Reserve Bank

$5.7 billion

Michael Reddell pandemic, Reserve Bank

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

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

lsap losses

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

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

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

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

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

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

Financing the fiscal deficit

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

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

Add in the effect of the LSAP

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

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

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

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

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

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

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

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

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

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

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

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

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

Are there caveats to all this, or alternative approaches?

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

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

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

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

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

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

Housing

Michael Reddell Housing, Monetary policy, Reserve Bank

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

(b) supporting maximum sustainable employment.

The main change being the addition of b).

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

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

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

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

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

There is quite a lot of this sort of stuff.

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

Funding for lending and other myths

Michael Reddell pandemic, Reserve Bank

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

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

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

FLP 2

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

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

There are at least two good reasons for that.

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

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

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

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

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

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

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

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

Housing, the Reserve Bank, and interest rates

Michael Reddell Housing, Reserve Bank

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

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

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

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

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

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

yuong ha

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

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

ha apr 20

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

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

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

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

ha quote on housing

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

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

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

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

Ha himself was asked about part of this

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

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

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

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

Among the many points traversed was this chart

housing and C

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

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

housing and c 2

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

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

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

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

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

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

Having the Governor’s back

Michael Reddell Reserve Bank, Reserve Bank Act reforms

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

RB salaries

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

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

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

Writing off the Reserve Bank’s government bonds

Michael Reddell Fiscal policy, MMT, Reserve Bank

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

The illegitimate central bank

Michael Reddell Adrian Orr, Reserve Bank

A standard proposition in the literature on delegating public powers to unelected (agents or) agencies in a free and democratic society is that such agencies should operate in a way that leaves no basis for any reasonable person to suspect that those running the agencies are using their platform, and the associated public resources and powers, for any purpose other than the very specific ones Parliament has provided those powers/resources for.   Abuses and departures from this norm need not –  and fortunately in New Zealand rarely do –  involve officeholders seeking to personally enrich themselves or their families.  Here it is more likely to take the form of using the platform/powers provided for specific narrow purposes to advance the personal ideological and policy preferences of top managers/Board in quite unrelated areas.

The fact that those individuals, in abusing their powers, do so believing –  probably quite sincerely –  that they are doing so in some conception of the “public interest” is wholly beside the point.    We have elections, and a wider of contest of ideas in the public square, to advance causes.   The fact that those individuals might be advancing the views of the government of the day is not just beside the point, but getting towards the heart of it.   The whole case – the only real case –  for delegating substantive policymaking powers (as distinct from narrow implementation/operations) rests with the notions that (a) the policy in question is separable from the rest of policy, and (b) those charged with it won’t be pursuing partisan or ideological agendas.  If not, we might as well have elected ministers make decisions (we can kick them out) and keep the agencies quietly in the backroom as advisers and implementers.

Central banks –  or rather central bankers – have long been at risk of falling into this trap, particularly as more of them were granted operational autonomy around monetary policy.   Rightly or wrongly, people tend to pay quite a bit of attention to central banks (probably rightly given how much difference their monetary policy actions can make to economic outcomes over, say, a 1 to 3 year horizon).   When they speak, the idea has been their words on monetary policy should influence expectations and behaviour –  on the presumption that the speaker has no agenda other than the narrow one s/he is charged with.      Central banks are also often supposed to be a repository of expertise and wisdom.   Sadly, even in the narrow specialist areas central banks have formal responsibility for that, too often neither has really been true (that isn’t just a comment about New Zealand).  But central banks do tend to have lots of resources, and provide cheap copy for media (literally, presumably, in the case of op-eds like the Governor’s one that I wrote about earlier this week).

But if your central bankers are using their position to advance personal ideological or partisan agendas –  or are perceived to be doing so, even if that is not their conscious intent – the legitimacy and authority of the institution itself will be damaged.  And if you believe that gubernatorial words can usefully shape expectations, it is likely that the effectiveness of the institution will be eroded as well.   A Labour voter will be less inclined to give serious heed to a Governor suspected of serving National interests or ideological preferences than if they think that person is only interested in doing his/her specific job.  And vice versa if the roles are reversed.    And if a Governor is perceived to be advancing partisan interests, the effectiveness of that Governor when operating under a government of a different political stripe is also likely to be impeded.

Wise people who have been “inside the temple” recognise the issue and risks.   Academic and former Bank of England MPC member Willem Buiter has written about it, as has former Fed vice-chair Alan Blinder.  More recently, former Bank of England Deputy Governor Paul Tucker devoted an entire book to the issues around Unelected Power.   It has also been a theme of mine.

Don Brash was Governor of the Reserve Bank for a long time.  Before coming to the Bank he’d been an unsuccessful National Party candidate.   After he left the Bank he went straight into Parliament as a National Party MP and later was briefly the ACT leader.    His interests always seemed more in ideas/policies than in specific parties, but there wasn’t much doubt about where on the spectrum of policy preferences he stood.   In some quarters, even if he never said anything much on topics outside his remit, that left a residue of mistrust.  I doubt Jim Anderton, or perhaps even Winston Peters, even really saw him as a neutral technocratic figure.  But probably where Don really stepped over the mark was quite late in his time at the Reserve Bank, with his speech to the 2001 Knowledge Wave conference. (I wrote about it here.)  The details don’t matter now, but it saw the unelected Governor use his position to champion policies that bore no relation to matters he was responsible for.  As it happens, in many/most cases they were quite at odds with the views of the government of the day, but it should have been just as unacceptable had he been championing preferences of that particular government.    Senior staff, including me, advised him against it –  and the version delivered was materially less out of line than the draft –  in many cases, including mine, even if we happened to personally agree with the substance of what the Governor was saying.   Fortunately Don welcomed challenge/dissent/debate.

One can debate the strengths and weaknesses and records of the two subsequent Governors. I imagine that both were fairly sympathetic to the governments of the day when they were first appointed, but there was never much ground to suppose that either was using his office to openly advance his personal ideological or political agendas.

With the current Governor, now almost halfway through his five year term,  almost from the first he has consistently used his office to openly champion causes for which he has no responsibility, even as his actual conduct in the things he is responsible for leaves a great deal to be desired.     If the Governor presided over consistently excellent, ahead of the game, monetary policy, if his radical policy initiatives around banking regulation had been well-grounded and authoritative, perhaps the wider abuse of office would be a little less worrying –  a worrying foible perhaps, but  arguably incidental to the success of the stewardship of the things he was responsible for.  It would still be worrying –  as it would if, for example, the Chief Justice or the Police Commissioner were openly using their offices to advance their personal political agendas –  but underlying  excellence tends to buy some grudging respect.

Sadly, that isn’t the Orr Reserve Bank.  It is as if the Governor really isn’t very interested in his core functions or even in building strong core capability beneath him.   Transparency and accountability around core responsibilities also seem to be alien concepts. Openness to debate and challenge –  whether inside or outside the Bank –  on core responsibilities also seem alien to him.  And, on the other hand, is very interested in using his powerful position to champion all sorts of issues dear to his own heart, and that of his ideological allies.  I don’t suppose the Governor necessarily sees himself as championing Labour’s interests or that of the Green Party (the two he would seem to have most in common with) but that is the effect when he weighs in on one topic after another, never in much depth, but consistently advancing those personal agendas in a quite undisciplined way.

There has been example after example of this sort of thing going back to when he first took office in 2018, whether it was views on agriculture, on infrastructure, on climate change, on fiscal policy, on Maori economic development, alleged short-termism or whatever.  It remains notable just how few, and unserious, have been the Governor’s speeches on core responsibilities, and how many his speeches and commentaries on these other issues.  It flows down the organisation.  We had another example yesterday.

The Bank from time to time sends out newsletters to those signed up to its email list.  Yesterday’s one was from one of Orr’s deputy chief executives, the Assistant Governor Simone Robbers (she of the 17 person communications department, among other bits of her domain).

RB corporate 2

The full text of the email is here.  It was sent out under the heading “Our priorities and key progress on our mahi” (“mahi” apparently means work, but whether in Maori it carries a sense of responsibilities or of self-chosen agendas isn’t clear to me).   Among the Bank’s self-chosen roles appears to be the campaign to change the name of the country, given the repeated use of “Aotearoa” for New Zealand.

The newsletter isn’t long but it is quite telling.

It begins with this bumpf

While a new ‘normal’ is emerging in New Zealand after the initial response to the COVID-19 pandemic, the pandemic continues to have significant and ongoing consequences across the globe. We are actively engaging with our Central Banking colleagues around the world to share policy advice and insights. As explained in this recent op-ed from Governor Adrian Orr, it is clear from our discussions that the COVID-19 health shock is impacting nations in similar ways, however, the economic and policy impacts differ greatly.

I wrote about that content-lite zone on Monday.

Here in Aotearoa, although we have successfully contained the virus, and many parts of the economy are back up and running, households and businesses face uncertain times and potential further disruption as the full economic impacts of the pandemic become evident.

Name of the country aside, I guess it is unexceptional, but also rather empty.  She goes on

We at the Reserve Bank, Te Pūtea Matua, need to keep working together with all of Government and industry, just like we did at the start of the pandemic, to respond to the challenges. We need to be prepared to manage our economic recovery well, while not losing sight of delivering for the long-term interests of all those in Aotearoa.

These “long-term interests” –  whatever they are –  are simply not something the Reserve Bank has responsibility for.  It seems to be cover dreamed up by the Governor to weigh in on anything he chooses.

And that is it on anything even close to the core responsibilities of the Bank.   Inflation –  let alone inflation expectations – doesn’t get a mention at all.  Nor does (un)employment, that the Bank was so keen on talking about last year.  Nor, perhaps to no one’s surprise, does the utter failure to have had the banking system positioned for negative interest rates –  supposed now to be work in progress, in a highly core area, but no mention here whatever.  Instead, we learn what the Bank has been devoting its energies to

Alongside supporting the economy and all New Zealanders by providing liquidity to banks and coordinating monetary and fiscal policy settings, we have also continued to deliver on our commitments including:

  • Jointly working with The Treasury to see the new Reserve Bank of New Zealand Bill introduced to Parliament
  • Publishing the Statement of Intent (SOI) for 2020-2023 and further embedding our Tāne Mahuta narrative
  • Agreeing to a new five-year Funding Agreement to ensure our long term commitments are met
  • Progressing our Te Ao Māori strategy through our economic research and proactive outreach to regulated entities, Government and Māori partners
  • Working closely with our fellow Council of Financial Regulators (CoFR) members to manage and co-ordinate regulatory work to enable the financial sector to focus on their customers.

During this time, some of our initiatives have received sharper focus as we look to respond to COVID-19 challenges. For example, the financial inclusion issues that are being faced by everyday New Zealanders. We congratulate the banking sector for their leadership in recently becoming the first living wage accredited industry in New Zealand.  It is also a good time to deepen our collective understanding of climate change risk in the financial sector, and ensuring we are all taking a long term and sustainable approach to economic recovery and future resilience.

We are using this period to consider what is ahead and what steps we need to take so we can live up to our vision of being ‘A Great Team and Best Central Bank’ and deliver as kaitiaki (caretaker) against the commitments we made in our SOI.

Actually, the Bank doesn’t “coordinate monetary and fiscal settings”: the Minister of Finance sets the Bank a target, and the government sets fiscal policy, and then the Bank (MPC) is just charged with getting on and doing its monetary policy job, given all of that.

But even set that to one side, what do we see prioritised?    Well, there is the tree god nonsense that the Governor seems so fond of.   Perhaps it does little harm –  although as I’ve unpicked it in the past it is often actively misleading –  but right up there at number two on the list?    Then, of course, we get the Bank’s Maori strategy –  something that is not clear is necessary at all (in a wholesale-focused organisation) –  or which has generated anything of substance (and no research, despite the claims here) in support of the Bank’s actual statutory responsibilities.  But it advances the Governor’s personal whims and preferences I guess.

Then we move off the bullet point list and on to the next paragraph, and even more highly questionable stuff.  There is that line about “financial inclusion” which, whatever it means, clearly has nothing whatever to do with the Bank’s twin responsibilities for financial stability and macroeconomic stabilisation.   There might be some worthy issues there, at least on some reckonings, but they are nothing to do with the Bank.

Then –  and this was the one that caught my eye –  there is the weird reference to the banking sector and the so-called “living wage”.    I’m sure the Green Party must love that settlement, and whatever deals banks want to sign up to for their staff is really their affair, but what has it to do with a prudential regulator, the Reserve Bank –  which is not, repeat, some general regulator of all banking sector activities?    I suppose we should be grateful not to see the Bank praising the Kiwibank decision to refuse banking facilities to lawful and creditworthy businesses doing business that the Governor profoundly disapproves of.

But perhaps that is encompassed by the next sentence.

“It is also a good time to deepen our collective understanding of climate change risk in the financial sector”

Not clear why it is a “good time” (one might have supposed a higher priority now might be, for example, understanding the risks to the financial sector from a prolonged downturn and limited monetary policy response, or to have understood better the issues and options around macro-stabilisation and the (current) effective lower bound on nominal interest rates).  But, for what it is worth, I think we can pretty easily conclude that the risks of climate change to the New Zealand financial sector are vanishingly small.  But acknowledging that might make the Governor’s position – endlessly weighing in on these personal causes –  seem more obviously inappropriate.

And who knows what lurks beneath that

ensuring we are all taking a long term and sustainable approach to economic recovery and future resilience

It isn’t even clear whether the “we” is supposed to refer to the Reserve Bank or the rest of us.  What is clear is that none of it has anything much to do with the monetary policy responsibilities of the Bank –  the bits actually to be able recovery.  Full employment, conditioned on price stability, should be what matters, but none of that gets a mention at all.

And then Robbers ends with this

We are using this period to consider what is ahead and what steps we need to take so we can live up to our vision of being ‘A Great Team and Best Central Bank’ and deliver as kaitiaki (caretaker) against the commitments we made in our SOI.

As I noted earlier in the week there was a speech on this topic a month ago.  It was startlingly empty, devoid of any real sense of (a) why this goal made sense, (b) how the Bank, and those it works for, might know if it was achieving the goal, or (c) what steps management was taking to deliver on the goal.  When he delivered the speech, I noted down a strange comment from the Governor about how it is “therapeutic” to be able to think about these issues.  Even at the time it struck me as a luxury most private businesses wouldn’t have, and one one might not expect a central bank grappling with a deep economic downturn, falling inflation expectations, rising unemployment etc  to have either, at least if it were doing its job.  Then again, the Bank has a big budget and no real accountability so I guess the Governor can simply pursue his whims.

And that is about it.

In a way none of it was that surprising.  This is the Reserve Bank that Orr has been creating in his own image: one that simply isn’t doing its job well, doesn’t have its eye on the ball, shows no sign of thinking deeply about the core challenges it should be addressing….all while pursuing the personal ideological agendas of the Governor (and his handpicked senior management –  most probably you don’t get or keep a job on the top team –  or perhaps further down the organisation either- unless you are all-in with his alternative, non-statutory agenda).  We deserve a lot better, the economy needs more, but there is no sign that the Bank’s Board –  paid to hold the Governor to account –  or the Minister of Finance care.  It is just another marker on the journey of the degrading of the capability of our economic institutions, and of the legitimacy and authority of our autonomous central bank.

There was one final thing I noticed deep down the email (which had various links to other bits and pieces).  As I’ve noted regularly, the new Monetary Policy Committee has now been in place since 1 April last year.  In that entire time, including through some of the bigger macro challenges in modern times, we’ve heard not a word from any of the three external members of the Committee, the ones carefully selected to not be awkward for the Governor, to meet the government’s gender quota, and to exclude –  consciously and deliberately – anyone with current monetary policy or macro expertise.  But now we have.  There is a couple of minute Youtube clip where we see and hear from the externals.   Not, of course, that they say anything of substance, anything about actual monetary policy, inflation, employment or anything.  But they wax lyrical about a wonderful collegial process, and what a learning opportunity has been –  and about how they don’t pay much attention to things for six weeks and then get together, with no undue influence from anyone.  No doubt they are all deeply sincere, but it did have a bit of sense of a hostage video, produced to show that the Committee really exists. It should assuage no concerns at all about the structure, the people, the lack of transparency, and the lack of accountability.

Empty vessels

Michael Reddell pandemic, Reserve Bank

A month or so ago I went along to hear the Governor of the Reserve Bank speak at the Law and Economics Association in Wellington.   LEANZ is a pretty geeky sort of organisation (or attracts pretty geeky sorts of people) and against the background it was quite surprising how little substance there was to the Governor’s speech, which was billed as “Delivering on Great and Best” at the Reserve Bank.  That is the Governor’s grandiose vision: his predecessor claimed to want the Bank to be the “best small central bank” in the world (although did little or nothing about it, including no relevant benchmarking) but Orr takes that a giant step further and claims to want to be the best central bank in the world.   You might think that harmless –  always good to aim high etc –  but in a small country, not very prosperous, it isn’t clear that it is even a sensible goal, and in practice it seems to function mainly as a way of distracting attention from the manifest inadequacies of the Bank, especially under the stewardship of Orr.

I don’t want to spend any time on last month’s speech –  there really isn’t much there –  but it came to mind when I read yet another empty piece from the Governor yesterday, this time a column in the Sunday Star-Times. I don’t suppose economists were the target audience, but a couple of non-economists I talked it over with seemed to have much the same reaction to it that I did.

It is framed as some sort of disclosure of the inner secrets of the central bankers’ temples.

As New Zealand’s Reserve Bank we hear directly ‘from the horse’s mouth’ what our global colleagues are experiencing and doing.

Thing is, there is this new-fangled invention called the internet, and we too can read all about the activities of other central banks, the speeches of their bosses, the minutes of their decision-making committees.    In New Zealand’s case, of course, there has been not a single serious speech on monetary policy or the economic situation from the Governor or any other member of the MPC since they finally woke up to the economic threat Covid, and associated responses (public and private), posed.  But that generally isn’t the case in other advanced countries.   Check out, just as examples, the websites of the Fed, the ECB, the RBA, or the Bank of England.   We can read them, or media reports of them, for ourselves.

But, setting that to one side for the moment, what fresh insights does the Governor have for us from his chats with his central banking peers abroad?

From our most recent interactions it is clear that the common and (almost) simultaneous Covid-19 health shock is impacting nations in similar ways, but the policy reactions and outlooks ahead vary greatly.

Hard to know what the first part of this is actually supposed to mean –  after all, the health risk might have been similar across countries, but the actual experience of the “health shock” varied, and varies still, very greatly.  And as for the second half of the sentence, it isn’t clear whether he is talking about economic policy responses, public health responses or what, let alone which outlook –  economic or virus – he is talking about.  It seems to be the economic side of things, judging from the next sentence.

The differences are in large part explained by the initial health of their economy, the underlying drivers of economic activity, and the degree of success in containing Covid-19.

But then it is not clear at all what he is basing anything of this on.   Some countries have a rich array of high frequency official data, in some cases even monthly GDP data.  Here in New Zealand, our latest official labour market relates to the March quarter.     We’ll get an update on that –  for the whole of a quarter centred back in mid-May –  early next month, but we’ll have no read at all on GDP for that June quarter until mid-September.  Not that long ago there was a general sense that our June quarter GDP might have fallen quite a bit further than that in most other advanced countries –  sufficiently onerous (rightly or wrongly) was our “lockdown” – but we are still flying blind even on that.

The column appears to be some sort of effort to suggest the New Zealand economy is now doing (relatively) well, but Orr cites no data to support that implication, unsurprisingly perhaps as there really is little such data.

He goes on

The more robust an economy was when first impacted by the pandemic, the more options and flexibility its local policymakers had to respond.

I guess it must be some sort of self-reinforcing conventional wisdom among economic policy elites, but where is the evidence for the claim?   Almost every advanced country has done very little very monetary policy and a great deal with fiscal policy –  whether it is the highly indebted US and UK, or countries with little public debt like New Zealand and Australia.

Orr continues

Amongst this ‘robust’ group, the initial policy actions have been very similar.

They generally included: ensuring credit and cash is cheap and accessible, increased government spending and investment, support for employers to pay wages and access credit, and additional welfare payments.

Although, of course, as already noted the typical central bank –  including the RBNZ –  has done very little that matters (lots of sound and fury though), and although I haven’t checked I’d surprised if credit conditions haven’t tightened in other countries too, as they have in New Zealand.   And what Orr doesn’t seem to want you to reflect on is that most of the sorts of measures he lists are palliatives: there is place for those, but they do little or nothing to get economies promptly back towards full employment.    That is/was the job of monetary policy, but central banks –  including our MPC –  seem to have abdicated that responsibility, with politicians (including ours) apparently content to let them.

However, the economic impact has varied significantly, especially across sectors of each economy.

The more reliant a nation is on primary production (especially food export revenue) and the manufacture of durable goods (especially e-technology), the better it has fared.

By contrast, the more reliant a nation is on the provision of face-to-face services (e.g., tourism and hospitality) the bigger their fall.

There seems to be no evidence for the loose claims in the second sentence.  At least in the OECD there is really only one country heavily reliant on “food export revenue”, and we just don’t have any data yet on how overall economic performance is doing, let alone how it will do as, for example, the wage subsidy ends.   (Oh, and if you are tantalised by, say, PMI readings above 50 –  as I heard the Minister of Finance going on about in the House last week –  recall that (a) these are directional measures only, and (b) our initial trough, even on these surveys was deep)

Then there was this odd comment

Common for all nations is that uncertainty and economic confidence is highly-related to perceptions that the pandemic is regionally ‘contained’.

Not quite sure what “regionally” has in mind here, but in New Zealand itself at present there appears to be no locally-transmitted Covid, in the wider South Pacific and east Asian region there isn’t much, and yet uncertainty remains high, confidence remains modest, because people realise (a) how easily things could unravel, and (b) increasingly, the severity of the worldwide economic downturn.

There was then this loose comment

The common view amongst our international colleagues is that their local economy cannot perform at capacity with the pandemic.

I guess it depends how you define capacity, but sure when people were forced by state edict to stay home many could not work at all.  Once we are beyond that point, again Orr’s interpretation of what his colleagues are saying seems like an abdication of responsibility by central bankers.  There are market-clearing interest rates (and exchange rates), but central bankers have decided to do little or nothing about getting actual rates to line up with those market-clearing rates.  They are simply content, it seems, to accommodate sustained higher unemployment.  Coming from someone who last year was only too keen to talk up the new employment references in the Bank’s mandate, it is somewhat surprising.

In general, household spending and business investment continues to lag behind incomes and earnings. This highlights one limitation of easy monetary conditions in expanding demand.

It does nothing of the sort.  What it highlights is the utter failure of macro policy in current conditions.  The first sentence of the Governor’s comment –  re saving and investment – is almost a classic statement of the case for temporarily much lower interest rates.  And yet, in New Zealand, the Governor and the MPC have pledged not to do anything about the OCR until at least March, never mind the attendant excess capacity.

The Governor turns to the future

Looking ahead, accurate prediction is impossible, but preparedness is necessary and feasible.

The type of scenarios policymakers are mulling include: options for when/if a vaccine is developed; the establishment of Covid-19 ‘safe’ trade and travel bubbles; and the management of rolling waves of regionally-contained Covid-19 outbreaks.

Accurate prediction is always impossible.  But that second paragraph is all about stuff that has nothing whatever to do with central banks.  And as he comes towards the end of his columns we get a series of content-lite bromides.  Thus

Globally, the general conclusions are that economic activity needs ongoing support by both government and central banks, and that government fiscal policy is the most potent.

Yes, we know that central banks have done almost nothing, so it is hardly surprising that whatever mitigation of the economic damage is being done by fiscal policy.  The Governor seems unable to distinguish timeframes: fiscal policy is/was good at offsetting immediate income losses, but monetary policy works powerfully on slightly longer lags, and the economic challenges aren’t going away.

Oh, and even the Governor recognises the limitations –  technical, or more likely political – to fiscal policy

There is also much awareness that fiscal policy cannot subsidise everyone forever. Examples of more targeted government interventions – such as sustainable infrastructure initiatives, and retraining and people mobility are being shared.

These policies are more complex to create and implement, especially at pace and scale.

Interest rates and exchange rates, by contrast, adjust almost instantly, get in all the cracks, and require no state mortgage on all our futures.

The Governor moves on to matters perhaps a bit closer to his responsibility.

Financial stability is also a key focus. The current broad consensus is that banks must be focused on the long-term interests of their customers, which will take strong regional bank leadership.

But it is not clear, at all, what that second sentence means.  Whose “broad consensus”?  And what about the interests, short or long term, of the people who actually own the banks.  And what is this “strong regional bank leadership” all about.   Oh, and how does the Governor square whatever it is with the (apparently entirely rational) tightening in credit conditions reported in the Bank’s recent survey.

Then we get this strange paragraph

The financial markets’ tools for measuring risk and allocating money must also be switched on and working, to best assist the reallocation of economic effort. The current big change drivers are more local-regional trade, simpler supply chains, and the rapid adoption of technology to deliver services.

Whatever it is supposed to mean, you might suppose that adjustments in interest rates and exchange rates would be among those “financial market tools”.  And quite what relevance does “simpler supply chains” have in a New Zealand, where few firms are part of complex supply chains, and I’d have thought we really didn’t want many people focused on “more local-regional trade” when our ministers and officials keep talking up keeping international trade connections strong.

And he ends

New Zealand had a robust economic starting point at the onset of the pandemic. We have a backbone of primary production and exports. And, for now, a credible containment of the Covid-19 virus.

But, we also have significant reliance on services that require face-to-face interaction. We need to be prepared for multiple health and economic scenarios so as to best manage through the pandemic and arrive at a more sustainable economic place.

But even if you agree with each of those individual sentence (and, at a pinch, I probably could) aren’t you left wondering “so what?”   And with no sense at all that whatever happens here, we in the teeth of a worsening global economic downturn, with monetary policy doing little or nothing and even the Governor –  most vocal champion of more use of fiscal policy in recent years – articulating a view that fiscal policy has its limits.

Surely we deserve more substance, on stuff the Bank is actually responsible for, from the Governor?  And from his senior management members of the MPC.  As for the external members, they collect a lot of money from the taxpayer each year, and yet seem to operate as if being invisible, silent, and unaccountable is some sort of badge of honour.

One would like to think that there is more depth, more substance, to offer but the Bank refuses to release any supporting analysis, publishes no relevant research, exposes most of the MPC members to no public scrutiny, and for those we do hear from –  the Governor foremost –  there is a disturbing sense of people really rather out of their depth, and perhaps just not that interested.  More fun to play tree gods and talk climate change than to actually do the core macro stabilisation role Parliament has charged them with, in the midst of the most severe global downturn in a long time, one in which little beyond immediate mitigation is being done to get countries quickly back to full employment.  Policymakers here are no better, but whatever is being done here, the less that is being done abroad, the more we need our own policymakers to be doing.  Unemployment is a terrible thing, and yet it barely rates an allusion in the Governor’s column.  As for inflation, it is a core part of the Bank’s responsibility, expectations have been falling here and abroad –  risking compounding the macrostabilisation challenges –  and it got not a mention at all.

Back in that speech a month ago, the Governor indicated that the government would be introducing new legislation reforming Reserve Bank governance before the House rises for the election (so this week or next).  That reform is long overdue, but under current stewardship –  Governor, Minister –  we should no more expect improvement from these next changes that we secured from the establishment of the MPC.  You’ll recall that the Governor and Minister got together to blackball anyone with current monetary policy or macro expertise from serving on the MPC.    That gap is really starting to show up now.

Little fiscal discipline at the RB

Michael Reddell Reserve Bank, Uncategorized

There was a story on Stuff the other day (that I’ve not seen anywhere else) than ran under the heading  “Reserve Bank restructures digital services team, cuts five roles”.    A family member drew it to my attention noting that “people at the Bank are losing their jobs”, and thought I might be interested.   It seemed a little surprising that the Bank was shrinking, with an empire builder in charge, but….

As it turned out, once I read the article it became clear that the Bank isn’t shrinking at all, but growing (quite substantially), increasing staff numbers in what are clearly non-core areas.

“The new operating structure is in response to the changing priorities, outcomes and initiatives that the bank has set out to achieve in its digital strategy, which is part of us achieving our vision of ‘great team, best central bank’. The new structure will improve the functional alignment across our digital services team.”

He said 14 new full-time-equivalent roles would be created across the department and its head count would increase to 58.

“Five roles have been disestablished as part of the changes. Affected staff are being offered full support at this time and are eligible to apply for these new roles.

Fourteen new FTEs just in this one bit of the Bank.  That looks like a case for the Taxpayers’ Union.

Especially as it would appear that this is not the only growth going on in the non-core areas of the Bank.

As it happens, much earlier in the year I had lodged an Official Information Act request with the Reserve Bank asking for the budget and organisation chart for what the Bank calls its Governance, Strategy, and Corporate Relations Group.  The Bank answered a pretty simple question not too many days beyond the statutory 20 working days, but by then everyone’s focus was almost wholly on coronavirus things and so I largely set the response to one side.    It is clearly one of those the Bank does not want to draw attention to, as this is not one of the OIA responses they have chosen to publish on their website, but here is the full response.

RB OIA response Governance Strategy and Corporate group

I lodged the request for various reasons.  Perhaps the most immediate one was the large number of different names (from the Communications section) that kept showing up on OIA responses, press releases and so on.    And then there were things like the Bank’s expensive –  and entirely unrelated to anything they have statutory responsibility for –  Maori strategy, and a story I’d heard from a friend who’d been approached by a headhunter to see if they were interested in a very well paid but not overly-senior role doing “stakeholder relations”, which my friend described as “seemed to involve having coffee with lots of people”.    There was a sense that public money was being used very loosely, even as the Governor repeatedly claimed that his core functions were underfunded –  and the evidence certainly suggested that they were not spending heavily on high-quality analysis, research, and policy development/implementation in their core areas of responsibility.

The Reserve Bank is not a particularly large organisation.  In the latest Annual Report we are told they have 274 FTEs last June (plus a few vacancies).   They do real stuff, including  (mostly) important things like monetary policy, the issuance of physical currency, clearing and settlement operations, prudential regulation/supervision of banks, non-bank deposit-takers and insurance companies, and things like AML for banks as well.

And then there are the luxury consumption items, which seem mostly to be grouped in this Governance, Strategy, and Corporate Relations Group, run by Assistant Governor Simone Robbers.      Within her group are a couple of functions I’m not going to say any more about.   There is a Legal Team of five lawyers (one of whom also acts as Board Secretary).   Given the range of regulatory responsibilities, that is probably inevitable.  And there is the Risk and Audit department with six roles dealing with those functions (recall that Bank has a large balance sheet and significant operational activities).

What caught my eye was the other two departments in Ms Robbers’ empire.  There was this one

RB corporate 1

and this one

RB corporate 2

Take Performance and Corporate Relations first.  It isn’t clear that almost any of this needs to exist at all.   Perhaps they need one person to jump through the bureaucratic hoops that Annual Reports and Statements of Intent require (if that is what the Senior Adviser, Planning and Performance does), but the entire rest of the department has the feel of a make-work activity or (which is worse) the Governor using scarce public money to pursue personal whims.     As I’ve noted before, the Reserve Bank is not really a public-facing organisation (in the way that, say, Police, Corrections, MSD, hospitals, schools or the like are), suggesting that the Maori stuff is just a virtue-signalling personal whim.  And if they make a case that there is connection between climate change and financial stability –  a very weak one in a New Zealand context at least –  shouldn’t the climate change function be with the financial stability one.  Again, it feels more like funding the Governor’s personal politics.   And, of course, what is “Corporate Relations” in a government agency, responsible primarily to the Minister of Finance?

But even that was as nothing compared to the Communications Department. I can remember a time –  and I’m pretty sure it would have been this century –  when there might have been four people in Communications, including a ministerials/OIA person and the person doing publications (design, layout, dealing with printers etc).  It was a step when it was decided, over some objection, to have a specialist internal communications person.    And yet by February this year there was 16 roles, and that Stuff story suggests they are just about to add a whole lot more people –  for statutory roles that really haven’t changed much.

I presume this latest restructuring was about the middle column –  the responsibilities of the Manager, Content and Channels.   One could easily see a case for change –  the Bank’s Twitter account, for example, doesn’t seem to be well-used, although whether that is the responsibility of the staff directly involved or of other senior managers is an open question (recall the episode earlier in the year when senior managers had them tweeting out in late February a belief that the world economy was going to be improving this year).  But quite how they warrant going from five people to 14 is a bit beyond me (I have requested a copy of the consultation document).  Perhaps some individuals will lose their jobs, but the empire seems set to grow a lot.

And then there are those other functions in the Communications Department.  The Manager, Government and Industry Relations for example.  In many private sector companies that might be a role for a lobbyist.  But this is a government agency itself.   Aren’t functional departmental heads, the Governor and the Board responsible for dealings with the Minister, the Treasury, and so on.   Isn’t the head of bank supervision responsible for dealing with banks?

And then there is the left-hand column –  notably, the Manager, External Stakeholders and not one but three Senior Adviser, External Stakeholders roles.  There must be a great deal of coffee being drunk.   It isn’t clear what the case is for any of these roles.

Let alone for adding lots more staff.  And note that Stuff article suggested that the head count of the relevant department (presumably Governance, Strategy, and Corporate Relations group) was rising to 58.  By my count in February the total of roles was 36, suggesting that all these new “digital channels” roles – whatever these people are supposed to be doing –  aren’t even the only non-core staff increases that have occurred this year.  It is as if the Bank has money galore, little or no sense of restraint –  all while still not doing their day jobs (the ones Parliament actually assigned them) at all well.

It is doubly puzzling because based on what is in the public domain, the Bank has authorised funding only until the middle of next week.

The Reserve Bank has a very odd funding structure. Formally, there are no binding constraints on the Bank’s ability to spend whatever it likes.  If seignorage revenue is not what it was with interest rates so low, it is still more than ample, and in any case the Bank does not even need positive capital to keep operating.

But 30 years ago when the 1989 Act was passed a strange and inadequate partial reform was put in place, whereby the Governor and Minister could (but did not formally need to) agree a five-year Funding Agreement.  If such a Funding Agreement was signed it was subject to ratification by Parliament.  There has been a succession of Funding Agreements in place since which, almost always, the Bank underspent.  It was very much a half-measures reform –  better at the time than what had gone before (no constraints at all) but well out of step with modern expectations for transparency and accountability.     The current Funding Agreement covers the period to 30 June 2020, and thus in effect expires next week.

Here are some observations I made when the current Funding Agreement was adopted

I don’t have any particular argument with the size of the Funding Agreement total, or the modest increase over the next few years (although it does seem to be a larger increase than many government departments, with flat baselines, have been experiencing).  My concern is about process.

In particular, for one of the most powerful government agencies in New Zealand, the agreement contains almost none of the information people might reasonably need, whether as MPs or citizens, to know whether $49.6 million is the right amount.  The entire document runs to just over two pages, but the meat of it is simply five lines

funding agreement

That is the same level of detail we get in the Estimates about the spending of the SIS – and at least Parliament (a) has to vote for the SIS’s spending, or the spending can’t happen, and (b) has to vote each and every year.

MPs were asked to vote on the Funding Agreement yesterday with no information about what the Bank and the Minister proposed that the Bank would do with the money.  Presumably the Minister is aware of the Bank’s plans, but he now has no control over them beyond the top line number.  In particular, the Bank has two quite distinct main statutory functions and it would be useful to know how the spending is split between monetary policy and financial stability.  And within financial stability, how much is being spent on responsibilities under the Reserve Bank Act and how much on those under the Insurance (Prudential Supervision) Act?  And how are those splits envisaged as changing over time?

It remains pretty extraordinary.    And it wasn’t as even as if this highly limited degree of detail was mandated by law

There is nothing in the Act that requires funding agreements to be so abbreviated, and there is certainly nothing that would have stopped the Bank, the Minister, and Treasury releasing background papers to accompany the Funding Agreement, either before it was put to Parliament.  That would have given MPs, and outside observers, the opportunity to scrutinise the plans for the Bank’s spending before the matter came to a vote in the House.  Estimates hearings for other departments spring to mind.

But the Bank (mostly, I imagine) and the then Minister and Treasury had no interest in serious scrutiny or accountability.  It probably won’t be any different this time, but we”ll see.

Even setting aside transparency issues, it is a very odd mechanism.  No other organisation I’m aware of, public or private, has a fixed budget five years in advance.  And whereas, for example, the Minister can override the Bank’s monetary policy target (for a time, transparently) he can do nothing to override the five-year spending allowance (which is not even binding anyway).  I remain convinced that when the rest of the Reserve Bank Act is overhauled the Bank should be moved to a conventional system of annual appropriations, with a proper breakdown by function.    The standard objection –  what about backdoor ministerial pressure? –  doesn’t stop us funding a whole bunch of other important agencies, including Police, annually through a proper system of parliamentary appropriations, including estimates hearings.

Presumably

(a) in the next few days a new Funding Agreement will be announced, and time will have to be made for a parliamentary debate on that agreement.  If/when that happens, hard questions should be asked about just how wisely and frugally the Bank is spending public money (even if you are unworried about the total government spending at present, an additional kidney transplant might be a better use of money than another “digital channels” person, let 14 of them),

(b) the Bank has already been told by the Minister that he is okay with them spending a lot more money or else in the dying weeks of the old agreement they wouldn’t be restructuring to add lots more positions.

I should perhaps add in conclusion that the Reserve Bank may be no more wasteful on these sorts of “corporate” functions than many other government agencies, some of which probably should not even exist at all.   But that is no consolation.  We should want senior officials and ministers spending money as frugally as if it were there own, not as liberally as tends to happen when it is other people’s money and there is little transparency and less accountability.

Still avoiding scrutiny and accountability

Michael Reddell OIA, pandemic, Reserve Bank

I’m not one of those inclined to join the new Leader of the Opposition in describing the government’s handling of the coronavirus situation as “impressive”, but sometimes other people are just determined the make the Cabinet and core government departments (notably Health, Treasury, DPMC) look not bad at all.

Transparency is one of those issues.  I was critical –  and still am –  about how slowly the government released key official documents relevant to the crucial decisions taken at various stages in March and April.    Difficult decisions made, inevitably, with partial information, and with consequences (either way) that are huge by the standards of any typical government decision should have been accompanied by the near-immediate release of all the significant relevant analysis and advice.

Nonetheless, and to their credit, the government is slowly getting there.  There was a big proactive release a couple of weeks ago of all sorts of central government documents (mostly advice to ministers and Cabinet papers) – individually important or not – on the coronavirus situation from the start of the year until mid-April, and there is a promise of another batch presumbly sometime next month.   What is done is now done, but the release of those papers –  many of them written to very short deadlines and in the fog of war – helps us, as citizens and voters, assess the quality of the central government advice and decisionmaking process.  And since Covid hasn’t gone away, it may even help clarify where improvements might be made –  even demanded –  in government contingency planning against the risks of further problems.

But, of course, there are other public sector agencies operating at arms-length from ministers, exercising a great deal of discretionary power (including through the Covid crisis), and not covered by the government’s own pro-active release.   I’m thinking most notably of the Reserve Bank and, these day, the Monetary Policy Committee, a statutory body –  members each appointed by the Minister of Finance –  charged with the conduct of monetary policy.

Without any great optimism about a positive response, and fully expecting the request would simply be the first step on the path to an appeal to the Ombudsman I lodged an Official Information Act request on 20 April.

I am writing to request copies all papers prepared by or for staff or
management of the Reserve Bank for the Monetary Policy Committee in
2020.

I am, of course, well aware of the Bank’s typically obstructive
approach to releasing such official information in normal times.
However, given the scale of the events the Committee has been
grappling with this year, the magnitude and unusual/unprecedented
nature of many of the interventions (and decisions on occasion not to
act), the scale of the economic and financial risks the wider public
and the taxpayers are being exposed to, there is a clear and strong
public interest in the release of these particular papers, without
necessarily creating a precedent for more-general release of MPC
papers.  In addition, I would note that the succession of meetings
this year, and the fast-moving nature of events, means that papers
written even a month ago are already likely to have aged beyond the
point of immediate market sensitivity much more quickly than would
normally be the case.

Public accountability demands much greater transparency.

“Typically obstructive approach” refers to the Bank’s adamant refusal to release any papers relating to monetary policy decisions, at least unless they are perhaps 10 years old (they did once release a set of those, and I haven’t tested whether the effective threshold is 3, 5, 7 or 10 years past).

“Public interest” is in reference to the provision of the Official Information Act which states that for many of the possible withholding grounds

Where this section applies, good reason for withholding official information exists, for the purpose of section 5, unless, in the circumstances of the particular case, the withholding of that information is outweighed by other considerations which render it desirable, in the public interest, to make that information available.

I had a reply on Thursday. In fairness, at least it was only a day or two beyond the 20 working day deadline, although I doubt it took the Bank any time at all to decide its response.  The substance didn’t really surprise me at all, even if it was a disappointing reflection on the continued refusal of the Reserve Bank to accept that the principles of open government, the principles of the Official Information Act, apply to them and to the Monetary Policy Committee as well.

They pointed to the various press releases and Monetary Policy Statements (which, personally, I wouldn’t have thought were in scope, although that is beside the point) and went on

We are withholding all remaining information within scope of your request under the following grounds:
 section 9 (2)(d) – in order to “avoid prejudice to the substantial economic interests of New Zealand.”
 section 9 (2)(g)(i) – to “maintain the effective conduct of public affairs through the free and frank expression of opinions by…members of an organisation or officers and employees of [an] organisation in the course of their duty.”

We have considered your views regarding the need for the information to be released including, the scale of the events the Monetary Policy Committee has been grappling with this year and potentially, strong public interest in the release of these particular papers.

The Reserve Bank is currently conducting monetary policy in an environment of great uncertainty and market volatility. In these circumstances it is especially important that the MPC has the space to assess all the available information, select monetary policy tools, convey clear messaging through its Monetary Policy Statements, and evaluate its actions as it proceeds. The release of such recent MPC papers would be likely to interfere with the effective implementation of monetary policy.

As you are aware the Reserve Bank has a statutory duty to make official information
available unless there is good reason for withholding it. In this instance the Reserve Bank believes that there is good reason for withholding the requested information and that the public interest in releasing it does not outweigh the reasons for withholding we have listed above.

Note that the request was not for every casual email staff and management might have loosely exchanged over the months, it was for the papers prepared for the Monetary Policy Committee, a statutory body that the Governor (who also sits on the Committee) and staff advise and service.

There is a close parallel to the way (a) government departments advise individual ministers, and (b) the way an individual Minister’s Cabinet paper seeks the approval of his/her colleagues.  Advice and recommendations and analysis flow to decisionmakers, and decisionmakers decide.  Sometimes that advice is poor, sometimes good, sometimes necessarily rushed, sometimes not.  But to their credit, the government has released the significant bits of advice/recommendations –  whether or not each of those pieces of advice make advisers or decisionmakers look good, whether or not decisionmakers accepted that advice or not, whether or not the advisers might now wish they’d advised something different?

What make the Reserve Bank –  the Governor as chief executive, or the statutory MPC he chairs –  think it should be exempt from that sort of scrutiny and transparency, through one of the most dramatic periods of modern times (including as regards monetary policy)?

One of the excuses the Bank has sometimes advanced for withholding monetary policy materials is that releasing them might give away information about future strategy.  Even if that were true, it is really grounds for selective redaction, not broadbrush refusal, but at present it is a particularly absurd argument.  For example, my request encompassed papers relevant to the February MPS –  you’ll recall that that was the one in which they played down coronavirus and were rather optimistic about the rest of the year, adopting a very slight tightening bias.  Whether or not those were reasonable views at the time, they were long since overtaken by events. Nothing in the advice and analysis provided to the MPC for that MPS has any possible bearing on actions the Bank or market is taking now.

But take more recent events.  The MPC issued, and has since reaffirmed, their pledge to not cut the OCR for a year.  They provided no supporting argumentation or analysis for that stance, but presumably there must have been some analysis and advice, perhaps around these mysteroius “operational obstacles” that the Governor, as the MPC’s spokesman, keeps referring to.

Or the LSAP programme?  Surely there must be staff analysis and advice, provided to MPC under the imprimatur of the Governor, on the likely effects of such a programme?  What possible grounds can there be for simply refusing to release any of it (as distinct perhaps from withholding specific paragraphs touching on the implementation plans for example)?

All the excuses about

In these circumstances it is especially important that the MPC has the space to assess all the available information, select monetary policy tools, convey clear messaging through its Monetary Policy Statements, and evaluate its actions as it proceeds. The release of such recent MPC papers would be likely to interfere with the effective implementation of monetary policy.

could no doubt equally be argued by officials in Health and Treasury etc, or by Ministers.  But to their credit, ministers have recognised the importance of openness and put the advice out there – rushed and perhaps inadequate, rapidly overtaken by events, as sometimes it inevitably was.   And at least Ministers have to face the electorate in September, but the only effective accountability for the Governor and his MPC (many of whom refuse even to be interviewed) is the sort of openness and transparency that the OIA has long envisaged.

The Bank likes to claim that it is very transparent, but solely on its own terms and its own definitions. Transparency does not mean telling people what you want them to hear when you want them to hear it –  everyone does that, in their own self-interest.  Transparency is about the stuff you sometimes find uncomfortable, even embarrassing, or just very detailed, but which you put out anyway.   Had she wanted to the Prime Minister could have run the sorts of excuses the Bank did –  claiming that she held a press conference every day and ran full page adverts in newspapers every day telling people what she thought they needed to know then –  but to her credit she is better than that, and recognised the very strong public interest in much greater transparency –  some of which might put her or her officials in a good light, some not.  It is what open government is about.

I’ll be referring this to the Ombudsman, and perhaps seeking from the Bank all material relevant to their consideration of this particular request, but if the government is serious about its commitment to openness and transparency, it is past time for the Minister of FInance to have a word with the Governor and with the others he himself appointed to the MPC, and with the chair of the Bank’s Board –  whom he appointed –  and strongly urge, come as close to insisting as he can, that extraordinary times, extraordinary monetary experiments, call for a much greater degree of openness that the Bank has, hitherto, been willing to display.

If The Treasury’s advice to the Minster of Finance on these matters is open to scrutiny in these exceptional fast-moving circumstances, why not the Reserve Bank’s advice to their decisionmaking body?  As it happens, the Secretary to the Treasury is now a non-voting member of the MPC, so perhaps she might have a word with her colleagues and draw attention to what transparency and accountability are supposed to mean in New Zealand.