Treasury

Sources of inflation

Michael Reddell Fiscal policy, inflation, Monetary policy, Treasury

I was on Newstalk ZB this morning to talk about the ASB recession forecasts and this article on the Herald reporting some recent statistical analysis from Treasury staff that attempted to provide another perspective on what has caused New Zealand’s high inflation rate.

I don’t want to add anything on the ASB forecasts other than to say that (a) their story and numbers seem quite plausible, but (b) macroeconomic forecasting is a mug’s game with huge margins of uncertainty and error, so not much weight should be put on anyone’s specific forecast ever (with the possible exception of a central bank’s forecast, which may be no more accurate than anyone else’s but on which they may nonetheless act, with consequences for the rest of us).

The Treasury staff analysis was published a couple of weeks ago as a 2.5 pages Special Topic in their latest Fortnightly Economic Update. You can tell from the Herald headline why one of their political journalists might have latched onto this really rather geeky piece

But there is less to the analysis than the headline suggests. The term “government spending” doesn’t appear in the Treasury note at all (I think “fiscal policy” gets one mention). The focus of the paper is an attempt to better understand the relative contributions of demand and supply factors to explaining inflation, and while fiscal policy is one (at times significant) source of demand shocks and pressures, there is no effort in the paper to distinguish the relative roles of fiscal and monetary policy (or indeed, to distinguish either of those policy influences from other sources of demand pressures). That isn’t a criticism of the paper. The technique staff used, introduced for those purposes a few months ago by a Fed researcher (his paper is here), isn’t designed for that purpose.

Loosely speaking, the technique uses time series modelling techniques to look at both prices and volumes for (most of) the items included in the CPI. When there are surprises with the same sign for both a price and the corresponding volume that is (in their words) suggestive of a demand shock (increased demand tends to lift prices and volumes) and when the surprises have opposite signs this is taken as suggesting a supply shocks (disruptions in supply tend to see lower volumes and higher prices go together). It is a neat argument in principle.

But it doesn’t look to be a very good model in practice. Here is The Treasury’s summary chart. the source of the line that (on this analysis) demand and supply shocks may have contributed roughly equal amounts to inflation over the last year, and that demand shocks were more important back in the early stages of the surge).

Not only is a large chunk of recent inflation not able to be ascribed to either demand or supply shocks, but there have been periods even in the quite short span shown here when the identified demand and supply shocks don’t explain any of the then-current inflation at all (eg 2019).

This is even more evident with some of the sub-groups they show results for. Thus, home ownership (which in the CPI is mostly construction costs)

For most of the decade, neither (identified) demand or supply shocks explain the inflation, and that is so again in the most recent data. And if the model suggests that sharp rises in construction cost inflation in recent times have little to do with demand at a time when house-building has been running at the highest share of GDP in decades, so much the worse for the model.

Services make up a large chunk of the economy, and a fair chunk of the CPI too. Here is the chart for that group

Not only are there periods when neither demand or supply shocks (as identified by the model) explain any of services inflation, but how much common-sense intuition is there is the idea (which the chart suggests) that for most of the period what services inflation can be explained is all either supply shocks or demand shocks and not some combination.

The Treasury paper notes some overseas comparisons, in particular that for the US

The results for New Zealand show lower supply-side contributions to inflation than estimates for the US and Australia. In the US, supply-side drivers account for about 60% of the annual change of the PCE deflator that the model can explain (Figure 7).4

(the footnote is to the original Fed paper)

and they show this US chart which I assume comes from the same model

Note, first, that the PCE deflator has a materially different treatment of home ownership – using imputed rents – than either the NZ or US CPIs.

But perhaps more importantly, in the original Fed paper there is this line

And here is a relevant chart from the same paper (grey-ed periods are NBER recessions)

Not only does it show the entire period since 1990 (one of my uneases about the New Zealand work by Treasury is showing only the last 10 years), but it also illustrates that, as defined for the purposes of these models, both supply and demand factors are large influences, almost always positive, over the entire 30+ years. In other words, if there is anything unusual about the current situation it is not the relative contributions of supply and demand influences but simply that inflation is high (both demand and supply influence). It simply doesn’t seem to add much value in making sense of why things unfolded as they did over the last couple of years. (Although it is interesting how different the last 10 years of the chart look for the US, as opposed to New Zealand in the first chart above.)

What these US charts also illustrate is that supply and demand shocks/drivers here don’t mean the same as they typically do when thinking about monetary policy. Monetary policymakers will (rightly) talk in terms of generally wanting to “look through” supply shocks – the classic example being spikes in world oil prices, which not only flow through to the CPI almost instantly (faster than monetary policy could react) but also make us poorer. The focus instead is on whether these headline effects flow through into generalised inflation expectations and price-setting more broadly. Climate-induced temporary food price shocks (from storms or droughts) are seen in the same vein.

Those sorts of shocks are generally thought of as being as likely to be negative influences on headline inflation as positive ones. Oil prices go all over the place, up and down. Much the same goes for fruit and vegetable prices. These are the two main things excluded in that simplest of core inflation measures, ex food and energy. Some of the Covid-related disruptions are probably more one-sided: there aren’t really obvious favourable counterpoints to severe supply disruptions (even if such disruptions themselves generally unwind over time). But even taken altogether they aren’t the sorts of things that will produce positive influence on core inflation over single year for over 30 years (as in the US core inflation chart immediately above).

When macroeconomists think of inflation they often do so with a mental model in their heads in which this period’s inflation is a function of inflation expectations, some influence from the output/employment gap, and then any residual (supply shock) types of items. Those supply shocks can run in one direction for a couple of years in succession (and probably did in the last couple) but the expected value over long periods of time is generally thought to be pretty close to zero. Monetary policy determines core inflation – monetary policy shapes expectations and influences and responds to developments in the output (or employment) gap. Of course, monetary policy takes account of trend supply developments – adverse shocks may not only raise headline inflation, and risk raising inflation expectations, but can lower both actual and potential output (many positive supply shocks work in the opposite manner).

I don’t want to be particularly critical of The Treasury. We should welcome the fact that their analysts are trying out interesting different approaches and keeping an eye on emerging literature, and even that they are making available some of that work in generally low-profile publications. That said, Treasury is not some political babe in the woods, and I’d have thought there should have been some onus on them to have provided a bit more context and interpretation in their write-up. For example, whereas the US is often treated as a closed economy, New Zealand clearly isn’t. I don’t have a good sense as to how general imported inflation – or that reflecting exchange rate changes – is going to affect this sort of decomposition. If, as I believe, a wide range of central banks made very similar policy mistakes, we’ll be seeing more inflation from abroad (if our Reserve Bank takes no steps to counter it) not tied to demand pressures in particular domestic sectors. I’m also not really clear how the lift in inflation expectations that we observe in multiple surveys fits into this sort of decomposition exercise.

Oh, and it was perhaps convenient that of the CPI groups Treasury showed, motor fuels was not one of them. Headline inflation currently is held down quite a bit by the NZ Cabinet shock – holding down petrol excise taxes etc.

My own approach to the question of where the responsibility lies for core inflation (and note that Treasury focuses on headline not core) tends to be simpler. When this century the unemployment rate has dropped below about 4 per cent core inflation has tended to become quite a serious problem (mid-late 00s and now). The Reserve Bank itself has been quite clear in its view that employment is running above the “maximum sustainable employment” (itself determined by other government policies), and thus, by implication, the unemployment rate – at near-record lows is below sustainable levels. That is a function of excess demand relative to the ability of the economy to supply. Core inflation – the bits we should most worry about, because we could usefully do something about them – is an excess demand story, risking spilling over into embedded higher inflation expectations.

And when ZB’s interviewer asked me this morning whether Mr Robertson or Mr Orr was to blame (fiscal or monetary policy), I was quite clear that the answer was monetary policy (Orr and the MPC). That isn’t because monetary policy loosenings in 2020 were necessarily the biggest source of stimulus to demand, but because the model is one in which (a) fiscal policy is transparent, and (b) monetary policy moves last, with the responsibility to keep core inflation at/near target. You might think (I certainly do) that less should have been done with fiscal policy, but it isn’t up to the MPC to take a view on that, it is their job simply to have a good understanding of how the whole economy, and the inflation process in particular, works, and to adjust monetary policy accordingly. In extremis, fiscal policy can overwhelm the best efforts of central banks, but that wasn’t an issue or a risk here, or most other countries, in recent years. Central banks simply got things wrong. (They had company in their mistake, but they were/are paid to get these things right.)

Interesting that the Minister of Finance asked for advice

Michael Reddell LSAP, Monetary policy, Treasury

In September last year, former Bank of England Deputy Governor Sir Paul Tucker published a substantial discussion paper suggesting paying a sub-market, or zero, interest rate on some portion of the huge increase in bank deposits at the central bank that had resulted (primarily) for the large-scale asset purchase programmes central banks had been running (in the Bank of England’s case since the 2008/09 recession, but in some countries – including New Zealand and Australia – just since 2020).

In late October, I wrote about Tucker’s paper, and you will get the gist of my view from the title of that post, “A Bad Idea”. The Herald’s Jenee Tibshraeny picked up on that post and the following day ran an article on the Tucker tiering proposal, with sceptical quotes from several people including me. There was a difference of view in those quotes. As in my post, I argued that such an approach could be adopted without impeding the fight against inflation but should not be adopted, while others (as eminent as the former Deputy Governor, Grant Spencer) suggested that not only that it should not be done, but could not (ie would tend to undermine the drive to lower inflation).

The essence of my “it could be done” line was the same as Tucker’s: monetary policy operates at the margin, and so what matters for anti-inflationary purposes is that the marginal settlement cash balances receive the market rate, not that all of them do. There was precedent, in reverse, in several (but not all) countries that ran negative policy rates, where the central bank applied the negative rate only to marginal balances, while continuing to pay a higher rate on the bulk of balances (thus supporting bank profits, although the argument made at the time was that doing so would help support the monetary transmission mechanism).

So far, so geeky. But it turns out that after Tibshraeny’s first article, the Minister of Finance sought advice on the Tucker proposal, not just once but twice (first from The Treasury and then later from the Reserve Bank). In yesterday’s Herald, she reports on the two documents she got back from an Official Information Act request to the Minister. She was kind enough to provide me with a copy of the material she obtained.

The Treasury advice, dated 6 December 2022, does not explicitly say that it was in response to a request from the Minister, but it seems almost certain that it was. Treasury is unlikely to have put up advice off its own bat on a matter that is squarely a Reserve Bank operational responsibility without formally consulting with the Reserve Bank and including some report of the Reserve Bank’s views in its advice. We can assume the Minister asked Treasury for some thoughts, and Treasury responded a few weeks later with four substantive pages.

I don’t have too much problem with The Treasury’s advice on a line-by-line basis. Their “tentative” view was that some sort of tiering arrangement could be introduced without undermining the effectiveness of monetary policy.

There were a couple of interesting things in the note nonetheless. For example, it was good to have this in writing

and it was also interesting to read that “in previous discussions with the Bank they have indicated that they would consider introducing a zero-interest tier if the OCR were negative”.

Treasury highlighted that a zero-interest tier in the current environment (large settlement cash balances, fairly high OCR) would be in effect a tax on banks with settlement accounts.

but strangely never engage with the question as to whether it would be appropriate for the Reserve Bank to impose such a tax (or whether they had in mind special legislation to override the Reserve Bank on this point).

They also note some potential reputational issues

but could have added that these might be particularly an issue if New Zealand was to adopt such an approach in isolation (they neither mention, and nor have I seen, any indication any other authorities have seriously considered this option).

The Treasury note ends recommending not that the issue be closed down and taken no further, but that if the Minister wanted to “pursue this option” he should seek advice from the Reserve Bank and they offered to help draft a request for advice.

And so the Minister turned to the Reserve Bank for further advice, and on 2 February 2023 they provided him four pages of analysis (plus a full page Executive Summary which is more black and white than the substantive paper itself). The Bank seems pretty staunchly opposed to the tiering idea, but on occasions seems to overstate its case. And, remarkably, they never even attempt to engage on the question as to whether the market-rate remuneration of the large settlement cash balances created by their LSAP (and Funding for Lending) programmes are any sort of windfall gain to the banks (a key element of Tucker’s argument).

But much of what they say is reasonable. From the full paper

There is no real doubt that it can be done, and they draw comparisons between regimes in some other countries, more common in the past, where some (legally) required reserves were not remunerated at all.

I largely agree with them on this

departing from them on that final sentence of paragraph 25 (any tier could, and sensibly would, be set on the basis on typical balances held prior to any announcement or consultation document), and in the first sentence of paragraph 26 (since, from the Bank’s perspective, benefits from the LSAP are supposed to be a good thing – the Governor repeatedly champions them – not bad).

The Bank attempts to play down the amounts at stake, suggesting any potential gains to the Crown (and thus, presumably, costs to those subject to the “tax) would be modest. But they include this

I guess when your MPC has thrown away $10bn of taxpayers’ money, $900m over four years doesn’t seem very much (and these calculations are materially biased to the low end of what could be raised without adversely affecting monetary policy) but…..$900m over four years buys a lot of operations, or teacher aids, or whatever things governments like spending money on.

It is also a bit surprising that although the Bank notes that such a tiering tax would be likely to be passed through to customers, they provide no substantive analysis as to how or to what extent, and thus what the likely incidence of such a tax would be. It isn’t that I disagree with the Bank, but the analysis isn’t likely to be very convincing to readers not already having the same view as them (tiering is a bad idea).

They make some other fair and important points, notably that hold a settlement account with the Reserve Bank would be likely to be less attractive if doing so was taxed, in turning providing an advantage to non-settlement account financial institutions (broader settlement account membership is generally a good thing, conducive to competition and efficiency). But then they over-egg the pudding. This line is from the Executive Summary – and draws on nothing in the body, so has the feel of something a senior person inserted at the last minute

One of the points commentators on central banks often have to make to less-specialist observers is that banks themselves have no control over the aggregate level of settlement cash balances. Individual bank choices – to lend or borrow more/less aggressively – affect an individual bank’s holdings but not the aggregate balances in the system. And thus banks cannot materially impede future LSAP-type operations since there is no reason why the Reserve Bank’s purchases need to be constrained only to entities that already hold settlement accounts at the Bank. If the Reserve Bank buys a billion dollars of NZ government bonds at premium prices from overseas investors/holders, the proceeeds will end up in NZ bank settlement accounts whether the local banks like it or not. Same goes for, say, large fiscal operations like the wage subsidy. What might be more accurate – and I made this point in my original post – is that a tiering model carried into the future might motivate local banks to lobby harder against renewed LSAPs. From a taxpayers’ perspective that would probably be a net benefit, but one can see why the Reserve Bank might have a different view.

While I don’t really disagree with the thrust of either the Reserve Bank or Treasury advice neither could really be considered incisive or decisive pieces. Perhaps the Bank’s piece was enough to persuade the Minister (although there is no indication in the OIA material or in Tibshraeny’s article that the Minister has abandoned interest). A tiering regime of the sort discussed in the RB/Tsy advice would be an opportunistic revenue grab, representing either an abuse of Reserve Bank power or a legislative override of monetary policy operational independence, with truly terrible signalling and precedent angles. It could be done – so could many many bad things – but it shouldn’t.

(If you want a typically-passionate opposing view, try Bernard Hickey’s column yesterday, from which I gather he has removed the paywall.)

Big mistakes were made. The LSAP was unnecessary, ill-considered, risky, and (as it turns out) very expensive. The Funding for Lending programme continued all the way through last year was almost incomprehensible (if cheaper and less risky). Mistakes have consequences and they need to be recognised and borne, not pave the way for still-worse compensatory fresh interventions.

I’m going to end repeating the last couple of paragraphs from my original post

It is, perhaps, a little surprising that neither set of official advice shows any sign of engaging with Tucker’s paper itself, or with the author, a very well-regarded and experienced figure.

Dipping into the HYEFU

Michael Reddell Fiscal policy, Taxation, Treasury

Just a few things caught my eye flicking through yesterday’s HYEFU summary tables – if you don’t count points like the fact that The Treasury projects we will have had five successive years of operating deficits (in a period of a high terms of trade and an overheated economy), and that net debt as a per cent of GDP (even excluding NZSF) is still increasing, notwithstanding the big inflation surprise the government has benefited (materially) from.

This chart captures one of the things that surprised me. It shows export volumes and real GDP, actual and Treasury projections. Exports dipped sharply over the Covid period (closed borders and all that), but even by the year to June 2027 Treasury does not expect export volumes to have returned either to the pre-Covid trend, or to the relationship with real GDP growth that had prevailed over the pre-Covid decade.

The Reserve Bank does not forecast as far ahead as the Treasury but has quarterly projections for these two variables out to the end of 2025. Here is a chart of their most recent projections

It is a quite dramatically different story.

The issue is here is not so much who is right – given the vagaries of medium-term macro forecasting there is a fair chance that none of those four lines will end up closely resembling reality – as that the government’s principal macroeconomic advisers (The Treasury) have such a gloomy view on the outward orientation of the New Zealand economy. One of the hallmarks of successful economies, and especially small ones, tends to be a growing number of firms footing it successfully in the world market. Earnings from abroad, after all, underpin over time our ability to consume what the rest of the world has to offer. Quite why The Treasury is that pessimistic isn’t clear from their documents – one could guess at various possibilities in aspects of government economic policy – but it does tend to stand rather at odds with the puffery and empty rhetoric the PM and Minister of Trade are given to.

Then there was this

On Treasury forecasts the CPI in 2025 will have been 13.3 per cent higher than if the Reserve Bank had simply done its core job and delivered inflation on average at 2 per cent per annum (the Reserve Bank’s own projections are very similar). It is a staggering policy failure – especially when you recall that the Governor used to insist that public inflation expectations were securely anchored at around 2 per cent. It is an entirely arbitrary redistribution of wealth that no one voted one, few seem to comment on, and no one seems to be held to account for, even though avoiding such arbitrary redistributions (benefiting the indebted at the expense of depositors and bondholders) was a core element of the Reserve Bank’s job. We don’t – and probably shouldn’t – run price level targets, but let’s not lose sight of what policy failures of this order actually mean to individuals.

And the third line that caught my eye was this

A good question for the National Party might be to ask how much of this 3.5 percentage point increase in tax/GDP they intend to reverse, and how, or would any new National government simply be content to leave little changed what Labour has bequeathed them?

As longer-term context (slightly different measure to get back to the 70s) the only similarly large increases in tax/GDP seem to have been under the 1972-75 and 1984-90 Labour governments.

Rodger Finlay

Michael Reddell Reserve Bank Board, Rodger Finlay, Treasury

If you have long since lost interest in my series of posts as to how Christchurch company director Rodger Finlay came to be appointed by the government as a director of the Reserve Bank (in its new governance model where the powers, including bank regulatory ones, rest with the Board) while, it was envisaged, he would keep on as chair of NZ Post, the majority owner of a bank (Kiwibank) the Reserve Bank prudentially regulates and supervises, and the spin around it, feel free to stop here. The title of the post was due warning. But sometimes you have to see things through to the end.

A couple of weeks ago, I wrote here about (and excerpted) The Treasury’s incident report about the Finlay affair, and specifically the events that led to the Secretary to the Treasury providing a written apology to the Minister of Finance for the failure of her staff and organisation to explicitly draw to the attention of ministers the conflict of interest issues around Finlay’s appointments, either when he was being appointed to the Reserve Bank Board a year ago, or when Cabinet was agreeing to his reappointment as chair of NZ Post in June this year.

Yesterday I had two more OIA responses. Appointments to SOE boards are on the joint recommendation of the Minister of Finance and the Minister of State-owned Enterprises, and I had asked both ministers for material relevant to Finlay’s NZ Post reappointment (and withdrawal from that post) in June. Megan Woods had been the SOE minister responsible, but she apparently declared a potential conflict of interest, around her personal and professional relationships with Finlay, and so formal responsibility was shifted to Kris Faafoi (as it turned out, by the end of this he was in his last few days in office). Faafoi having left office, his papers on the issue are coming only slowly (early next year I’m told) but The Treasury did yesterday release the papers they had relevant to the appointment process Faafoi was involved in.

Treasury OIA response re acting Minister of SOEs and reappointment of Rodger Finlay as NZ Post chair Oct 2022

and Grant Robertson also provided his response to a similar request, but which also covered contacts with journalists on the Finlay appointments.

MoF OIA response re Rodger Finlay and the NZ Post board Oct 2022

In total there is about 50 pages of material

Taking the Treasury response first, there isn’t a great deal that is new.  The relevant paper to the Cabinet Appointment and Honours (APH) Committee is included in full.  It doesn’t note any conflict of interest issues (but we knew that from the Secretary to the Treasury’s apology and their report) but their description of NZ Post itself is a little surprising.

with no mention that NZ Post is also the majority owner of the 5th largest bank in the country.

I was slightly amused by what was, and wasn’t, kept secret about Finlay’s personal details

and the fussing around in the paper about whether the board was going to be suitably “representative”

But perhaps the point of substance was an email to Treasury officials from Faafoi’s private secretary on 8 June after the APH meeting noting that “Finlay’s reappointment went through APH today with no issues”.

While The Treasury had clearly been remiss in not including the conflict of interest issue in the papers, quite where were ministers (whether those proposing to make the appointment – and especially Robertson – or those deliberating on it)? Did it not occur to any of these people – either then, or when the RB Board appointment was made – to question whether it was really quite right to have someone responsible for bank regulation also chairing the majority owner of a bank. It is hardly as if Kiwibank’s ownership was a secret, and the APH paper does note that Finlay had been appointed as a Reserve Bank Board member (and from the Robertson bundle of documents we find talking points The Treasury had prepared for Faafoi, one (of a handful) of which explicitly states that he has been appointed to the Reserve Bank Board)? Or do conflicts of interest, real or apparent, just not matter to this government?

Most of the interest in the Robertson bundle is in the exchanges by members of his staff with various journalists about the Finlay issue.

But there is also an email exchange on 10 June, the day my first post on the Finlay issue appeared. We know from The Treasury’s incident report that prior to 8 June (the day of the APH meeting) Finlay had approached Treasury suggesting that he could take leave of absence from the NZ Post role until the (then not known to the public) reshuffle of Kiwibank ownership went through – it had initially been planned, so the documents show, to have had this reshuffle wrapped up by 30 June).

Anyway, on 10 June my post went out at about 8:30am (it is in my email inbox at 8:32) and at 9.34am Finlay himself sent a link to the post, without further comment, to four Treasury and NZ Post addressees. At 3:21pm, Treasury is emailing people in the relevant ministers’ offices, cc’ing the NZ Post people

I found it interesting that the official states “This potential concern has been on our radar” – what, just waiting for someone (whether me or another observer) to notice the egregious conflict involved in having the chair of the majority owner of a bank sitting on the governance board of the bank regulator? And so they suggest rolling out what Finlay himself had proposed – that he temporarily step aside from the NZ Post role – and had gone far enough to get the agreement of another director to act in Finlay’s place if ministers were to go with this option.

But that didn’t happen. The Treasury report says Finlay himself called the Minister of Finance, and the Minister took the view that as the potential conflict had been considered when the initial (RB) appointment was made and nothing had changed, there was no reason for Finlay to stand aside. Except, of course, that we know that the advice to Ministers and Cabinet in late 2021 had not mentioned the conflict, and neither had the advice to other political parties when, as the RB Act requires, they were consulted on Finlay’s RB appointment.

It is also pretty extraordinary – and this isn’t picked up in Treasury’s report – that there was no sign that these Treasury officials (or perhaps Finlay) really recognised the character of the Finlay conflict. He could have temporarily stepped aside as NZ Post chair and would still be responsible for bank regulation and supervision around Kiwibank during that period, and almost all regulatory decisions have effects longer than a few months standdown might imply. To address the conflict by means of temporary stand-down it would have to have been the Reserve Bank Board he stood down from, but the Reserve Bank role isn’t even mentioned here, and nor were Reserve Bank officials copied on the emails from either Finlay or Treasury.

And so Cabinet went ahead and on 13 June reappointed Finlay for three years. And on 14 June Finlay wrote declining the appointment.

The first journalist to have asked Robertson anything about the Finlay issue was the Herald’s Jenee Tibshraeny.

At the time of this phone call and email, it was full steam ahead. Cabinet had approved Finlay’s reappointment and the letter of offer was going out.

It took the best part of two days, and multiple reminders, to get an answer out of Robertson.

The delay was convenient as by this time – and against the wishes of the Minister – Finlay had stepped aside, and finally personally resolved the conflict issue. Against that backdrop, the Minister’s answer to the Herald was pretty much active and deliberate disinformation.

The next lot of media inquiries worth mentioning was on 1 July (the day after the rest of the new Reserve Bank Board was announced, including reference to Finlay as “previously” chairing NZ Post. Stuff’s Rob Stock asks Robertson’s senior press secretary

Who, in a series of email exchanges also engages in an active attempt to put the journalist off the trail (pretty sure the government would call this “disinformation” if anyone else was doing it).

First, the Minister was sick and couldn’t comment, but there was no news because Finlay’s term was due to end on 30 June. Stock responds that he didn’t recall either the RB, the Minister or Finlay “mentioning this was the plan for managing the conflict”, to which Bramwell responds disingenuously “I’m not sure if it was the ‘plan’…..you’d have to talk to Mr Finlay about that – or perhaps the RBNZ?”. Stock immediately responds (presumably of attempts to get others to comments) “No comment, not available, talk to Minister”. Whereupon Bramwell (for the Minister) again avoids answering the actual question with this response

Stock must have given up at that point. But if Bramwell’s last response was a non answer, it was nonetheless interesting since (a) it points us to Reserve Bank involvement in the political spin, and b) tells us that the Bank concedes that there may well have been “material conflicts of interest” from 1 July had the government gone ahead with its plans and Finlay not, at the end, done the decent thing.

There is a final rounds of exchanges between Tibshraeny and Robertson’s office at the end of August. These requests came after some earlier OIAs had begun to shed more light. You can read the exchange for yourself. On Finlay, the key question is “How was it ever ok for Rodger to be NZ Post chair and on the new RBNZ Board at the same time? [as the government deisred and intended]. Even [if] this would’ve been within the law [which it was] it surely would not have been within the spirit of the law”. There is never a straight answer from the Minister, just a deflection to the Reserve Bank who, she was told, concluded that “any conflict of interest…could be managed”.

Tibshraeny’s final question is about an issue I was not aware of until she identified it: that Finlay is a director of Ngai Tahu which now owns a 24.94% stake in Fidelity Life Assurance, an insurance company regulated by the Reserve Bank. That deal was not settled until early 2022 but had been agreed on before Finlay was appointed to the Board (and “transitional board”) late last year. That appears not to have been disclosed or discussed when his appointment was made. In Tibshraeny’s final email she notes “So, not great…..”

There have been so many issues to keep track of – including the other new director who when appointed was also on the board of an insurance company that for some reason was not regulated by the Reserve Bank (before there was a belated rethink and he resigned from the insurance company board) – and the Fidelity stake isn’t controlling so that on its own I can’t get too excited about it. But it does tend to speak to a pattern – running across all those involved here – that all that matters is the letter of the law, and nothing at all about the appearances, and the potential for actual or apparent conflicts. Finlay should, right upfront, have identified both the Kiwibank and Fidelity stakes as potential conflicts – and should never have put himself forward if he intended to stay on at NZ Post. In combination, they should have been disqualifying – to The Treasury and to Ministers.

As far as I can see no one emerges very well from this whole saga, with some slight brownie points to Finlay who did after all finally step aside. The Treasury did poorly, perhaps so too did their recruitment consultants, the Brian Roche interview panel (for the RB roles) did really poorly (and that includes the head of APRA who sat on the panel), ministers did poorly (Grant Robertson most of all). No one called stop at any point, and all seemed to be focused (if at all) on the letter of the law rather than the substantive issues that mean it would not be acceptable anywhere to have as director of the bank regulator the chair of a majority owner of a bank.

But if any of these people or groups of people should have stood up and called a halt (before Finlay finally did), so too (and perhaps above all) so should the Governor of the Reserve Bank. the chair of the Reserve Bank Board, and all their attendant senior managers and Board colleagues. Every one of them should have known the conflict was untenable and unacceptable (it was the immediate reaction of a whole bunch of former central bankers after my first post appeared), and quite damaging to the credibility of the institution.

But if you have been following this story since June, you may have noticed that there have been OIA responses, fairly timely ones, from the Minister and from The Treasury, and nothing at all from the Bank (just references to them and their involvement in some of the other documents). It isn’t for want of trying.

On 1 July, the day after the full Board was appointed, I lodged with the Reserve Bank a request for

…copies of all material relating to appointments to the new Reserve Bank Board, including all material relating to appointments to the “transition board”. 

Without limitation, this request includes all papers and other material generated within the Bank (other than of a purely administrative nature), any advice to/from or discussions with The Treasury, and any advice to and interaction with the Minister of Finance or his office on these issues.

It was directly parallel to similar requests lodged with the Minister and with The Treasury (both of whom responded substantively).

On 13 July, one of the many communications staffers got in touch to tell me

We have transferred your request to the Treasury as the information is believed to be more closely connected with the functions of the Treasury. In these circumstances, we are required by section 14 of the OIA to transfer your request.

You will hear further from the Treasury concerning your request.

I rolled my eyes – it was evidently a ploy (note I explicitly asked about material generated within the Bank, which other agencies would not necessarily be expected to have) and no doubt the Bank knew by then of my other requests – but did nothing more while I waited for responses from the Minister and The Treasury.

Having received those responses, on 3 September I went back to the Bank to renew my request (all on the same email chain, so there was no ambiguity about what the request was)

I am writing to renew my request.  You transferred the request to The Treasury, but (as I’m sure you know) their release provided nothing on anything the Bank, its staff or management, Board or “transitional board” members said, wrote or did.  I now know from the responses to similar OIAs to The Treasury and to the Minister of Finance, that the Board chair was involved in the selection of new board and transitional board members, Rodger Finlay (then a “transitional board” member) served on the interview panel for the second round of Board appointees, that RB legal staff had discussed issues around potential conflicts of interest for Rodger Findlay.    Against that backdrop (and the media coverage of the Findlay situation in late June), it is inconceivable that there were no papers, emails or the like on any matters relating to the selection and appointment of Board members, whether or not such material was conveyed to The Treasury or to Minister.

That was almost two months ago. It was only yesterday I thought to check up on it and have sent them a note pointing out that I did not yet appear to have had a response. It increasingly appears as though the request will have to be referred to the Ombudsman.

But no doubt the Governor and his colleagues will keep on with the spin about being a highly transparent central bank. At this point, you really wonder what they can have left to hide, but perhaps the secrecy and obstructiveness is just some point of unprincipled principle?

UPDATE: About 40 minutes after this post went out I had an email from the Reserve Bank offering what appears to be a fairly abject apology for allowing this request to have fallen through the cracks, promising process improvements etc. Accidents happen, system aren’t foolproof (even with 20 comms staff), so I am inclined to take them at their word, but I guess it means I might finally get a response by Christmas.

Rodger Finlay: The Treasury’s incident report

Michael Reddell Reserve Bank Board, Rodger Finlay, Treasury

Regular readers will recall that since June I’ve been on the trail of events surrounding the appointment of Rodger Finlay as, first, a “transitional board” member (attending actual Board meetings) and then a full Reserve Bank Board member, at the same time that he was chair of NZ Post, the majority owner of Kiwibank, an entity subject to Reserve Bank prudential regulation and supervision. From 1 July, the new Reserve Bank Board had legal responsibility for all the powers the Reserve Bank had on prudential policy and implementation. Finlay’s term as NZ Post chair was due to expire on 30 June, but processes were in train that saw Cabinet reappoint him on 13 June.

The most recent post was here. The story gets a little complicated, and there have been various documents (from the Minister of Finance and from The Treasury), and comments from the Minister or his office reported by the Herald. From that 31 August post

In the earlier documents, it was noted that the Secretary to the Treasury had asked for a report from her staff as to what had happened, how, and what if any process changes needed to be made. That report was released to me this afternoon and is here.

Treasury incident report on Rodger Finlay conflicts and appointments

This was the first stage

It reflects very poorly on The Treasury staff concerned (Treasury is after all responsible for monitoring reviewing the Bank), the Reserve Bank Governor and Board chair (who seem to have been more interested in some legalistic narrow definition than in either appearances or substance), and the interview panel, including the head of the Australian Prudential Regulatory Authority who, if the issue came up as Brian Roche says, should have been making the point that it should be unacceptable to have the chair of the majority owner of a bank sitting on the board of the prudential regulatory authority.

As I’ve noted before, it reflects poorly on Finlay too, who signed an application stating that he had no conflicts.

Treasury goes on to note that they did not advise the Minister of the potential conflict issue so that he could make his own informed choice, and nor were other political parties (who had to be consulted) advised.

They go on to note that in the process of planning to reappoint Finlay as NZ Post chair (a process that ran for some months) the issue of the potential conflict was also not advised to ministers.

And then we get this

I guess it is encouraging that Finlay belatedly raised the issue, even if he then let the bureaucrats convince him there wasn’t an issue.

Then there was this

From context, Project K is clearly the scheme to have the Crown buy out the existing (Crown bodies’) shareholdings in Kiwibank. Again, it is perhaps encouraging that Mr Finlay again broached the issue of potential conflicts. It also makes sense of this from the minutes of the RB “transitional board” on 9 June (which I had been puzzling over).

and the story rounds off here (Cabinet having made the NZ Post appointment on the 13th)

Which, as these things seem so often to do, again sheds particularly poor light on Grant Robertson as Minister of Finance, who was apparently totally unbothered by the actual or perceived conflicts even when Finlay himself had raised the issue – not even to accept the offer from Finlay to stand down from NZ Post until the Kiwibank deal was resolved (although as the RB was the regulator, if he was really serious he should have sought to take leave from that Board).

The report sums up

All of which is no doubt true, but it isn’t only (or even primarily) The Treasury’s reputation that should have been damaged by this (even if I now look on Finlay himself a little more charitably).

Anyone interested can read the rest for themselves, including the multi-page note on process improvements.

UPDATE:

It also reflects poorly on Robertson that (extract from my previous post) it is pretty clear that he actively misrepresented the situation to the Herald’s journalist.

We deserve better

Michael Reddell Taxation, Treasury

A few weeks ago there was the debacle of the government introducing one afternoon a bill that would have imposed GST on investment management fees, ministers defending that bill the next morning, but then by lunchtime the policy was gone.

The proposed law change seemed on the face of it perfectly sensible in principle. I even read the Regulatory Impact Statement that was published with the bill, and most of the reasoning and argumentation made sense there too.

But it contained this little section

Perhaps unsurprisingly, those big numbers got a fair amount of media and political attention. As an example, here was an RNZ story

I was a bit curious about this “modelling”, which was not published at the time the bill was introduced. It wasn’t described in the RIS, the numbers weren’t put in any sort of context, they were just baldly stated. Quite probably ministers don’t read RISs, but perhaps you might think that the political advisers in their offices would (looking for fishhooks and headlines if nothing else). And you might have hoped that officials (Treasury/IRD) might have done a bit more than drop big numbers into the RIS – numbers that might reasonably be seen as creating problems for a sensible rational tax reform – rather than just stick the numbers out there waiting for the first curious journalist or Opposition MP to find them.

My suspicion was that something very simple, and potentially quite misleading, had been done. After all, one wouldn’t normally look to the FMA to undertake any serious modelling (it is a regulatory implementation agency). So I lodged a request for the modelling, and got a reply back this afternoon.

It is a helpful reply. They have set out their assumptions clearly, and even offered that I could talk to the responsible senior manager if I wanted to discuss matters further.

And it was pretty much as I had expected. They had assumed (probably reasonably enough [UPDATE; but see below]) that all of any GST burden would be passed on to customers/investors, and thus that overall returns would be a bit lower. But then they simply assumed that all the additional tax went to the government, which sat on it, and neither the government nor the savers made any subsequent changes in behaviour……..over the subsequent 50 years. And thus, mechanically, future managed fund balances would be lower than otherwise (about 4.5 per cent lower)

It might be a reasonable approximate assumption for a first year effect. Just possibly it might even be valid for the KiwiSaver component, since KiwiSaver contributions are largely salary-linked. But it makes no sense over a 50 year horizon, across all managed funds (let alone all private savings) and especially as the only macro-like number to appear in the entire document.

Over a 50 year view surely it would be reasonable to assume that one modest tax change makes no difference to the fiscal outlook, and thus that what is raised with this tax won’t be raised by some other tax. Household income won’t really be changed, and since most of the evidence tends to be that household savings rates in aggregate aren’t very sensitive to rates of return (partly because there are conflicting effects – low rates of return on their own might discourage saving, but on the other hand people with a target level of accumulated savings in mind for retirement will need to save a bit more when returns are lower than they had previously assumed) neither will the overall rate of household saving. There is more sensitivity (to return) on the particular instrument people choose to put their savings in, so that if returns on investment management products are a little lower than otherwise, people might prefer, at the margin, to hold a bit more of some other assets. But what of it? Supporting investment management firms’ businesses is no part of a sensible government’s set of goals.

Surely the best assessment would have been that over anything like a 50 year view, a small tax change like this, affecting returns on one form of savings product, simply would not be expected to make any material difference to accumulated household wealth in 2070, with perhaps some slight change in the composition of household asset portfolios: a little less Kiwisaver, not much change in other investment management products, and a little more in other instruments.

The FMA were at pains to point out that they “had limited time to feedback to IRD as part of IRD’s policy consultation”, although it isn’t clear whether IRD/Treasury requested these numbers or the FMA took it upon themselves to do it. And thus in a way I don’t much blame the FMA. They tend to be enthusiasts for and champions of KiwiSaver, and simply do not have a whole-economy remit or set of expertise.

What disconcerts me is that neither IRD nor Treasury (the latter especially) seem to have been bothered by FMA’s numbers, and neither seems to have made any effort to provide any context or interpretation. There wasn’t any obvious reason why those FMA numbers had to be in the RIS, but if they had put them in with a rider “On the (unlikely) assumption that governments simply accumulate the additional tax revenue for 50 years and neither they nor households make any other changes in behaviour, then FMA ‘modelling’ suggests……”, it might have done materially less damage, through highlighting the sheer implausibility of the assumptions over a 50 year horizon.

Of course, you might also have hoped that ministers and their political staff would have noticed that something seemed odd.

What was proposed still seems as though it would have been a sensible tax change. Perhaps it will even happen one day. Perhaps it would have been derailed anyway, even if those FMA numbers – unqualified – had never made it into the document. But neither ministers nor officials really seem to have helped themselves.

UPDATE

A reader got in touch and suggested I might have been too generous in accepting the FMA view that all the GST would have been passed on to customers. With that reader’s permission, here are his comments

“Having owned a fund manager as part of a wider business, the GST exemption was a pain.  We could not recover GST on certain inputs and so therefore had to charge more – about 7.5% more because of this.  Plus we had an extra employee in the finance area that we could have got rid of.  It is not obvious to me that the fees would have gone up for this reason at all, except that the industry would probably have used it as an excuse to raise fees as it means that at some future point they could cut them and get a pat on the back from the FMA.”

LSAP losses

Michael Reddell pandemic, Reserve Bank, Treasury

The Minister of Finance and The Treasury appeared before Parliament’s Finance and Expenditure Committee yesterday. It was encouraging to see National MPs asking questions about the Reserve Bank’s Large Scale Asset Purchase programme, which was undertaken with the agreement of both the Minister and The Treasury and which has now run up staggering losses for the taxpayer.

A standard way of estimating those losses is the mark-to-market valuation of the Bank’s very large LSAP bond portfolio. As of the latest published Reserve Bank balance sheet, for 31 October, those losses were about $5.7 billion. When the 30 November balance sheet is out, probably next week, the total losses will be lower (bond rates fell over November), but with a very large open bond position still on the books taxpayers are exposed to large fluctuations in the value of the position (up or down), with no good basis for supposing that the expected returns are likely to compensate for the risk involved. If there was a case for putting on a large open bond position early last year – I doubt it, but take that as a given for now – there is no case for one now, in a fully-employed economy with rising inflation, and with the conventional instruments of monetary policy – which expose taxpayers to no financial risk – working normally and effectively.

A post from a few weeks ago set out the issues.

I didn’t watch the whole 2 hours (link to the video above) but from exchanges with various people I think I have seen all the questions and answers relevant to the LSAP issues.

First, at about 43 minutes in, National’s Andrew Bayly asked the Minister of Finance (a) why, when Crown indemnity was approved the Minister did not then require a plan for unwinding the position (the Bank is currently talking about having a plan early next year, almost two years on), and (b) why there was no limit to the indemnity.

I’m not sure either question was that well-targeted, and the Minister had no real trouble responding. As he noted, the LSAP programme had been initiated in the middle of a crisis, time was short etc. And although there isn’t a limit on the indemnity itself there is a limit of how many bonds can be bought, and the government determines which bonds are on issue which amounts to much the same thing. That said, both responses take as more or less given that the idea of an LSAP had never occurred to anyone on any corner of the Terrace/Bowen St triangle until late March 2020. We know the Bank had been (rather idly) talking about the option for several years, including saying they’d prefer not to use it, but it seems they had not done the hard ground work, and neither had The Treasury nor the Minister insisted on it, well in advance. There is no sign any cost-benefit analysis for something like the LSAP was ever done, no analysis of likely Sharpe ratios, no analysis of potential peak taxpayer losses and so on. The Bank should be held accountable for that, but…the Minister is primarily responsible for holding them to account, and The Treasury is the Minister’s principal adviser (and the Secretary is a non-voting member of the MPC).

After the Minister left, Bayly returned to the LSAP (at about 68 minutes), supported by National’s new finance spokesman Simon Bridges. Bayly asked the Secretary to the Treasury whether an increase in the OCR would increase the liability for the Crown for the indemnity. The Secretary responded that the indemnity was net neutral from a whole of Crown perspective. What followed was a slightly confused discussion with Bridges ending up suggesting that the Secretary was “plainly wrong”. I don’t think the Secretary answered well, and she certainly didn’t answer in a way designed to help clarify the issues around the LSAP, but she is correct that the indemnity itself does not affect the overall consolidated Crown financial position (the claim the Bank currently has on its balance sheet is fully offset by an obligation the (narrowly defined) central government has on its balance sheet. It is quite likely that without the indemnity the MPC would have been very reluctant to have run a large-scale LSAP programme (the Bank’s own capital would not support the risk), but once the programme was established what determines the financial gains or losses is, in short, just the movement in market interest rates. The indemnity just reallocates any losses within the wider Crown accounts. In that particular exchange, The Treasury made none of this clear, and Secretary herself seemed a bit confused when the discussion got onto the different ways the bond position might eventually be unwound (there is little or no indemnity if the bonds are held to maturity, but that doesn’t mean there are no costs to the taxpayer). And thus (reverting to Bayly’s initial question) an increase in the OCR – particularly one now expected – doesn’t itself change the Reserve Bank’s claim under the indemnity

About 25 minutes further on, Bridges returned to the fray and a rather more enlightening conversation followed. Bridges asked whether the LSAP did not represent a significant increase in Crown financial risk. The Secretary agreed and both she and one of her colleagues explained – as I have here repeatedly – that what had gone on was that the Bank had bought back long-term fixed rate bonds, effectively swapping them for the issuance of settlement cash, on which the interest rate is the (variable) OCR. Unfortunately some of the discussion still got bogged down in matters of Crown accounting (the difference between the purchase price of the bonds and the face value, which is of no economic significance), and the Secretary was very reluctant to allow herself to be pushed into acknowledging that the position of the LSAP portfolio – implemented with her support – is deeply underwater. As a simple matter of analysis, she was never willing to distinguish between the mark-to-market loss to now, and the potential gains, losses, and risks on continuing to hold a large open position from here on. One is a given – now a sunk cost – and conflating the two (in the hope “something will turn up”) obscures any sense of accountability, including for the choices to keep running the position. She and her staff wouldn’t accept that sort of explanation from any other government agency running large financial risks.

Were the position to be liquidated today – as, at least in principle (crisis having passed, economy full-employed) it should be – a large loss for the taxpayer would be realised. At a narrow financial level it is as simple as that. If the position continues to be run – in the limit through to maturity, finally in 2041 – what will matter is where the OCR averages relative to what is currently priced into bond yields, but it won’t change the fact that the portfolio is starting behind – the OCR is already much higher than was expected at the time most of the bonds were bought. And if the portfolio is let continue to run, taxpayers are exposed to ongoing large risk for no expected return (there is no reason to suppose the Bank is better than the market at guessing where the OCR will need to go over the next 10-20 years).

(The current agreement between the Minister and the Bank requires that if the Bank looks to sell the LSAP bonds it do so only to the Treasury itself. Such a sale, of course, changes nothing of economic substance (purely intra-Crown transactions don’t) – the high level of settlement cash balances would still be there, earning whatever OCR the macro situation requires – but from a political perspective it would be convenient, as there would no longer be monthly updates on the Bank’s website as to the extent of the losses caused by the MPC’s rash choices (backed by The Treasury).

Treasury officials did chip in a couple of caveats. First, the Secretary noted that in assessing the overall LSAP programme one had to look also at the (any) macroeconomic benefits. In principle, of course that is correct, but (as I’ve argued previously) any such gains are unlikely to have been large:

  • the LSAP was designed to lower long-term bond rates, but these are a very small element in the New Zealand transmission mechanism,
  • it is hard to see much evidence here or abroad of sustained effects of LSAP-like programmes on long bond rates (eg movements beyond what changing expectations of future OCR adjustments themselves would simply),
  • the Bank always had the option of cutting the OCR further (on their own telling, to zero last year, and lower still since the end of last year), at no financial risk to the taxpayer, and
  • if there is a macro effect, perhaps it was modestly beneficial last year, but must be unhelpful now (recall that the literature suggests it is the stock of bonds that matters, not the flow of purchases, and we now have an overheated economy with above-target inflation.

And one of her deputies chipped in noting that there might have been some savings to The Treasury from having been able to issue so heavily at such low rates last year, the suggestion being that without the LSAP the Crown might not have been able to get away so many bonds so cheaply. There is probably something to that point, in an overall accounting, but (a) the effect is unlikely to have been large relative to the scale of the subsequent rise in bond yields, and (b) especially with hindsight a better model would have been for the Bank not to have been purchasing bonds and the Crown to have been issuing fewer.

The Select Committee discussion ended with the offer that National MPs could lodge a follow-up question for written response by the The Treasury. I hope they avail themselves of that offer.

The Treasury could be, and should be, much clearer and more upfront about the analytics of the LSAP issues, but it isn’t clear – given their involvement all along – that their incentives are in this case that well-aligned with the interests of the public in scrutiny, transparency, and accountability.

Long-term spending and revenue

Michael Reddell Fiscal policy, Treasury

The Public Finance Act requires that every four years The Treasury publishes a “statement on the long-term fiscal position” looking “at least” 40 years ahead. Parliament allowed them to defer the report due last year, but yesterday they published a draft – for consultation – of the report they will formally publish later this year. Quite why they have chosen to go through this additional step, of consulting formally on the draft of a report that is likely to have next to no impact even when finalised, is a little beyond me.

These long-term fiscal reports are fashionable around the world. As I’ve noted previously I was once quite keen on the idea, but have become much more sceptical. They take a lot of work/resource – which should be scarce, and thus comes at a cost of other analysis/advice The Treasury might work on – and really do little more than state the obvious. As I noted when the last long-term fiscal report was published.

I was once a fan, but I’ve become progressively more sceptical about their value.  There is a requirement to focus at least 40 years ahead, which sounds very prudent and responsible.    But, in fact, it doesn’t take much analysis to realise that (a) permanently increasing the share of government expenditure without increasing commensurately government revenue will, over time, run government finances into trouble, and (b) that offering a flat universal pension payment to an ever-increasing share of the population is a good example of a policy that increases the share of government expenditure in GDP.  We all know that.  Even politicians know that.  And although Treasury often produces an interesting range of background analysis, there really isn’t much more to it than that.  Changes in productivity growth rate assumptions don’t matter much (long-term fiscally) and nor do changes in immigration assumptions.  What matters is permanent (well, long-term) spending and revenue choices. 

And I’m old enough to remember people lamenting the potential fiscal implications of an ageing population – at least conditional on government choices – well before long-term fiscal reports were a thing.

What’s more, lots of countries have these sorts of reports, and of them some have very high and rising levels of government debt, and others don’t. It isn’t obvious that access to these sorts of long-term reports really makes any difference at all (see, for example, the US, with a rich array of private and public sector analysis – although do note that the US is well ahead of us in raising the eligibility age for Social Security retirement benefits).

New Zealand, to the credit of politicians in both main parties, has been one of the (not so small) other group of countries where government debt as a share of GDP has been kept fairly low and fairly stable. We’ve had recessions and earthquakes, and governments with big spending ambitions but if you reckon – as I do – that low and fairly stable government debt is generally a “good thing”, New Zealand has been a success story. We even ramped up the NZS eligibility age from 60 to 65 (back to the 1898 eligibility age) in fairly short order. For good or ill – and no doubt there is an argument to be had – government health spending as a share of GDP was not much higher last year than it was 40 years ago (recall, 40 years is the statutory timeframe for long-term fiscal statements).

health 2021

At the start of last year I’d probably have put myself in the camp of those saying “we’ve done okay on fiscal management and there is no obvious reason to suppose we won’t adjust as required in future”. Among other things, there is a certain absurdity in paying out a universal state welfare benefit to everyone at 65 as an ever-increasing share of those 65+ are still in the workforce, so change was likely to happen – it had in other countries, it had here previously and actually Labour in 2014 and National in 2017 and 2020 had campaigned on beginning to raise the age of eligibility (to which you might respond that none of those parties then got elected, but National still won 44.4 per cent of the vote in 2017).

I’m no longer so sure.

One chart that didn’t feature in the draft long-term fiscal report was this one from the Budget.

mcl 2

On their own numbers and estimates, the cyclically-adjusted primary deficit for the current (2021/22) financial year is projected to be really large (in excess of 5 per cent of GDP), at a time when – again on their own numbers – the economy is more or less back to full employment, with an output gap estimate close to zero. Note (again) that this is not a dispute about appropriate policy in the June quarter of last year when most of us were ordered to stay home and many were unable to work. It is about now.

In their text, Treasury is at pains to play down the current fiscal situation. They don’t mention these cyclically-adjusted estimates, but they claim that the situation is temporary, the spending is temporary, and will go away quite quickly. Of course, they have lines on a graph that show such an outcome, but that isn’t the same thing as hard fiscal choices over a succession of years. No doubt there are still some temporary programmes – the subsidies for Air New Zealand and exporters, MIQ costs, and vaccine costs – but a cyclically-adjusted primary deficit in excess of 5 per cent of GDP is getting on for a gap of $20 billion per annum. And every instinct of this government appears to be to spend more.

Here is the chart from the draft report

LTFS 2021

The primary deficit for 2060 on this scenario actually isn’t much larger than the primary deficit The Treasury smiles benignly on this year (assuming it will all go away quite easily). There are long-term issues that need addressing, but perhaps a less complacent approach to the current situation – and the poor quality of a lot of the new spending decisions – might be a better place to start.

Ah, but of course we heard from The Treasury a couple of weeks ago – the Secretary no less – that they are now keener on more government debt and a more active use of fiscal policy. Which probably isn’t the best backdrop against which to make the case for adjustment.

More generally, one of the things that has shifted over the last couple of years – and certainly since the 2016 LTFS – is some sense, especially on the left, that lots more public debt is something to embraced or welcomed, coming at little or no cost (so it is claimed). The focus is always on interest rates (low) and never on opportunity cost (when the coercive power of the state is at work in the spending choices). It makes it a bit harder to mount fiscal arguments about NZS if – as is probably the case – New Zealand could have government debt of 177 per cent of GDP without being cut out of funding markets (although note that, in the nature of such scenarios, the debt ratios mechanically explode beyond that 40 year horizon). And that is another reason why I’m sceptical of the benefits of reports like this: The Treasury really can’t offer any useful insights on the appropriate level of public debt, even if they can offer useful technical advice on the implications of various specific measures that might raise or lower the debt. The real debates to be had are political – both about the debt and the numerous progammes and even (to some extent) around the tax choices.

On NZS here were my thoughts from a post a couple of years ago (emphasis added)

As for NZS itself, personally I’m not overly interested in arguing the case for reform on fiscal grounds but on a rather more moral ground.    Even if we could afford it, even if there were no productive costs from the deadweight costs of the associated taxes, there just seems something wrong to me in providing a universal liveable income to every person aged 65 or over (subject only to undemanding residence requirements).    45 per cent of those 65-69 are now in the labour force –  suggesting they are physically able to work –  which is substantially greater than the 30 per cent of those aged 60-64 who were in the labour force 30 years ago when NZS eligibility was at age 60.

I don’t consider myself a welfare hardliner.  I think society should treat quite generously those genuinely unable to work, especially those who find themselves in that position unforeseeably.  Old age isn’t one of those (unforeseeable) conditions, but personally, I have no particular problem with something like the current flat rate of NZS, or even of indexing it to wage movements (which would be likely to happen over time anytime, whether it was the formal mechanism from year to year), from some age where we can generally agree a large proportion of the population might not be able to hold down much of a job.  I don’t have a problem with not being overly demanding in tests for those finding work increasingly physically difficult beyond, say, 60.   But what is right or fair about a universal flat rate paid – by the rest of the population – to a group where almost half are working anyway?  It is why I would favour raising the NZS age to, say, 68 now (in pretty short order) and then indexing the age in line with further improvements in life expectancy, and I’d favour that approach even if long-term fiscal forecasts showed large surpluses for decades to come.    At the margin, I’d reinforce that policy change with a provision that you have to have lived in New Zealand for 30 years after age 20 to be eligible for full NZS (a pro-rated payment for people with, say, between 10 and 30 years of actual residence).  Why?  Because in general you should only be expected to be supported by the people of New Zealand, unconditionally, in your old age, if most of your adult life was spent as part of this society.

Reasonable people can, of course, debate these suggestions.  But they are where I think the debate should be –  about what sort of society we should be, what sort of mix between self-reliance and public provision there should be, even about what mix of family support and public support there should be, or what (if any) stigma should attach to be funded by the taxpayer in old age –  not, mostly, about long-term fiscal forecasts.

And Treasury can’t help with very much of that. It is what we have politicians, think tanks, and citizens for.

I don’t think enough weight is given to the role that rules of thumb play in disciplining choices. If, in modern floating exchange rate open-capital account economy, many governments can take on almost any amount of debt as they want, and even the interest rate consequences of higher public debt are really quite small, what constrains government choices? No doubt there are a few zealots who think no constraints are necessary, but most people – left, right, or centre – don’t operate that way.

I favour running fiscal policy to two rules of thumb (not legal restrictions, but political covenants/commitments). First, aim to keep the (cyclically-adjusted) operating balance near zero, and second, aim to keep net public debt (all inclusive measures) near zero.

Note that (a) neither rule of thumb would be binding year by year (the state needs to cope with pandemics, earthquakes, or the like), they would be constant aiming points, the standard reference points towards which policy is oriented over several years, and (b) neither rule of thumb says anything about the appropriate size of government (if we conclude we want governments to do more (less) longer-term than adjust tax rates to pay for that. Adjusting tax rates – especially upwards – is a much higher hurdle (and appropriately so) than the Cabinet (commanding a majority in Parliament) simply deciding one morning to substantially alter spending.

There is probably less dispute about the operating balance rule of thumb than about the debt one. Smart people will mount arguments about (a) infrastructure, or (b) the potential capacity of the Crown to capture various high returns. A typical householder or company will, after all, have some debt. But (a) the disciplines on individuals and firms are much stronger, and more internalised, than they are for governments, and (b) much of government activity acts to reduce private savings. I’m not going to pretend there is any great difference between the narrow economics of a 20% debt target vs a -20% one, but zero has a resonance that no other number is ever likely to have. (And if you think this benchmark is demanding, on my preferred analytical measure – the OECD series on net general government financial liabilities – New Zealand has been between 10 per cent and -5 per cent of GDP continuously since about 2004.)

If you want the state to do more, make the case, have the debate for higher taxes – which takes the resources from specific identifiable types of people (tax incidence arguments aside), rather than by monetary policy squeezing out other private sector activity to make way for the government (in a fully-employed economy they are the only two options, there are no free lunches).

This has gotten rather rambly and I’m going to stop here, except to point you to this interesting table at the back of the Treasury report.

LTFS 2021 2

I noted:

  • the sharp drop in the long-term assumed birth rate (largely reflecting recent developments presumably)
  • the reduction in the assumed improvement in life expectancy
  • the significant reduction in assumed long-term productivity growth, and –  unlike the others, substantially a policy matter, 
  • the substantial increase in the assumed long-term annual rate of net inward migration

Pandemic income insurance

Michael Reddell pandemic, Treasury

Way back on 16 March, the day before the government brought down the first of its pandemic economic response packages, I ran a post here in which – among other strands of an approach to the rapidly worsening economic situation – I suggested that the government should legislate quickly to provide, for the coming year, a guarantee that no one’s income would fall below 80 per cent of what it had been in the previous year. The proposed approach was to treat individuals and companies in much the same way. The underlying idea was to provide some certainty – to individuals, firms and lenders – without offsetting all losses (society was going to be poorer) and without locking people in to employment or business relationships that may have been sensible/profitable previously, but which wouldn’t necessarily be in future. And to recognise that individual firms and people are better placed to reach those judgements – about what makes sense for the future, what makes sense (say) to borrow to support – that government ministers or officials.

I knew that any such scheme might be very expensive, and rereading the post I see that I proposed it even though I was talking about economic scenarios for potential GDP losses that were materially worse than most think we will now actually face. But part of the mindset was the parallel with ACC – our no-fault accident compensation system. Being able to treat people in a fairly generous way when a serious pandemic – that was no one’s fault – hit could be conceptualised as one of the bases for the low-debt approach successive governments had taken to fiscal policy over recent decades. And it did not require governments to pick winners – firms they thought might/should flourish – or pick favourites.

Since it was sketch outline of a scheme, dreamed up over the previous few days, I was always conscious that there were lots of operational details that would have to be worked through before an idea of this sort could be implemented, and any scheme would need to be carefully evaluated for the risks that might lie hidden just beneath the surface. But evaluated not relative to standards of perfection, but relative to realistic alternatives approaches in a rapidly unfolding crisis.

I wrote a couple of other posts (here and here) touching on aspects of the pandemic insurance idea, and as I reflected a bit further and discussed/debated the idea with a few people, I suggested some potential refinements, including greater differentiation between companies and individuals. Other people, here and abroad, also suggested ideas that had some similarities in spirit to what I was looking to achieve.

Of course, nothing like the pandemic insurance scheme was adopted. Instead, we had a flurry of schemes and of individual bailouts, the main attraction of which seemed to be a steady stream of announceables for Cabinet ministers in election year (generally a negative in terms of the public interest, in which similar cases should be treated similarly), all while offering little or no certainty to individuals, firms, or their lenders.

I’ve continued to regard something like the pandemic insurance scheme as a superior option that should have been taken, but mostly I moved onto writing about other things. But the return of community-Covid, more or less severe government restrictions on economic (and other) activity, and arguments about whether and for how long the wage subsidy should be renewed only reinforced that sense that there would have been a better way. But a few tweets aside, I hadn’t given the issue much thought for a while until a few weeks ago a TVNZ producer got in touch to say that they had found reference to the pandemic insurance idea in an OIA response they had had from The Treasury, and asking if I’d talk to them about it.

It was only late last week that I got to see the response Treasury had provided (Treasury having fallen well below their usual past standards has still not put the response – dated 12 August – on their website (or even acknowledged my request for a copy of the same material). A little of the subsequent interview with TVNZ was aired as part of their story on Saturday night, itself built around the notion that the government had rejected this (appealing sounding) idea.

OIA Response Pandemic Insurance etc

The TVNZ OIA request had actually been for material on “helicopter payments”, which was refined to mean

“one-off payments made by the Government to citizens with the purpose of stimulating the economy,

(which in some respects does not describe the pandemic insurance idea well at all).

And yet most of the material in the quite lengthy OIA response (77 pages) turned out to be about the work The Treasury had undertaken on the pandemic insurance idea over the couple of weeks from 7 April, including some advice to the Minister of Finance.

There seems to have been quite serious interest in the option, and there is paper to the Minister of Finance providing a fair and balanced outline of the scheme – merits and risks – dated 9 April

tsy pandemic

and suggesting that if the Minister was seriously interested Treasury would do more work and report later in the month. Although there is no more record of the Minister’s view, he must have been sufficiently open for more work to have been done, including drawing in perspectives from operational agencies (including IRD and MSD) on feasibility and operational issues.

My impression is that Treasury did a pretty good job in looking at the option.

tsy pandemic 2

That final paragraph was always one of the key attractions to me.

As I went through the papers, I didn’t find too many surprises. The issues and risks official raised were largely the ones I’d expected – including, for example, the risk that some people might just opt out of the labour market this year and take the 80 per cent guarantee, and issues around effective marginal tax rates for those facing market incomes less than 80 per cent. Perhaps the one issue I hadn’t given much thought to was a comment from IRD about the risk of firms being able to shift revenue and/or expenses between tax years, with the observation that existing rules were not really designed to control that to any great extent. But, and operating in a second-best world, the officials involved generally seem to have regarded few of these obstacles as insuperable, bearing in mind the pitfalls of (for example) the plethora of alternative schemes.

The work seems to have come to an end on or about 23 April with Treasury finally deciding not to recommend the pandemic insurance approach. This email is from a Principal Advisor heavily involved in the evaluation to the Secretary and key (on the Covid issues) Deputy Secretary.

tsy pandemic 3

It probably shouldn’t surprise readers that I think the wrong call was made in the end, but equally it is probably not that surprising that the decision went the way it did. One reason – not, of course, acknowledged in the Treasury papers – is how slow officials were (across government) in appreciating the seriousness of what was already clearly unfolding globally – and as a major risk to New Zealand – by the end of January. As I’ve noted before there is no indication in any of the papers that have been released, or public comments at the time, that (for example) Ministers or the heads of the key government departments had begun serious contingency planning – devoting significant resource to it – any time before mid-March. This particular work didn’t get underway until well into April, by when a great deal had already begun to be set in stone, and when rolling out bite-sized new announcements – robust or not – no doubt seemed, and was, easier than a new comprehensive approach.

As it happens, even though there was a great deal of concern back in April about the affordability of the pandemic insurance scheme, with the benefit of hindsight there is a reasonable argument that it could even have been cheaper than the approaches actually adopted (GDP losses having been less severe, on a sustained basis, than feared in April), which in turn might have left more resources for the stimulus and recovery phase (pandemic insurance – like wage subsidies – was always more about income support and managing uncertainty in the heat of the crisis than about post-crisis recovery stimulus).

From my perspective, the post was mostly about recording my pleasant surprise at how seriously the pandemic insurance idea (mine, and some other variants) was taken by officials, and by what appears to have a pretty good job in evaluating it as an option, in what will have been very trying and pressured times.

From this vantage point – with the advantage of knowing how the first six months of the virus went, and with a sense of the economic ramifications – I still reckon it would have been a better approach. And yet – and I don’t recall seeing this in Treasury’s advice (perhaps it isn’t the thing for officials to write down) I can also see political pitfalls – around very large payouts to some companies, even if they weren’t gaming the system – that might have made it impossible, and unsustainable if tried, without (at least) a very strong degree of political leadership and marketing that such a no-fault no-favour approach was a better way to have gone. As I noted in an earlier post, I’d have hated having the Crown pay out to casino companies, but I would have endured for the sake of a fair across the board scheme. But every single person, every single lobby group, would have found some potential recipient to excoriate.

The TVNZ interviewer asked me about the pandemic insurance idea still had relevance for the future. My initial response to him was that yes it did, and that we might be much better off to have the infrastructure required to make it work in place and on the shelf ready to go for when future pandemics happen. Taxes will, after all, be a bit higher than otherwise as we gradually lower debt ratios, amid repeated talk of being ready for the next major adverse event, whether earthquake, volcano or pandemic.

And yet reflecting on it again over the weekend, I’m no longer quite so confident of that answer. More detailed work, and more thought, is probably required once this pandemic is behind us to strike the right balance – individuals vs firms, generosity in a no-fault shock vs moral hazard as just some of the examples of issues to be thought through, and planned for, ideally in a way that would survive contact with a new real severe adverse shock.

A speech from the new Secretary to the Treasury

Michael Reddell New Zealand economic performance, Treasury

Early last month the new Secretary to the Treasury, Caralee McLiesh, gave her first on-the-record speech in the new role.    The Treasury was a bit slow to release the text, but it is now available here.     It wasn’t a long speech, but it was to a fairly geeky audience –  the Government Economics Network’s annual conference – most of whom wouldn’t yet have seen much of the new Secretary.  With not much else to go on yet, it seems reasonable to look at what she said for any indications of whether/how The Treasury is changing for the better under new leadership.

I’ve been uneasy about the new Secretary for several reasons:

  • first, because she isn’t a New Zealander and has no background or experience in New Zealand issues or people, no domestic networks, and (most probably) little in-depth understanding of the idiosyncrasies of New Zealand, including its longrunning economic underperformance, and
  • second, because she has no work experience in a national economic agency/ministry, dealing with national economic issues (financial crises, monetary policy, exchange rates, immigration, trade, or even very much exposure to fiscal or tax policies), and yet is now the principal economic adviser to our government (itself light on economic expertise or experience).

On the other hand, she has some fairly good academic qualifications and may well be quite capable as the sort of generic public service manager favoured by the current State Services Commissioner.   Whether she can bring to the table more than that –  and New Zealand economic policy, and The Treasury (weakened over the previous 10-15 years) needs more than that –  remains to be seen.

The topic for the GEN Conference was “the role of regional and urban development in lifting living standards”. It is fair to say that my response to the title was along the lines of “there is no such role”, but it was still going to be interesting to see how the Secretary chose to respond to the topic, and perhaps to nest any specific insights on regional/urban issues in an understanding of the much bigger national productivity failings.

Of course, there are distinct limits to what serving senior public servants can and can’t say.  One could argue they mostly shouldn’t be doing public speeches –  their job is primarily to advise ministers, not to spin government PR (or to explicitly challenge it).  But successive Secretarys have chosen to give speeches.

Here is McLiesh running spin for the government

The theme of today’s conference is how well-performing regions and cities can contribute to our wellbeing and raise living standards for all. Those of you familiar with the Government’s Economic Plan will know that the Government has identified ‘strong and revitalised regions’ as one of the key economic shifts it is working towards. And work on government’s urban growth agenda and resource management reforms is well underway.  So this is a significant and substantial topic for New Zealand.

She, if no one else, I guess has to take the government seriously, at least in public, when it says it has a (30 year) Economic Plan.

But in the rest of speech there really wasn’t much substance.  There was the best part of two pages recounting the Living Standards Framework – in text that is fine, but which offers nothing fresh.  At least it ended with a reminder that economic performance matters

The Treasury always has an important role to play in advising government on how to lift economic productivity and performance, and this remains a core part of our LSF thinking. A roomful of economists doesn’t need to be told, but I will say it anyway, that high living standards depend on strong economic performance, and that markets that operate well – and I emphasise, “well” – can, and do, powerfully lift living standards. They enable people to participate in labour markets, earn higher incomes, and apply those incomes towards whatever wellbeing means for them. The story of development is basically a story about investment in the institutions and mechanisms that enable people to flourish in deep and complex markets – that is, to grow.

But really that should be “motherhood and apple pie” stuff to an audience of economists.  And sadly, there hasn’t been much sign of rigorous or systematic advice on lifting productivity and economic performance in recent years.

She moves on to highlight that there are regional differences across New Zealand.  There is quite a nice graphic drawing on OECD data, but she conveniently omits to highlight that (according to the graphic) not one New Zealand region has incomes in the top third of OECD country regions.  Productivity is a huge failing in New Zealand, and that failing just isn’t region-specific.  If anything, the gap between highest and lowest income regions within New Zealand is unusually small by OECD standards.

And thus when the speech says

Regions may contribute more to national economic development if we can tap unrealised economic potential.  A policy approach that emphasises strengthening regional comparative advantage means we may be able to lift national economic performance rather than just shifting economic activity around the country.

it has the feel of someone who is stuck with the Provincial Growth Fund, rather than someone who has thought hard about New Zealand (and what does that counteractual –  “just shifting economic activity around the country” – mean: who has been doing that?)

The next paragraph isn’t any better

There can be a role for government in helping communities to identify strengths and opportunities or strengthening local governance. There can be a role in working across agencies, local authorities, local people, and the private sector to coordinate and facilitate private investment. Or in investing in infrastructure where this directly unlocks economic opportunities. And can we do more to coordinate between social interventions and economic opportunities to ensure these approaches are complementary?

I guess bureaucrats would like to think so, but is there any evidence of governments being able to specifically catalyse regional economic development in a useful and sustainable long-term way, other than by getting the overall national policy settings right, and understanding the national failings?

There are some strange observations

More than a third of New Zealanders live in Auckland, a city with house prices vastly in excess of the marginal cost of supply.

But house prices aren’t “vastly in excess of the marginal cost of supply”, rather national and local regulatory policies have driven the marginal cost of supply –  especially the land component –  well above where it would otherwise be, so that there is no huge gain on offer to people developing new houses.

It was encouraging to see the Secretary allude to Auckland’s longer-term economic underperformance

Between 2000 and 2018 our national population grew by 26 percent, but all of the above-average population growth has been from the Bay of Plenty northwards, with Auckland the fastest growing at 37 percent. Contrast that with population growth of 7 percent in Southland, 5 percent in Gisborne and 4 percent on the West Coast.

This population growth is despite the fact that Auckland’s GDP has grown at only 82 percent of the national average in the 2000 to 2018 period.  In contrast, GDP growth was well above the national average in every region of the South Island, while Bay of Plenty and Northland had above-average growth too.

But there isn’t much sign that she or her department have thought hard about a compelling narrative that explains what has gone on.  Instead we get this rather confused paragraph

Other cities and regions may have plenty of available land.  However, they will need to improve their quality of business and quality of life attributes too if they are to significantly ease pressure in Auckland. And worldwide we see that agglomeration into major cities continues despite congestion and high property prices. Clearly, both employers and employees often see better long-term prospects in these major cities, despite efforts to develop other regions.

In both New Zealand and Australia, we certainly see more people in major cities, but little evidence of the vaunted productivity gains from continued concentration of people in these places.  Natural-resource-based economies tend to be like that, but there is no hint of that as an issue in the Secretary’s story.

And from there the speech heads downhill again

Central government has created more capability through urban growth functions in HUD, and appointing senior regional officials to lead engagement and coordinate government across regions.

Of course lifting wellbeing across the regions is not just up to central government, which is why we see more partnering with local government and regional economic development agencies over recent years to develop action plans.

Lots of busy bureaucrats, lots of meetings for ministers and officials to open and attend, but not much sign of any understanding of quite why the overall economy has performed so poorly over so long (when almost all the tools of economic policy are controlled at the central government level).

Of the final page, I could commend her sense of humour, including this old Tom Scott cartoon (if memory serves from back in the late 80s or early 90s)

scott

But then it is straight back to the self-congratulatory stuff

In closing, I want to acknowledge that being an economist working in public policy is incredibly rewarding, but it can also be challenging. We are a community of professionals that sometimes has to be loud to be heard. When people want the comfort of policy that is simple, certain, and swift, we can find ourselves the sometimes uncomfortable voice of technical rigour, nuance, and realism.

I guess that it might have been music to the ears of some in the audience.  But we don’t –  or shouldn’t –  hire senior public servants to tell people (including ministers) what they want to hear.   Sadly, there has been little consistent sign of The Treasury offering that “uncomfortable voice of technical rigour, nuance, and realism” in recent years, especially on these big-picture economic performance failings.  They seem to have been content to just go along, to maintain access (perhaps) by not addressing the hard issues, and playing distraction with the fluffy stuff while the economic prospects – the living standards prospects –  of New Zealanders, regional or urban, drifted further behind.

It is still early days for McLiesh.   I have heard a few positive things about the new Secretary, including hints of renewed emphasis on rigour. I hope this particular speech isn’t a foretaste of the standard we can expect, but that the Treasury really does begin asking the hard questions, doing robust analysis, not simply going along with conventional political verities (eg regional development).   Perhaps there isn’t a political demand for such advice and analysis –  are there any politicians who really care? – but shouldn’t stop The Treasury being a voice, perhaps at times crying in the wilderness, pointing to how things might be such better here.  As a hint, regional economic development agencies aren’t likely to be any substantive part of the answer.