An update, and a book recommendation

My last short post was a month ago. At that stage post-Covid it was seriously taxing to read anything more demanding than Trollope, let alone even think about writing anything.

But with time, things improve. I had even harboured thoughts of a serious post this week – the one I’d like to write is about how we assess the culpability of central banks for the current and prospective inflation outcomes.

But….I had a commitment to write a 1000 word book review for a publication I write for. I did a draft of that yesterday, and doing so so badly knocked me back I won’t be trying anything similar for a while yet.

The gist of the post would have been:

  1. Based on the information, understanding, and risks at the time, interest rate cuts in early 2020 were well-warranted.
  2. (Core) inflation outcomes (globally) are largely the outcome of monetary policy choices 12-18 months previously.
  3. 12-18 months previously no one was forecasting inflation (or unemployment) outcomes akin to what we actually now see (check RB forecasts, NZ private sector forecasts, or overseas official or private forecasts).
  4. That was a huge forecasting/understanding error, but……it is hard to hold central banks very culpable when no one much else saw the outlook any better (even if it is their specific job).
  5. There is much more culpability about sluggish policy responses (or lack of them) from about a year ago, as the upside risks became increasingly apparent. Central banks took a punt, which hasn’t worked out, and we are all paying the price (in NZ it wasn’t until February that the OCR got to pre-Covid levels and the Funding for lending crisis programme is still running).
  6. Serious scrutiny of central bank policymakers is now warranted, with a presumption against reappointment (but here two were just reappointed).
  7. Oh, and the massive losses to the taxpayer from the bond buying programmes – purchases often occurring well after it was clear worst-case downside outcomes were no longer likely – are something central bankers are entirely culpable for.

And the book? Two Hundred Years of Muddling Through: The Surprising Story of the British Economy by UK journalist Duncan Weldon. It is short (300 pages), accessible (even chatty), judicious, informed by the literature, and strongly recommended (especially for the period up to about 1950) for anyone who wants to know a bit more economic and economic policymaking history. I’ve read a lot in that area, and so probably didn’t learn a lot new, but was interested to learn that on the eve of World War One, not only was the UK “the dominant manufacturer of exported goods, the centre of international finance” but also “the world’s largest net energy exporter” (that was the coal).

One Palliser, two Pallisers…

Three weeks ago I last wrote here, in a blithely optimistic tone

No posts last week between some mix of the war news (including related economics and financial markets news) being more interesting, and Covid – in our house that is. Not being too sick, but not being entirely well either I wasn’t concentrating very hard for very long. Fortunately, the isolation is now half over and no one’s health is particularly concerning. So back to some domestic economics and policy.

When our isolation began I’d picked off the bookshelves the first of the six of Anthony Trollope’s Palliser novels. Having been on the shelves for almost 20 years it seemed like a good opportunity to make a start on the series.

Unfortunately, although the whole family got Covid to one degree or other and all of them recovered fully, I – quite a bit the oldest, and perhaps previously prone to slow recoveries – did not.

And this morning I’ve just finished the last of the six Palliser novels (an enjoyable read if, perhaps, not as good as his Barsetshire novels).

As those who follow me on Twitter will know, it is not as if I have lost all interest in economic policy etc, but have just lost the ability to concentrate on anything more taxing than Trollope for more than perhaps 10 minutes without feeling really quite unwell and needing to lie down. Reading one 8 page memo bright and early yesterday morning completely did me in for the day.

There are many people much less well positioned than I am (including that I have an ample supply of novels etc on the shelves), so this is really just an advisory that it seems likely to be a few weeks at least before there are any other posts here. Which is a shame, as interesting issues abound (should, for example, the MPC consider a 75 or even a 100 basis point increase in the OCR next month?), but for now it is the way things are.

Inflation

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Long live our noble Queen

On 7 February 1952, New Zealanders woke and – whether they turned on the radio or picked up the morning newspaper – only then did most learn that the previous afternoon King George VI had died, and that his daughter Princess Elizabeth was now our queen, Queen Elizabeth II. 70 years ago, before most of us were even alive.

To look at today’s New Zealand media one might suppose that some decades ago New Zealand had angrily tossed out the monarchy. There has been barely any mention of the 70th anniversary of the accession of New Zealand’s Head of State and what coverage there has been seems determined to treat it as British news, not as news about our own Head of State – she holds that office by laws passed by New Zealand’s Parliament, and polls suggest that today’s New Zealander’s still favour the system of constitutional monarchy that we share with the UK, Australia, Canada, and a variety of other countries. Much as a significant chunk of the media class might lament it, Elizabeth is our Queen, and has been for 70 years now. Whether as Queen of New Zealand or of her other realms and territories, her reign is now one of the very longest ever in recorded history. If one dates modern New Zealand from some time in 1840, she has been our head of state for almost 40 per cent of our history. A remarkable life of service.

(And, in fairness, while the media have preferred to play down any sense of Elizabeth as our Queen, the Prime Minister did put out a gracious and fitting statement.)

Anyway, I got a bit curious about how the accession of the Queen, 70 years ago, had been marked in New Zealand and recorded in the New Zealand media. Papers Past is a wonderful resource although of the major city papers sadly only the Press is available for 1952.

I started with the edition of Tuesday 5 February. In that paper it was reported that preparations were well underway for the planned visit to New Zealand in May of Princess Elizabeth and Prince Philip – undertaking the tour that the King himself had originally hoped to do. The Assistant Comptroller of the Royal Household had arrived on the 4th “to discuss final details and matters of etiquette. The economist is me could not, however, help noticing this element of the story.

It was a different time indeed, when the Cabinet was allocating cement.

The arrival of the Princess and her husband at the Kenyan lodge, where she was receive the grim news of the death of her father, was recorded in another story in which it was noted that the Queen and the Duke had attended Evensong at the small local church where “she spoke to the man who alone laid every stone of the church”.

What of Wednesday 6 February? It was a normal working day in New Zealand (and, as far as I can see from the table of contents there were no stories about the Treaty of Waitangi or the like). The Prime Minister – Sid Holland – was in Paris. Back here there were further reports of the forthcoming royal visit, including a push to keep handshakes to a minimum, and stories from the visit to Kenya. It was mid-summer and in Dunedin the touring West Indies cricket team had just beaten Otago.

King George VI died at Sandringham in the early hours of 6 February (New Zealand time being 12 hours ahead of that in the UK). The news was announced to be public at 11am (UK time).

In those days, the front pages of newspapers still seemed to be devoted to classified advertisements. It was no different in the Press of 7 February 1952. The news of the King’s death, and of the accession of Queen Elizabeth, appeared on page 5. This appears to be the editorial, and these were the first few sentences.

The Cabinet had met as soon as our government received the news, and the acting Prime Minister (Keith Holyoake) issued a statement in the early hours of the morning.

Despite the late hour – and presumably only for later editions – there are large numbers of stories, and photos (including one of the new heir to the throne, Prince Charles) over two pages (even managing to note that the forthcoming visit to New Zealand was now cancelled). There was an article about the visit by the then Duke and Duchess of York to New Zealand – and Christchurch in particular – in 1927 (among many other details, the Duke had had dinner with Labour leader Harry Holland in Westport).

The death of the King was marked immediately by the closure of all New Zealand schools on 7 February, and the closure of all government departments (other than essential services) for the afternoon of 7 February. No doubt there were many statements by local dignitaries around the country, but this was the statement by the (Labour) mayor of Christchurch.

In Greymouth, the mayor had requested that the bell of the local Catholic church be tolled 15 times (soon after the news first came through), once for each year of the King’s reign.

By the next issue of the newspaper – that for Friday 8 February – we still got through a great deal of other news first (the cricket test began that day in Christchurch) before the best part of three pages of coverage of the royal news.

There was a thoughtful editorial, even if it was a little wide of the mark with its suggestion “many [ in New Zealand] will never see her”, given the huge crowds for her first tour of New Zealand two years later. There was news of the forthcoming New Zealand official proclamation of the accession of the Queen, to occur the following Monday (more details here from the next day’s paper). The article is well-worth clicking through to for the details of official mourning, for the suggestion that employees should as far as possible be given time off on that Monday to attend local ceremonies marking the accession. This is just one snippet

Tributes from all manner of individuals and bodies – here and abroad – flowed in, and find a place in the pages of the Press. Here is an account of official American tributes and observances. And preparations for the funeral. From the next day’s paper, many resolutions of sympathy and loyalty.

By Monday 11 February, plans were in place. The King’s funeral was to be held that Friday (the Queen had requested that the day not be a public holiday). And the Prime Minister – who had been visiting West Germany when the King died – made a broadcast to New Zealand from London. In the same article it was reported that Mr Holland would be received by the Queen on Wednesday. Meanwhile back here the Governor-General, the Cabinet, and other dignitaries had attended a memorial service at (now Old) St Paul’s in Wellington. There were reports too of the special services in the churches of many denominations. If you wanted legal detail on the accession process, the Press had it covered.

In the Press of the 12th, you could read the (quite lengthy) account of the Christchurch civic proclamation of accession ceremony held the previous day – several thousand attended that ceremony, and there were similar smaller occasions in the boroughs around the city.

On the 13th we read that both the Prime Minister and the Leader of the Opposition (Walter Nash), both of whom had already been in London, would represent New Zealand at the funeral for the King. We also read of the Queen’s own declaration in taking her oath.

Back in New Zealand, in the following day’s paper we read some remarks made by the Minister of Education at a combined (four schools) memorial service in Wellington Town Hall.

The next day’s paper was full of articles about the funeral, but also carried this report of the Prime Minister’s meeting with the Queen, including this snippet.

And on the 16th, we read of the two minutes silence in memory of the King, and of great bell in Christchurch Cathedral tolling 56 times, once for each year of the King’s life, and so much more.

It was another age in many ways, but these surely were the monarchs of New Zealand, not by force or coercion but by the free consent, and loyalty of people, high and low, of all races and religions up and down New Zealand.

As indeed, Elizabeth II today is, by free choice of our own Parliament,

“Elizabeth the Second, by the Grace of God Queen of New Zealand and Her Other Realms and Territories, Head of the Commonwealth, Defender of the Faith—”

We shall not see her like again, whether in New Zealand or in her other realms and territories. But the 70th anniversary of her accession, to our throne, should very much have been New Zealand news.

Debt and deficits

The OECD’s latest Economic Outlook came out a few days ago. As always with the OECD, the value is rarely in the analysis or policy prescriptions, but mostly in the vast collection of more-or-less comparable tables, collating data for a wide range of advanced economies (and a few diversity hires).

Take public debt as an example. Next week our Treasury will be out with their HYEFU and more-detailed New Zealand numbers for central government. But there is no easy way of comparing Treasury’s New Zealand numbers with those for other countries. And so I tend to focus most often on the OECD series of “net general government financial liabilities”, which includes all layers of government, and doesn’t exclude things that particular national governments find it convenient to exclude (in New Zealand’s case, all the assets in the Crown’s hedge fund, the NZSF).

The OECD’s forecasts only a couple of years ahead, but that is probably about the most that is useful anyway, Here are their recent forecasts for net general government liabilities as a per cent of GDP (for the 30 countries they do these numbers for).

debt 2023

For New Zealand, the 2023 number is 14.82 per cent of GDP and on these forecasts we’d be 7th lowest of (these) OECD countries. There isn’t a forecast for Norway for 2023, but they have net financial assets of about 350 per cent of GDP, so call it 8th.

Going into the pandemic, our net general government liabilities as a per cent of GDP in 2019 was 0.8 per cent. (Including Norway) we were 8th lowest of these OECD countries.

That is a not-insignificant increase in net debt as a per cent of GDP. Between 2007 and 2012 – serious recession and the earthquakes – net general government financial liabilities were increased by about 12 percentage points of GDP. But, and on the other hand, in five good-times years (from 2002 to 2007) net general government liabilities as a share of GDP dropped by 23 percentage points of GDP.

Here is the cross-country comparison over time

gen govt liabs

I’m not suggesting we should be totally comfortable about that picture, but our net public debt is forecast to remain (a) low, and (b) much lower than the typical advanced country.

What if we break out the countries. Some argue (I’m not really convinced) that big countries, at least those with a history of reasonable government etc, can comfortably ran higher ratios of public debt than smaller countries. And, on the other hand, perhaps the countries most like New Zealand are the fairly-small places with their own central bank and floating exchange rate. Here are the relevant comparisions over time (medians in both cases).

gen govt small and big

The big countries – Germany excepted – really have been on a rising debt path. I’m not one who believes crisis and/or default is looming (generally – Italy remains a wild card) but were I a voter in one of those countries I’d be seriously uneasy. Were I involved in an opposition political party, I hope the high and rising debt would be made a salient political issue.

But – and generally – the small advanced countries have done pretty well (true on this sample of countries, or if one uses all the small countries – including those in the euro – in the database), and there has been (and is) nothing startling or particularly impressive about the New Zealand performance. If anything, one might note the widening gap at the end of the period.

Of course, none of this includes the fiscal challenges imposed by the rising NZS fiscal burden from maintaining the age of eligibility at 65 (although it is now a decade since baby boomers started turning 65) and the expected trend increase in public health expenditure….but I really can’t see public debt itself being a particularly salient issue in 2023.

But what about deficits? No one argues the government should have been running a balanced budget last year, and perhaps not even this year (given the renewed lockdowns and big output losses the government left itself open to), but why not 2023? These are the OECD’s projections – the primary balance excludes financing costs, and a common rule of thumb is that even a small primary surplus is consistent with keeping debt in check. “Underlying” captures cyclical-adjustment.

primary defs

In 2023, with the economy projected to be fully-employed (a reasonably significantly positive output gap), with a strong terms of trade, and (as ever) with some of the highest real interest rates anywhere in the advanced world, the OECD estimates that the government’s fiscal policy will see us in 2023 with a large primary deficit, a bit worse than the median OECD country. (Norway’s primary deficit is much larger, but remember that they have big net earnings (finance receipts) on the government’s huge net asset position.

Were one confident that spending initiatives were being ruthlessly scrutinised to keep waste to an absolute minimum, perhaps one might be a little less worried – although small structural surpluses, where spending is funded by taxes remains a good rule of thumb – but does anyone suppose that describes current New Zealand approaches to public spending.

I don’t suppose Ardern and Robertson are likely to let things get really out of hand. They seem oriented enough towards broad macro stability – in the traditions of all New Zealand governments of recent decades – even as they too watch our real economic performance decline, but at present the structural deficit picture (as the OECD interprets our data and policies) isn’t looking that good.

primary def nz

There should be considerable scrutiny on the government’s plans in the forthcoming Budget Policy Statement, and the Treasury’s HYEFU projections.

Reserve Bank people

There is a lot of personnel change going on at the upper levels of the Reserve Bank. It has been an ongoing process since Adrian Orr took office as Governor only just over 3.5 years ago. It seems to be the way with new public sector CEOs – clear out the previous lot, and then churn until you get the tolerable set of loyalists – perhaps compounded in Orr’s case by a reputation over the years for not tolerating dissent and really only welcoming true believers (or those who can simulate the appearance and live by the lies/rhetoric/spin). He seems to be in the midst of a second clear out….in under four years. Compare, for example, the senior management group in the first Orr Annual Report (2018) with the group Orr will have gathered around him by early next year (when recently announced departures take effect). There isn’t much overlap, and not one of the changes – I’ve seen – has involved people moving on to bigger and better jobs.

A couple of months ago it was announced that the Deputy Governor, Geoff Bascand, was leaving. Bascand is probably in his early 60s but there was no hint that he was retiring. I guess he was old enough that, if Orr gets a second term, he was never going to be Governor, and perhaps some mix of a bit more golf, some consulting, some directorships (and no more involvement in the trying Reserve Bank superannuation scheme) had its appeal, but on paper it looks like quite a loss to the Bank. Of the internal people on the Monetary Policy Committee (and it is an internals-dominated committee) he seems to be the most capable – thoughtful, fluent, and with the intellectual capability to churn out, say, a somewhat-respectable speech. Did he come to find working for Orr all a bit too much?

Who knows. But then yesterday there was a second curious departure from the upper ranks of the Bank, and the Monetary Policy Committee. And that brought to mind the Oscar Wilde line from The Importance of Being Earnest”, in whic Lady Bracknell remarks, “‘To lose one parent, Mr Worthing, may be regarded as a misfortune; to lose both looks like carelessness.”

The unexplained departure of one senior monetary policymaker might not be very interesting, but when two (of four) leave in quick succession, it looks like more of a story, and probably not one reflecting entirely well on the Governor.

The latest departure is Yuong Ha, the Bank’s Chief Economist, who has been in the role for less than three years (an Orr appointee) and is only about 45. The Bank’s press release gives no hint of what he will be doing next, suggesting that he does not know.

It was a curious appointment in the first place. Ha may have been a competent section manager, but had never been seen as one of the Bank’s thinkers or intellectual leaders (and surely the Chief Economist should normally have been where the MPC looked for such leadership). It was always possible that he could have surprised and stepped up in the role, but sadly it wasn’t to be. There were a succession of (often individually small) mis-speaks – my favourite was when he suggested in public that things like the LSAP couldn’t offer much, about 10 days before the Governor/MPC went all-in on their new and very expensive toy, claiming a great deal of effect. And in almost three years, he had not been allowed to do a single on-the-record speech, through some of the most difficult and turbulent times for monetary policy in quite some time. If Orr has now engineered his departure, it is probably for the good of the institution. But it doesn’t speak well of Orr’s judgement in having appointed him in the first place – especially as the vacancy arose only after Orr engineered the departure (by demotion, and then resignation) of Ha’s predecessor, John McDermott.

Of course, in the public sector one can’t just buy-out people you no longer want around, suggesting that some further restructuring has been used to achieve the outcome. McDermott was got rid of by creating a new rank between McDermott and the Governor, and (presumably) telling McDermott he wasn’t going to get the more senior one (the one that carried the title he already had). The Assistant Governor role is soon to be vacant – Christian Hawkesby having been appointed as Deputy Governor – so perhaps Orr is going to collapse the two jobs into one again, with Ha being given to understand he wouldn’t get the more elevated (direct report) position. We’ll see soon enough I guess (more adverts to follow after the raft of Assistant Governor positions advertised a month or two back).

But whichever way Orr goes, there are now two vacancies on the Monetary Policy Committee (and, which we’ll come to shortly, two of the three external members have terms which expire early next year). This is, supposedly, a very powerful and important statutory body, and you might hope for a bit more media and parliamentary scrutiny (there almost certainly would be if more than half the committee was potentially changing in the US or the UK). It isn’t as if there are outstanding candidates for the two internal positions – whether outside economists or internal people who buy their research or other intellectual leadership cry out to be appointed. And of course, anyone appointed has to be willing to work with and for Orr, independent thought discouraged. One possibility is that Orr (and the Minister) appoint the head of the financial markets department and the new chief economist, but who (really capable) will want the chief economist job is an open question.

For a serious, open, and accountable central bank, the first wave of external members of the MPC have been something of an embarrassment (for a Governor who wanted to keep control, and a Minister happy to go along, all has probably been fine). Not one of the three has given even a single on-the-record speech, and I’m pretty sure that among the three of them there has been only a single media interview. There is no transparency, no accountability, and little reason to suppose these three have added any value. One (probably the least qualifed for the role) was, so the papers revealed, appointed primarily for diversity reasons. The other two – Bob Buckle and Peter Harris – have terms that expire early next year. Buckle is the only one of the three with a focus on macroeconomics, but recall that Orr, Robertson and the Board chair got together to ban from the Committee anyone likely (now or in future) to be doing any active work or research on macro/monetary issue – one of the more ludicrous (if revealing) aspects of the entire RB reform process. Unless, the Minister – perhaps encouraged by Treasury – has had a rethink, presumably the incumbents will be reappointed. The title looks good on the CV, and the fees make reasonable retirement pocket money. But taxpayers and citizens deserve more and better. At present, not one of the remaining members of the MPC commands – and demands – respect as a key thought leader in a powerful independent government agency.

But it isn’t just the MPC and management where change is afoot. Parliament has recently passed amending legislation that means that from the middle of next year the current Bank board – a largely toothless beast, notionally charged with monitoring and holding management to account – will be replaced by a real Board, in which will be vested all the powers given to the Bank, other than those explicitly assigned to the Monetary Policy Committee. On paper, it is a step forward, and will finally put in end to the 30 years in which the Governor alone held huge discretionary policymaking powers. And the Bank wields huge powers, as policymaking agency in many areas of financial regulation (as well as implementing agency). The new Board – despite its primary focus being organisational and financial regulatory – will also be charged with the appointment of the Governor and the MPC members (subject only to ministerial veto).

Even the government and Parliament recognised that – on paper at least – they were handing a lot of power to these people, and in the new law there is explicit provision that the Minister of Finance can’t just appoint his mates, but must consult with other political parties in Parliament before making an appointment. They don’t get a veto, but the consultation requirement is presumably supposed to act as something of a dragging anchor.

Some weeks ago, with no fanfare, the first appointments were announced (or appeared well down a Bank web page). The Governor and these first three appointees are acting as a “transitional board” to oversee preparations for the new regime, but all three have been apparently appointed by the Governor-General, and presumably have been consulted on. Unfortunately, the three appointees are at least as underwhelming as the government’s MPC appointments.

The current Board chair, Neil Quigley (Vice-Chancellor of Waikato University) is staying on as chair of the new Board and the two other appointees are both professional director types, each with a long list of (present and past) directorships but no obvious expertise in the matters they are to be responsible for. There are, we are told, five more appointments to be made, but it is hardly confidence-inspiring (unless your model is one in which everything changes but everything stays the same, with all power in Orr’s hands). It doesn’t seem like good practice – and must be quite unusual now – to keep on a chair who has already done almost a decade on the Board, especially when that Board had a reputation for doing little but providing cover for the Governor.

But the bigger issue is that no one involved – management or Board – has any reputation for excellence as practitioner or thinker on these important areas of policy the Board will be responsible for. Take management. Orr and his new deputy (and head of financial stability) are both economists by trade. Nothing wrong with that of course, but to the extent they have wider experience it is solely in funds management (Orr as head of NZSF, Hawkesby a few years at a local funds manager). Neither has any real background in the core business of banking, or in regulation. And neither have any of the new Board members announced to date. Those with long memories might think of Quigley as something of an exception, in that earlier in his career he did some interesting (mostly historical) work on banking regulation, but…..that was probably 25 years ago, and in recent decades he has largely been an enterprising university manager, skilled at playing the PBRF game etc. It could have been a good opportunity to have found some really good people, including perhaps one from overseas, who could have added gravitas and standing to the new institution. A former top banker perhaps? A leading thinker on financial regulation? Instead, so far, we have a typical group of the sort of people who end up on all manner of government boards, supposedly playing a key role in setting an important area of policy, of appointing future key monetary policy makers, all with a management team that is underwhelming at best, and evidently subject to frequent churn. One can only wonder if any of the other political parties pushed back at all.

I write more about the Reserve Bank because it is the organisation (and policy areas) I know best. I don’t suppose the Bank is much worse than most other New Zealand government agencies, and perhaps it is unrealistic to expect it to for long ever be much better than the rest, but what a lost opportunity the expensive and longrunning reform process of recent years has been. The government could have laid the foundations for an excellent and highly-regarded institution. Instead, it seems only interested in the appearance of change, the shadow not the substance.

House and land prices

The local Wellington magazine, Capital, which seems to be a curious mix of the serious and the lifestyle, earlier in the year asked if I would write a piece on house prices. That article outlined the story I’ve run here repeatedly, that durable and very large reductions in house and land prices are quite possible – we see everyday examples in perfectly pleasant urban areas in the United States – but are only likely to happen if there is genuine aggressive competition among owners of land beyond existing urban areas. It is that sort of competition, from land whose best other use is probably for something agricultural in nature, that would durably lower land (and house) prices in existing urban areas.

That article ran in April. In late September the editor got in touch and asked if I was interested in doing another piece. Since there had been numerous policy announcements around housing this year – from the government, from the Reserve Bank, sometimes from the government to the Reserve Bank – I suggested that a piece along the lines of “sound and fury, signifying not much at all other than some new inefficiencies and distortions” might be in order. That article is in the issue on sale in Wellington now, and the text is here. I will include the full text at the bottom of this post.

I wrote the article four weeks ago. It isn’t quite the article I would write today because since then we’ve had the joint Labour-National announcement on new legislation that is being rushed through which will allow more intensive (but still relatively low-rise) development in existing urban areas of our larger cities, but appears to do nothing of substance to free up land-use beyond existing urban areas (and, as I noted in both articles, there is lots of undeveloped land in greater Wellington, much of it with little economic value in alternative uses). But if I’d write a slightly different article today, the bottom line does not change: there is no sign (from ministers, Opposition spokespeople, city councillors or whoever) that those who hold power have any interest at all in delivering much lower house prices on a durable basis. They refuse to express any such interest, and nothing they have done or are now doing seems likely to bring about such an outcome. Urban density may be all very well and good, for those who like that sort of lifestyle (and good luck to them), but the international evidence offers no example I’m aware of in which allowing much-greater density in cities has been followed by move towards house/land prices dropping back towards what we see in (typically quite low-density) cities in much of the US.

In the article I suggested that much of what had been announced this year was little more than “performative display” – doing stuff for the sake of being seen to act, seen to care. That seems right for most of the initiatives, since typically the supporting advice that has been published doesn’t suggest any likelihood of a sustained impact on prices. It is possible that the parties to the latest deal actually believe that this initiative might actually make a difference – partly because they have been cheered on by some people from the genuinely pro-liberalisation side of things. But even if they do believe that – and refuse to openly say so for fear of scaring some heavily-indebted voters – they are almost certainly wrong.

The second reason for scepticism I included in the article was this

The second clue is that prices have kept on rising, and at best are perhaps expected to fall back just a few percentage points over the period ahead (despite the huge increases we’ve seen). If people – smart people with lots of money at stake – really thought that the policy changes already made (tax rules, access to finance) or those in the works (such as the replacement for the RMA, or the National Policy Statement on urban development) were going to make an enduring difference, we’d see to
see it in the prices of the assets already. That is how asset markets work, whether stock markets, foreign exchange markets, or (a little more murkily) land markets. But there are no signs or reports of substantial falls, whether for existing properties or potentially-developable land

I still reckon that is basically right, but were I writing today I might put more emphasis on the possibility of quite a shakeout over the next year or two, even while the structural problems are unchanged. In a way, this is just the sort of point the Reserve Bank has been making in its discussion around “sustainable” house prices. “Sustainable” in their terms does not mean affordable, or US-style normal. It really just means where a market might be expected to settle given all the policy-settings and distortions in the system (that underpin land prices well above best alternative use price). One can see material, even significant, falls in house prices in such markets without the longer-term structural fundamentals being fixed at all. Such falls aren’t likely to last (and in New Zealand aren’t likely to pose a financial stability threat) but they could get the headlines for a time. Many of the falls in house prices that happened around 2008/09 were of that sort – whether those in San Francisco (now incredibly expensive), New Zealand (now incredibly expensive), or even Dublin.

Building activity in and of itself does not solve the underlying problem – land prices – but it can still lead to shorter-term overhangs in the market. There has been quite a lot of housebuilding going on.

Interest rates have risen and seem likely to rise further. A return to rapid population growth, from immigration, still seems some way off. The fiscal stimulus which has helped boost economic activity will be fading, and there are all those tax and access-to-credit restrictions. None of these address the longer-term problem of a rigged market that renders peripheral (developable) land incredibly expensive in a land-abundant country, but in combination they could be a recipe for a non-trivial fall at some point soon. Of course, prices ran up so much in the last year or so that even such a fall is unlikely to take prices back to real levels even two years ago, but…..falls of that sort would grab the headlines, and would probably lead some politicians to want to claim credit for having solved a problem they haven’t really even begun to address.

Without further indenting or block-quoting here is the full text of that article.

Lots of action, but none that will fix the housing market

Michael Reddell

(Published in Capital magazine, November 2021)

October 2021

Even before Covid, house prices in much of New Zealand were very high.  Over the last year or so they’ve again risen sharply almost everywhere, putting home ownership further beyond the reach of most, and underpinning rising rents.  This dreadful situation, transferring resources (wealth) from the relatively poor and young to the relatively rich and the risk-takers, is utterly unnecessary and deeply unjust. 

In a well-functioning market, times like these should be a renter’s dream.  Purchasing a house should never have been cheaper, and rents should be lower (in real terms) than ever.

That’s because interest rates are at record lows.  The New Zealand government’s 20-year inflation-indexed bond currently trades at about 0.8 per cent.  25 years ago the comparable rate was about 5 per cent.  Basic finance theory suggests that when rates of returns on one long-term asset fall so will those on other long-term assets. And in a well-functioning market, rents are the main source of return to the owner of the rental property.

But a well-functioning market is one in which it is easy to bring to market and develop new land and new houses. In that sort of market, developing the new land (building the new houses) would now be easier and cheaper than ever.   It takes time to develop a subdivision and build houses, and finance costs are one of the major costs those in that business face.   New Zealand has abundant land, that could readily be converted to urban uses. So, of course, does Wellington, and much of the land surrounding Wellington isn’t worth much in alternative uses.   But if regulations make land artificially scarce, then lower interest rates (or other sources of higher demand) can translate quite quickly into higher house/land prices.

The alternative isn’t just some theoretician’s dream.  When I wrote here six months ago, I highlighted Little Rock, Arkansas, as one example of the many growing, pleasant and highly-affordable US cities.  Real house prices in Little Rock hadn’t changed much in 40 years and median house prices appeared to be about NZ$300000.  Interest rates are at least as low as those here.  Check any website and you’ll easily find modern townhouses to rent in Little Rock for no more than NZ$1000 per month.   Try that in Wellington.

In a well-functioning market, when interest rates fall and prices look like beginning to rise, owners of land (whether existing sites in the city or new areas at the periphery) should be falling over themselves to get new land, and then new houses, to market, and owners of rental properties should be competing aggressively to get and keep tenants.  The alternatives would be a vacant property (earning nothing) or money in the bank (earning little more).

But this is New Zealand where, absent a well-functioning market, house/land prices have surged again, where rents have been rising, and where price to income ratios –  which should be less than 4 in well-functioning markets –  are now more like 10.

There has been all manner of policy announcements this year, some substantive and others little more than rhetorical.   The government has extended the “bright-line test”, so that investors selling properties within 10 years will pay a sort of capital gains tax, and – in one of the more bizarre moves – is legislating to stop businesses owning investment properties deducting their interest costs against taxable income.  A select committee is looked into new resource management legislation.    And, of course, some councils – including Wellington’s – are moving to allow some more intense development in some parts of the city.     Bureaucrats have got in on the act too, with renewed loan-to-value (LVR) restrictions from the Reserve Bank and the threat of more restrictions to come.  And the government has insisted that the Reserve Bank should talk more about house prices.

But there are two pointers that none of this amounts to much more than performative display. The first is that government ministers – from the Prime Minister down – refuse to express any interest in lower house prices.  Instead, they talk repeatedly about just lowering the rate of increase. Councillors, and Opposition parties, are rarely much better.

The second clue is that prices have kept on rising, and at best are perhaps expected to fall back just a few percentage points over the period ahead (despite the huge increases we’ve seen).   If people – smart people with lots of money at stake – really thought that the policy changes already made (tax rules, access to finance) or those in the works (such as the replacement for the RMA, or the National Policy Statement on urban development) were going to make an enduring difference, we’d see it in the prices of the assets already.  That is how asset markets work, whether stock markets, foreign exchange markets, or (a little more murkily) land markets.  But there are no signs or reports of substantial falls, whether for existing properties or potentially-developable land.

This year’s measures aren’t designed to fix the broken housing market, just to throw some sand in the wheels, be seen to be doing something, and perhaps to buy a bit of temporary relief.  Nothing done or promised is likely to make very much sustained difference at all, because none of it gets to the source of the problem.

Some put a lot of hope in provisions allowing for greater urban density – even as our cities are already quite densely populated by New World standards.  They are probably wrong to do so.   Increasing density has already been a feature of the last few decades – think of all the infill housing a decade or two back – and, of course, the physical footprint of our cities has also expanded.  But in the face of rapid population growth – likely to resume once Covid passes – these grudging changes have only been enough to avoid house prices rising sooner to even more outrageous levels.  

Without a radical freeing-up of land use at the periphery, creating aggressive competition between development options in cities and those at the margins, simply allowing a bit more densification will not bring land prices down. It may even bid up the prices of some sections, now able to be developed more intensively.  A lot of houses are being built right now, but there is no prospect of enduringly much lower prices unless or until owners of vacant land, on the peripheries of our city, are free to bring that land into housing and other urban uses.

New Zealanders should be able to count on a well-functioning housing/land market and ready access to finance.  Increasingly we have neither; just more complexity, more inefficiency, and more-unaffordable house/land prices.


USSR, Russia, and China

I’ve been reading a couple of books in the last week or so about the decline and fall of the Soviet Union (USSR). The first is Armageddon Averted: The Soviet Collapse 1970-2000, by Stephen Kotkin a Princeton historian who has since gone on to write an (as yet unfinished) three-volume life of Stalin, and the second The Struggle to Save the Soviet Economy: Mikhail Gorbachev and the Collapse of the USSR, by Chris Miller, another US academic historian.

Both are quite short, but for anyone interested in the era they are well worth reading. Kotkin’s book was first published in 2000 so really rather close to the events he was trying to make sense of (the revised edition I read dates from 2008), while Miller’s book is much more recent, published in 2016. Kotkin attempts to synthesise and offer an overall interpretation, while the Miller book draws deeply on Soviet-era archives, up to and including minutes of Politburo meetings. I found Kotkin interesting for a number of points, including the (obvious once you think about it) way in which this heavily armed behemoth, heir to hundreds of years of Russian imperial expansionism, dissolved so peacefully. He highlights the contrast, not far away and at much the same time, with the wars of the Yugoslav succession, but also with the unwinding of European empires a few decades earlier. Another point he emphasises is that the dissolution of the empire was, at least in part, a consequence of way the Soviets had set up their system. The tie that bound the individual republics (set up after the Revolution) together was not, so he argues, the central state itself (republics were not legally subservient to the central state) but rather the Communist Party, and once the Party’s monopoly on power was reduced/eliminated by Gorbachev there was little left to hold the Union together – other perhaps than brute force which by 1991 no one was willing to consistently use (not even those who staged the feeble coup of August 1991).

The Miller book was much closer to the usual concerns of this blog. It was a fascinating discussion of economic policy in the last years of the Soviet Union, with a particular emphasis on what the Soviets were learning from China. I hadn’t known how closely and carefully Soviet officials and scholars were studying the Chinese experiments with economic liberalisation after the late 1970s, or the extent to which (a) they were recognised as successful and (b) especially after 1985 were imitated. Miller also highlights how Soviet officialdom already knew what gains could be on offer from reform, from previous (abortive, short-circuited) experiments, including under Brezhnev in the 1960s. The macroeconomics was also enlightening – both the extent to which the Soviet Union had maintained macroeconomic stability and fiscal discipline up to the early 1980, but then the extent to which budget discipline was thrown to the wind in the Gorbachev years. That was partly bad luck – falling oil prices, partly the consequences of ill-thought-through initiatives (eg loss of tax revenue from the assault on heavy vodka drinking) – but much of it was in an attempt to buy off reluctance to reform from the powerful interests and patronage networks which – so Miller argues – by this time dominated the Soviet system (be it the agriculture sector, oil and gas, the military and the associated industrial complex or whatever. Miller argues that those around Gorbachev thought of this partly as a reasonable gamble – if they could materially accelerate growth, as in China, they could grow their way through the deterioriating fiscal (and hence monetary) position. It was not, of course, a gamble that worked, and the first few years after 1991 saw widespread economic chaos.

Miller argues that the strategy was never likely to have worked, and contrasts that with the experience in China. Why couldn’t it have worked? In the end, his claim reduces to the proposition that those who really favoured reform simply did not have the political clout to make it happen, even if one of those was the General Secretary himself. For decades after Stalin – under whose reign of terror many were shot, senior people were moved around frequently – the patronage networks (within which people often spent an entire career) were able to grow to become a force they simply weren’t in China (just after the further upheaval of the Cultural Revolution). Add to that things like the fact that life in the USSR was relatively comfortable in 1985, in a way that it hadn’t been in China in the late 70s. The imperative for change was much weaker, whether near the top, or at the grassroots (he contrasts the attitude to agricultural reforms of Chinese peasants and Russian farm workers). And there was the military, consuming a huge proportion of GDP in the USSR and reluctant to adjust, in contrast to the reduced military expenditure in China in the first years of economic reform.

There is one contrast between the USSR and the PRC that emphasises that in China the Communist Party kept hold on power and Russia it gave up power. For the CCP that is a clear victory (whatever it means for the Chinese people). But the other often attempts to tell a story about relative economic performance, with an emphasis on those first few severely disrupted years after 1991 in the (former Soviet Union) and, of course, the high growth rates the PRC continued to report for a long time. In this part of the world, New Zealand politicians and business people are nauseatingly prone to praising what they see as the economic success of the PRC (as if somehow this covers for the innumerable abuses of the regime).

China was, of course, richer than Russia for a long time. For not inconsiderable periods of history China was at least as rich – or richer – than anywhere on the planet. Russia never was. But here is the (rough) picture of GDP per capita comparisons for various years, drawn from the (widely-used) Maddison database.

russian and china

By 1913 – the eve of World War One – estimated GDP per capita for the “former USSR” (of which Russia is the largest chunk) was almost three times that of China. The “former USSR” in turn enjoyed real GDP per capita less than a third that of the leading bunch of countries (including New Zealand), and less than a third that of (say) France and Germany

By 1980 – several decades each of Communist Party rule – real GDP per capita was about six times that in China (as noted above, the starting points for reform were very different). China really was an utter basket case.

But where do things stand now, after decades of fairly rapid growth in China, and decades on from the chaos of the immediate post USSR period?

Here are the IMF’s estimates for real GDP per capita for the former Soviet Union countries and China.

former USSR

Even using these official numbers – and people like Michael Pettis will argue compellingly that GDP in China does not mean what it does elsewhere – China currently has real GDP per capita a bit less than Belarus, a bit more than Turkmenistan. The Baltic states are stellar performers but even authoritarian Russia, heir to all that 1990s dislocation, has real per capita incomes 55 per cent higher than those in China.

And what about labour productivity? The IMF doesn’t produce estimates for that, but the Conference Board does. Here are their latest estimates for the whole former Soviet bloc, and China.

former eastern bloc

China makes Belarus look really rather good, and on these estimates China is still lagging behind Moldova. The gap between China and Russia is huge and – as best as can be told from these estimates – Chinese productivity growth has slowed sufficiently it is no longer obvious they are even closing the gap.

Russia, of course, is hardly a stellar performer. You can see it even on these charts, and in GDP per capita terms it is still only about half the incomes earned per capita in France and Germany/

And then one last set of comparisons.

prod comparisons russia

China pales by comparison with all of these economies, even grossly-underperforming New Zealand.

There were things the USSR was able to learn from the PRC 40 years ago. But how to generate a high income country, that might match the material living standards in the West – a constant aspiration – was not then, and is not now, one of them.

Rising house prices do not make New Zealanders better off

I didn’t really read the housing section of last week’s Reserve Bank MPS – housing isn’t their responsibility and their analysis of it has rarely been up to much, often lurching unpredictably from one story to another. And their new material on house prices in each MPS only stems from the Remit change Grant Robertson foisted on them early in the year, knowing it would make no substantive difference to anything, but designed to look as though the government cared.

So it was only when the Herald’s Thomas Coughlan tweeted this chart yesterday that I noticed it.

RB house prices

The chart is prefaced with this text

The MPC sets monetary policy to achieve its inflation and employment objectives in the Remit. It considers the outlook for the housing market because house prices can influence broader economic activity, employment, and consumer price inflation (figure A5).

So we are presumably supposed to take this as the best professional view of the seven members of the Monetary Policy Committee. After all, it isn’t a throwaway line from a single member in an ill-considered press conference or interview comment. There is a bunch of different channels identified (and no obvious space constraints – they could easily have added more if they thought others were important), and nothing of substance gets into a Monetary Policy Statement without a fair degree of senior management scrutiny and review.

There are so many problems with this graphic it is difficult to know where to start. But perhaps first with the clear impression a casual reader would take away from this that the seven Robertson-appointed members of the MPC think that higher house prices are “a good thing”. After all, for most of the last decade inflation undershot the Bank’s target (unemployment lingered disconcertingly high for a disconcerting period of time too). More would have been better on both counts. Perhaps a charitable reader might wonder if the MPC really only had some short-term effects in view, but there is nothing in the substance of the chart or its title to suggest that.

And then there is the problem of the left-hand box: they start from “house prices” and “housing market activity” but these things never occur in a vacuum (as, for example, they would no doubt – and rightly – point out if they were talking about any other price (say, the exchange rate). Most often, surges in house prices (at least in New Zealand) have been associated in time with surges in economic activity driven by a range of different (policy and non-policy) factors.

But perhaps the biggest problem is with the claim – almost explicit in the top box of the second column – that higher house prices leave New Zealanders as a whole (remember, this is a whole-economy macroeconomic agency) better off. They don’t.

That they don’t, in principle, is easy enough to see. Everyone in the country needs a roof over his or her head. If I need a roof over my head for the rest of my life, ownership of one house meets my housing consumption needs. What matters is the shelter services the house priovides not the notional value the house might be sold at. Whether my house is valued today as $0.5m (roughly what I paid for it years ago), $1.75m (roughly what an e-valuer site tells me it is worth today) or $3.5m makes not the slightest difference to me. I still want to consume the bundle of services (location, size, sun etc) that this particular house provides.

Now, I might feel differently if I had a large mortgage: after all, negative equity gives the bank the right to foreclose (which can be both expensive and inconvenient), and even if the bank didn’t foreclose (mostly they don’t) it might also make it impossible for me to buy a similar house elsewhere if job opportunities suggested a move.

But this is where one needs to step back and think about the population as a whole. To a first approximation, for every apparent winner from higher (national) house prices there is a loser and for most – perhaps especially middle-aged owner occupiers – it makes no difference at all. There is no more economywide purchasing power created. And real gains that accrue to some people are offset by real losses to others. Owners of rental properties really are better off when real house prices go up. After all, they don’t own houses to live in them, but mostly for the profit they expect to make and the future consumption opportunities for themselves and their families. They can realise their gains and move on, or simply borrow against them.

But on the other hand, there are a lot of people made materially worse off by higher house prices – the people who don’t own a house now who either want to buy one in future or who are, and expect to, keep on renting. Consider someone just graduating from university who, a few decades ago, might have expected to buy a house after a couple of years working. But with real house prices in New Zealand as they are now not only does the deposit requirement push back any feasible purchase date, but the total amount of the lifetime income of the young graduate will have to devote to house purchase costs is so much greater. (Of course, real interest rates are lower than they were decades ago but recall that in the Bank’s scenario we are just thinking about house prices.) Earnings that are (eventually) used for the acquisition of a house can’t be used for other things. Earnings saved now to accumulate a deposit are not spent.

The story isn’t so different for long-term renters since in the medium-term (the adjustment isn’t instantaneous) if house prices are higher one can expect rents to be higher (than otherwise). In latter day New Zealand that has taken the form of rents holding up, or rising a bit, even as real interest rates have fallen a lot, which would otherwise have been expected to lower rents. Earnings spent (and expected to be spent) on rents can’t be spent on other things.

What (mostly) happens when house prices rise is that purchasing power is redistributed – usually towards those who have (houses) and away from those who have not (houses). Of course, it is further muddled by things like the Accommodation Supplement which shifts some of the losses onto the Crown……but that only means that taxes will be higher than otherwise in future. There is no net new purchasing power for society as a whole. (Were one inclined to an inequality story one might note that wealthier people tend to have lower marginal propensities to consume than poorer people.)

Are there possible caveats to this in-principle story? The story I used to tell was that, in principle, we might be better off from higher house prices if we all sold our houses to foreigners (at over the odds prices) and rented for the rest of our lives. But it was a story to illustrate the absurdity (and marginal relevance) of the point, and that was before the current government made such foreign house-buying illegal.

I’ve told you an in-principle story. The Bank likes to claim that the data don’t back this sort of story, And it is certainly true that there will often be a correlation between increases in house prices and increases in consumer spending. But that is mostly because – as I noted earlier – in the real world something triggers house price increases, and that something is often strong lift in economic activity and employment (in turn with triggers behind those developments). When the economy is running hot – and especially when land supply is restricted – buoyant demand, buoyant employment, rising wage inflation, increased turnover of the housing stock, and surges in house inflation are often happening at the same time. And in recessions vice versa. It isn’t easy to unpick chains of causation in the data.

Since higher house prices do not add to the lifetime purchasing power of New Zealanders as a whole, the Bank’s wealth effect story has to rest largely on some sort of view that households are systematically fooled by the house price changes. It is possible I suppose, at least the first time prices surge, but it doesn’t seem very likely. It isn’t as if surges in house prices – nominal and/or real have been uncommon in modern New Zealand.

The Bank also sometimes likes to highlight a story (it is there in that graphic) that even if the population doesn’t feel any wealthier, rising house prices might also boost consumption – at least bring it forward, without boosting lifetime consumption – by easing collateral constraints. In principle, a bank would lend even more to me secured on the value of my house than they might have done a couple of years ago. But again my ability to borrow a bit more has to be set against the reduced ability to borrow of the young graduate who now has to save even more in a deposit to get on the (residential mortgage) borrowing ladder at all. Sadly, in today’s bizarrely distorted housing market, we often find parents with freehold or lightly-indebted houses gifting or lending money to children, net effect on consumption probably roughly zero. With real house prices surging to fresh highs each cycle for decades now, it doesn’t seem that likely that many people are very collateral constrained.

For years I’ve been running a commonsense test over the Bank’s claims. This chart is of New Zealand real house prices

house prices aug 21

This series ends in December last year, so as of now we can probably think of real New Zealand house prices being four times what they were in December 1990 (I chose the starting point because that quarter was just prior to the 1991 recession getting underway, but you can see that real house prices hadn’t moved much for several years).

These are huge increases in real house prices, some of the very largest (for a whole country) seen anywhere over a comparable period (notably a period in which productivity growth was underwhelming). Were there to be much to the Reserve Bank’s wealth effects story (or its collateral constraints story) at the whole economy level mightn’t one have expected to see consumption as a share of national income rising, savings as a share of national income falling?

Of course there is all sorts of other stuff going on, but this is a really big – unprecedented in New Zealand – change in real (and nominal) house prices. But here is consumption as a share of national disposable income, back to the late 80s, just before house prices began to surge. The data are for March years.

consumption and NDI

The orange line is private sector (households and non-profits) consumption, while the blue line adds in public (government) consumption spending.

Of course, there are cycles in the series. There are two peaks, during the two big recessions (1991/92 and 2008/09): consumption tends (quite rationally) to be smoother than income. There is quite a dip in the early-mid 2000s, which can readily be shown to line up with the really big surpluses the government was running at the time – the country was earning a lot of income, but the Crown was temporarily sitting on a disproportionate share of that income.

And what of the house price booms. There were three during the period in the data (so not including the last year) – the few years running up to 1996, the period from 2003 to 2007 (particularly the early part of that period), and the period from about 2013 to about 2016. There is nothing in the consumption/savings data over those periods that would surprise someone who didn’t know about the house price surges.

And across the period as a whole, at best consumption has been flat as a share of income over 30 years of unprecedented house price increases. Looked at in the right light perhaps it has even been trending down a bit (private consumption as a share of income was as low in the March 2020 year as it was 16-17 years early when not only was the Crown running huge surpluses but real house prices were much lower.

I’m not suggesting any of this is definitive but when there is (a) no reason to think that New Zealanders as a whole are any wealthier when real house prices rise, and (b) no sign over decades in the macroeconomic data of the sort of effect the Bank likes to talk up, it might be safer to conclude that the effect just isn’t there to any meaningful macroeconomically significant effect.

Of course, as noted earlier there are all sorts of short-term correlations, typically resulting from common third factors at work, but the story the Bank seemed to be trying to tell in that graphic was neither representative of the economy as a whole, nor helpful.

The line I’ve run in this post is not new. In fact, 10 years ago now the Reserve Bank itself published an article in its then Bulletin discussing many of the same issues, and suggesting very similar sorts of conclusions (with, of course, 10 years less data). I was one of the authors of the article but – as was the norm – Bulletin articles carried the imprimatur of the Bank, and were not just disclaimed as the views of the authors.

Perspectives on New Zealand immigration policy

Several years ago the Law and Economics Association hosted an event in Wellington in which the New Zealand Initiative’s Eric Crampton and I each told our stories about New Zealand immigration policy. My account is here, and a link to the talk I gave is here.

A few months ago a couple of Victoria University of Wellington academics responsible for a Masters class (in a programme I didn’t even know existed (Masters in Philosophy, Politics and Economics)) invited us to do something similar for their class. We did that today.

My text (a bit fuller than what I actually used) is here (if Eric chooses to link to his slides on his blog I will include a link) (UPDATE: link here). My focus was solely on the economic dimensions of immigration policy, and in particular on the implications for economywide productivity (as the best proxy for whether large-scale policy-led non-citizen immigration has been beneficial for New Zealanders). My focus was primarily on the long-term programme, and entirely on the situation in normal times (ie I was not addressing the current Covid mess, which reflects poorly on the government but has no necessary connection to the appropriate medium-term approach).

My approach tends to start from a series of stylised facts about New Zealand’s economics performance in recent decades. This was the list I used this time.

But first, the gist of my story, which starts from a set of stylised facts about our economy.  Most of them are not in contention, even if the meaning and implications are debated:

  • New Zealand’s productivity growth has continued to languish, and even after the reforms of the 80s and early 90s (including a return to large-scale immigration) there has been no narrowing of the gaps. We’ve fallen further behind Australia, and increasingly behind central and eastern European OECD countries.  It would now take a two-thirds lift in the level of productivity to catch the OECD leading bunch,
  • Foreign trade as a share of GDP has stagnated, and this century has gone backwards. This in the new great age of globalisation,
  • New Zealand’s exports have remained overwhelmingly reliant on natural resources (whether agriculture, tourism or whatever).
  • Consistent with this, the rapid growth areas in our economy have been the non-tradable, not internationally competitive, sectors,
  • Also consistent with this, our real exchange rate has remained high, even as productivity has declined relative to other countries over decades,
  • Even as real interest rates have fallen, they have remained persistently higher than those in other advanced economies,
  • Business investment as a share of GDP has been weak (OECD lower quartile),
  • Indications are, globally, that if anything distance has become more important not less, with high value economic activity increasingly clustered in big cities near the major markets of the world,
  • Unlike what we see in the US and Europe, GDP per capita in by far our biggest city isn’t much better than that for the country as whole – if anything the gap has been narrowing.
  • Over the last few decades, no country has aimed to bring more migrants (% of population) than New Zealand did – although Canada and Australia have come close to matching us, and Israel too.   
  • OECD data show the NZ migrants also have the highest average skills levels (but still a bit behind natives) of migrants to any OECD countries.

Not one of the expected economywide benefits of a large-scale immigration promotion policy has shown up. Not one.   And we aren’t five years into this experiment, by 25 to 30.

I stepped through my standard arguments for why large scale immigration here may have been damaging to our medium-term economic performance. I noted that of the handful of OECD countries that have tried anything on the scale of New Zealand’s experiment (Canada and Australia and – in a slightly different context – Israel) none stands out as a productivity leader, and yet very little of the literature on the economics of immigration looks specifically at this group of countries. What isn’t always appreciated is that New Zealand has much more experience of large scale immigration and emigration (the latter, of nationals) than almost any other country – the sustained outflow of natives has been a thing since at least the mid 1970s, while our governments have actively promoted large-scale non-citizen immigration for all but about 15 years since World War Two.

When we’ve considered the economic performance over recent decades of the active immigration-promoting countries, and the countries experiencing outflows of their own people, the ball should really be in the court of the pro-immigration economists to show us, concretely, where and how large-scale immigration is lifting the productivity and incomes of the natives.   That is particularly so in New Zealand, given the disadvantages we can enumerate in advance – distance and continued natural resource reliance – and the signal implicit in the decades-long outflow of natives.

I talked about a number of other problems, and (in particular) gaps, in the existing literature before ending with this conclusion.

There might be all sorts of reasons for favouring high immigration – better ethnic restaurants[1], defence, a liking of big cities, or trains. If your country has prospered greatly, you might be happy to share the gains widely.  But the economic case for large scale immigration, as a way of boosting the productivity outcomes for natives in already advanced economies[2], looks thin at best.  Not many countries have run the experiment in modern times, notwithstanding the models that are claimed to support such an approach.  New Zealand has been at the forefront – actively promoting large scale immigration for all but 15 years since World War Two.  Unfortunately, New Zealand has had the worst relative economic performance of any advanced economy over those decades – we haven’t just come back to the pack, but now languish well down the rankings, have led the GDP per capita tables just 100 years ago (when abundant land, small population, and asymmetrically favourable technology shocks combined in our favour).

As I review the experience of advanced countries, if one wanted to take a punt on policy promoting large scale immigration (and few have) the best places to try look to be countries:

  • Close to the centres of global economic activity (whether Europe, North America, or East Asia),
  • Having experienced an asymmetric productivity shock – whether from the market or other policy reforms – favouring longer-term economic prospects in your country,
  • With economies with substantial reliance primarily on sophisticated manufactured products and high-tech services,
  • With their own people coming back home

And it looks like a highly risky strategy if your country is

  • Very far from anywhere,
  • Heavily dependent on (fixed) natural resources,
  • And has seen little sign of asymmetric favourable productivity shocks for your industries in a quite a long time,
  • Somewhere your own people have been leaving in large numbers

These look to be quite general insights.  And yet few if any of the countries that have three or four of the first characteristics have gone in heavily for policy-led immigration (perhaps Ireland or the UK might have been the closest- but UK immigration per capita was also about a third of New Zealand’s (per capita), and the UK is no productivity star).   Of the countries that went heavily for policy-led immigration, even Canada and Israel each meet only one of the three criteria – and neither can readily show the economic gains from large-scale migration. Australia and New Zealand meet none.

As for New Zealand, we can (sadly) tick all four items in that second class of conditions.  This was – and is – perhaps the least propitious advanced economy on earth to experiment with a large-scale immigration strategy.  And yet we did. If it was perhaps defensible in 1946, and optimistic in 1990, persisting now it just stubbornly wrongheaded, defying experience and evidence.    It isn’t quite as wrongheaded as a strategy to promote mass migration – however able the people – to Kerguelen, the Chathams or the Falklands, but not far short of it.  Australia has coped better with its experiment only because they were able to bring to market lots of natural resources previously lying idle.

It isn’t that people are any different here – locals or migrants.  And water still flows downhill.   But the opportunities just aren’t very good at all.  It is an old line but no less true for that: a definition of insanity is doing the same thing again and again and expecting a different result.  We’ve tried this one far too many times for our own good.

[1] I recall Eric Crampton once suggesting an Ethiopian quota

[2] The contrast, say, to the economic gains New Zealand Maori may have received from 19th C immigration.