Reserve Bank

Thoughts prompted by the FSR

Michael Reddell Financial stabilty, Reserve Bank

I had only a limited number of specific comments to make on the details of the Reserve Bank’s Financial Stability Report released yesterday.  But it is the last such report for the outgoing Governor Graeme Wheeler, and that itself prompts a few other thoughts.

The Bank continues to tout the line that monetary policy in much of the world is “very accommodative” –  relative to what benchmark is never clear –  and yesterday they claimed that

“a sustained period of very accommodative monetary policy has supported the long-awaited recovery in global economic activity”

That seems questionable on multiple counts.  First, the recovery or growth phase has been underway since at least 2009/10.  There have been setbacks and what felt a little like “growth pauses”, and the overall experience has been pretty underwhelming.  But there also isn’t really much sign of that changing for the better.

And since what the Bank calls “very accommodative monetary policy” has been concentrated in the advanced economies, one obvious place to look for upbeat news might be investment spending.  Lower interest rates, all else equal, make investment today more attractive than otherwise.   But here is the IMF data –  and the IMF is the Bank’s standard reference point for comment on the wider world – for investment as a share of GDP in advanced economies.

investment imf

The latest actual data –  for 2016 –  are still below the cyclical lows in the early 2000s.  And if investment isn’t picking up strongly, neither is the IMF picking a slump in savings rates to support an acceleration of demand.

Across the advanced world, there just isn’t much consistent sign of anything very different in the next few years than we’ve had in the past few.  That suggests interest rates are low for a good –  if not fully-explained –  reason, rather than just that monetary policy is “very accommodative”.

At one level, the terminology doesn’t matter very much, but coming from a central bank offering insights on financial stability, it doesn’t suggest that they really have a good sense of what is going on.   They might be in good company on that score, but it isn’t exactly reasssuring.  If you don’t have a good “model”, the prognostications might not be of much value.

I also found it rather surprising that there was almost nothing in the Financial Stability Report  – the major statutory document on financial stability issues, including the Bank’s conduct of its various regulatory responsibilities – on the recently-released report on New Zealand under the IMF’s financial sector assessment programme (FSAP).   It was a major independent report, which seems to have also involved a substantial commitment of resources by the New Zealand authorities (including the Reserve Bank), in some areas it reached conclusions quite different from current policy, and yet it is barely mentioned in the Bank’s own review.  It isn’t because they didn’t have time –  the papers were released to the public three weeks ago, and the Bank will have had them well before that.  Perhaps it isn’t yet time for a definitive responses to all the points, and some of the issues the FSAP reports raise are really for the government rather than the Bank to decide, but…the silence was deafening.   Perhaps the Bank thought the IMF report really wasn’t much use at all, and was simply being polite?   (I would have some sympathy for such a view, and will before long have my own post on some aspects of the report.)

And there was something a little odd in the box the Bank included on “Vulnerability of owner-occupiers to higher mortgage rates“, clearly softening us up for the consultation paper on debt to income ratios.  They argue that

New Zealand is particularly vulnerable to a sharp rise in mortgage rates as the banking system funds a large proportion of its mortgage credit from offshore wholesale markets. The cost of this funding can increase sharply if there is an unexpected increase in global interest rates or a change in investor risk appetite, and banks are likely to pass on the higher funding costs to customers through higher mortgage rates.

 

But mostly this is just untrue.  The Reserve Bank sets the OCR in New Zealand based on overall inflation pressures in New Zealand.  If funding spreads rise –  as they did in 2008/09 –  and domestic inflation pressures don’t the Reserve Bank can easily offset most or all of the potential impact on retail interest rates by lowering the OCR.    That is what happened in 2008/09.

Of course, retail interest rates can rise, quite materially.  As the Bank points out, new floating mortgages rose from “around 7 per cent to over 10 per cent between early 2004 and 2007”.  Of course, as we used to stress at the time, fixed mortgage rates rose nowhere near that much.  But, more importantly, interest rates here didn’t rise because foreign rates were rising, but because the economy was cyclically strong, unemployment was low and falling, and wage and price inflation were increasing.  Wages rose roughly 20 per cent in that period.

It is fine and good for the Reserve Bank to do these sorts of stress-testing exercises, looking at what happens if interest rates rise to 7 per cent, or 9 per cent.  But in any realistic assessment, those sorts of substantial increases are only remotely likely if the economy is doing really cyclically well.  If jobs are readily available and wages are rising, not many people will be under that much stress even if interest rates rise quite a lot.  And those that are should quite readily be able to sell their house and move on.  It might be painful for them, but it simply isn’t a financial stability event.

There was some good news in the report.  Previous stress tests conducted by the Reserve Bank with the major banks have used very severe adverse macroeconomic shocks (in some respects –  notably the critical unemployment assumptions –  beyond anything ever seen in a modern floating exchange rate country).  Banks came through those tests largely unscathed.  So this time, the Bank did something a bit different.

The most recent regulator-led exercise was a ‘reverse’ stress test completed in late 2016. This test required the largest four New Zealand banks to determine the most plausible scenario that would lead to a breach of a minimum capital requirement. The results highlight that severe risks would need to materialise before this would occur, beyond the sustained macroeconomic downturn assumed in a typical stress test.

It was another way of reaching the same conclusion the previous tests pointed to: our major banks appear to be strong, and well-managed.   The Reserve Bank is quite explicit that the regulatory regime is not a “zero-failure” one –  in a market economy, firms will fail sometimes, and that includes banks  – but with the sorts of loans the banks had on their books late last year, the latest stress test suggests (again) that it would take something almost inconceivable for one of them to fail.

Which does leave one wondering, again, quite what all the fuss has been about in the last few years, with successive rounds of LVR controls, and the forthcoming consultative document in which the Bank tries to persuade us (and more importantly the Minister of Finance) that it should be able to impose debt-to-income limits too.      When it discusses the world economy, the Bank is quite fond of invoking concerns about “policy uncertainty”, but what certainty and stability has it provided in the markets/institutions it regulates in recent years?  And to what end has all the uncertainty been?

The Bank likes to claim that its successive interventions have ‘improved the resilience of the banking system”.  In fact, they offer us no evidence on that score.   No doubt, as their data show, the number and value of high LVR loans on the books of banks have both fallen.   But high LVR loans require banks to hold higher amounts of capital, and loans that are just below some regulatory threshold, supplemented perhaps by other forms of credit (eg family support), may be only very slightly (if at all) less risky than the loans the banks would have made in an unconstrained world.     The Bank’s claim would be more convincing if (a) they directly addressed the clear and simple point that lower risk lending also lowers the amount of capital banks have to hold (so that the risks might be lower, but so are the buffers if things do turn bad), and (b) if they ever addressed the question of what banks do instead of the high LVR housing lending they are now largely barred from.  Banks’ own risk-appetite probably hasn’t changed, and neither (probably) have the return expectations of their shareholders, so have they pursued other types of risk.   FSR after FSR the Bank never engages with this fairly straightforward point.  It also never engages with the question of how direct controls, frequently revisited, better advance the efficiency of the financial system than indirect mechanisms (primarily the capital requirements for banks, which don’t interpose government regulators directly between banks and their customers).

Perhaps there are good and convincing responses to these sorts of points.  The Wheeler Bank has never even attempted to provide them.

I’m also uneasy about the Bank’s treatment of the housing market.  They have a long list of various factors that play a part at various times in influencing house prices.  I’m pleased that they quite openly state the obvious point –  well, it should be obvious if we didn’t have business think tanks and government-funded researchers arguing that opposite –  that when housing and urban land supply is less than fully elastic, strong net migration inflows can and do boost house prices.

But, for an organisation that has chosen to intervene repeatedly, and which weighs in every six months with an assessment of the risks around the stock of housing lending, they don’t seem to have anything very authoritative to offer.      They have never once noted that land use restrictions –  not just here, but in a variety of similar countries –  could make urban land prices permanently higher.    Without major changes to those laws, other interventions –  taxes, LVR restrictions, government housebuilding programmes, and even immigration restrictions –  will typically only make a modest difference for a relatively short period of time.   And there are no natural market forces that will undo those restrictions –  they aren’t like a temporary credit bubble.     When bank lending standards deteriorate rapidly, there is good reason for people who have lent to banks (and for the regulators) to worry.  When governments enable pernicious land use restrictions, there are plenty of reasons for many to worry – notably the young, who might struggle to ever get a place of their own – but it isn’t much of an issue for financial stability regulators (in that climate, higher gross credit is mostly just an endogenous response).  And yet, for all their interventions, the Reserve Bank has never been able to give us an authoritative story (“model”) on what role the various possible explanatory factors are playing now, and have played over the last 25 years.

I can imagine that the Reserve Bank is uneasy about wading into what can be a rather political debate. I can understand that.  But if you are a government agency actively intervening in a market –  itself a highly “political” choice, favouring some groups of potential buyers over others – you have an obligation to show us your robust supporting analysis.  The Reserve Bank simply hasn’t done so thus far.  Perhaps the robust cost-benefit analysis in the forthcoming consultative document will be different?

And, years on, there is still no robust analysis or research suggesting that the Reserve Bank has thought hard about what the important differences might be between countries where banks’ domestic loan books got into serious trouble and those where they did not?  In 2008/09 for example, New Zealand, Australia, Canada and the UK saw quite different things than the United States and Ireland did (and even those two latter experiences were themselves quite different). It seems like a pretty elementary line of inquiry –  and we do, as taxpayers, pay for a lot of researchers at the Reserve Bank –  but there has been just nothing.  In the meantime, people who are regulated out of credit markets pay the price.

If the Bank doesn’t know the answers to these sorts of questions, perhaps they need to be rather more agnostic about the outlook and the case for their own direct policy interventions in the market.  Focus on stress tests and capital requirements, and eschew direct interventions which have little economic foundation, and are arguably ultra vires anyway.

These are now mostly challenges for the new Governor.  Both Graeme Wheeler and his deputy (and Head of Financial Stability) Grant Spencer are leaving shortly –  Wheeler in September, and Spencer next March.  I hope the new guard takes more seriously some of these issues.  If they do, writing FSRs will be harder, but there would be a great deal more value in the resulting documents even if, in many cases, the resulting analysis leaves as many questions as answers.  That might simply reflect the limits of what we know about the world (and housing markets, housing finance, and banking risk).

Earlier in the year, the Minister of Finance intervened and instructed the Board of the Reserve Bank to stop their search for candidates for a new permanent Governor, and instead to recommend a candidate to be a temporary (acting) Governor.   Doing so avoided trespassing on conventions which restrain governments from making major permanent appointments which would take effect around the time of general elections.  Deputy Governor, Grant Spencer, was –  with what still looks like little secure legal basis –  appointed acting Governor for six months, allowing whichever government takes office after the election to make the appointment of a permanent new Governor.

You might have thought –  I did –  that such a temporary appointment was designed to leave the new government free, and also not to tie the hands of the new Governor.  An acting Governor would make the decisions that really had to be made, keep a steady hand on the tiller, and otherwise leave substantive decisions until a permanent appointee was in place next year.

But it seems that Graeme Wheeler, and the Reserve Bank’s Board –  the latter perhaps still smarting at having to end their earlier search process – didn’t quite see it that way.

With Spencer stepping up to acting Governor, and then retiring when that term ends, there was going to be a vacancy in his substantive roles.  There were two of those.  One was the fulltime day job as Head of Financial Stability (a role in which three departmental heads report to him, covering financial markets and financial stability/supervision.  And the second was the statutory position of Deputy Chief Executive.

A month or so ago, there was a press release from the Reserve Bank filling both positions.    The other current Deputy Governor, Geoff Bascand, was to transfer from his current role (oversight of the operations and admin sides of the Bank) to become Head of Financial Stability, and he was also promoted to become Deputy Chief Executive.  In addition, a search process would get underway straightaway to fill Bascand’s role (adverts have subsequently appeared, and applications have already closed).

Frankly it all seems rather odd.  For a start, even though Bascand has no background in banking, financial markets, or the regulation of those activities, there was no sign that any sort of competitive or contestible process was undertaken before he was appointed Head of Financial Stability.

But it also looks like an attempt to box in the new Governor, whoever he or she may be.  Sure, it is common for a chief executive to inherit a senior management team –  although often enough that is a prompt for a (often disruptive) restructuring etc to allow the new person to shape his or her own team.  Moreover, the qualities one might want in other members of the top team surely depend, at least in part, on the skills, experience, and other qualities of the person at the top.    A more obvious (and common elsewhere) solution would have been to have appointed an acting Head of Financial Stability and then let the new Governor make his or her own choice about the sort of structure and people they want in the roles.  For example, it might be fine to have a macroeconomist as Head of Financial Stability  –  key point of contact with senior people in the financial sector and other regulatory agencies –  if the new Governor has a strong banking background.  If not, it might be a lot more problematic, especially given how large and prominent the Reserve Bank’s regulatory role now is.   (Of course, if Bascand himself becomes Governor, that issue solves itself.)

These points are more important than usual given that talk of statutory reform of Reserve Bank decisionmaking is in the air.  Labour and the Greens are committed to change, and the government has had Iain Rennie looking at the issue.  Again, depending how those matters are resolved (including those around the Bank’s financial regulatory powers), it could easily influence the sort of person one wants in key senior management roles.   (That includes the Assistant Governor position they are filling now.  For all Graeme Wheeler’s talk of the key role of the Governing Committee in making key policy decisions in the Bank, the advert for that position, had hardly any mention of monetary policy and, from memory, none at all of financial regulation.  In many respects that makes a lot of sense –  while the Governor in law actually makes those decisions –  but perhaps not if the Act was to be changed to make a holder of this position a statutory decisionmaker on major areas of public policy.)

And then, of course, there is question of whether all of this was even lawful.   In the Reserve Bank Act,  the role of deputy chief executive is filled by the Board on the recommendation of the Governor.  But there is no vacancy in the role of deputy chief executive while Graeme Wheeler is Governor.  And, even though the press release was worded as coming from both Wheeler and Spencer, the Act does not talk of an acting Governor being able to recommend a deputy chief executive appointment.  Perhaps it is a small issue, but details matter, and the law matters.

All else equal, I happen to think that Geoff Bascand would normally be a sensible appointment for deputy chief executive.    I’m less convinced he is right for the role of Head of Financial Stability, and generally think he would be better-suited (despite his fling with LUCI) for the role of Head of Economics (a role which should have become much more important as the Governor has had to focus increasingly on the Bank’s various regulatory roles).

There is a public sector culture of generalist managers.  I’m not sure it serves particularly well.  Of course, Grant Spencer also had a background in macroeconomics but had also served as the Bank’s Head of Financial Markets, and then had almost 10 years in various relatively senior roles at ANZ in New Zealand and Australia.   It wasn’t doing credit –  perhaps the essence of banking –  but it was much more of an exposure than Bascand has had (and the Head of Financial Stability job is itself much bigger than it was when Spencer was first appointed to it).  Sure, Bascand has sat around the internal committees on regulatory issues for the last three or four years, but it really isn’t that much depth of involvement.  And I say this even though, when I also sat on those committees, Bascand’s was often more willing to challenge and questions the interventionist inclinations of staff than many of his colleagues were.  I welcomed that.

Perhaps he is the single best person in the country (or abroad) for the role.  And there is something to be said, in high-performing organisations, for promoting from within.  But the appointment has an uncomfortable feel about it, including the dimensions of Wheeler either trying to box in his successors, or give Bascand another leg up in the succession stakes.

And there is also the uncomfortable fact that, for someone soon to be charged with oversight and regulation of much of our financial system –  regulating in the interests of the wider economy, not that of the banks –  Bascand doesn’t exactly have a spotless track record.   Defensive behaviour and an attempt to close down issues, rather than open them up, seems to be his style.  There was his attempt to tar the whistleblower –  me –  last year when I alerted the Bank to what turned out to be a leak of an OCR decision and a systematic weakness in their processes.  There was the seeming inability to distinguish between his (and others) role as trustee and as Bank employee –  particular worrying to the Bank I’d have thought if a financial sector employee had a similar cavalier attitude.  There was the attempt to close down, without substantive inquiry, significant complaints from a member of the Reserve Bank superannuation fund, only to find later that a breach of the law had occurred (and various other –  still ongoing – issues identified), for which breach trustees later had to apologise to members.  And, meetings with fellow regulators might be interesting, given that there is an outstanding complaint with the Financial Markets Authority –  regulatory body responsible for superannuation schemes –  around the decisions and processes adopted by the superannuation scheme trustees under Geoff’s chairmanship.

I know we don’t have depositor protection as one of the statutory elements in New Zealand’s banking regulation, but whether as a depositor or citizen I’m not sure this sort of track record would fill me with confidence in Bascand’s ability to lead financial regulatory functions, with the drive and willingness to leave no stone unturned that, in some circumstances would surely be required.  Bankers will often be keen to close things down quickly, and paper over problems.  The last thing we need is officials who will be content, or perhaps even complicit, in letting that happen.    At very least, this was a decision the new Governor should have been left to make.

 

Some Reserve Bank forecast surprises

Michael Reddell inflation, Reserve Bank

The Reserve Bank of Australia had an interesting Bulletin article out recently, offering some insights on this chart

rba wage inflation surprises

The RBA’s wage inflation forecasts have been persistently too strong.  Mostly, they’ve forecast an acceleration of wage inflation, and yet actual wage inflation has continued to fall.

I was curious what a comparable New Zealand picture might look like.  The way wage inflation series are calculated differs from country to country.  In our Labour Cost Index, we have two measures of private sector wage inflation –  the headline one, and what is labelled the Analytical Unadjusted series.  The latter seems to be more comparable to the Australian measure in the RBA chart, while the headline LCI series attempts to adjust for changes in productivity (ie capturing only wage increases in excess of  what firms identify as productivity growth).    Here is what the two series look like.

LCI series

The fall in New Zealand wage inflation (between 2 and 2.5 percentage points since 2008) is pretty similar to the fall in Australian wage inflation in the first chart.

The Reserve Bank of New Zealand publishes forecasts of annual wage inflation for the LCI private sector wages and salaries series (the orange line).  I dug out their forecasts published in the June quarter of each year and this is the chart I came up with.

Reserve Bank wage forecasts

It isn’t quite the same picture as in Australia –  they had a genuine business investment boom which had taken wage inflation almost back up to pre-downturn levels –  but the broad picture is much the same.  Each year since 2010, the Reserve Bank has forecast an increase in this measure of wages (notionally at least productivity-corrected) and each year it hasn’t happened.   Perhaps this year’s forecast will prove more accurate?

What I found interesting is that the errors seem not to have been related to productivity surprises (I’ll come back to those), but simply to misreading overall inflation pressures.

Why do I say that?  Well, here is a chart showing the Bank’s furthest ahead forecasts for wage and price inflation.   They forecast three years ahead, so the forecasts associated with June 2017 (and published in that quarter) relate to inflation in the year to March 2020.   Inflation forecasts that far ahead aren’t thrown around by things like unexpected petrol prices changes or weather shocks to fruit and vegetable prices.  They are closely akin to forecasts of core inflation.

rb wages 2

The wage inflation and price inflation forecasts are so close together that it is quite clear that for some years the Bank has simply been forecasting this measure of wage inflation on the basis of an assumption of unchanged real unit labour costs.    Whatever happens to productivity growth, the Bank assumes that over the medium-term, this measure of wages (notionally productivity-adjusted) will rise at around the same rate as CPI inflation.     (That in itself is interesting as throughout this period the unemployment rate has been above Bank estimates of the NAIRU.  I can’t really show you a meaningful chart of their unemployment forecast surprises, because of the historical revisions to the HLFS).

The grey line shows actual inflation outcomes for the period that lines up with those medium-term forecasts.  I’ve used the Bank’s preferred sectoral core inflation measure, not because it is ideal but because (a) it is available, and (b) it is their own preference.   The last observation is sectoral core inflation for the year to March 2017, which is compared to forecasts for that period published in the June quarter of 2014.

What about the Bank’s productivity forecasts?  In many ways, their view on future medium-term productivity growth doesn’t greatly affect their view of inflation pressures (higher assumed productivity growth will tend to raise both potential and actual output).  So the productivity surprises chart is mostly about simply charting the declining performance of the New Zealand economy.

The Reserve Bank publishes forecasts for growth in a trend measure of productivity, and the trend estimates are revised as new data are added.   But here are the forecasts, lined up against their most recent estimates of trend productivity growth (again using the forecasts published in each June quarter).

rb productivity forecasts

The Bank has, again, consistently forecast a pick-up in productivity growth (the first observation on each line is the Bank’s then-current estimate of the most recent actual).  And for some of the earlier years (2009 to 2011) their latest estimates of actual trend productivity growth are higher than they thought at the time (it happens, as new revisions to GDP data come out).    But as their estimates of actual trend productivity growth rates have continued to fall  –  near zero for the last couple of years –  they’ve continued to forecast a rebound.  Indeed, the rebound in the latest set of forecasts –  out just a couple of weeks ago –  is as steep as any of those in recent years.   Perhaps in their shoes I’d also forecast a rebound –  it seems excessively pessimistic to assume zero productivity growth for ever –  but you do have to wonder what they think is about to change that means we’ll see the rebound beginning strongly in 2017/18 –  ie, right now.

This post is probably already excessively geeky for many readers.   But, as I do, the further I got into the data the more fascinated I got.  I could show you a similar chart for output gap estimates and forecasts, but it is hard to read and fairly predictable –  the Bank has fairly consistently over-estimated how much resource pressure would build up over successive forecast periods.  That shouldn’t be a surprise, given the weak inflation outcomes.

But they did get some things pretty much right over this period.    This chart shows two lines.  One –  the orange line –  is their latest (June 2017) estimate for the average output gap for the year ending March of each year.  And the others shows the contemporaneous forecasst done in each June quarter for the year ending March of that year.  Thus, the 2017 observation is the June 2017 MPS estimate of the average output gap for the year to March 2017.  When those estimates are done, the GDP numbers for March 2017 still aren’t known (but the first three quarters of the year are).  Potential output is always an estimate.

contemporaneous output gap forecasts

With one (important) exception, the contemporaneous estimates and the current ones are astonishingly close.   That isn’t so surprising for the last couple of years, and additional data could yet lead to material revisions in the estimates for the output gaps for 2015 and 2016.      But for the earlier years, despite all the revisions to the data, and all the new information, the Bank’s contemporaneous estimates for the then-current output gap hold up very well against today’s estimates.  These are annual averages, not estimates for the output gap in the March quarter itself, but….still…..I was pleasantly surprised.     The forecasts might be pretty hopeless (as I noted last week, and as is typically true of other forecasters too) but the contemporaneous estimates aren’t bad at all.   Simple monetary rules, such as the Taylor rule, encourage central banks to not put much emphasis on medium-term forecasts, but to adjust policy based on how they assess the current situation (output or unemployment gaps, and inflation gaps).

Of course, one observation in that chart does stand out.  In 2014, the Bank thought there was a reasonably materially positive output gap.  They now recognise that there wasn’t.  And that was the time when they made the policy mistake, of raising the OCR by 100 basis points (and talking up even further increases beyond that), only to have to reverse those increases quite quickly.    In any serious post-mortems of that episode (such as they suggest will be coming out shortly), they should be looking hard at how they got that output gap assessment so wrong –  much more wrong than in any of the other post-recession years illustrated on the chart.

Getting the read on the current situation right is hard enough, and medium-term forecasting is typically adding no value, whether in understanding the actual future, or in understanding how the Bank itself might react to its own mistakes.  The Bank would be better advised to focus its energies –  analysis, communications, and policy deliberations –  on what it knows at least something about, rather than on what it (and the rest of us) know little or nothing about.

Has the Reserve Bank shrunk the country and not told us?

Michael Reddell Reserve Bank

In the press release (and in the full text) for Reserve Bank Assistant Governor, John McDermott’s speech the other day we were told that

the economy is populated with thousands of households and businesses responding to their own particular circumstances and opportunities,

In fact, there are well over 1.5 million households, and many hundreds of thousands of businesses.  There are plenty of uncertainties the Reserve Bank has to grapple with, but that shouldn’t be one of them.

It is often not entirely clear why the Reserve Bank chooses to make some of the on-the-record speeches it does.    Sometimes there is a specific and important message they want to get across.  But often, at least when I was still there, it seemed that the Governor was keen to give his senior managers a bit more public profile, and so they gave speeches (and published them) even when there wasn’t very much to say.

McDermott’s speech on forecasting seems to be in that category.   There seem to be a couple of substantive points: a brief attempt to defend how well the current monetary policy decisionmaking process works (even as both major parties are considering the possibility of change), and an even briefer bid for a monthly CPI.  I happen to agree with them that a monthly CPI would be welcome (so would monthly unemployment data, a gap that also stands out in cross-country comparisons).  It is, thus, a shame that 15 years ago the Bank pushed back against Lars Svensson’s recommendation, in his inquiry conducted for the then Minister of Finance, that New Zealand should have a monthly CPI.     Having said that, I think the Bank’s chief economist is fooling himself if he really believes, as he claims in his speech, that “this is likely to be a fruitful avenue for future improvement that would greatly improve the Bank’s forecasting ability”.      Incrementally useful is probably a more accurate summary.

As for the rest of the speech, it would have been better not delivered at all.   It is a curious mix of bits and pieces from a couple of popular recent books on forecasting, and a convoluted attempt to defend what the Reserve Bank does as, it would seem, the very best it can do, and just the right approach to adopt.

When speaking abstractly, McDermott is happy to talk about the importance of acknowledging mistakes.  Thus, and for example

To learn from our errors, we need to recognise that they are errors.

Hard to disagree with that.  But in the entire course of the speech, McDermott never once describes any stance the Bank has taken, or forecast it has made, simply as an “error”.   He devotes almost two pages of the speech to 2014 increases in the OCR which had subsequently to be more than fully reversed.  But the only evaluative word used in the entire two pages is “correct” –  that to describe the point where they realised that it didn’t make sense to keep on increasing the OCR as much as they had previously been suggesting they would.    But human beings make mistakes.  We all do.   It doesn’t speak well of the Bank’s senior management that they are still so reluctant to even use the words, applied to themselves.

As McDermott notes, to some extent, forecasting is an inevitable part of much of what we do in life.   There are the mundane things.  If I put a tin full of cake mixture in the oven at 180 degrees, I do so implicitly forecasting that in an hour or so it will be cooked.  Those sort of examples could be multiplied endlessly.

But monetary policy is today’s topic.   Forecasting isn’t an inevitable part of monetary policy.  One could, for example, simply peg the exchange rate (as we did for many years) or fix the money base.  I don’t recommend either approach, but neither requires much in the way of forecasting.

Much more conventional approaches also needn’t require much forecasting.    Decades ago, US economist John Taylor illustrated that a simple rule, in which monetary policy responds to changes in the current inflation rate (deviation from target) and to changes in the output gap (or, similarly, to changes in an unemployment gap) pretty well described how the Federal Reserve had actually run monetary policy.   Estimating a Taylor rule might take quite a lot of ongoing analysis (you need estimates of the neutral interest rate and of the output gap) but it needn’t involve any active forecasting at all.   Because monetary policy works with lags, there is an implicit forecast involved in using a Taylor rule, but it is very different from the sort of forecasting McDermott is talking about.

Our Reserve Bank goes beyond that in two ways:

  • it publishes numerical forecasts for a range of key macroeconomic variables (including inflation) for about three years ahead, and
  • it publishes forecasts of what it itself will do with monetary policy over that same period ahead.

The first leg of that is quite common.  Most advanced country central banks now publish economic forecasts in some form or another.

The second leg is quite uncommon.  The Reserve Bank of New Zealand was the first central bank to do so 20 years ago (without a great deal of debate at the time) and not many have followed us.    The OCR forecasts are, of course, subject to change (and we often preferred to call them “projections”) but at the time they were published they were really close to the best unconditional forecast by the Bank (or more specifically the Governor) of its own future actions.

And when you read, as we do in the Bank’s press release for McDermott’s speech, that forecasting  is “helping the Bank plan for the future” and that “forecasts also help people form expectations of the future and therefore guide current actions” you might suppose that the Bank thinks it knows something about the future.     If so, silly you.   Because we are also told that

Forecasting is not supposed to be prophecy

Setting aside the quasi-religous connotations of the word “prophecy”, the OED suggests I should take it as meaning a prediction of the future.

If you can’t predict the future, your predictions can’t help you plan, and they can’t help anyone else plan either.   The Reserve Bank really can’t have it both ways.  Of course, forecasts don’t have to be 100 per cent accurate to help you or others plan, but if they have no information at all about the future they are also no use at all.  Indeed, if your forecasts end up biased one way or another, and you actually think they are telling you something about the future, they can lead you (and anyone else who took them seriously) quite badly astray.

(As it happens, it is less than a year since the Reserve Bank was out touting evidence of the accuracy of its forecasts. I wrote about that work here.)

There is none of this is McDermott’s speech.  And while he claims that through the Reserve Bank’s particular approach

the predictability of monetary policy decisions is enhanced and policy uncertainty is reduced.

he offers no evidence of this.  Is there, for example, evidence of less monetary policy uncertainty in New Zealand than in other countries?  I’d have thought not, but the Bank doesn’t even try to back its claims.   As we are the only advanced country to have initiated two tightening cycles since the 2008/09 recessions, only to have to reverse them both, a detached observer might reasonably be sceptical.

There isn’t even an attempt to distinguish between the various possible forecast horizons.  As I understand it, for example, the Reserve Bank isn’t bad at forecasting inflation and GDP one quarter ahead (although even these claims are relative –  on the eve of the GDP release we were often reminded that the actual number could easily be +/- 0.5 percentage points different than our forecast).

At the other extreme, when (as they did last  week) they forecast the OCR itself for the June 2020 quarter, there is no information value at all about the future.  The right OCR for June 2020 will, in their way of thinking and allowing for the lags, depend on inflation pressures in 2021 and 2022.  No one has the foggiest idea what those pressures will look like.   The Reserve Bank’s forecast accuracy work (linked to earlier) highlighted both the huge errors and the biased nature of those errors, for periods even two years ahead, let alone four to five years ahead.

And then there are the in-between periods.  Perhaps very good forecasters might be able to add a little value in forecasting inflation and GDP a year ahead,    But even then, that value might be quite small, and subject to huge error bounds.

But there is none of that sort of differentiation in McDermott’s speech either.

To be clear, my criticism is not (mostly) that the Reserve Bank is bad at forecasting.  Everyone is.   My concern is that they show little sign of even recognising the limitations of what they are doing (and not much ability to even maintain a consistent story about the role of forecasts from one year to the next).

The fallback line is that even if forecasts tell one nothing about the future, they help guide people (presumably especially financial markets) on how the Bank might change policy if the data come out differently than the Bank expected.   By publishing forecasts, one could better understand the mental “model” the Bank had in mind, and one could get a sense of the “reaction function” (ie how the Bank responds to a particular inflation outlook, and changes in that outlook).     But even this point is vastly overstated, for a variety of reasons:

  • it doesn’t apply at all to, say, the Bank’s current forecasts of the OCR in 2020.  By then, there will have been another dozen or so sets of forecasts out.
  • it doesn’t even really apply to forecasts of inflation or GDP a year hence.  By the time we discover whether those forecasts are correct, there will have been another three or four sets of forecasts published.

There is a case that published forecasts of the very next round of quarterly data might be helpful.  If the Bank thinks the next quarter’s GDP data will show an increase of 0.4 per cent, and the actual outcome is 0.9 per cent, then (all else equal) markets are likely to think the Bank is a bit more likely than previously to tighten a bit sooner than previously.     But even then, it is never that simple.   After all, there is noise in the actual data.    But that is where McDermott’s case is strongest, which has nothing to do with the medium-term forecasts.

The line, which pervades the speech, that it really doesn’t matter if forecasts are right, because they still have useful information, would probably be true in one very specific set of circumstances.

If the Reserve Bank had, through hard work, divine insight or whatever, uniquely acquired the perfect “model” of how the economy works, but simply didn’t know what new shocks might hit the economy, then the model –  and the associated forecasts –  would have some use.  If a shock hits out of the blue, everyone can be clear how much that shock will affect the forecasts and, hence, how the Reserve Bank will optimally react.

But to write that down is to expose just how unlike the real world that is.  Typically forecasters have only at best only a vague approximation to the correct “model”, and when data come out that surprise them, it often isn’t a genuine shock – a new event arising outside the system – but rather something that challenges the “model” of the economy the forecasters (or central bank) have been using.    To a considerable extent, that has been the story of the last decade –  not just for the Reserve Bank of New Zealand, but for all of us here and abroad.    It also isn’t a criticism (of the Bank or anyone else), just a description of the limitations of our knowledge.    What is worth criticising is the pretence that the forecasts are offering more.

A common benchmark is whether a forecast (whether by judgement or a formal model, or some combination) can beat a random walk –  a simple model in which the best prediction of the next period is the actual outcome for the last period.   If not, there really is no point in doing forecasts, since the forecasts are just adding noise.   Over the last eight years, the Reserve Bank’s medium-term OCR forecasts have clearly been worse than a random walk forecast, and they’ve been biased too.  It is harder to do on the other variables (since, for example, they don’t publish core inflation forecasts), but there is little in the evidence to suggest that the medium-term forecasts in particular are adding any value at all.  And yet, as McDermott notes, they take a lot of resources to produce.

To be clear, I’m not denying that markets and commentators pay some attention to the Reserve Bank’s OCR track all the way out to 2020.  But they do so not because that track has any substantive information about what the OCR will actually be in 2020 –  their guess is probably as good as the RB’s, and both are typically terrible –  but simply because it has become a communications device.  If the Reserve Bank wants to communicate a more hawkish stance, it will typically choose to revise up that forward OCR track (and I’ve sat in many meetings where Governors didn’t want to communicate a hawkish stance and forecasters were told to go away and flatten out the track).   But from a substantive perspective, it is unlikely that there is any more useful information than was contained in this simple sentence from the front page of last week’s MPS.

Developments since the February Monetary Policy Statement on balance are considered to be neutral for the stance of monetary policy.

Agree with them or not, there really wasn’t much more to the document –  for all its pages – than that.

There is a great deal in McDermott’s speech about how helpful the Bank finds its forecasting –  indeed, it must surely be a first for the word “precise” to appear twice in a Reserve Bank press release.  But if (a) you know almost nothing about the future, and (b) you can reasonably confident you don’t even have the right model, it is really all sound and fury, signifying nothing, akin to the ritual incantations of some ancient tribe.

Almost all the value in the economic analysis the Bank does is in understanding the past and the present.  That is no small challenge in itself.  Making sense of what the output gap (or unemployment gap) is right now, making sense of what explains current inflation or unemployment, is plenty enough to keep lots of smart analysts occupied (after all, look at the revisions to the historical estimates).  There may well be a useful role for some short-term forecasting –  the next quarter’s GDP or CPI outcomes –  and even perhaps for scenario analysis, but anything else should be of almost no value to policymakers –  who will mostly update their OCR decision on the next set of actual outcomes –  or to anyone else.   When we say that we can meaningful forecast medium-term economic developments, we deceive ourselves, and the truth is not in us.

Finally, McDermott is at pains to try to stress how open to scrutiny and challenge the Bank is –  and repeats the claim that the Reserve Bank is one of the most transparent central banks in the world.    Again, you can’t really have it both ways.  If the forecasts don’t tell the future (as the Bank today wants to claim), there isn’t really any information in them.    It is akin to being transparent about a set of random numbers.   As I’ve noted before, the Bank ranks well on transparency about things it knows almost nothing about –  the future –  while being highly secretive about the stuff it does know about.    We don’t see the background papers the Governor considers in coming to his published forecasts, we don’t see even summaries of the advice the Governor receives on the OCR, we see nothing of the minutes of the Monetary Policy Committee or the Governing Committee and so on.  And it is not as if the Bank could really justify secrecy on the basis of the old line “trust us, we know what we are doing”.   Demonstrably, they haven’t convincingly passed that test for some time.  Instead, they hide behind all this talk of “precise” thinking, detailed processes, alleged openness to new ideas, encapsulated in ongoing updates to the forecasts.  The unnerving thing is that McDermott at least appears to believe it.

I popped into the Wellington Public Library’s annual book sale yesterday and came away with an interesting little book by a Princeton academic, The Road to Delphi: The Life and Afterlife of Oracles.  Flicking through it, I couldn’t find a good quote that was both apt and fair to apply to the Bank, but it isn’t hard to think that the Bank’s forecasts may play more of quasi-oracular role, with all the actual forecasting capability of the oracles of Delphi or modern astrologers (for which there is clearly a revealed demand), than a substantive economic one.

And since readers often respond with “so what would you do?”,  I would

  • stop publishing OCR forecasts at all,
  • restrict published economic forecasts to the year ahead, and
  • re-orient the analytical (and particularly) the communications effort much more squarely on making sense of where we are now.  That is quite hard enough, and without a good fix on that, everything else is largely sailing blind.

 

 

 

 

A questionable indicator of the labour market (geeky)

Michael Reddell Reserve Bank, unemployment

The Reserve Bank has long been averse to too much focus on the unemployment rate.  Some of that was political.  Opposition MPs back in the 1990s would try gotcha games, trying to extract estimates of a non-accelerating -inflation rate of unemployment (NAIRU) with the aim of then being able to tar us with lines like “Reserve Bank insists full employment is x per cent unemployment” [at the time x might have been 7 per cent or more] or “Reserve Bank insists on keeping x per cent of New Zealanders unemployed”.   So there was an aversion to using the concept, and most certainly to writing it down.  If you don’t write things down, it is hard to have them OIAed.

But for decades there has been something a lot like a NAIRU embedded in successive versions of the models the Bank uses as a key input to the forecasting process.   But there was still an unease.  Some of it was those old political concerns.  Some of it was the aversion to being pressured into any sort of dual objective model –  even though discretionary monetary policy was only ever introduced to allow short-term macro stabilisation together with medium price stability.

In the last decade or so, it seemed to be some mix of things.   In 2007, the unemployment rate was down at around 3.5 per cent, but the official view at the time was that the overall economy was more or less in balance (as I noted yesterday the output gap estimates then were positive but quite small).  So, the unemployment rate tended to be discounted.   To the extent there were NAIRU estimates implicit in the thinking, they had been trending down for 15 years.  Perhaps, some felt, 3.5 per cent unemployment wasn’t much below a NAIRU at all.

In the years after the 2008/09 recession, there seemed to be two problems.  The first was a quite genuine one.  The HLFS unemployment rate numbers were quite volatile for a while, and while it was clear that the unemployment rate was still quite high, it was hard to have much confidence in each new quarterly observation.    The rise in the unemployment rate in 2012 only further undermined confidence among some of my then colleagues.  The economy seemed to be recovering.

U 2006 to 13

So there had always been a tendency to discount the unemployment rate.  Odd short term developments in the series itself reinforced that, and then as the recovery began to develop the Bank kept convincing itself that the output gap had all but closed.  If the output gap  –  which tended to be central focus for much of the analysis, even though it was something of a black-box, and prone to significant revisions –  had really closed, then surely the labour market must also be more or less in balance?  If the unemployment rate appeared to suggest otherwise, so much the worse for that particular indicator, which many at the Bank had never much liked.    When the Bank started the ill-fated tightening cycle in March 2014, they thought then that excess capacity had already been used up for a couple of years.  This is the output gap chart they ran then.

output gap mar 14 mps

At the time, the unemployment rate was still 5.6 per cent

(Contrast that output gap chart with the one from yesterday’s MPS, which I included in yesterday’s post.  At first glance, they look quite similar, but whereas in 2014 they thought excess capacity had been exhausted in 2011/12, now they think it was only exhausted in 2013/14.)

Various people had various ideas for how best to look at labour market data.  But mostly the unemployment rate was just ignored.

A year or two back, some US researchers had done an interesting exercise, trying to combine formally the information in a whole variety of labour market indicators, to distill an overall picture.  And somewhere along the line, someone got the idea of doing something similar for New Zealand.  And thus was born the Reserve Bank’s Labour Utilisation Composite Index, with the pleasing acronym of LUCI.

One day last April, Reserve Bank Deputy Governor Geoff Bascand gave a major address on monetary policy matters, Inflation pressures through the lens of the labour market.  As I noted at the time, it was little odd for him to be giving the speech –  as his day job was mostly responsibility for notes and coins, and the Bank’s corporate functions.  Then again, his ambition for higher office was pretty apparent, and earlier in his career he had led the Department of Labour’s Labour Market Policy Group.   Geoff on labour market matters should have been worth listening to.

The broad thrust of the speech was that high immigration wasn’t going to put much pressure on demand (contrary to the usual experience, and past Bank research), and that the labour market was pretty much operating at full capacity.  In support of these propositions, the Bank simultaneously released not just the speech, but three new Analytical Notes.    Since I had been harrying the Bank about its change of view of immigration, I focused then on the two immigration research papers, and identified a number of issues with them.     At the end of a long post I noted

There is a more material on other topics in Bascand’s speech, and another whole Analytical Note on other labour market issues which I haven’t read yet. I might come back to them next week.

But I never did.  Other things presumably distracted me, and thus I never got round to reading the Analytical Note introducing LUCI.   I didn’t until yesterday afternoon – I’d heard the Governor, or the Chief Economist, mention it at the press conference, and it was a wet afternoon, so I went and downloaded the paper.

The Reserve Bank has given quite a lot of attention to this brand new indicator.  In the Deputy Governor’s speech, it gets three whole paragraphs

Over the business cycle, a key driver of wage growth is the balance of supply and demand, or labour market ‘slack’. However, the unemployment rate is an inadequate indicator of labour market slack, particularly when the participation rate fluctuates. Researchers at the Bank have recently constructed a labour utilisation composite index, or LUCI, to help address this problem. Such indices combine the information in a large number of labour market variables into a single series of labour market tightness, and are used internationally to help gauge labour market pressures. The New Zealand index uses official statistics such as the HLFS and survey measures of the difficulty of finding labour, such as the QSBO.

By construction, the LUCI has an average value of zero. A LUCI value above zero indicates greater labour market tightness than usual – a value below zero indicates greater labour market slack than usual. Our research shows that, historically, a higher LUCI has been associated with stronger wage growth.

The LUCI suggests there was a large degree of slack in the labour market at the trough of the 2008-09 recession. The LUCI then gradually returned to zero, and has been around that level since early 2014 (figure 7). This movement is consistent with the range of the Bank’s suite of output gap indicators.

This wasn’t just some speculative new tool dreamed up down in the engine room by smart researchers, but still needing road-testing.  The Deputy Governor (presumably with the approval of the Governor and the Chief Economist) seemed sure it was action-ready.

Consistent with that approach, a chart of LUCI has appeared in all but one of the five MPSs since that speech.    Here was LUCI as she appeared yesterday

LUCI may 2017

On the Deputy Governor’s telling

A LUCI value above zero indicates greater labour market tightness than usual – a value below zero indicates greater labour market slack than usual.

In other words, on that particular interpretation, labour market tightness was now more severe than it had been in 2007 (just prior to the recession), and almost as severe as at the peak of the series in around 2004.

And, of course, Geoff Bascand didn’t just make up that interpretation.  It was what the researchers had said in their Analytical Note, almost word for word.   It was also what the footnotes on the LUCI charts in the MPSs said.  At least until yesterday.     In yesterday’s MPS, slipped in so quietly, the interpretation of LUCI had changed rather materially.   The chart was still there, it still looked the same as ever.  But below it, it has these words written

Note: a positive value indicates a tightening in labour market conditions

Lay readers may not immediately notice the difference, but it is substantial.  When the indicator was launched, with some fanfare (there are many clever new indicators, and not many get three paragraphs in a Deputy Governor speech), a positive value was interpreted as the labour market being tighter than usual (thus the pesky single indicator, the unemployment rate could keep on being largely ignored).   But now a positive value simply means that the labour market is a bit tighter than it was last quarter.    If there was lots of slack last quarter, it simply doesn’t matter to the indicator –  all that matters is the direction of change.

The Bank didn’t draw this to readers’ attention at all.  They didn’t change the heading on the chart either.  It was a bit naughty really.       What it means is that whereas we once had an indicator –  using 16 different variables –  that might have suggested the unemployment was completely misleading as a measure of slack, what we actually have now in LUCI saying similar things to the unemployment rate.  The unemployment has been edging down, and LUCI has been positive.   But that LUCI number is now felt to tell us nothing at all about the absolute level of labour market slack (or even the level relative to a long run of history).

I don’t quite know how the Bank fell into this –  except, perhaps, for the wish (for a labour market measure suggesting the market was at full capacity –  in line with the output gap estimates) getting the better of hard-headed challenge and scrutiny.

The approach they used to construct LUCI was very much the same used to construct the sectoral factor model of core inflation.  In essence (there), get the rates of price increases for all the CPI components, and look for a common theme (or “factor”) that runs through them all.    It seems to work quite well there.  All the variables are expressed the same way (percentage changes).      But LUCI is a bit different.     Here is the list of all the variables used.

LUCI components

They take each variable and standardise it relative to its own mean.

But it is an odd mix of variables.   There are annual percentage changes mixed in with levels.  And some of those levels measures (eg the QSBO ones) are the outcome of questions that are actually technically expressed in change terms.  It is also a mix of quantity measures and price (wage) measures.   When I looked through the list, the first real oddity that struck me was that unemployment itself is not expressed as a percentage rate.  Rather, they take the number of people unemployed and calculate the percentage change.   If, then, every single person was fully employed –  so the labour market was very tight –  this component  (used in calculating LUCI)  would be showing a zero percentage change.  They’ve done the same thing to all the quantity variables, so it should have been obvious from the start that what they were doing (at least for that half of the inputs) was looking at variables that would produce a change indicator, not a levels one.

I understand why they did it.  The unemployment rate trended down for 15 years or so.   The gap between the actual unemployment rate and the average unemployment rate wouldn’t be a very meaningful indicator.   But it meant, almost inevitably, that the new indicator couldn’t be an indicator of absolute labour market tightness, only (at best) an indicator of changes in tightness.

But there are other problems.  Think about what would happen if (to be deliberately extreme) the population doubled, and yet there was no change in “true” labour market tightness.    That isn’t far from the Reserve Bank’s story about the recent immigration shock –  they told us again yesterday that, contrary to past common experience, they think the demand and supply effects have more or less offset each other.

But if the population doubled, and there was no change in “true” labour market slack,  we would still expect to see employment, numbers unemployed, the number of short-term unemployed, numbers underemployed, the number of filled jobs, hours worked, the working age population, the number of job ads, and the number of registered job seekers all increase (that is roughly half the variables in LUCI).   The unemployment rate (%), for example, might stay the same, but both the numerator and the denominator would increase a lot.  Since LUCI uses annual percentage changes, it seems highly likely that such a shock would show up as a big increase in LUCI in the year the population shock happened  (in my extreme examples, the APCs would go to 100 per cent that year), even if there had been little or no actual change in labour market tightness.

It seems astonishing that, for a variable launched by a Deputy Governor in a speech playing down the net demand effects on a large immigration shock, this issue never seems to have occurred to them.

There are other, probably more minor and mundane, problems too.  These ones  probably weren’t foreseeable in April last year, but probably still should have been highlighted as they became apparent.  The revised HLFS was introduced in June last year.  It is pretty clear that the modifications to the questions have led to material step changes in the HLFS measure of hours worked and of employment (you can see the anomalies in the charts in this post from earlier in the week).   (For some reason, they don’t even use the QES measure of hours in LUCI).     Perhaps a distortion of this sort to only two of the component variables won’t have affected the common factor that the model is trying to identify.  But we don’t know.  I hope the Reserve Bank does.   This particular problem will wash out of the data in the next HLFS release (since a year will have passed, and LUCI uses annual percentage changes), but for now it is another reason not to have much confidence in LUCI as any sort of indicator of labour market tightness (level or changes).

I did put some of these points to the Reserve Bank yesterday, mostly just to check that my understanding of the technical points was correct. I had a helpful response this afternoon which essentially establishes that they are (obviously I’m not associating the Bank with the interpretations I’ve put on those technical points).

Overall, it isn’t a case of the Reserve Bank at its best.  I have no problem at all with them doing the research in the first place.  We should always be looking for new or better ways to understand what is going on, and how best to combine sometimes conflicting bits of data.      But it doesn’t have the feel of something that was at all well road-tested before being launched as a major indicator variable.  And then, when they did finally realise that it was much more like an indicator of changes in labour market pressure rather than the level of pressure, that recognition was sneaked through without even an explanatory note, leaving anyone who had taken the earlier use of LUCI at face value none the wiser unless they were a particularly assiduous reader (and I’m usually not, when it comes to changes in footnotes on charts).

We now have a recognition that LUCI isn’t a measure of overall pressure on the labour market.  It may be, loosely speaking, an indicator of changes in labour market pressure, but even then that reading is made more difficult when you get large population shocks (of the sort that NZ is prone to, with quite variable large immigration flows, in a way that many other countries are not), and when the Reserve Bank repeatedly assures us that its overall interpretation is that this particular population shock isn’t putting additional net pressure on demand, and may even be easing capacity pressure in the labour market.

We really should expect better from our central bank.  Speeches like Bascand’s, and documents like the MPS, will have had heavy involvement from all the members of the Governing Committee –  the Governor himself, the incoming acting Governor, the incoming Deputy Chief Executive, and the long-serving Chief Economist.   One can’t help thinking that they’d have been better served taking the unemployment rate –  actually designed directly as a measure of excesss capacity –  and wage developments rather more at face value.   And of recognising that, contrary to LUCI, no serious observer thought that the labour market was at its tightest in 2004.   It isn’t much harder than that.

Full, accurate, and accessible records

Michael Reddell Reserve Bank, Reserve Bank Board

That is what the Public Records Act 2005 requires of all “public offices”.    Specifically

Every public office and local authority must create and maintain full and accurate records of its affairs, in accordance with normal, prudent business practice, including the records of any matter that is contracted out to an independent contractor.

and

Every public office must maintain in an accessible form, so as to be able to be used for subsequent reference, all public records that are in its control,

Under the Act “public office”

a) means the legislative, executive, and judicial branches of the Government of New Zealand; and

(b) means the agencies or instruments of those branches of government;

I don’t think there would be any doubt that the Reserve Bank, and its Board, would qualify as “public offices”.  And yet the Board, in particular, appears to have, at best, a shaky grasp on its statutory responsibilities in this area.

As regular readers know, I’ve been trying to understand the process that led to the appointment in February of an acting Governor of the Reserve Bank, including understanding how, if at all, officials and ministers convinced themselves that the appointment is lawful.

As I noted in a recent post

Section 48 of the Act covers a vacancy in the office of Governor.    The key bits read as follows

If the office of Governor becomes vacant, the Minister shall, on the recommendation of the Board, appoint….[a person] to act as Governor for a period not exceeding 6 months or for the remainder of the Governor’s term, whichever is less.

The critical phrase here appears to be “whichever is less”.      When Don Brash resigned as Governor in April 2002, there was about sixteen months to run on his term.  The then Minister appointed Rod Carr to act as Governor.    He could be appointed for as long as six months, because there was still sixteen months to run on “the Governor’s term”.  By contrast, on 26 September this year there will be no days left on the Governor’s term.  Graeme Wheeler’s term will have expired at midnight the previous day.   So an acting Governor can only be appointed for…….. zero days, since there are no days left on “the Governor’s term”.  In other words, the Act simply does not appear to allow an acting Governor appointment along the lines of the (purported) Spencer appointment.

In an earlier post, I covered the extensive material The Treasury had released on the period leading up to the acting Governor appointment.

By contrast, the Reserve Bank Board released almost nothing.    I had lodged a pretty comprehensive request seeking

copies of all papers of the Reserve Bank Board relating to the end of Graeme Wheeler’s term as Governor, the process for appointing a permanent replacement, and the appointment of Grant Spencer as acting Governor.   This request includes papers on the Board’s agenda, minutes of relevant discussions, papers/letters sent to the Minister of Finance or Treasury, and filenotes of any relevant meetings.

I got back a copy of a single very brief letter from the chair of the Board to the Minister of Finance recommending the acting Governor appointment (with no supporting analysis or advice).    The only material they told me they were withholding was some Human Resources advice and some in-house legal advice.  The latter apparently covers the questions around the relevant provisions of the Reserve Bank Act, and I have appealed the Ombudsman the decision to withhold.   There was, if the Board was to be believed, nothing else at all.

But that seemed odd.  I knew that Board meetings had minutes, and if those minutes were often quite loosely written (in another context, I’m dealing with legal uncertainty created by loose Board minutes from 25 years ago), at least the minutes seemed likely to exist.  In fact, the letter from the Board chair to the Minister of Finance explicitly referred to an agreement by the Board on 30 January to make the acting Governor recommendation.  Surely there were minutes of that meeting (and the Bank’s Act explicitly covers both physical meetings and teleconference ones)?    They should have been captured in my earlier request, but perhaps there had been an adminstrative oversight?

I also knew from the papers Treasury had released that by late last year the Board had already been well-underway in getting going a process for appointing a new permanent Governor once Graeme Wheeler’s term expires in September, and had been told as late as the end of November by the then Minister of Finance to keep on with that process, apparently regardless of the election issue.  In fact, the Treasury papers referred to the Board already having appointed a search firm.  So out of curiousity, I lodged a new request, not just for the minutes of the 30 January meeting, but also for minutes of any Board meeting in the December quarter last year.

I got a response to that request yesterday.  They released in full the minutes of the half hour (teleconference) Board meeting held on 30 January.  They were brief, but of some interest.

The Board received advice from the Minister of Finance that, on advice the Cabinet Office and after consultation with Cabinet, he had decided to appoint an acting Governor for a six month period to cover the post-election caretaker period, allowing the next Government time to make a decision on the appointment of a permanent Governor for the next five-year term. The Minister asked the Board to recommend a candidate for acting Governor.

The Board agreed unanimously to recommend Grant Spencer, currently Deputy Governor and Head of Financial Stability, for the role of acting Governor. The Chair would forward this advice to the Minister.

The Board chair’s letter to the Minister, dated 31 January, had sought to imply that the initiative for the acting appointment recommendation had come from the Board itself (the Act certainly envisages the Board taking the lead).  That never seemed likely, given the material Treasury and the Minister of Finance had released.  These minutes confirm that the Board was simply told what to do, and complied.  It is a poor reflection on the Board  that they had simply seemed unbothered about moving ahead to make a long-term appointment, which would take effect around the time of the election, in a climate in which there was little cross-party consensus on Reserve Bank matters.  Fortunately they were stopped in their tracks by the Minister of Finance.

It is another illustration of the weakness of the Board (not necessarily the current individuals, but the structure).  It reinforces my call to remove the recommendation/appointment powers from them back to the (normal international) model in which the Minister of Finance simply appoints a Governor.   These people simply don’t have the background, or any legitimacy, to be making an appointment of one of the most powerful people in New Zealand.   If there is a change of government (in particular), amending this provision of the Reserve Bank Act should be an early legislative priority.

But what also caught my interest is that although the Board released the minutes of its three meetings held in the December quarter (I will post a link when the Bank puts the material on its website), there is no record at all of any of their deliberations or decisions around the process they had underway of moving towards appointing a new Governor.  We know a lot about it from the Treasury documents, but if these releases are to believed, the Reserve Bank’s Board simply kept no records.

There was plenty of material omitted from the minutes that were released, but all the headings of the individual items were released.  Some of the decisions to withhold look questionable, but since I wasn’t really interested in that other material, I won’t take that any further.

In the October 2016 meeting there is an item 8.3 “Director’s-only discussion”.    That may well have been an occasion on which they dealt with the coming gubernatorial appointment.  But, if so, we’ll never know.    The minutes of this discussion weren’t withheld (in which case that withholding could be challenged to the Ombudsman, and future historical researchers would probably get access anyway) but simply don’t exist at all.    Minutes are typically taken by the Board secretary, who is a Bank staff member, but there is no reason why one of the Board members themselves could not have minuted this discussion, and recorded them in a version of the minutes not given general circulation.  But there appears to be no record at all.

In the November 2016 meeting there was nothing similar at all, and no (apparent) discussion of these issues.   In the December 2016 meeting, despite coming only a couple of weeks after Bill English had told the Board chair he was comfortable with them moving ahead with selecting a Governor recommendation, there is also nothing recorded.  Again, there is an item 8.3 “Non-executive directors only Session”, but there are no minutes at all (again, to stress, the minutes aren’t withheld; they simply don’t seem to exist).

It is quite extraordinary, given that we know from the Treasury material that there had been interactions with the Minister of Finance, the directors had appointed a search firm, and were planning to start advertising in January, only a month later.  But where are records of any of this?  It is possible that some of the decisions had been made earlier, but it is simply inconceivable that there was no substantive discussion, and no decisions taken, in the last three months of last year.   But none of it appears to be recorded.

Now perhaps there are some secret records –  file notes, email exchanges among directors – that the Bank staff who handled my request were not aware of. But any such material would have been covered under one or both of my OIA requests, and when I lodged the OIA requests I was quite explicit that they were requests to the Board, not to the staff of the Bank.

We seem to be in the sad state of affairs where either the  powerful Board of a major government agency is denying the existence of records that do actually exist about the process they had underway, and had to call to a halt, to appoint a new Governor.   That would be in breach of the Official Information Act.    Or the same Board is so shoddy in its record-keeping that it would seem almost certain to be in breach of the Public Records Act.    I’m not quite sure which to believe (although I suspect it is mostly the latter explanation).  Neither seem remotely satisfactory.  Neither option seems like what one should expect from a government-appointed Board responsible for recommending the next Governor of the Reserve Bank, holder of the most powerful unelected role in New Zealand.

It is not even as though this is material about something under active consideration.    The search process they were working on late last year, apparently oblivious to the significance of the election, was called to a halt.    In fact, as the Bank told us last week

The Reserve Bank Board of Directors’ recruitment process to identify a successor to Mr Wheeler is to commence later in the year.

We have record-keeping requirements on public agencies, and disclosure requirements such as the OIA, in significant part to enhance accountability and

thereby to enhance respect for the law and to promote the good government of New Zealand

If records simply aren’t kept, we have no way of knowing whether public appointees have done their job adequately,  That doesn’t enhance respect for the law, or promote good government.  Specifically, we still have no basis for knowing how the Board of the Bank concluded, or whether they advised the Minister, that the appointment of an acting Governor in these circumstances was lawful.

Full, accurate, and accessible records are a statutory obligation.  The Reserve Bank’s Board doesn’t appear to have been complying, even though the appointment of a new Governor is one of the few areas in which the Act gives them explicit decisionmaking powers.   It simply isn’t good enough.

UPDATE: The Bank appears to have decided not to put this material on its website, contrary to their usual OIA practice.  Here are the minutes of the three December quarter meetings.

1.3 Board Minutes – 20 October 2016 – for release

1.3 Board Minutes – 17 November 2016 – for release

1.3 Board Minutes – 15 December 2016- for release

“Whichever is less”

Michael Reddell Governance, Reserve Bank

I’ve done a few posts over the last couple of months about the lawfulness of the Minister of Finance’s decision to appoint an acting Governor of the Reserve Bank for six months after the expiry, just a couple of days after the election,  of Graeme Wheeler’s term.  As a reminder, I had several times argued that making a substantive five year appointment, to commence just after the election would be inappropriate –  indeed, as Treasury officials advised, it would also be inconsistent with the long-established conventions that govern behaviour in the period close to a general election.  As a further reminder, I have no particular concerns about Grant Spencer; if the appointment is lawful I’m sure he will mind the store capably until a permanent appointment is made by the incoming government.

This post was written on the day the acting appointment was announced, this one following responses to my OIA requests for information relevant to the appointment, and this one from last week on an appeal to the Ombudsman, on the grounds that the public interest (including because of the extent of the powers that rests with any appointee) should lead to the release of any legal advice the Minister, the Board, and officials received on the legality of the appointment.

And there I would have left it, with perhaps a repeat post the day Spencer took office.  My main concerns were about (a) the lack of transparency about an unusual appointment (even if it is lawful), and (b) about the importance of laws being followed, even if the legally questionable appointment was, on the face of it, quite a pragmatic response to the clash of dates (election, and end of Governor’s term).   But they weren’t necessarily points of general interest.

But then a reader got in touch.  The reader wasn’t sure, reading the legislation, whether or not Spencer’s appointment looked lawful, but pointed out that the Reserve Bank Act vests all the powers of the Bank in the Governor personally.  Thus, if there were doubts about the validity of the appointment of a Governor (or in this case an acting Governor), that would appear to raise doubts about the validiity, and potential enforceability, of any actions taken by the Bank during the term of the acting Governor.  That got my attention.

After all, the Governor wields a great deal of power.  He sets the OCR, he sets much of prudential regulatory policy, he authorises enforcement actions against regulated entities, and the Bank –  under his authority –  undertakes large volumes (and values) of financial transactions in domestic and international financial markets.  All delegations to staff are delegations directly from the Governor.   And those are just the routine activities of the Bank.  But a big part of why we have a Reserve Bank is about crisis management –  whether in foreign exchange markets, the economy more generally, or some or all parts of the financial system.   Many of the crisis powers rest with the Minister of Finance.   But many of the operational bits rest with the Bank, in which, as already noted, all powers are vested in the Governor.  That is what a single decisionmaker structure means.  It was a deliberate and conscious choice by Parliament.   Of course, in any particular six month period –  the term of the acting Governor – one hopes the crisis management powers aren’t needed at all.  But crises can flare up quickly, and the last thing one wants is doubts about the powers of the Bank, or the authority of those purporting to exercise such powers, in the middle of a crisis.  Let alone legal action afterwards seeking to invalidate some or all interventions by our central bank.

So I want to go slowly and carefully through the reasons why I think

a) it is not lawful for the Minister of Finance to appoint an acting Governor when the full term of a previous Governor has expired, and

b) why any defects in the appointment of a Governor/acting Governor appear to raise serious doubts about the validity and enforceability of any actions take by the Reserve Bank during the term of any acting Governor.

And I will suggest two possible practical solutions.

The Reserve Bank Act clearly allows for an acting Governor in some circumstances.

Section 47 of the Act allows for the case where the Governor is absent or incapacitated.   If the Governor is on holiday, or indeed seriously ill, the deputy chief executive can act automatically.  But if both the Governor and the deputy chief executive are absent or incapacitated, an acting Governor must be appointed by the Minister on the recommendation of the Board.    There is no limit to the term of such an appointment, although by implication –  since it is to cover an absence of an appointed Governor –  it could last no longer than the expiry of the Governor’s own term.    This section of the Act has never been used, and is not relevant to the current appointment.

Section 48 of the Act covers a vacancy in the office of Governor.    The key bits read as follows

If the office of Governor becomes vacant, the Minister shall, on the recommendation of the Board, appoint….[a person] to act as Governor for a period not exceeding 6 months or for the remainder of the Governor’s term, whichever is less.

The critical phrase here appears to be “whichever is less”.      When Don Brash resigned as Governor in April 2002, there was about sixteen months to run on his term.  The then Minister appointed Rod Carr to act as Governor.    He could be appointed for as long as six months, because there was still sixteen months to run on “the Governor’s term”.  By contrast, on 26 September this year there will be no days left on the Governor’s term.  Graeme Wheeler’s term will have expired at midnight the previous day.   So an acting Governor can only be appointed for…….. zero days, since there are no days left on “the Governor’s term”.  In other words, the Act simply does not appear to allow an acting Governor appointment along the lines of the (purported) Spencer appointment.

This is all consistent with the fact that the Act makes no provision for a Policy Targets Agreement with an acting Governor (it isn’t needed within a Governor’s term, since there is already a PTA in place), even though the PTA is central to the monetary policy parts of the Act,  and that the Act requires all new appointments of a Governor to begin with a five year term.   The Minister and the Board can’t just appoint someone for a succession of short terms –  no matter how well-intentioned the reason –  and thus compromise the effective independence of that person.

It is also, perhaps, worth noting that the previous (1964) Reserve Bank Act –  the one in place when the policy and drafting decisions on the current law were being made  –  also made no provision for the appointment of an acting Governor after the completion of a Governor’s term  (section 18 here ).  Under that legislation there could be an acting Governor only during the term of an appointed Governor (if the Governor and Deputy Governor were absent or incapacitated).  And Governors had to be appointed for five year terms.

In other words, the drafting looks conscious and deliberate.   The 1989 Act explicitly added provisions allowing for an acting Governor when the Governor resigned or died, leaving a vacancy during his term.  But the Bank’s legislation has never, in at least 50 years, allowed for an acting Governor to be appointed to commence after the end of the previous Governor’s term.  But that is what the Minister of Finance, on the recommendation of the Reserve Bank Board, purports to have done (the Minister having received no advice from the Board on the legality of such an appointment).

Does it all matter?    Sometimes laws contain provisions stating that any problems in the appointment of an officeholder, or doubts about the validity of the appointment, don’t affect the validity of enforceability of the actions/decisions taken by that person.

In fact, the Reserve Bank Act has one of those provisions.    For the Board.  Under section 54(4)

The validity of any act of the Board is not affected by—

(a) any vacancy in its membership; or
(b) any defect in the appointment of a director; or
(c) the fact that any non-executive director is disqualified from appointment under section 58.

But there is simply nothing comparable for the Governor.

Curiously, there is protection for the Deputy Chief Executive when exercising delegated authority from the Governor.   Under section 51

The fact that the Deputy Chief Executive exercises any powers or functions of the Governor shall be conclusive proof of the authority to do so, and no person shall be concerned to inquire whether the occasion for doing so has arisen or has ceased.

But there is nothing like it for the Governor, or any acting Governor.  There is simply a requirement on the Board and the Minister to make a proper appointment, and to have that person in place once the previous Governor’s term ends (and presumably an expectation that Governor appointments are sufficiently high profile, and as all powers of the Bank rest with the Governor, no questions should ever arise about the authority of the Governor him or her self to make decisions.

(Again, it is perhaps worth noting that there are also no such protections in the 1964 Act – the one in place when the 1989 Act was being drafted.  The drafters presumably made conscious choices about what to add and what not to.)

Perhaps some legal expert has an authoritative interpretation of these statutory provisions suggesting that

  • an appointment like that of Spencer is legal, and
  • even if there are any doubts, nonetheless there would be no basis to question the legality of the actions of the Bank during his term as “acting Governor”.

If so, surely they now owe it to us to release that advice, or even a summary of the argumentation that led the Minister to conclude that, under the existing statutory provisions, he could appoint Spencer as acting Governor.  Failure to do so appears to leave real doubt about the authority for any actions the Bank takes, or purports to take, during Spencer’s term.     It isn’t a remotely satisfactory situation for such a powerful agency, especially when –  since many routine decisions could simply be deferred –  a big part of the Bank’s responsibility is crisis management.  That uncertainty should unsettle financial market participants here and abroad, it should unsettle Parliament’s Finance and Expenditure Committee (charged with monitioring the Bank), it should unsettle entities regulated by the Bank, and –  given the pervasive reach of many of the Bank’s powers –  it should unsettle citizens more generally.  It simply isn’t a satisfactory situation.

But it is a relatively easily remediable one.    The first option would have been simply to have offered Graeme Wheeler a six month extension on his term.  There are no restrictions on the term of any reappointment of the Governor.  It is a common way to deal with difficulties –  whether logistic or political/constitutional –  in appointing a new chief executive.     Had this option been taken there would have been no doubts about the invalidity of any of the Bank’s actions during that term.   We don’t know whether the Board/Minister refused to countenance another six months of Wheeler, or whether Wheeler simply wanted to be out as sooon as possible.  Given the legislative restrictions, and the election-related constraints, neither would –  on the face of it – seem to have been a particular responsible, public-spirited stance.  Presumably the Wheeler extension option is no longer available, but if it is it should be revisited urgently.

The second option would be for Parliament to act.  With the agreement of the Opposition parties it would be easy and quick to pass a single substantive clause amendment allowing for the appointment of an acting Governor to cover the period 26 September 2017 to 25 March 2018 (the period envisaged for the Spencer acting appointment).   In this case, the acting appointment is a pragmatic solution, but done without legal authority.  So don’t rush to change the legislation permanently –  it looks likely to be back in the House next year whoever wins the election –  but the acting “appointment” itself could easily be validated. It might be a little embarrasing to do so, but it would be a one day wonder, and a small price to avoid any doubts about Bank actions during the acting Governor period.

Of course, the other way would be to appoint Spencer to a five year term as Governor, on the implied expectation that he would resign after six months.   But that is how we got into this situation in the first place.  The conventions around election periods strongly discourage making substantive appointments to powerful public offices, when the appointee would take up the position close to, or shortly after, a forthcoming election.

(This is one of those issues on which I would really like to be wrong.   But I’m increasingly uncomfortable that an error was made by the Minister of Finance and the Bank’s Board.)

Bits and pieces

Michael Reddell New Zealand economic performance, OIA, Reserve Bank

As regular readers will know I have been uneasy about whether the Minister of Finance’s recent appointment of Grant Spencer as acting Governor of the Reserve Bank (while pragmatic) is in fact lawful.    I dealt with the issue first on the day the appointment was announced, and again when the Bank’s Board, the Treasury, and the Minister of Finance released material in response to my OIA request.

What made me most uneasy is that there was no suggestion in any of the papers –  whether the Board’s recommendation to the Minister, the Minister’s Cabinet paper, or in any of the various Treasury papers –  that officials, the Board, or the Minister had even considered seriously the lawfulness of such an appointment.  There is no summary of any legal advice in any of the papers, and no reference to the issue.  This is so even though the Act quite clearly makes the Policy Targets Agreement (PTA) the centrepiece of the balance between autonomy and accountability, and yet it makes no reference to the possibility of a PTA in a case where an acting Governor is appointed after a Governor’s term, and that Governor’s PTA, expires.   As an expression of good intent, the Minister of Finance and the incoming acting Governor have indicated that they expect policy will continue to be conducted according to the current PTA, but……(a) the whole point of the acting appointment is that Grant Spencer will take office a few days after the election (so the current Minister of Finance may be irrelevant) and (b) none of this is legally binding, even though the monetary policy provisions of the Act are built around quite detailed, and legally binding, rules.

All three agencies/people noted that they had withheld legal advice (from the Reserve Bank’s in-house lawyer and from Crown Law).  That wasn’t a surprise.   Protection of legal professional privilege is a grounds on which material can be withheld under the OIA.  But it is not an absolute grounds, and any possibility of withholding such material on that ground must first consider whether the public interest is such that the material should be released.  Recall that the whole point of the OIA is to allow more effective public scrutinty, accountability, and participation in public affairs.

I was initially inclined to let the matter lie.   But on further reflection, and having a look at some of the material the Ombudsman has put out in recent years (and a report of an even more recent decision), in which it has been ruled that either legal advice, or a summary of it, should be released, I have decided to lodge an appeal with the Ombudsman in this case.     It isn’t a case where, for example, the legal advice is contingent on facts known only to the parties commissioning the advice.  The relevant facts are all in the public domain already.  All that is being protected is the assessment of the interpretation of legislation on which powerful government entities are acting/advising.  If their interpretation of the acting Governor provisions is robust –  and it may well be –  then the Act is less robust –  in ensuring that the monetary policy decisionmaker is at arms-length from the Minister (not eg subject to six monthly rollovers), and yet is at all times subject to a legally binding accountability framework –  than had previously been thought.     There is a clear public interest in us being aware of any analysis the government, the Board, and the Treasury are relying on in making an appointment of this sort.  They act on those interpretations, and in so doing create “facts on the ground”.

I suppose it will take some considerable time for the Ombudsman’s office to get to this request –  perhaps even after the acting Governor’s term has ended –  but with the possibility of reviews to the Reserve Bank Act governance provisions in the next couple of years, it would still be valuable for this advice and intepretation (in full or in summary) to be put in the public domain. This is, after all, about the appointment and accountability provisions for the most powerful unelected public office in New Zealand.

On another matter altogther, I noted the other day that one of my readers, and periodic commenter, Blair Pritchard had published his own set of policy proposals for New Zealand.   Blair sets out seven policy goals and 15 policy proposals under the heading What’s a platform Kiwi Millenials could all get behind?    There is lots to like in his agenda –  and he graciously refers readers to some of my ideas/analysis –  although I’m sure most people, even non-millenials,  will also find things to strongly disagree with (for me, cycleways and compulsory savings –  although I’m also sceptical of nominal GDP targeting).      But I’d commend it to readers as a serious attempt to think about what steps might make a real and positive difference in tackling the challenges facing New Zealand.  And I really must get round to a post on a Nordic approach to taxing capital income –  one of the topics that has been on my list for two years now, and never quite made it to the top.   Cutting company taxes is the headline-grabbing option, and it would make quite a difference to potential foreign investors, but for New Zealanders pondering establishing and expanding businesses here, the company tax rate is much less important than the final rate of taxation on capital income which, in an imputation system, is determined by the personal income tax scale.   The Nordic approach quite openly sets out to tax capital income more lightly than labour income.   It isn’t a politically popular direction at present, but is the direction we should be heading, if we want to give ourselves the best chance of closing those persistent productivity chasms.

 

 

Possible Reserve Bank reforms: some reactions

Michael Reddell labour party, Monetary policy, Reserve Bank

Some of the media reaction to talk –  from both the government and the Labour Party –  of possible changes to the Reserve Bank Act  has been a bit surprising.  One leading journalist behind a paywall summed up both the review Steven Joyce has requested and Labour’s proposals as “utter balderdash”, apparently just because there are more important issues politicians should be addressing.  No doubt there are –  housing, the languishing tradables sector, non-existent productivity growth and so on –  but competent governments, backed by a large public service, can usually manage more than one thing at a time.    And although there are plenty of details to debate on Reserve Bank governance, they aren’t exactly divisive ideological issues.   A parliamentary under-secretary or Associate Minister handled most of the details of the 1989 Reserve Bank Act, in a government that did a great deal of other (often more important) stuff.

Bernard Hickey’s story on the government’s review and Labour’s proposals is headed Monetary Policy Reforms a Mirage.     That could be so.  If National is re-elected, they might advance no governance reforms.  Or they might just legislate for something very like the sort of internal committee that, in various shapes and forms, has been the forum in which the Governor made OCR decisions ever since the OCR was introduced.  But apparently at his post-Cabinet press conference, the Prime Minister –  who had rejected earlier Treasury advice in this area in 2012 –  opened up the possibility of a committee not just composed of insiders.

Meanwhile, English hinted Treasury might look at whether a rate-setting committee could include non-Reserve Bank personal. That would be a matter for the review, he said.

Beginning a process of discussing reform options tends to put a range of issues and options on the table.

The sort of decision-making and governance reforms being advanced by Labour and the Greens would be most unlikely to be “simply a mirage”.     There are number of concerns that what Labour is proposing does not go far enough, but again they are probably best seen as the starting point for a more detailed review if/when Labour and the Greens take office.  There is a risk that it could all come to not very much.   After all, even over the last 15 years the Reserve Bank has had a couple of Governor-appointed outsiders involved in the advice and decisionmaking process –  the Prime Minister’s brother is one of them at present –  and that hasn’t made much difference at all.  And requirements to publish minutes/votes can be subverted too.      But that it is why the appointment of the new Governor is so important.  If Labour and Greens are serious about reforming the way the Reserve Bank operates,  then if they become government they need to move quickly to find a person (perhaps a top team) they have confidence in, to work with The Treasury and the government to implement legislative reforms, and to lead the internal process changes to make the new, more open, vision a reality.    If they are serious about greater openness, they need to ensure they have a Governor who shares that reforming vision.   Such a Governor could make a considerable difference even if, for example, the new Monetary Policy Committee (MPC) were to have a majority of executive members.

In some ways, much the same goes for the, less substantively important, proposal to add some sort of full employment aspiration/objective to the statutory goal for monetary policy.    I’ve described it as virtue-signalling, but on reflection that might be slightly unfair.  In the narrow context of the Reserve Bank Act, it is probably about right –  if the Bank has had things a bit tight over the last few years, leaving unemployment higher than it needed to be, then often enough over the life of the Act, the unemployment rate has been below the NAIRU.   Changing the words of section 8 of the Act in isolation won’t make much difference. After all, Australia and the United States have wording Labour prefers, and yet the cyclical behaviour of their economies hasn’t, on average over time, been much different from New Zealand’s.

So I’m sure there is a bit of pure product-differentiation about Labour’s proposal in this regard.  That isn’t unusual. Most changes to the Policy Targets Agreements over the years –  from both sides of politics –  have been more about product differentiation than substance, about scratching itches rather than making much difference to how monetary policy is actually run.  For Labour there is probably is some perceived need to differentiate, and a desire to campaign (and govern?) on a whole-of-government commitment to promoting and facilitating full employment.   That is an unquestionably worthy goal.    If monetary policy choices aren’t going to make very much difference to the medium or long-term rate of unemployment, they can (and have) made quite a difference in the shorter term.  So one way of telling Labour’s story is that they want the word to get out to the public that they are committed to (medium-term) full employment, and they want the public to know that the Bank isn’t in any sense an obstacle to that, and to hear the Bank talking of the importance of the issue.  These are real people’s lives.   I noted yesterday

So the problem typically hasn’t been that the Reserve Bank doesn’t care about unemployment –  although they don’t mention it often, and there is little sense in their rhetoric of visceral horror at waste of lives and resources when unemployment is higher than it needs to be.

They probably should be talking about it more, with conviction.  The legitimacy of independent public agencies depends on part of people believing that those entities have the public interest at heart.  And everyone knows –  central banks acknowledge –  that in the shorter-term their choices do have (sometimes painful) implications for the numbers of people unemployed in New Zealand.  At a bloodless technocratic level, I’ve suggested Labour could amend the Act to require the Bank to regularly report on its estimate of the NAIRU, and how monetary policy is affecting the gap between the actual unemployment rate and the NAIRU.  But this isn’t just a bloodless technocratic concern.

So again, getting the right Governor matters –  someone who will talk convincingly and engagingly as if what they are about affects ordinary people, including those at the margins (vulnerable to unemployment and the resulting dislocation to their lives).

So, from the perspective of both strands of the Labour reform proposal, my concrete suggestion to them is that if they lead a new government after the election, they should quickly pass a one (substantive) clause amendment to the Reserve Bank Act.

Section 40 of the Act at present reads

40 Governor

(1) There shall be a Governor of the Bank who shall be appointed by the Minister on the recommendation of the Board.

(2) The Governor shall be the Chief Executive of the Bank.

Simply deleting “on the recommendation of the Board” would make our practice much more consistent with that in most other countries.  It would remove the controlling influence of a Board appointed entirely by the previous government, and it would allow Labour to have in place to lead the rest of their Reserve Bank reforms, someone of their choosing, someone in whom they have confidence.  That is how other advanced democracies do things.  It isn’t about appointing party hacks –  it is how Janet Yellen, Mark Carney, Ben Bernanke, Glenn Stevens and Phil Lowe were all appointed; capable people who commanded the confidence of the government that appointed them.

(Although it isn’t a priority for me, making this change might actually strengthen the effectiveness of the Bank’s Board in holding the Governor to account.  At present, when the Board (in effect) appoints the Governor they have a strong interest in backing their own judgement, and providing cover for the Governor.   If they were responsible for monitoring the performance of a Governor directly appointed by the Minister, they’d have less vested interest in the individual, and perhaps be more ready to represent the interests of the Minister and of the public).

As I was finishing this post, I noticed a highly critical article on interest.co.nz by Alex Tarrant.  Although he isn’t quoted, it reads in part as if Tarrant has been interviewing his father, Arthur Grimes, one of the designers of the current Reserve Bank Act monetary policy provisions, and former chair of the Reserve Bank Board.   There is a lengthy discussion of time-inconsistency issues –  a regular theme of Grimes’s.    I’m not going to attempt to respond in any detail now, but would just observe that whatever the explanations for the rise of inflation in the 60s and 70s (and I’m not persuaded by the story Tarrant quotes), what Labour seems to be proposing is something not far removed from the sorts of formal wording, and policy rhetoric, routinely used at the Reserve Bank of Australia and the Federal Reserve.  One can debate whether it makes much sense to use such langugage, or whether the formal statutory provisions in those countries make much difference, but it is hard for any detached observer to suggest credibly that the Reserve Bank of Australia or the Federal Reserve have suffered greater difficulties with credibility, or with the willingness of the public and markets to take their words seriously, than the Reserve Bank of New Zealand has faced with the current section 8 wording.   If anything, the Reserve Bank of New Zealand has had rather more problems –  odd experiments like the MCI, and two quickly-reversed tightening cycles in the last decade –  even if those particular mistakes and problems don’t have their roots in the wording of section 8.  And unlike other inflation targeting countries, there has never been an election since the Act was introduced in which some party or other (and not just the remnants of Social Credit) has not been campaigning for changes to the Reserve Bank Act or the PTA.  You don’t find anything like it in other inflation targeting countries.

Joyce requests review of Reserve Bank governance structure

Michael Reddell Governance, Rennie review, Reserve Bank, Uncategorized

Some will have seen Hamish Rutherford’s Stuff article reporting on the review the Minister of Finance has commissioned (to be undertaken by former State Services Commissioner, and former Treasury deputy secretary  responsible for macroeconomics,) Iain Rennie) on two aspects of Reserve Bank governance:

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

This is very welcome news.  As I noted in a post a couple of months ago on governance issues,  Steven Joyce has previously been on-record less averse than some to changing the model.

 

Who knows if the new Minister of Finance is interested, but flicking through some old posts, I was encouraged to find one from September 2015, reporting an exchange in the House between then Associate Minister of Finance Steven Joyce and the Greens then finance spokesperson Julie Anne Genter.  In response to a question on governance, Joyce responded

Hon STEVEN JOYCE : The suggestion that the member makes, of having a panel of people making the decision, is, I have to say, not the silliest suggestion in monetary policy we have heard from the Greens over the years, and many countries—

A backhanded dig at the Greens at one level, but not an outright dismissal by any means.

And with the Governor confirming that he is leaving in September, and a year now until a permanent new Governor is in place, it is good time to have such a review, so as to be open to the possibility of reform, including in discussion with potential candidates for Governor.   Treasury tried to interest the previous Minister of Finance in legislative reform before Graeme Wheeler was appointed, but were knocked back (even though Treasury had found support for reform from market economists).   Graeme Wheeler also sought to initiate reform –  legislating for his Governning Committee –  in 2013 (although he still keeps all the relevant papers hush-hush), and was also knocked back by the Minister of Finance.  So, I’m encouraged that Steven Joyce has initiated the review.

That said, it is a pretty small step.  Iain Rennie will bring some relevant background to the issue, although his track record as State Services Commissioner might not command much confidence in circles other than those who appointed him.  And the Minister of Finance is not committing the National Party to supporting change.  But with almost all other political parties favouring change, and Rennie likely to point out the simple fact that no other New Zealand public sector entity is governed the way the Reserve Bank is (all power formally in one official’s hands), and no other central bank and financial regulatory agency in other advanced countries puts so much power (monetary policy and banking etc regulation) in one person’s hand, it is likely to set in place momentum leading towards some legislative reform next year.

I spoke to Rutherford about this yesterday and am quoted in the article

Michael Reddell, a former special advisor to the Reserve Bank who says he sat on a committee on OCR decisions for 20 years, said formalising the current structure would make only a marginal difference, as the members all reported to the governor.

“If your pay and rations are determined by the governor, then the extent that you’re willing to stand up is questionable, particularly to a tyrannical governor,” Reddell said.

“If the minister [of finance] were appointing the people on the committee, it would be a material step forward.”

All three Governors who have operated under the current legislation have operated pretty collegially.  For a long time, the OCR Advisory Group (OCRAG) was the forum in which the Governor took formal written advice and recommendation, and then made his decision (I was part of that group for a long time).  Mostly his decision was in line with the (usually) clear-cut majorities of advice.  All members of that committee were appointed by the Governor, including two external advisers.   The current Governor has put in another layer of hierarchy, taking advice from a wider group and then making his decision in a smaller group (him, his two deputies and the chief economist).

I should stress that the reference to “tyrannical” Governors was not intended as a reflection on anyone who has served as Governor.    But you need to design institutions around poor or insecure Governors: good ones will want, and will encourage, debate and alternative perspectives.  Poor ones will squash it, and if they control all the members of the statutory committee, it offers little or no protection  –  and actually puts monetary policy decisionmakers at a further remove from the voters and Minister of Finance.   As I’ve argued previously, we need more involvement of the Minister in appointing monetary policy (and financial regulation) decisionmakers, and also need external perspectives brought into the process, in the form of full formal participation in the decisionmaking.  As, for example, it is in Australia, Canada, the UK, the US, Sweden and so on.

Rutherford’s report doesn’t say whether the Rennie review will also look at the formal decisionmaking structure for financial regulation.  Those issues will have to be considered in any legislative reform, and it is probably more important to get collective and external decisionmaking processes formalised, since in these areas the Bank does not operate to something like the PTA, but rather exercises huge amounts of barely-fettered discretion.

The second half of the review –  looking at whether the Bank should stay responsible for its legislation – is not one of the (long list) of reform issues I’ve focused on.  It will probably have many people at the Reserve Bank spitting tacks, and looking at all sorts of bureaucratic tactics to retain something as close as possible to the status quo.  I favour change (but will openly acknowledge that until perhaps the last five years I had the same insider hubris that affects many RBers –  a belief that “we are different” and no one else in positioned to do the legislation-ownership role well).  That is simply wrong –  and if the expertise isn’t there right now, it could be developed over time (probably in Treasury) without too much difficulty.  Again, it would bring the Reserve Bank into line with other Crown entity types of bodies, few (if any) of which are now responsible for their own legislation (altho in years gone by some important ones –  eg ACC – were).  It might seem to many readers like an “inside the Beltway” issues, that doesn’t really matter to citizens.  That would be a mistaken view.  Reform in this area is just one part of the overall agenda to improve the accountability of the now very-powerful Reserve Bank, and bring its goverance more into line with that for other Crown agencies, and with central banks and financial regulatory agencies abroad.

And so for the second time this week, I commend Steven Joyce.  It is only an unambitious start, but the start matters.

 

 

 

 

 

 

Appointing an Acting Governor: what the documents show

Michael Reddell Governance, Reserve Bank, Uncategorized

I had an email the other day suggesting that I should reduce my coverage of Reserve Bank issues.  No doubt the topic isn’t that interesting to that particular reader, but the main criterion for coverage here is what I’m interested in, and as I noted in response I’m interested in Reserve Bank issues, know something about them, and am fortunate to be much less constrained in what I can say than many other economists (often employed by entities the Reserve Bank regulates).   (As it happens, for any Wellington readers interested in monetary policy issues, I will be speaking briefly as a discussant responding to a presentation by Grant Robertson at Victoria University next Monday lunchtime.)

Which is by way of introducing a post which may not be of great interest to some readers.

For much of the time this blog has been running I had been pointing out, every few months, that the Governor’s term was due to expire almost three years to the day since the last election, and thus any replacement would normally be taking up the role right in the middle of a possible change of government.   As the Governor is the most powerful unelected public official in New Zealand, and there is currently no political consensus on monetary policy and Bank issues, it seemed inappropriate for the current government to be making an appointment to take effect just around the time of the election, materially tying the hands of a possible alternative government.     I’d suggested asking the current Governor, Graeme Wheeler, to stay on for, say, one more year (it was widely understood that Wheeler was not seeking a second full term).     There would have been no doubt about the lawfulness of that option, and had he been offered and accepted such an extension there would have been a new Policy Targets Agreement signed, as the Act provides.  Ever since 1990, the PTA has been the centrepiece of monetary policy arrangements in New Zealand, and the benchmark against which the Governor’s performance is to be assessed.

On 7 February, the Minister of Finance announced that (a) Graeme Wheeler would leave office at the end of his term, and (b) that because of the election the current Deputy Governor Grant Spencer would be appointed acting Governor for six months, allowing a permanent appointment to be made under whichever government takes office after the election.  It was also confirmed that Spencer would not seek appointment as permanent Governor.

In my post that day I welcomed the fact that the Board and the Minister had recognised the significance of the issue around the election, and raised no concerns about Spencer personally (he was my boss for two periods earlier in my career and I always got on well with him).   But I raised questions about whether such an appointment was lawful, under the terms of the Reserve Bank Act.

The Act allows for the appointment of an acting Governor –  and it has been done once before, when Don Brash resigned with immediate effect to go into politics –  but it appeared to provide for such an appointment only to cover a vacancy that arises during a Governor’s term, not to allow the Minister and Board to delay making a substantive appointment at the end of a Governor’s term (such an option would increase potential  political leverage over the Bank).     Consistent with that reading of the law is (a) that the Act makes no provision for agreeing a PTA with an Acting Governor (in a case like that when Rod Carr temporarily replaced Don Brash there was already a PTA is place –  which there will not legally be once Graeme Wheeler leaves office) and (b) that the PTA plays such a central role in the governance provisions around monetary policy (even in the event of a ministerial override of the Bank, a new PTA still needs to be put in place quickly.    But, technically, Grant Spencer will be conducting monetary policy with no PTA, and thus no (formal) checks and balances.

I was curious about (a) how this appointment came to be, and (b) how confident officials and ministers were of their legal ground.  So I lodged OIA requests with the Bank’s Board, with the Minister of Finance, and with the Treasury.   I didn’t really expect them to release the legal advice each agency might have obtained (although the Ombudsman has made clear that legal advice is not always absolutely protected, and (eg) this isn’t a matter of contractural dispute etc) but I assumed that the insights from that advice would be reflected in the policy advice and analysis that officials provided.

The Reserve Bank was about as obstructive as ever.   It took them seven weeks to release a single two paragraph document, the short letter from the Board chair to the Minister recommending the appointment of Spencer as Acting Governor.     There is no mention at all in that letter of the legal issues, not even a specific reference to the provision of the Act governing acting Governor appointments.  Clearly, and perhaps not unexpectedly, a lot else had been going on behind the scenes.

I had asked for

copies of all papers of the Reserve Bank Board relating to the end of Graeme Wheeler’s term as Governor, the process for appointing a permanent replacement, and the appointment of Grant Spencer as acting Governor.   This request includes papers on the Board’s agenda, minutes of relevant discussions, papers/letters sent to the Minister of Finance or Treasury, and filenotes of any relevant meetings.

The Board’s response suggested that the only other relevant material was (a) some advice from the Bank’s Human Resources, and (b) some internal legal advice.

It is simply incredible that there are no minutes of the Board meeting (even if it was just a teleconference) at which they made the recommendation to the Minister of Finance, and highly unlikely (as we shall see) that there are no minutes of earlier discussions, or even email filenotes of discussions that, for example, the Board chair might have had with the Minister of Finance on the forthcoming appointment.    If any of this is written down, it was covered by my request.  And if it is not written down, it might be operationally smart in the short-term (bureaucrats often say to each other, “be careful what you put in writing”) but it is particularly poor governance.  Both the head of the Prime Minister’s Department and the Ombudsman have been explicit that the provisions of the Official Information Act don’t justify taking a slapdash approach to documenting advice, decisions etc.

As I’ve come to expect, there was a much more helpful and fuller response from the Treasury.  It took some time, but there was 63 pages of material.    They haven’t yet put the response on their website – I’ll link to it when they do, and if anyone wants the material sooner just email me.  (Link to the released documents.)

I won’t bore readers by attempting to step through every paper, but what is clear is how late in the piece the decision was made to go the Acting Governor route, and that credit for that decision goes to the new Minister of Finance Steven Joyce.

The first papers are from August last year.  At that point, Treasury was aware that the expiry of the Governor’s term would fall in the period not far from the likely date of the 2017 election.  They didn’t seem to see the issue as a substantive one, and advised the Secretary to the Treasury that it might just mean that the appointment of a new Governor should be announced quite early (eg May 2017), which  in turn would mean the Board would have to begin the search process relatively early.

A month or so later they were specifically highlighting the convention under which governments are quite restrained in making significant appointments in the three months prior to the election. By this time, it is clear from the documents that the Bank’s Board was already actively planning their search and recommendation process.  Treasury note that it would be desirable to have an appointment announced by the end of May, but to do that a recommendation from the Board would have to be available by early-mid April, but “their current timeframe is to provide a recommendation to the Minister in May”.

By mid November, Treasury had taken formal advice from Cabinet Office, whose “legal and constitutional adviser” informed them that simply announcing an appointment early would not get around the pre-election conventions.  What mattered was the effective date of the appointment, not when it was announced.    That prompted an approach to staff in the Minister’s office highlighting the potential problem.  They note that one way around it would be to extend the current Governor’s term, or appoint an acting Governor for six months, but there is no discussion of whether the Act really allows for that latter option. (The other option was simply to barge ahead and make an appointment anyway, with or without consultation with opposition parties).

On 29 November, the Minister of Finance (still Bill English) held a meeting with Neil Quigley, chair of the Reserve Bank Board.  Treasury provided a briefing note.  It noted that “the Board is running the process….we understand that the recommended candidate for your consideration will be provided in May 2017” but flagged the issue around the pre-election period, and noted the possible options (as above).  Suggesting that they still hadn’t looked that carefully at the details of the legislation, they advised the Minister that a new PTA would be required, even if an acting Governor was appointed.

Among the documents is a note for the new Minister of Finance, which was in the end not sent.  But it states that “the previous Minister of Finance met with Professor Quigley on 29 November 2016 and indicated comfort with the Board continuing their appointment process as outlined to him”, and noted that Treasury had no further advice planned on this appointment.

Things seemed to move quite quickly from late December.  In a 20 December note to Gabs Makhlouf, staff pass on reactions to the news that “Hon. Joyce might look to delay the appointment of a new RBNZ Governor until after the election”

Staff themselves remain “neutral” about such an approach –  it is not at all clear what credible alternatives they saw there as being –  but noted the need to engage the Board quite quickly, noting “the Board’s original plan was to put out a job advertisement in late January, the Board has already engaged headhunters, and the previous Minister had signalled a preference for proceeding to appoint a new Governor next year”.

Christmas holidays intervene, and the next paper is a briefing for the Minister in advance of a 20 January meeting with Neil Quigley, which again notes the options of extending the current Governor’s term or appointing an acting Governor for six months (again, incorrectly noting that either option would require a new PTA).  Even at that meeting, the Minister does not appear to have communicated a decision, as there is then a (not very informative) note suggesting another discussion on the issue with Treasury officials on 24 January.   Only by 1 February is there a formal Treasury report providing the information to facilitate the Minister’s preference to appoint Grant Spencer as Acting Governor (which, according to the paper, had not yet been discussed between Spencer and the Minister).  Only at this point is Treasury uncertain about the PTA position, noting that they were seeking Crown Law advice.

It all went to Cabinet on 7 February –  with no hint of any issue as to whether an acting Governor could legally be appointed –  and was announced later that day.

I’m not usually a big fan of Steven Joyce, but as far as I can tell from these papers (and a very similar set I got from his office) he is the only one to emerge from this process deserving credit.  The Bank’s Board had seemed to see no problem at all in making an appointment pre-election to take office in the midst of a possible change of government.  The Treasury didn’t either –  they would have been happy, if they could, simply to have had an appointment announced early.  And as late as the end of November, the then Minister of Finance (now Prime Minister) was apparently happy to carry on towards appointing the most powerful public official to take office just (as it turns out) a few days after the election.    It was only very late in the piece that Treasury realised that there was no provision for a PTA with an acting Governor (Crown Law presumably confirmed that, as there will be no PTA with Spencer) and there is no sign that any officials ever seriously considered whether an acting Governor appointment was strictly legal.

But shortly after taking office, Joyce seemed to cut through most of this, eventually presumably instructing/requesting the Board not to proceed with the planned process that had already begun, and instead to recommend him an acting Governor appointee.   In a sense (whatever the formal legalities) they were lucky to find Spencer willing –  I have heard that he was planning to have left the Bank by now.

To repeat, my concern isn’t that something will go badly wrong in the six months Grant is in charge.  It is a practical solution to a problem that is made so severe by the fact that so much power is vested in one person’s hands.  That should be changed by whoever becomes the Minister of Finance after the election (and the role of the Board in making appointments should also be revisited).   But the practical outcome they have adopted still looks rather dubious on legal grounds, and we are supposed to be ruled by laws, not by what is opportune.   I’m not a lawyer, and some of the doubt could have been resolved if the Board and Treasury had pro-actively released any legal advice they obtained on the points, but it doesn’t look clear-cut that the chosen path was strictly lawful.

And perhaps as concerning is that key figures – including the current Prime Minister –  saw no problem in an outgoing government making a long-term appointment to such a powerful position, to take office in the midst –  or immediately after –  an election campaign, especially one where there is the potential for material changes of policy emphasis and legislation in areas directly the responsibility of the Governor.