could, at least as part of a new team, do the job, and we should at least be open to the possibility of a foreign Governor (even if such an appointment might be less easy than it sounds)).

This post has been focused on the Reserve Bank. But there are other agencies a new Minister of Finance will have to pay attention to. There is little point expecting different outcomes if you leave the same people (and sorts of people) in place (and there is a wider question there about what sort of person a new government will replace Peter Hughes, the Public Service Commissioner) with in mid 2024). But the open question still is whether National really cares much about different outcomes, or is primarily interested just in gaining and holding office. Voters might like some idea of the answer.

All his boasted pomp and show

The Reserve Bank Governor appears to have been communing with his tree gods again, and last week released a speech he’d delivered online to an overseas audience headed “Why we embraced Te Ao Maori”. It isn’t clear quite how many people were in the audience for this commercial event run by the Central Banking (private business) publications group, but I’m guessing not many. The stream Orr spoke in featured just him, a panel discussion on how “digital finance can drive women’s inclusion”, and a presentation on “how can central banks put climate change at the core of the governance agenda”. While it was called the “governance stream”, a better label might be the woke feel-good stream, far removed from the purposes for which legislatures set up central banks.

In many ways, the smaller the overseas audience the better, and I guess his main target audience was probably domestic anyway. He claims to be keen on the concept of “social licence” (personally, I prefer parliamentary mandates, deliberately adhered to and closely monitored) and no such “licence” flows from second or third tier central bankers abroad.

There are several things that are striking about the speech. Sadly, depth, profundity or insight are not among them.

Orr has now been Governor for just over four years (his current term expires in March). In his time as Governor he has given 23 on-the-record speeches (fewer as time has gone on)

The speeches have been on all manner of topics – although very rarely on the Bank’s core responsibility, monetary policy and inflation, a gap that has become more telling over the last year or so. Unfortunately, coming from an immensely powerful public official, it is hard to think of any that are memorable for the valuable perspectives they shed on the Reserve Bank’s core policy responsibilities or its understanding of, and insights on, the macroeconomy and the financial system. His Te Ao Maori speech is no exception, and is probably worse than average. From a central bank Governor.

In the speech, we get several pages of a quite-politicised black-armband take on what might loosely be called “history”. Perhaps it will appeal to elements on the left-liberal electorate in New Zealand (eg the editors and staff on the Dominion-Post). I’m not going to try to unpick it – it simply has nothing to do with central banking or the Governor’s responsibilities – although suffice to say that if one wanted to traverse history in a couple of pages, one could equally choose quite different points to emphasise. In essence, we have the Governor using his official platform to (again) champion his personal politics. That is – always is, no matter the Governor, no matter their politics – inappropriate, and simply corrodes the confidence that should exist that the Reserve Bank is a disinterested player serving in a non-partisan way the narrow specific responsibilities Parliament has given it independence over.

The speech burbles on. The audience is reminded of the tasks Parliament has given the Bank to do

But this is immediately followed by this sentimental bumpf

But – and rightly – “environmental sustainability, social cohesion and cultural conclusion” (whatever their possible merits) are no part of the job of the Reserve Bank. Parliament identifies the Bank’s role and powers, not the Governor. And all this somehow assumes – but never attempts to demonstrate – that some (“a”) Maori worldview is better for these purposes that either some other “Maori worldview” or any other “worldview” on offer. As for the “long-term”, a key part of what the Reserve Bank is responsible for is monetary policy, where they are supposed to focus on cyclical management, not some “long term” for which they have neither mandate nor powers.

Get right through the speech and you’ll still have no idea what the Orr take on “a” Maori worldview is. Thus, we get spin like this

Except that, go and check out the Bank’s Statement of Intent from 2017, the year before Orr took office, and the values (those three i words) were exactly the same. All they’ve done is add some Maori translations on the front. If anything, it seems more like a Wellington public-sector worldview (“sprinkle around some Maori words and then get on with the day job”), but Orr seems to sincerely believe……something (just not clear what).

Then we get the repeat of the “Reserve Bank as tree god” myth. The less said about it the better (and I’ve written plenty before, eg here). But even if it had merits as a story-telling device, it is substance-free.

We get claims about “the Maori economy”. Orr cites again a study the Bank paid BERL to do, the uselessness of which was perhaps best summarised by the report’s author at a public seminar at The Treasury last year, of which I wrote briefly at the time

Even the speaker noted that “the Maori economy” is not a “separate, distinct, and clearly identifiable segment” of the New Zealand economy

The last few pages of the speech purport to tell readers about their Maori strategy. There are apparently three strands. First, is culture

To which I suppose one might respond variously (to taste), “well, that’s nice”, “what about other world views?” and “wasn’t that last paragraph rather suggestive of the public sector worldview above – scatter some words and get on”.

Then “partnering”

There is more of that, but none of it seems to have anything to do with the Bank’s statutory goals, it is more about officials using public money to pursue personal political objectives. Incidentally, it also isn’t obvious how any of it reflects “a Maori worldview”. I’d think it was quite a strange if the Reserve Bank were to delete “Maori” from all these references and replace, say, Catholics (another historic minority in Anglo-oriented New Zealand).

The final section is headed “Policy Development” and you might think you were about to get to the meat of the issue – here finally we would learn how “a” “Maori worldview” distinctively influences monetary policy, banking regulation, insurance regulation, payment system architecture, the provision of cash etc. The section is a bit long to repeat in full, but you can check the speech for yourself: there is just nothing there, of any relevance to the Bank’s core functions. Nothing. No doubt, for example, there are some real issues – and real cultural tensions – around questions of the ability to use Maori customary land as collateral, but none of it has anything to do with anything the Reserve Bank is responsible for. And nothing in the text suggestions any implications of this vaunted ill-defined Maori world view for the things the Bank is supposed to be responsible or accountable for. And still one would be left wondering why, if there were such implications, Orr’s personal and idiosyncratic take on “a Maori worldview” would take precedence over other worldviews, or (indeed) the norms of central banking across the world.

It is a little hard to make out quite what is going on and why. A cynic might suggest it was all just some sort of public service “brownwash”, designed to impress (say) the Labour Party’s Maori caucus and/or the editors and staff at Stuff. But it must be more than that. They seem sincere, about something or other. Recent minutes of the Bank’s Board meetings released under the OIA show that all these meetings now begin with a “karakia”, a prayer or ritual incantation. It isn’t clear which deities or spirits these incantations are addressed to, or whether atheists, Christian or Muslim Board members get to conscientiously object to addressing the spirits favoured by Messrs Orr and Quigley (the Board chair). But whoever they address, these meetings happen behind closed doors, only rarely given visibility through OIAs, so I guess we have to grant them some element of sincerity, about something or other.

But it seems to be about championing personal ideological agendas, visions of New Zealand perhaps, not policy that this policy agency is responsible for, all done using public funds, public time. And would be no more appropriate if some zealous Catholic-sympathising Governor were touting the importance of “a” Catholic worldview to this public institution, even if – as with the Governor and his “Maori worldview” – it made no difference to anything of substance at all. There is pomp and show, but nothing of substance that makes any discernible difference to how well or badly the Bank and the Governor do the job Parliament has assigned them.

Go through the Bank’s Monetary Policy Statements and the minutes of the MPC meetings. They might be (well, are) fairly poor quality by international standards, but there is nothing distinctively Maori, or reflective of “a Maori worldview” about them. Do the same for the FSRs, or Orr’s aggressive push a few years ago to raise bank capital requirements. Read the recent consultative document on the future monetary policy Remit, and there is nothing. Read – as I did – six months of Board minutes recently released under the OIA, and there is no intersection between issues of policy substance and anything about “a Maori worldview”.

The Bank has lost the taxpayer $8.4 billion so far (mark to market) on its LSAP position.

The Bank has published hardly any serious research in recent years

The Bank and the Minister got together to ban well-qualified people from being external MPC members

Speeches with any depth or authority on things the Bank is responsible for are notable by their absence.

We have the worst inflation outcomes for several decades

And we’ve learned that Orr, Quigley and Robertson got together and appointed to the incoming RB Board – working closely now on Bank matters – someone who is chair of a company that majority owns a significant New Zealand bank.

The Bank has been losing capable staff at an almost incredible rate, and now seems to have very few people with institutional experience and expertise in core policy areas

There is one failure or weakness after another. But there is no sign any of it has to do with Orr’s (non-Maori) passion for “a Maori worldview”; it is simply on him. His choices, his failures (his powers – the MPC is designed for him to dominate, and until 30 June all the other powers of the Bank rest solely with him personally). If the alternative stuff (climate change, alternative worldviews, incantations to tree gods) has any relevance, it is as a symptom of his unseriousness and unfitness for the job – distractions and shiny baubles when there was a day job to do, one that has recently presented the biggest substantive challenges in decades.

Shortly after the speech was delivered, another former Reserve Banker Geof Mortlock, who these days mostly does consultancy on bank regulation issues abroad, wrote to the Minister of Finance and the chairman of the Reserve Bank Board (copied widely) to lament the speech and urge Robertson and Quigley to act.

I agree with most of the thrust of what Geof has to say, and with his permission I have reproduced the full text below.

But asking Robertson and Quigley to sort out Orr is to miss the point that they are his enablers and authorisers. A serious government would not reappoint Orr. A serious Opposition would be hammering the inadequacies of the Governor’s performance and conduct on so many fronts. In unserious public New Zealand, reappointment is no doubt Orr’s for the asking.

Letter from Geof Mortlock to Grant Robertson and Neil Quigley

Dear Mr Quigley, Mr Robertson,

I am writing to you, copied to others, to express deep concern at the increasingly political role that the Reserve Bank governor is performing and the risk this presents to the credibility, professionalism and independence of the Reserve Bank. The most recent example of this is the speech Mr Orr gave to the Central Banking Global Summer Meetings 2022, entitled “Why we embraced Te Ao Maori“, published on 13 June this year.

As the title of the speech suggests, almost its entire focus is on matters Maori, including a potted (and far from accurate) history of the colonial development of New Zealand and its impact on Maori. It places heavy emphasis on Maori culture and language, and the supposed righting of wrongs of the past. In this speech, Orr continues his favourite theme of portraying the Reserve Bank as the Tane Mahuta of the financial landscape. This metaphor has received more public focus from Orr in the last two years or so than have the core functions for which he has responsibility (as can be seen from the few serious speeches he has given on core Reserve Bank functions, in contrast to the frequent commentary he makes on his eccentric and misleading Tane Mahuta metaphor).

For many, the continued prominent references to Tane Mahuta have become a source of considerable embarrassment given that the metaphor is wildly misleading and is of no relevance to the role of the Reserve Bank. For most observers of central bank issues, the metaphor of the Reserve Bank being Tane Mahuta fails completely to explain its role in the economy; rather, it confuses and misrepresents the Reserve Bank’s responsibilities in the economy and financial system. It is merely a politicisation of the Reserve Bank by a governor who, for his own reasons (whatever they might be), wants to use the platform he has to promote his narrative on Maori culture, language and symbolism. 

If one wants to draw on the Tane Mahuta metaphor, I would argue that the Reserve Bank, as the ‘great tree god’ is actually casting far too much shade on the New Zealand financial ‘garden’ and inhibiting its growth and development through poorly designed and costed regulatory interventions (micro and macroprudential), excessive capital ratios on banks (which will contribute to a recession in 2023 in all probability), poorly designed financial crisis management arrangements, and a lack of analytical depth in its supervision role. Its excessive and unjustified asset purchase program is costing the taxpayer billions of wasted dollars and has fueled the fires of inflation. In other words, the great Tane Mahuta of the financial landscape is too often creating more problems than it solves, to the detriment of our financial ‘garden’. Some serious pruning of the tree is needed to resolve this, starting at the very top of the canopy. We might then see more sunlight play upon the ‘financial garden’ below, to the betterment of us all.

There is nothing of substance in Orr’s speech on the core functions of the Reserve Bank, such as monetary policy, promotion of financial stability, supervision of banks and insurers, oversight of the payment system, and management of the currency and foreign exchange reserves. Indeed, these core functions are treated by Orr as merely incidental distractions in this speech; it is all about the narrative he wants to promote on Maori culture, language, the Maori economy, and co-governance (based on a biased and contestable interpretation of the Treaty of Waitangi).

I imagine that the audience at this conference of central bankers would have been perplexed and bemused at this speech. They would have questioned its relevance to the core issues of the conference, such as the current global inflation surge, the threat that rising interest rates pose for highly leveraged countries, corporates and households, the risk of financial instability arising from asset quality deterioration, and the longer term threats to financial stability posed by climate change and fintech. These are all issues on which Orr could have contributed from a New Zealand perspective. They are all key, pressing issues that central banks globally and wider financial audiences are increasingly concerned about. Instead, Mr Orr dances with the forest fairies and devotes his entire speech (as shallow, sadly, as it was in analytical quality) on issues of zero relevance to the key challenges being faced by central banks, financial systems and the real economy in New Zealand and globally.

I have no problem with ministers and other politicians in the relevant portfolios discussing, in a thoughtful and well-researched way, the issues of Maori economic and social welfare, Maori language, and the vexed (and important) issue of co-governance. In particular, the issue of co-governance warrants particular attention, as it has huge implications for all New Zealanders. It needs to be considered in the light of wider constitutional issues and governance structures for public policy. But these issues are not within the mandate of the Reserve Bank. They have nothing to do with the Reserve Bank’s functional responsibilities. Moreover, they are political issues of a contentious nature. They need to be handled with care and by those who have a mandate to address them – i.e. elected politicians and the like. The governor of the central bank has no mandate and no expertise to justify his public commentary on such matters or his attempt at transforming the Reserve Bank into a ‘Maori-fied’ institution.

No previous governor of the Reserve Bank has waded into political waters in the way that Orr has done. Indeed, globally, central bank governors are known for their scrupulous attempts to stay clear of political issues and of matters that lie outside the central bank mandate. They do so for good reason, because central banks need to remain independent, impartial, non-political and focused on their mandate if they are to be professional, effective and credible. Sadly, under Orr’s leadership (if that is what we generously call it), these vital principles have been severely compromised. This is to the detriment of the effectiveness and credibility of the Reserve Bank.

What is needed – now more than ever – is a Reserve Bank that is focused solely on its core functions. It needs to be far more transparent and accountable than it has been to date in relation to a number of key issues, including:

–  why the Reserve Bank embarked on such a large and expensive asset purchase program, and the damage it has arguably done in exacerbating asset price inflation and overall inflationary pressures, and taxpayer costs;

–  why it is not embarking on an unwinding of the asset purchase program in ways that reduce the excessive level of bank exchange settlement account balances, and which might therefore help to reduce inflationary pressures;

–  why the Reserve Bank took so long to initiate the tightening of monetary policy when it was evident from the data and inflation expectations surveys that inflation was well under way in New Zealand;

–  how the Reserve Bank will seek to balance price stability and employment in the short to medium term as we move to a disinflationary cycle of monetary policy, and what this says about the oddly framed monetary policy mandate for the Reserve Bank put in place by Mr Robertson;

–  assessing the extent to which the dramatic (and unjustified) increase in bank capital ratios may exacerbate the risk of a hard landing for the NZ economy in 2023, and why they do not look at realigning bank capital ratios to those prevailing in other comparable countries;

–  assessing the efficacy and costs/benefits of macroprudential policy, with a view to reducing the regulatory distortions that arise from some of these policy instruments (including competitive non-neutrality vis a vis banks versus non-banks, and distorted impacts on residential lending and house prices);

–  strengthening the effectiveness of bank and insurance supervision by more closely aligning supervisory arrangements to the international standard (the Basel Core Principles) and international norms.  The current supervisory capacity in the Reserve Bank falls well short of the standards of supervision in Australia and other comparable countries.

These are just a few of the many issues that require more attention, transparency and accountability than they are receiving. We have a governor who has failed to adequately address these matters, a Reserve Bank Board that has been compliant, overly passive and non-challenging, and a Minister of Finance who appears to be asleep at the wheel when it comes to scrutinising the performance of the Reserve Bank. We also have a Treasury that has been inadequately resourced to monitor and scrutinise the performance of the Reserve Bank or to undertake meaningful assessments of cost/benefit analyses drafted by the Reserve Bank and other government agencies.

It is high time that these fundamental deficiencies in the quality of the governance and management of the Reserve Bank were addressed.  The Board needs to step up and perform the role expected of it in exercising close scrutiny of the Reserve Bank’s performance across all its functions. It needs directors with the intellectual substance, independence and courage to do the job. There needs to be a robust set of performance metrics for the Reserve Bank monitored closely by Treasury. There should be periodic independent performance audits of the Reserve Bank conducted by persons appointed by the Minister of Finance on the recommendation of Treasury. And the Minister of Finance needs to sharpen his attention to all of these matters so as to ensure that New Zealand has a first rate, professional and credible central bank, rather than the C grade one we currently have. I would also urge Opposition parties to increase their scrutiny of the Minister, Reserve Bank Board, and Reserve Bank management in all of these areas. We need to see a much sharper performance by the FEC on all of these matters.

I hope this email helps to draw attention to these important issues. The views expressed in this email are shared by many, many New Zealanders.  They are shared by staff in the central bank, former central bank staff, foreign central bankers (with whom I interact on a regular basis), the financial sector, and financial analysts and commentators.

I urge you, Mr Quigley and Mr Robertson, to take note of the points raised in this email and to act on them.

Regards

Geof Mortlock

International Financial Sector Consultant

Former central banker (New Zealand) and financial sector regulator (Australia)

Consultant to the IMF and World Bank

“Frankly simply daft”

I wasn’t going to write anything here today, but I couldn’t let the final question and answer from this morning’s Finance and Expenditure Committee hearing on the Monetary Policy Statement go without record and comment.

Simon Bridges, National’s FInance spokesman, asked the Governor whether the current prohibition – agreed between the Governor, the Board and the Minister – on any (external) MPC member having any active, engaged (present or future) analytical/research interest in monetary policy was not “frankly simply daft”, and did it not “ruin the ability to have thought diversity”.

He might well have added, but time was short, “and without precedent anywhere else in the advanced world” (or quite probably in most of the less-advanced world). Ben Bernanke would be disqualified, Lars Svensson would be out, and one could run a very long list of the sort of people who’ve served with distinction on the MPCs of other countries, whom Orr, Quigley and Robertson bar as a matter of determined policy.

Labour chairman Duncan Webb attempted, somewhat half-heartedly, to stop the question being asked, suggesting that it wasn’t really relevant to this Monetary Policy Statement (as if that was not also the case with several other questions, notably those from government MPs).

But in the end, the Governor did answer. He claimed first it was a matter of “legislation and government”. What he might have meant was not clear, but here is what the legislation says. The Minister makes the appointments, but can only appoint people the Board recommends, and the Board has to consult the Governor on those recommendations. These types of people are (rightly) disqualified.

People with a strong ongoing, and possible future, analytical/research interest in macroeconomics or monetary policy are not. That ban – the blackball – is pure Orr/Quigley/Robertson in concert. And none of them has ever mounted a substantive defence of this extraordinary ban, a ban without precedent.

But then Orr went on to end with a claim that the Monetary Policy Committee has a “very high level of expertise in monetary policy”.

It is worth distinguishing here between the external (non-executive) members – to whom the formal ban applies – and the executive (and majority) members.

There are three non-executive members:

  • Professor Caroline Saunders, who knows quite a bit about international trade but even her RB bio does not suggest knows anything in particular about monetary policy,
  • Peter Harris, former adviser in Michael Cullen’s office and former chief economist at the CTU. His RB bio also lays no claim to any particular background or expertise in monetary policy, and
  • Professor Bob Buckle. Buckle is a retired academic, who also worked in The Treasury for several years. He has something of a background in macroeconomic matters, but his focus tended to be more on tax and fiscal issues. Buckle is not self-evidently unsuited for the role – although he has long tended to be a “don’t rock the boat” establishment figure – but has no particular track record on monetary policy, let alone “high level expertise”. And he has, presumably, signed on to the understanding that he will never again do any writing or research on matters associated with monetary policy or macroeconomics (that is part of the ban).

Hardly a “very high level of expertise”.

Then, of course, there are the executive members, to whom the formal ban does not apply:

I’m not going to dispute that either the Governor or the Deputy Governor has some relevant qualifications and experience (although the deputy governor’s day job is now financial regulation and supervision), but neither is what most people would call a high-level expert. That needn’t be a criticism – the central bank is more than monetary policy – but you might hope for high level expertise (even “a very high level of expertise”) somewhere on the MPC. As it happens, neither Orr nor Hawkesby has even given a serious and thoughtful speech on monetary policy in their time on the MPC.

There was, for yesterday’s decision, the outgoing chief economist Yuong Ha. But he is leaving, with no other job to go to, and in his three years on the MPC gave not a single speech, delivered not a single paper, on matters monetary or economic.

The new appointee is Karen Silk. She has been a general manager at Westpac for some years, and will have senior management responsibility for financial markets where, just possibly, her skills might be a match. But her qualifications are in marketing and accounting, and she has no work experience relevant to being a monetary policymaker, or the senior executive responsible for those functions. Hard to imagine that morale among the Bank’s remaining economists did not dip quite a bit further when her appointment was announced. It is as if they wanted to go above and beyond and apply the ban to executives too,

It is now more than three months since it was announced that Yuong Ha was leaving, and the Bank has still not been able to fill the role – a job that would once have been one of the best jobs in New Zealand for a macroeconomist with policy interests. Perhaps they will appoint the person who will be filling the vacancy on an acting basis, but we don’t know.

There are some competent people on the MPC, and as I’ve written previously I don’t believe all 7 need to be (or even should be) research economists, but there is really no one there now who – by any reasonable global standards – could be described as offering a “very high level of expertise in monetary policy”.

That isn’t good enough – and the problems are especially evident with recent macro and inflation developments – but it is a choice, by Orr, Quigley and (above all) Robertson. So I hope MPs and journalists keep asking about what possible justification there can be for this extraordinary ban on some of the potentially most talented people who might otherwise be appointed to the Committee.

Misleading?

Back in mid-December, the Reserve Bank fronted up to Parliament’s Finance and Expenditure Committee for the Annual Review hearing on the Bank. I wrote about it here. You may recall that this was the appearance where (a) the Bank (unsuccessfully) tried to kept secret before the hearing the loss of another couple of senior managers, and (b) seemed to mislead the Committee on just how many of their senior managers had gone or were going. In the wake of it, the Governor forced the early departure of his deputy Geoff Bascand a couple of weeks before he was due to leave anyway, over unauthorised contact with the media [CORRECTION: “shared information to a third party”] (most likely over those two new senior management departures).

But towards the end of the hearing (about 50 minutes in here) there was a brief exchange on matters climate change, with an unusually clear and unconditional answer from the Governor. Here was my December account

The study by the Federal Reserve Bank of New York is here, and a Wall St Journal write-up is here. Here is the abstract

Which seems plausible and not very surprising. But it is just one working paper, on one aspect, and I’m not here to praise or critique the paper. My interest is in the Reserve Bank, and Orr’s response. “Yes”, he said, they certainly had done modelling of their own.

This is the Bank’s own climate change page. Even now, two months on, the only thing they are showing under Research Papers is this (their own words) preliminary analysis of some of the issues, dated July 2018 a few months after Orr had taken office. This was from the summary of that paper

So, I lodged an OIA request that day asking for copies of the modelling the Governor has been referring to, and of any write-ups of it. One might have supposed they would be keen to air it, but it still took them until 10 February to respond. They say they intend to put it on their website eventually, but it still isn’t on either the climate change or OIA responses page. So the full document is here

Climate change modelling OIA response from RBNZ Feb 2022

The first part of the response is a long (three page) letter, obviously attempting to provide some framing for what does (and particularly does not) follow.  Their Senior Adviser, Government and Industry Relations assures me that 

The RBNZ’s view is that there are significant climate-related risks for the New Zealand economy and financial system. This means that we consider that sectors of New Zealand’s economy will be at risk of being affected by physical risks, such as drought, flooding and sea level rise, and transition risks, such as international and national changes in policy/regulation, trade, investment and consumer preference. We consider that it is inevitable that policies and conditions will change in response to this global challenge, and that New Zealand’s economy will be affected and changed by these global and national changes. New Zealand banks and their international counterparts have set up teams to monitor and understand these risks and to respond as necessary.

While we are certain that there will be changes in the economy and financial system resulting from climate change and actions to mitigate climate change, the degree to which risks apply to financial stability will depend on a number of factors including how risks are understood and managed. New Zealand banks and their international counterparts have set up teams to monitor and understand these risks and to respond as necessary. 

At which point, I’m drumming my fingers and going “yes, so you say, but my question was about the modelling the Governor assured Parliament had been done”.

There then followed a 15 page memorandum, dated 13 October 2021, to one of the Bank’s internal committees on “Prioritisation of climate-related risks for financial stability analysis”. It is mildly interesting

So it seems that they intend to do some work, but haven’t done anything very serious yet. This is their own summary

and

The only thing the Bank itself seemed to have done was this

The rest of the OIA release consisted of 15 pages of a Powerpoint presentation (from July 2021) on that dairy scenario, reporting work undertaken jointly with MPI (the Ministry for Primary Industries). Much of the presentation is withheld, and we really learn nothing from it beyond what is in that extract just above. None of this appears to have been independently reviewed, none of it has been published, and the Bank’s own description (see quote above) is that there is “very little” New Zealand research on the (possible) threat to the financial system. All we have is a statement of the fairly blindingly obvious: a serious drought out of the blue (as 2013 was) combined with low dairy prices – an unusual combination given that earlier Bank research found that New Zealand droughts tended to boost global dairy prices, but not impossible – would result in some losses to banks’ dairy loan books. And? It sheds no light at all on risks to the New Zealand economy and financial system as a whole, and especially not from climate change – a multi-decade process.

To be clear, I don’t think the Reserve Bank should be spending lots of scarce taxpayers’ money (well, not scarce to them given how lavish their funding now is) on modelling climate change risks, at least not without a great deal more serious robust international analysis suggesting that there was a substantive issue/risk emerging. But it is the Reserve Bank that holds forth on the issue, asserting the existence of a threat….and, it appears, it has done almost no work itself, in a New Zealand context, to support its handwaving.

For anyone interested in reading further, I can recommend a couple of pieces by Ian Harrison – who would no doubt have been heavily involved in this sort of stuff were he still at the Bank. The first, from October 2021, is on Climate Change and Risks to Financial Stability more generally. The second, from January this year,

Did the Governor actively mislead Parliament with his answer in December?   At very best, it looks borderline.  As is clear, from the OIA release and the Bank’s own papers, what little semi-formal work has been done to date sheds very little light of anything of interest, despite repeated claims by the Bank and the Governor about alleged “significant” financial system risks. 

A deteriorating institution

I write a lot here about issues around the Reserve Bank. Some of those issues are quite obscure or abstract, and I know some readers find some of those posts/arguments a bit of a challenge to grasp.

But yesterday we had as straightforward an example as (I hope) we are ever likely to find.

Inflation is very much in focus at present. Measure of inflation expectations get more attention than usual. There is a variety of measures, both surveys (in New Zealand mostly conducted for the Reserve Bank and by ANZ) and market prices. The Reserve Bank has been surveying households for 27 years, with a fairly consistent (although expanded on a couple of occasions) range of questions. At the Bank there was always a degree of scepticism about the survey – household respondents always seemed (eg) to expect inflation to be quite a lot higher than it actually was – but it was one more piece in the jigsaw, and if one couldn’t put much weight on the absolute responses, changes over time did seem to line with what households might be supposed to be feeling/fearing.

Of the questions, probably the one least hard for households to answer seemed to be the fairly simple one

No numbers needed, just something directional. We have 27 years of data.

The latest results of the survey came out yesterday. The Bank puts out a little write-up and posts the data in a spreadsheet on their website. Yesterday, the write-up didn’t mention this question at all, but the spreadsheet suggested that a net 95.7% of respondents expected inflation to increase over the next 12 months. That seemed like it should be a little troubling, given how high the inflation rate already is.

Except that……it turned out that the Reserve Bank had changed the question, without telling anyone, without marking a series break or anything. The new question is

And that is a totally different question. The old question is about whether inflation will increase or decrease, while the new one is about whether there will be inflation or deflation. At almost any time in the 88 year history of the Bank it would not be newsworthy if 95.7 per cent of people expected there to be inflation. There almost always is.

It isn’t necessarily a silly question in its own right (on rare occasions there are deflation “scares”) but (a) it is a much less useful question most of the time than the question that had been asked and answered for 27 years, and (b) you can’t just present the answers to one questions as much the same thing as the answer to the other. Especially when not telling users of the data.

It was real amateur-hour stuff. Now, in fairness to the Bank, there is a detailed account of the changed questions on the website, but when there was no hint that question had changed there was no motive to go on a detective hunt to find it.

The Bank tells us they have had a 38 per cent increase in the number of senior management positions in the last year, with no increase in the things they are responsible for, and they can’t even get fairly basic things like this right. They’ve destroyed the single most useful question in the survey, and right at the time when every shred of information on attitudes to inflation should be precious. And then seemed barely even to be aware of what they’d done – presenting the answers to two quite different questions as if they were in fact very much the same.

There were a few people yesterday suggesting it was some nefarious plot to reduce access to awkward data at an difficult time. I don’t believe that for a moment – although for wider peace of mind I have lodged an OIA request to confirm (and to find out whether, for example, MPC members even knew of the change). This was a stuff-up pure and simple, which management and senior management (for which the Governor is accountable) should never have allowed to happen. High functioning organisations don’t make stuff-ups like this.

Which is a convenient lead in to an article published this morning.

About five weeks ago Stuff’s business editor asked if I’d like to write a column for them on the Reserve Bank under Adrian Orr. I did so (a few days later) and the final version appeared this morning. I only had 800 words, and there was a lot of ground one could have covered, so much of the story has to be very compressed (and quite a few problem areas left out altogether). You can read the final Stuff version here, or the text I originally wrote is below. Were I writing it now rather than a month ago, I would put more weight on the inflation story – core inflation now having blasted through the top of the target range – but I wanted to distinguish between forecasting mistakes (which are somewhat inevitable, and the best central banks will make them) and things that are much more directly within the control of the Governor, the Board, and the Minister of Finance.

Alarming Decline

By Michael Reddell

Over the four years Adrian Orr has been Reserve Bank Governor, this powerful institution, once highly-regarded internationally but already on the slide under his predecessor, has been spiralling downwards.  The failings have been increasingly evident over the last couple of years.  Here I can touch briefly on only a few of the growing number of concerns.

One can’t criticise the Reserve Bank too much for running monetary policy based on an outlook for inflation and the economy that, even if wrong, was shared by most other forecasters. Until late 2020 the general view of the economic consequences of the Covid disruptions had been quite bleak. Notably, inflation was widely expected to be very low for several years.  The Bank got that wrong, and so inflation (even the core measures) has been a lot higher than expected.  If they were going to err – after 10 years of inflation undershooting the target – it may have been the less-bad mistake to have made.  But they have been slow to reverse themselves – the OCR today is still lower than it was two years ago – and slower to explain.

The Bank is much more culpable for the straightforward lack of preparedness and robust planning.  Orr had been quite open, pre-Covid, that he wasn’t keen on big bond-buying programmes, and if necessary preferred to use negative interest rates.  But when Covid hit it turned out that the Reserve Bank had done nothing to ensure that commercial bank systems could cope with a negative OCR.  They couldn’t.  So instead, as if keen to be seen to be doing something, the Bank lurched into buying more than $50 billion of government bonds.  Buying assets at the top of the market is hugely risky and rarely makes much sense, but the Bank kept on buying well into 2021.  As interest rates rise, bond prices fall. The accumulated losses to the taxpayer are now around $5 billion ($1000 per person, simply gone).  And yet the Bank has never published its background analysis or risk assessment, it offers up no robust evidence that anything of any sustained value was accomplished, and the Governor refuses to even engage on the huge losses.

What of the new Monetary Policy Committee itself?  From the start the Governor and the Minister agreed that anyone with current expertise in monetary policy issues would be excluded from the Committee.  For the minority of outside appointments, a willingness to go along quietly seems to have been more important than expertise or independence of thought.  Meanwhile, staff (Orr and three others who owe their jobs to him) make up a majority of the Committee.  Minutes of the Committee are published but deliberately disclose little of substance, there is no individual accountability, and four of the seven MPC members have not given even a single published speech in the almost three years the Committee has been operating.  Speeches given by the senior managers rarely if ever reach the standard expected in most other advanced countries.  Meanwhile, the in-house research capability which should help underpin policy and communications has been gutted.

And then there is the constant churn of senior managers.  In some cases, people who were first promoted by Orr have since been restructured out by him.  In just the last few months, the departures have been announced – not one of them to another job – of four of the five most senior people in the Reserve Bank’s core policy areas: the Deputy Governor, the chief economist, and the two department heads responsible for financial regulation and bank supervision.   It isn’t a sign of an institution in fine good health. 

And all this has unfolded even as total staff numbers have blown out, supported by the bloated budget the government has given the Governor.   Orr often seems more interested in things he has no legal responsibility for than in the handful of (sometimes dull but) important things Parliament has specifically charged the Bank with.  Perhaps worse, he has a reputation for being thin-skinned: not interested in genuine diversity of views or at all tolerant of dissent, internally or externally.  One might just tolerate that in a commanding figure of proven intellectual depth, judgement, and operational excellence, but Orr has exemplified none of those qualities.

How to sum things up?  Lack of preparedness, lack of rigour and intellectual depth, lack of viewpoint diversity, lack of accountability, lack of transparency, lack of management depth, lack of open engagement, and lack of institutional memory.  It is quite a list.  The Governor is primarily responsible for this dismal record of a degraded institution but it is the Minister of Finance who is responsible for the Governor.

This really is a matter of ministerial responsibility.

Finally, earlier in the week I wrote a post here about expertise and the Monetary Policy Committee in which, among other things, I lamented again the absurd policy adopted three years ago by Adrian Orr, the Bank’s Board, and the Minister of Finance, excluding from consideration for (external) MPC positions anyone with any ongoing systematic interest in macroeconomics or monetary policy. This morning Jenee Tibshraeny of interest.co.nz had a new article focused on that restriction. She has comments from various economists, the only one sort of defending it one who was adviser in Robertson’s office at the time the restriction – one without parallel in any other advanced country central bank – was put on, but had also asked Robertson and the Bank (Orr or Quigley or both?) whether the same restriction would be applied to filling the upcoming vacancies.

It should be incredible, literally unbelievable, if we had not seen so much from Robertson and Orr over recent years careless of the reputation, capability or outcomes of the Bank. As it is, it is just depressingly awful. One hopes – probably idly – that the Opposition political parties might think it an issue worth addressing. After all, not only are qualified people with an ongoing analytical etc interest in monetary policy excluded from the external MPC positions, but the latest appointment to an internal position (by Orr, Quigley and his board, and Robertson in concert) suggests the bias against actual expertise and knowledge might now be being extended to encompass executive roles.

Expertise and the MPC

I’m yielding to no one in my low view of the Reserve Bank Monetary Policy Committee. I’ve been writing about the problems – structural and personal – since the new Potemkin-village model (designed to look shiny and new, but to change little) was set up three years ago, and it was (for example) one of my Official Information Act requests that got the written confirmation that the Minister, Governor and the Bank’s Board had formally agreed that no one with ongoing expertise in monetary policy or macroeconomics, or likely future interest in researching such matters, would be appointed (as an external member) to the new Monetary Policy Committee (three relevant posts here, here, and here). It was a simply extraordinary exclusion, which reflected very poorly on all involved, but which never seemed to get the scrutiny from media or MPs that it deserved. In no other modern central bank would such an approach be adopted.

But, for all that, I thought Eric Crampton’s op-ed in the Herald today overbalanced in the opposite direction. The column is behind a paywall, so I’m not going to quote extensively, but the gist seemed to be that you need a PhD in macroeconomics AND to be actively engaged in ongoing research to serve on the MPC. Crampton and an Otago university academic then report the results of a little survey they’d run of New Zealand academic macroeconomists to find out who those people thought should be appointed to the MPC, when the terms of two of the current externals expire shortly. It wasn’t noted that the most favoured candidate – one of the incumbents, Bob Buckle – does not have a PhD in macroeconomics, and has presumably taken a self-denying ordinance not to do any relevant research or analysis now or in the future (or otherwise he’d fall foul of the exclusionary rule, see above).

I don’t want to run commentary on all the individuals reported on. One or two might well be excellent additions, one or two would probably be dreadful, but none should be disqualified in advance simply because they might keep thinking about the issues, or writing about them in future. Even if the pickings are fairly slim, that far I agree (strongly) with Crampton. Of course, at present none of it probably matters much as management enjoys a permanent majority on the MPC, and the Orr/Robertson approach has been to prevent external members from speaking in public or even having their views recorded in the minutes. Three years sightseeing aside, it is difficult to know why really able people would seek, or accept, appointment at present. Management appointees matter much more, and the most recent appointment – the new executive deputy in charge of macro and monetary policy, with not a shred of relevant experience – suggests things are heading in the wrong direction there too.

But I think the “cult of the PhD” can be carried too far, at least when it comes to policy roles (as distinct from, say, staffing the Economics Departments of our universities). Don Brash had one, but had been primarily a banker and intellectually curious as he was (and is) had no demonstrated ongoing interest or expertise in macroeconomic research. Alan Bollard had one. Graeme Wheeler didn’t. But little or nothing about how well or badly those individuals did their jobs – and reasonable people may debate each – came down to how complex an NBER paper they could each critique (let alone produce). I’ve noted several times over the years that of the Reserve Bank’s chief economists over my working life, about half had PhDs and half did not. But there was no obvious correlation between those who did (or didn’t) and effectiveness or intellectual energy. Some (one?) of the best did, some (two?) of the best didn’t, but one who did was almost surely the worst of them. In English-influenced countries even 30-40 years ago it wasn’t particularly common for even the most able people to pursue PhDs unless they wanted an academic career. A couple of the more published researchers at the Reserve Bank in the last decade or so either didn’t have a PhD, or got one only rather belatedly (having already published quite a bit).

Or we could look around the world. Alan Greenspan was an economist but didn’t have a PhD (Update: thanks to the reader who pointed out that he acquired one well into his policy career). Jay Powell was a lawyer and private equity executive. Glenn Stevens, the previous RBA Governor, seemed to do a pretty reasonable job, and had neither a PhD nor a research track record. I’m not a great Lagarde fan, but she’s a lawyer and politician. Andrew Bailey has a PhD – in history – but spent his career in banking-oriented roles at the Bank of England. On the other hand, Phil Lowe, Mark Carney, Ben Bernanke, and Stefan Ingves have economics PhDs, even if not always with much sign of ongoing research interest.

Which is by way of saying that despite my many criticisms of Adrian Orr, the fact that he doesn’t have a PhD doesn’t bother me in the slightest. And the fact that Caroline Saunders – another of the independents – has one, if in quite unrelated areas of economics, allays not in the slightest my concern about the weakness (and tokenism) of her appointment.

A parallel I sometimes draw with the MPC is with the Cabinet. As Crampton notes, the MPC makes decisions that are final. So, in many areas, does the Cabinet (and often individual ministers). Very rarely do we expect the Prime Minister or Cabinet ministers to be professional technical experts in any of the areas they are minister for, let alone with the whole ambit of policies for which Cabinet is responsible. It often isn’t even helpful to have had a health expert as Minister of Health, and I’m pretty sure that in all New Zealand’s history we’ve never had an economist as Minister of Finance (nor is it common in parliamentary systems elsewhere). That isn’t a problem. We expect there to be a distinction between professional and technically-expert advisers on the one hand, and decisionmakers on the other. When either group tries to do the job of the other, or the advisory expertise is lacking, things run into difficulty.

[UPDATE: Bill Rowling, Minister of Finance 1972-74, did have an economics degree.]

The parallel with the MPC isn’t exact. We want the Cabinet to be making intrinsically “political” calls, about preferences, priorities, values etc. But we also want them to be judicious people – not unduly swayed by the latest whizz-bang research paper or think-tank idea, or the latest data point. We want/need them to be thinking about communications, public acceptability and so on.

So I’m not suggesting an MPC made up of the first 10 names in the Wellington phone book, or a bunch of pleasant (or otherwise) political hacks. But there is a place for a balanced committee, served by a highly expert staff (research, analytical, policy, markets, operational – all quite different components of what a capable monetary policy function needs). It seems quite likely that some of those roles would these days naturally be filled by people with PhDs – key figures in the research functions, most often perhaps the Chief Economist – but technical research virtuosity (of the sort a highly productive PhD may still offer – many do, many don’t) is just one, important, part of the relevant set of skills. Even in that sort of area, a passion to make sense of what is going on, to interpret evidence and data carefully, to be open to new ideas and fresh perspectives, seem to me to be what we should be looking for. Qualifications aren’t irrelevant, but qualities matter at least as much. And in an MPC that is dominated by management (which also controls all the staff resources), the willingness to think independently and ask hard but realistic questions, to engage effectively with experiences in other times and other countries, are what are likely to add most value. Some functioning academic researchers may be able to do that well, and their particular talents and experience should add value to the Committee. But so, far example, might someone who’d spent decades at the interface of economics and financial markets, or even – and one wouldn’t want this type dominating the Committee – the sort of classic old-school corporate director who is not afraid to ask questions when things don’t make sense, and who may act as a really effective test for how well the expert arguments, analysis, and lines of reasoning may be received in wider public audiences (I can think of a couple of these types who were on the RB Board in years past). Temperament is often at least as important as virtuosity. And effective public communications – not always an academic (or bureaucratic) strength – is vital.

Of course, the bottom line at present is that almost every dimension of the Reserve Bank (and particularly its macro/monetary functions) is weak: little research, little transparency, weak senior management appointments, a Governor with the wrong temperament for the job, an MPC structured to be ineffective, and weak appointees to the MPC. The ban on people with ongoing research interests – almost laughably bad as it is – is more like a symptom of a weak institution…..and a Minister of Finance who seems just fine with all that. And not even, it seems, bothered when core inflation bursts out the top of the target range.

UPDATE: I’d been aware that several of the top figures at the Bank of England in recent decades, including Eddie George and Paul Tucker, had not had PhDs (the latter having gone on to write a very serious book about central bank governance etc), but when I wrote the post I’d been labouring under the impression that the most prominent and eminent such figure – Mervyn King – had had a PhD. A reader got in touch to point out that he hadn’t. I’ve disagreed with many of King’s views, including in posts here, but no one can doubt that he was (and is) a figure of considerable intellectual eminence and thoughtfulness, whose speeches (for example) read well and make one think. He would seem ideally suited for an MPC.

Forecasting and policy mistakes

Yesterday’s post was a bit discursive. Sometimes writing things down helps me sort out what I think, and sometimes that takes space.

Today, a few more numbers to support the story.

I’m going to focus on what the experts in the macroeconomic agencies (Treasury and Reserve Bank) were thinking in late 2020, and contrast that with the most recent published forecasts. The implicit model of inflation that underpins this is that even if the full effects of monetary policy probably take 6-8 quarters to appear in (core) inflation, a year’s lead time is plenty enough to have begun to make inroads.

Forecasts – and fiscal numbers – in mid 2020 were, inevitably all over the place. But by November 2020 (the Bank published its MPS in November, and the Treasury will have finalised the HYEFU numbers in November) things had settled down again, and the projections and forecasts were able to be made – amid considerable uncertainty – with a little more confidence. And the government was able to take a clearer view on fiscal policy. The Treasury economic forecasts in the 2020 HYEFU incorporated the future government fiscal policy intentions conveyed to them by the Minister of Finance. The Reserve Bank’s forecasts did not directly incorporate those updated fiscal numbers, but…..the Reserve Bank and The Treasury were working closely together, the Secretary to the Treasury was a non-voting member of the Monetary Policy Committee, and so on. And, as we shall see, the Bank’s key macroeconomic forecasts weren’t dramatically different from Treasury’s.

The National Party has focused a lot of its critique on government spending. Here are the core Crown expenses numbers from three successive HYEFUs.

expenses $bn

From the last pre-Covid projections there was a big increase in planned spending. But by HYEFU 2020 – 15 months ago – Treasury already knew about the bulk of that and included it in their macro forecasts. By HYEFU 2021 the average annual spending for the last three years had increased further. But so had the price level – and quite a bit of government spending is formally (and some informally) indexed.

Here are the same numbers expressed as a share of GDP.

expenses % of GDP

By HYEFU 2021 the government’s spending plans for those last three years averaged a smaller share of GDP than Treasury had thought they would be a year earlier. (The numbers bounce around from year to year with, mainly, the uncertain timing of lockdowns etc).

There are two sides to any fiscal outcomes – spending and revenue. The government has been raising tax rates consciously and by allowing fiscal drag to work, such that tax revenue as a share of GDP, even later in the forecasts, is higher than The Treasury thought in November 2020. And here are the fiscal balance comparisons.

obegal

Average fiscal deficits – a mix of structural and automatic stabiliser factors – are now expected to be smaller (all else equal, less pressure on demand) than was expected in late 2020.

Fiscal policy just hasn’t changed very much since late 2020, and the fiscal intentions of the government then were already in the macro forecasts. Had those macro forecasts suggested something nastily inflationary, perhaps the government could have chosen to rethink.

But they didn’t. Here are the inflation and unemployment forecasts from successive HYEFUs.

macro forecasts tsy

In late 2020, The Treasury told us (and ministers) that they expected to hang around the bottom end of the target range for the following three years, with unemployment lingering at what should have been uncomfortably high levels. If anything, on those numbers, more macroeconomic stimulus might reasonably have been thought warranted.

There were huge forecasting mistakes, even given a fiscal policy stance that didn’t change much and was well-flagged.

That was The Treasury. But the Reserve Bank and its MPC are charged with keeping inflation near 2 per cent, and doing what they can to keep unemployment as low as possible. For them, fiscal policy is largely something taken as given, but incorporated into the forecasts.

Their (November 2020_ unemployment rate forecasts were a bit less pessimistic than The Treasury’s, but still proved to be miles off. This is what they were picking.

RB U forecasts

And here were the Bank’s November 2020 inflation forecasts, alongside their most recent forecasts.

rb inflation forcs

Not only were their forecasts for the first couple of years even lower than The Treasury’s, but even two years ahead their core inflation view was barely above 1 per cent. (The Bank forecasts headline inflation rather than a core measure, but over a horizon as long as two years ahead neither the Bank nor anyone else has any useful information on the things that may eventually put a temporary wedge between core and headline.) All these forecasts included something very much akin to government fiscal policy as it now stands. Seeing those numbers, the government might also reasonably have thought that more macroeconomic stimulus was warranted.

As a reminder the best measure of core inflation – the bit that domestic macro policy should shape/drive – is currently at 3.2 per cent.

core infl and target

There were really huge macroeconomic forecasting mistakes made by both the Reserve Bank and The Treasury, and – so it is now clear – policy mistakes made by the Bank/MPC. You might think some of those mistakes are pardonable – highly unsettled and uncertain times, not dissimilar surprises in other countries etc – and I’m not here going to take a particular view.

But of all the things Treasury and the Bank had to allow for in their forecasts, fiscal policy – wise or not, partly wasteful or not – just wasn’t one of the big unknowns, and hasn’t changed markedly in the period after those (quite erroneous) late 2020 macro forecasts were being done.

I guess one can always argue that if fiscal policy had subsequently been tightened, inflation would have been a bit lower. But Parliament decided that inflation – keeping it to target – is the Reserve Bank’s job. The government bears ultimate responsibility for how the Bank operates in carrying out that mandate – the Minister has veto rights on all the key appointees (and directly appoints some), dismissal powers, and the moral suasion weight of his office – but that is about monetary policy, not fiscal policy or government spending,

Inflation

The National Party, in particular, has been seeking to make the rate of inflation a key line of attack on the government. Headline annual CPI inflation was 5.9 per cent in the most recent release, and National has been running a line that government spending is to blame. It is never clear how much they think it is to blame – or even in what sense – but it must be to a considerable extent, assuming (as I do) that they are addressing the issue honestly.

I’ve seen quite a bit of talk that government spending (core Crown expenses) is estimated to have risen by 68 per cent from the June 2017 year (last full year of the previous government) to the June 2022 year – numbers from the HYEFU published last December. That is quite a lot: in the previous five years, this measure of spending rose by only 11 per cent. Of course, what you won’t see mentioned is that government spending is forecast to drop by 6 per cent in the year to June 2023, consistent with the fact that there were large one-off outlays on account of lockdowns (2020 and 2021), not (forecast) to be repeated.

But there is no question but that government spending now accounts for a larger share of the economy than it did. Since inflation was just struggling to get up towards target pre-Covid, and I’m not really into partisan points-scoring, lets focus on the changes from the June 2019 year (last full pre-Covid period). Core Crown expenses were 28 per cent of GDP that year, and are projected to be 35.3 per cent this year, and 30.5 per cent in the year to June 2023 (nominal GDP is growing quite a bit). That isn’t a tiny change, but…..it is quite a lot smaller than the drop in government spending as a share of GDP from 2012 to 2017. I haven’t heard National MPs suggesting their government’s (lack of) spending was responsible for inflation undershooting over much of that decade – and nor should they because (a) fiscal plans are pretty transparent in New Zealand and (b) it is the responsibility of the Reserve Bank to respond to forecast spending (public and private) in a way that keeps inflation near target. The government is responsible for the Bank, of course, but the Bank is responsible for (the persistent bits of) inflation.

The genesis of this post was yesterday morning when my wife came upstairs and told me I was being quoted on Morning Report. The interviewer was pushing back on Luxon’s claim that government spending was to blame for high inflation, suggesting that I – who (words to the effect of) “wasn’t exactly a big fan of the government” – disagreed and believed that monetary policy was responsible. I presume the interviewer had in mind my post from a couple of weeks back, and I then tweeted out this extract

I haven’t taken a strong view on which factors contributed to the demand stimulus, but have been keen to stress the responsibility that falls on monetary policy to manage (core, systematic) inflation pressures, wherever they initially arise from. If there was a (macroeconomic policy) mistake, it rests – almost by definition, by statute – with the forecasting and policy setting of the Reserve Bank’s Monetary Policy Committee.

I haven’t seen any compelling piece of analysis from anyone (but most notably the Bank, whose job it is) unpicking the relative contributions of monetary and fiscal policy in getting us to the point where core inflation was so high and there was a consensus monetary policy adjustment was required. Nor, I think, has there been any really good analysis of why things that were widely expected in 2020 just never came to pass (eg personally I’m still surprised that amid the huge uncertainty around Covid, the border etc, business investment has held up as much as it has). Were the forecasts the government had available to it in 2020 from The Treasury and the Reserve Bank simply incompetently done or the best that could realistically have been done at the time?

Standard analytical indicators often don’t help much. This, for example, is the fiscal impulse measure from the HYEFU, which shows huge year to year fluctuations over the Covid and (assumed) aftermath period. Did fiscal policy go crazy in the year to June 2020? Well, not really, but we had huge wage subsidy outlays in the last few months of that year – despite which (and desirably as a matter of Covid policy at the time) GDP fell sharply. What was happening was income replacement for people unable to work because of the effects of the lockdowns. And no one much – certainly not the National Party – thinks that was a mistake. In the year to June 2021, a big negative fiscal impulse shows, simply because in contrast to the previous year there were no big lockdowns and associated huge outlays. And then we had late 2021’s lockdowns. And for 2022/23 no such events are forecast.

One can’t really say – in much of a meaningful way – that fiscal policy swung from being highly inflationary to highly disinflationary, wash and repeat. Instead, some mix of the virus, public reactions to it, and the policy restrictions periodically materially impeded the economy’s capacity to supply (to some unknowable extent even in the lightest restrictions period potential real GDP per capita is probably lower than otherwise too). The government provided partial income replacement, such that incomes fell by less than potential output. As the restrictions came off, the supply restrictions abated – and the government was no longer pumping out income support – but effective demand (itself constrained in the restrictions period) bounced back even more strongly.

Now, not all of the additional government spending has been of that fairly-uncontroversial type. Or even the things – running MIQ, vaccine rollouts – that were integral to the Covid response itself And we can all cite examples of wasteful spending, or things done under a Covid logo that really had nothing whatever to do with Covid responses. But most, in the scheme of things, were relatively small.

This chart shows The Treasury’s latest attempt at a structural balance estimate (the dotted line).

In the scheme of things (a) the deficits are pretty small, and (b) they don’t move around that much. If big and persistent structural deficits were your concern then – if this estimation is even roughly right – the first half of last decade was a much bigger issues. And recall that the persistent increase in government spending wasn’t that large by historical standards, wasn’t badly-telegraphed (to the Bank), and should have been something the Bank was readily able to have handled (keeping core inflation inside the target range).

The bottom line is that there was a forecasting mistake: not by ministers or the Labour Party, but by (a) The Treasury, and (b) the Reserve Bank and its monetary policy committee. Go back and check the macro forecasts in late 2020. The forecasters at the official agencies basically knew what fiscal policy was, even recognised the possibility of future lockdowns (and future income support), and they got the inflation and unemployment outlook quite wrong. They had lots of resources and so should have done better, but their forecasts weren’t extreme outliers (and they didn’t then seem wildly implausible to me). They knew about the supply constraints, they knew about the income support, they even knew that the world economy was going to be grappling with Covid for some time. Consistent with that, for much of 2020 inflation expectations – market prices or surveys – had been falling, even though people knew a fair amount about what monetary and fiscal policy were doing. In real terms, through much of that year, the OCR had barely fallen at all. It was all known, but the experts got things wrong.

Quite why they did still isn’t sufficiently clear. But, and it is only fair to recognise this, the (large) mistake made here seems to have been one repeated in a bunch of other countries, where resource pressures (and core inflation) have become evident much more strongly and quickly than most serious analysts had thought likely (or, looking at market prices, than markets themselves had expected). Some of that mistake was welcome – getting unemployment back down again was a great success, and inflation in too many countries had been below target for too long – so central banks had some buffer. But it has become most unwelcome, and central banks have been too slow to pivot and to reverse themselves.

Not only have the Opposition parties here been trying to blame government spending, but they have been trying to tie it to the 5.9 per cent headline inflation outcome. I suppose I understand the short-term politics of that, and if you are polling as badly as National was, perhaps you need some quick wins, any wins. But it doesn’t make much analytical sense, and actually enables the government to push back more than they really should be able to. Because no serious analyst thinks that either the government or the Reserve Bank is “to blame” for the full 5.9 per cent – the supply chain disruption effects etc are real, and to the extent they raise prices it is pretty basic economics for monetary policy to “look through” such exogenous factors. It seems unlikely those particular factors will be in play when we turn out to vote next year.

Core inflation not so much – indeed, the Bank’s sectoral core factor model measure is designed to look for the persistent components across the whole range of price increases, filtering out the high profile but idiosyncratic changes. Those measures have also risen strongly and now are above the top of the target range. That inflation is what NZ macro policy can, and should, do something about. But based on those measures – and their forecasts – the Reserve Bank has been too slow to act: the OCR today is still below where it was before Covid struck, even as core inflation and inflation expectations are way higher. Conventional measures of monetary policy stimulus suggest more fuel thrown on the fire now than was the case two years ago.

When I thought about writing this post, I thought about unpicking a series of parliamentary questions and answers from yesterday on inflation. I won’t, but suffice to say neither the Minister of Finance, the Prime Minister, the Leader of the Opposition, or Simon Bridges or David Seymour emerged with much credit – at least for the evident command of the analytical and policy issues. There was simply no mention of monetary policy, of the Reserve Bank, of the Monetary Policy Committee, or (notably) the government’s legal responsibility to ensure that the Bank has been doing its job. It clearly hasn’t (or core inflation would not have gotten away on them to the extent it has). I suppose it is awkward for the politicians – who wants to be seen championing higher interest rates? – and yet that is the route to getting inflation back down, and the sooner action is taken the less the total action required is likely to be. With (core) inflation bursting out the top of the range, perhaps with further to go, the Bank haemorrhaging senior staff, the recent recruitment of a deputy chief executive for macro and monetary policy with no experience, expertise, or credibility in that area, it would seem a pretty open line of attack. Geeky? For sure? But it is where the real responsibility rests – with the Bank, and with the man to whom they are accountable, who appoints the Board and MPC members? There is some real government responsibility here, but it isn’t mainly about fiscal policy (wasteful as some spending items are, inefficient as some tax grabs are), but about institutional decline, and (core) inflation outcomes that have become quite troubling.

Since I started writing this post, an interview by Bloomberg with Luxon has appeared. In that interview Luxon declares that a National government would amend the Act to reinstate a single focus on price stability. I don’t particularly support that proposal – it was a concern of National in 2018 – but it is of no substantive relevance. Even the Governor has gone on record saying that in the environment of the last couple of years – when they forecast both inflation and employment to be very weak – he didn’t think monetary policy was run any differently than it would have been under the old mandate. That too is pretty basic macroeconomics. It is good that the Leader of the Opposition has begun to talk a bit about monetary policy, but he needs to train his fire where it belongs – on the Governor – not, as he did before Christmas, forcing Simon Bridges to walk back a comment casting doubt on whether National would support Orr being reappointed next year. In normal times, you would hope politicians wouldn’t need to comment much on central bankers at all. But the macro outcomes (notably inflation), and Orr’s approach on a whole manner of issues (including the ever-mounting LSAP losses) suggest these are far from normal times. Core inflation could and should be in the target range. It is a failure of the Reserve Bank that it is not, and that – to date – nothing energetic has been done in response.

Inflation, monetary policy and all that

The CPI for the December quarter was finally released yesterday – even later in the month than that other CPI laggard the ABS. The picture wasn’t pretty, even if at this point not particularly surprising. My focus is on the sectoral factor model measure of core inflation – long the Reserve Bank’s favourite – and if, as my resident economics student says “but Dad, no one else seem to mention it”, well too bad. Of the range of indicators on offer it is the most useful if one is thinking about monetary policy, past and present.

Factor models like this provide imprecise reads (subject to revision) for the most recent periods – that’s what you’d expect, especially when things are moving a lot, as the model is looking to identify something like the underlying trend. The most recent observations were revised up yesterday, and the estimate for core inflation for the year to December 2021 was 3.2 per cent. That is outside the 1-3 per cent target range (itself specified in headline terms, although no one ever expected headline would stay in the range all the time).

It is less than ideal. It is a clear forecasting failure – which would be even more visible if we show on the same chart forecasts from 12-18 months ago.

But…it isn’t unprecedented. In 28 years of data, this is the third really sharp shift in the rate of core inflation – although both were in periods before this particular measure was developed. And, at least on this measure, at present core inflation is still a bit below the 3.6 per cent peak in 2007, or the 3.5 per cent the annual inflation rate averaged for a year or more in 2006 and 2007.

What perhaps does stand out is how little monetary policy has yet done, how slow to the party the Bank has been. Over 1999 to 2001, the OCR was raised 200 basis points. From 2004 to 2007, the OCR was raised 300 points. And as core inflation fell sharply from late 2008, the OCR was cuts by 575 basis points.

So far this time the OCR has been increased by 50 basis points, and is not even back to pre-Covid levels – even though, on this measure, core inflation never actually dipped in 2020. I refuse to criticise the Reserve Bank for misreading 2020 – apart from anything else they were in good company as forecasters – but their passivity in recent months is much harder to defend.

The sectoral factor model measure is itself made up of two components. Here they are

Because the model looks for trends, the big moves in this measure of core tradables inflation have often reflected the big swings in the exchange rate – which affects pretty much all import prices – but this time there has been no such swing. Just a lot more generalised inflation from abroad (as well as the one-offs that this model looks to winnow out). So a lot more (generalised) inflation from abroad – not something to discount – and a lot more arising from domestic developments (demand, capacity pressures, and perhaps some expectations effects too). It is a generalised issue – above target, and probably rising further (both from the momentum in the series, and continued tight labour markets and rising inflation norms).

The headline inflation number gets media and political attention it doesn’t really warrant. Headline inflation is volatile, and even if in principle it might be more controllable than what we see, it usually would not make economic sense to control it more tightly. For that reason, in 30+ years of inflation targeting it has never been the policy focus.

And to the extent that wage inflation fluctuates with price inflation, the relationship is much closer with core inflation (we’ll get new wages data next week, and most likely the annual wage inflation will have risen a bit further).

It is worth noting – for all the headlines – that in every single year of the last 25, wage inflation has run ahead of core (price) inflation. As it has continued to do even over the last year. That is what one would expect – productivity growth and all that – even if the economy were just growing steadily with the labour market near full employment.

It is true that the gap between wage and price (core) inflation is unusually narrow at present

Perhaps the gap will widen again over the coming year – overfull employment and all that – but bear in mind that true economywide productivity growth is probably atrociously (partly unavoidably) low at present, so the sustainable rate of real wage growth is also less than it was.

(None of this means wage earners aren’t now earning less per hour in real terms than they were a year ago, but that drop is, to a very considerable extent, unavoidable. The gap between headline and core inflation is typically about things that have made us poorer, for any given amount of labour supply.)

What does all this mean for policy? First, for all the criticism – often legitimate – of wasteful and undisciplined government spending over the last two years – core inflation is primarily a monetary policy issue, and sustained core inflation above target is a monetary policy failure. The government is ultimately accountable for monetary policy too, but if what we care about is keeping inflation in check, it is the Bank and the MPC that should primarily be in the frame, not fiscal policy. Monetary policymakers have to take fiscal policy – just like private behaviour/preferences – as given.

To me, the recent data confirms again that the Reserve Bank was far to slow to pivot, and far too sluggish when they eventually did. They are behind the game, as was clear even by November before they – like the government, but even longer – went for their long summer holiday in the midst of a fast-developing situation. It is pretty inexcusable that we will go for three months with not a word from the MPC, even as inflation has surged in an overheating economy.

What disconcerts me a bit is the apparent complacency even in parts of the private sector. (If I pick on the ANZ here it is only because they put out a particularly full and clear articulation of their story quite recently). As an example, ANZ had a piece out last week suggesting that the OCR would/should go to 3 per cent by about April next year, but that this would/should be accomplished with a steady series of 25 basis point adjustments. I’m also hesitant about making calls about where the OCR might be any considerable distance into the future (and in fairness they do highlight some of the uncertainties) but if you are going to make a central-view call like that most people might suppose it was consistent with a gradual escalation of capacity pressures, gradually leaned against with policy. But on their own description, the economic growth outlook over the next year doesn’t look spectacular at all – the word “insipid” even appeared – while the pressures (inflation and capacity) seem very real right now, in data that (at best) lags slightly. Core inflation has (unexpectedly) burst out of the target range, the economy is overheated, inflation expectations have risen (even in the last RB survey the two-year ahead measure was 2.96 per cent – up 90 points in six months, when the OCR has risen only 50 points. ANZ’s economists did address the possibility of a 50 basis point increase next month. They seemed to think it unlikely, because no ground has been prepared. They may well be right about that – and that may be what their clients care about – but, as advisers, they seemed unbothered about it. Why not urge the Bank to get out now and prepare the ground for next month’s review? Why not thrown caution to the wind and suggest the world wouldn’t end if the MPC actually took the market by surprise and took actions that increased the changes of keeping inflation in check? Based on what we know now, the economy would be better off if the Bank raised the OCR by 50 basis points next month (and sold some of that money-losing bond stockpile) and suggested it would be prepared to do the same again in April if the data warranted.

What difference does is make? The big risk right now is that people come to think that a normal inflation rate isn’t something near 2 per cent, but something near 3 per cent (or worse). If that happens – and no single survey will tell the story – it will take a lot more monetary policy adjustment (and lost output) at some point to bring things back to earth, all else equal. And whereas we have no real idea what monetary policy should be in the middle of next year, it is quite clear that considerably tighter conditions are warranted now, and that the Bank so far has not even kept up with the slippage in inflation and expectations.

What about Covid? By 23 February when the MPC descends from the mountain top, it seems likely that we might be nearing the peak of the unfolding Omicron wave. Experience abroad suggests that even when the government doesn’t simply mandate it, a lot of people will be staying at home, a lot of spending won’t be happening. Who knows – and we may hope not – MPC members themselves, or their advisers, may be sick and enfeebled. Tough as those weeks might be, they should not be an excuse for a reluctance to act decisively. MPC went slow last year, and to some extent now pays the price in lost optionality. Delay in August didn’t look costly then. Delay now looks really rather risky.

But who are we to look to for this action. As (core) inflation bursts out of the target band, and expectations of future inflation rise, we already have an enfeebled MPC, even pre Covid.

  • We have a Governor who has given few serious speeches in his almost four years in office,
  • A Deputy Governor who didn’t greatly impress when responsible for macro, and is now likely to be focused on learning his new job, and finding some subordinates after he and Orr restructured out his experienced senior managers before Christmas,
  • We have a Chief Economist who has been restructured out, and on his final meeting. No doubt he’ll give it his best shot but….that wasn’t much over the three years he was in the job, including not a single speech,
  • And we have the three externals, appointed more for their compliance than expertise, who’ve given not a single speech between them in three years, and two of them are weeks away from the expiry of their terms (and no news on whether they’ll be reappointed or replaced).

It was pretty uninspiring already, to meet a major policy, analytical and communications challenge. And then yesterday, the dumbing-down of the institution –  exemplified in speeches (lack thereof) and the near-complete absence now of published research –  continued, with the appointment of Karen Silk as the Assistant Governor (Orr’s deputy) responsible for matters macroeconomic and monetary policy.  And this new appointee –  who it seems may not be in place for February – seems to have precisely no background in, or experience of, macroeconomics and monetary policy at all (but apparently a degree in marketing)     But she seems to be an ideological buddy of the Governor’s, heavily engaged in climate change stuff.    Perhaps the superficial customer experience –  pretty pictures etc –  of the MPS will improve, but it is hard to imagine the substance of policy setting, policy analysis, and policy communications will.  It was simply an extraordinary appointment –  the sort of person one might expect to see if a bad minister were appointing his or her mates.  And if this appointment was Orr’s, Robertson has signed off on it, in agreeing to appoint her to the Monetary Policy Committee.  It would be laughably bad, except that it matters.  How, for example, is the new Assistant Governor likely to find any seriously credible economist to take up the Chief Economist position even if  –  and the evidence doesn’t favour the hypothesis at present – she and Orr cared?   Coming on top of all the previous senior management churn and low quality appointments it is almost as if Orr is now not vying for the title “Great team, best central bank”, but for worst advanced country bank.  (It is hard to think of serious advanced country central bank, not totally under the political thumb –  and rarely even then –  who would have such a person as the senior deputy responsible for macroeconomic and monetary policy matters: contrast if you will places like the RBA, the ECB, the Bank of Canada, the Bank of England, and numerous others.)

I sat down this morning and filled in the Bank’s latest inflation expectations survey.  For the first time –  in the 6/7 years I’ve been doing it –  I had to stop and think had about the questions about inflation five and ten years hence (I’ve typically just responded with a “2 per cent” answer –  long time away, midpoint of the target, 10 years at least beyond Orr’s term).  With core inflation high and rising, policy responses sluggish at best so far, and with the downward spiral in the quality of the MPC (and the lack of much serious research and analysis supporting them), how confident could I be about medium-term outcomes.  Perhaps it is still most likely that eventually inflation is hauled back, that over time core inflation gets towards 2 per cent, with shocks either side.  The rest of the world, after all, will still act as something of a check, no matter how poor our central bank becomes.  But the decline and fall of the institution is a recipe for more mistakes, more volatility, more communications failures, and less insight, less analysis, and fewer grounds for confidence that the targets the Minister sets will consistently be delivered at least cost and dislocation.  That should concern the Minister, but sadly there is no sign it –  or any of the other straws in the wind of institutional decline –  does.