Losing $128 billion

I don’t usually pay much attention to forecasts of nominal GDP.  Not many people in New Zealand really seem to.  But The Treasury takes nominal GDP forecasts more seriously than most, since nominal GDP (in aggregate) is, more or less, the tax base.

Out of little more than idle curiosity I dug out the numbers from last December’s HYEFU forecasts –  the last before the coronavirus –  and compared them to the numbers published in last week’s BEFU, accompanying the Budget.  And this was what I found.

Nominal GDP ($bn)
HYEFU BEFU Difference
2019/20 319.8 294.2 -25.6
2020/21 336.4 294.2 -42.2
2021/22 354.1 328.3 -25.8
2022/23 371.5 352.3 -19.2
2023/24 389.2 374.3 -14.9
Total 1771 1643.3 -127.7

Over the full five years, New Zealand’s nominal GDP is projected to be $128 billion less than The Treasury thought only a few months ago.

Recall that changes in nominal GDP can be broken down into three broad components:

  • the change in real GDP  (the volume of stuff produced here),
  • the change in the general price level (inflation), and
  • the terms of trade

On this occasion, changes in the terms of trade make only a tiny difference over the five years taken together.

General (CPI) inflation is expected to be lower than previously thought.    On average over the five years, the price level in the BEFU forecasts is about 1.8 per cent lower than in the HYEFU forecasts.  That accounts for about $33 billion in lost nominal GDP.

The balance –  the overwhelming bulk of the loss –  is real GDP.

I haven’t written anything much about The Treasury’s forecasts, which were done quite a while ago, and could not fully incorporate the final fiscal decisions the government made.  But for what it is worth, I reckon Treasury’s numbers were on the optimistic side –  quite possibly on all three components of nominal GDP.  On inflation, for example, they are more optimistic than the Reserve Bank (which finished its forecasts later), even as they assume tighter monetary conditions than the Bank does.

But the point I really wanted to make was that these forecast GDP losses will never be made back (in the sense that some future year will be higher to compensate –  resources not used this year mostly represents a permanent loss of wealth).  And that these losses occur despite all the fiscal support (and rather limited monetary support).   And fiscal here includes both the effects of the automatic stabilisers (mainly lower tax revenue as the economy shrinks) and the discretionary policy initiatives (temporary and permanent).

How large are those fiscal numbers?  Well, here is core Crown revenue (more than 90 per cent of which is tax)

Core Crown revenue ($bn)
HYEFU BEFU Difference
2019/20 95.8 89.5 -6.3
2020/21 101.6 87 -14.6
2021/22 106.5 94.6 -11.9
2022/23 112.7 104 -8.7
2023/24 117.7 109.9 -7.8
534.3 485 -49.3

Almost $50 billion the Crown was expecting but which it won’t now receive.  Some of that will be the result of discretionary initiatives –  the corporate tax clawback scheme, much of which will result in permanent losses, and the business tax changes announced in the 17 March package –  but the bulk of the loss will be the automatic stabilisers at work.

And on the expenditure side?

Core Crown expenses ($bn)
HYEFU BEFU Difference
2019/20 93.8 114 20.2
2020/21 98.8 113.5 14.7
2021/22 102 119.8 17.8
2022/23 106.3 118.6 12.3
2023/24 109.2 113 3.8
Total 510.1 578.9 68.8

Almost $70 billion of current spending the Crown didn’t expect to make only a few months ago.  A small amount of this will be the automatic stabilisers at work (the unemployment benefit), but The Treasury is pretty optimistic about unemployment.  Most of the change is discretionary policy initiatives (announced or provided for).

And here is the change in net debt

Net core Crown debt (incl NZSF) as at year end  ($bn)
HYEFU BEFU
2018/19 14.1 14.1
2019/20 14.6 47.6
2020/21 17.6 82.8
2021/22 17.1 111.7
2022/23 12.3 131.7
2023/24 3.9 138.2 134.3

That will be almost $135 billion higher than expected.

As I’ve noted in earlier posts, I don’t have too much problem with the extent of overall fiscal support (although I would have structured it differently and made it more frontloaded –  consistent with the “pandemic insurance” model).

But even on this scale, fiscal policy is nowhere near enough to stop the losses.  Some of those losses are now unavoidable.  It is only five weeks until the end of 2019/2020, so we can treat $26 billion of nominal GDP losses (see first table) as water under the bridge now.   As it happens, fiscal policy looks to have more than fully “replaced” the income loss in aggregate (whether $27 billion from operating revenue and expenses in combination, or the $33 billion increase in net debt) –  not as windfall, but as borrowing (narrowing future choices).   (UPDATE: Even in quote marks “replaced” isn’t really quite right there, as without the fiscal initiatives it is near-certain that actual nominal GDP would have been at least a bit lower than The Treasury now forecasts, even for 19/20.)

But there is a great deal of lost income/output ahead of us, even on these (relatively optimistic) Treasury numbers.

Which is really where monetary policy should be coming in.   The Treasury assumes that monetary policy does almost nothing: there is no further fall in the 90 day rate (the variable they forecast), and as they will recognise as well as anyone inflation expectations have fallen, so real rates are little changed from where they were at the start of the year.  And although the exchange rate is lower throughout than they assumed in the HYEFU, the difference is less than 5 per cent –  better than nothing of course, but tiny by comparison with exchange rate adjustments that have been part of previous recoveries.  It isn’t entirely clear how The Treasury has allowed for the LSAP bond purchase programme, but whatever effect they are assuming…….there is still a great deal of lost output.

The Governor has often been heard calling for banks –  private businesses – to be “courageous”.  It is never quite clear what he means, but he apparently wants to risk other peoples’ money.  But the central bank is ours –  a public institution.   A courageous central bank, that had really grasped the likely severity of this slump, could have begun to make a real difference.  If they’d cut the OCR back in February, and taken steps to ensure that large amounts of deposits couldn’t be converted to physical cash, and then cut the OCR to deeply negative levels (perhaps – 5 per cent) as the full horror dawned, we’d be in a much better position now looking ahead.     Wholesale lending and deposit rates would be substantially negative at the short end, and even real rates on longer-term assets might be as low as they now, without much need for bond purchases.   Retail rates might also in many case be modestly negative –  perhaps for small depositors achieved through fees.   And, almost certainly, the exchange rate would have fallen a long way, assisting in the stabilisation and recovery goal.  There are winners and losers from such steps –  as there are from any interventions, or from choices just to sit to the sidelines –  but it is really just conventional macroeconomics: in a time of serious excess capacity and falling inflation expectations, act to seek to bring domestic demand forward, and net demand towards New Zealand producers.    Working hand in hand with the substantial fiscal support (see above), we’d be hugely better positioned to minimise those large future nominal GDP losses –  losses that at present, we risk never making back.

But neither the Governor nor, apparently, the Minister of Finance seem bothered.

Finally, if nominal GDP appears to be a slightly abstract thing, it is worth recalling that almost all debt is nominal and it is nominal incomes that support outstanding debt.  There is about $500 billion of (intermediated) Private Sector Credit at present (and some other private credit on top of that).  Most likely that stock won’t grow much over the next few years. But government debt will –  on Treasury’s numbers net debt rises by $134 billion.   Against those stocks, a cumulative loss of nominal GDP of $128 billion over five years is no small loss.  As noted earlier, amid all the uncertainties, the precise numbers are only illustrative, but the broad magnitude of the likely losses (on current policies) are what –  and that magnitude is large, if anything perhaps understated on The Treasury’s numbers.

 

Still falling short

Your main focus today, as mine, may well be this afternoon’s Budget, but I’m not letting the Monetary Policy Committee’s statement yesterday go by without comment.

Back in February, the Committee was really rather upbeat.  There was this temporary disruption to some exports to China, but it really wasn’t much to worry about.  Once we got beyond that things were looking good this year.  In fact, a couple of weeks later they were still singing from that upbeat songbook, tweeting out their upbeat message.  It wasn’t just management, but also the silenced ciphers who sit as external members of the Committee, collecting generous fees –  no word of any 20 per cent cuts there? – while never being available for questioning or any serious accountability.

Since then, of course, they’ve been mugged by events, but always with the sense that they were never quite taking things seriously enough, never willing to do what might make a real and material difference.  So they cut interest rates once, and then firmly pledged not even to think about doing any more of that for another year.  They claim to have (very belatedly, given that they had 10 years notice) discovered that some banks weren’t “technically ready” for a negative OCR –  a very fishy story, given we heard it nowhere else in the world in the last decade –  but even having “discovered” that there appears to be not the slightest urgency to resolving the matter.  The government can get in place wage subsidy schemes or company tax clawback schemes paying out within days, but the Reserve Bank is still just asking nicely that could the banks please, please, think about having systems ready by the end of the year –  still the best part of eight months away.

I saw one funds manager quoted in the media suggesting that the Bank really wanted to cut the OCR yesterday but just couldn’t.  With respect –  and I like and generally respect the person concerned – that has to be nonsense.   Even if there really really are technical obstacles in one or two banks –  and why do no journalists go round and ask them individually? –  nothing stopped the Bank cutting the OCR to zero.  Nothing would have stopped them letting it be known they’d insisted that any technical obstacles be resolved before the end of June.  But there was nothing of the sort.

Instead, there was the repeated pretence that a gigantic asset swap –  buying government bonds and issuing government deposits instead (which is what Reserve Bank settlement cash is) –  was somehow a fully effective substitute.   This little clip is from the cartoon version the Bank does for the general reader (never clear how many of them there are).

snapshot

So, yesterday’s substantive policy announcement was an 80 per cent increase in the (maximum) amount of government and local body bonds the Bank may buy over the year.

This was my initial reaction

Now as it happens, the exchange rate appears to have fallen by about 1 per cent on yesterday’s statement, and interest rates are down as well.  But much of that appears to be not because of the bond purchase programme – which was widely expected –  but because of the explicit references to the possibilities of a negative OCR next year.  It wasn’t really new, but apparently some must have focused on it afresh, and as a contrast perhaps to the outlook in the US and Australia.  Apparently, the OIS market is now pricing negative rates for much of next year.  The Governor may get his reported wish and retail interest rates may fall a little.

The bond purchase programme itself, however, remains largely theatre.  What isn’t clear is whether the Governor knows it and doesn’t care, or is a true believer.  There are hints in the text of the document that the staff know there is less to the programme than the Governor likes to make out.

As I noted in that tweet, there would be a credible case that big bond purchase programmes would make a real macroeconomic difference –  what we look for from monetary policy, as a key countercyclical actor – if:

  • insufficient settlement cash were an important constraint on banks’ activities, willingness to lend etc.  There is no evidence of that at all (and the Bank does not emphasise this channel either),
  • a lot of New Zealand borrowing was taking place at long-term fixed interest rates, and the interest rates on those products were significantly linked to interest rates on long-term government bonds.

But that isn’t so either.  Most New Zealand borrowing is done either at variable rates –  where the OCR is a key influence – or short-term fixed rates (lots of action in the mortgage market tends to centre on 1 or 2 year fixed rates).  Even when corporates go out and issue long-term bonds, they typically enter into swaps to shift back to floating rate terms (but with secure long-term funding).    The key entity that borrows long-term and is directly exposed to long-term rates is…..the ultimate non-market actor, the government.  In fact, it was telling that the MPS specifically claims one of the benefits of the asset purchase programme as being lowering the borrowing costs of the Crown –  but monetary policy is generally supposed in a neutral way across all sort of savers/borrowers.

There were a couple of interesting graphs in the MPS which seemed make my point.

bond mkts

In late March, there was a huge sell-off in all sort of asset markets, including global government bond markets.  The Bank has another chart nicely illustrating the blow-out in bid-ask spreads (which flowed through to investors more generally).  The bond market was not functioning very well, and you can see in the top chart how far long-term government bond rates rose relative to rates on interest rate swaps.  But it is the swaps that matter for general credit pricing in the economy, not the bonds themselves.  In the second chart, from a few days ago, government bond yields had come right back down again relative to swaps, but the swaps curve itself was only down about 20 basis points.

To repeat, I am not opposed to the Reserve Bank doing a bond purchase programme –  although I think they would be more sensible to follow the RBA and focus on targeting a short-term bond rate (say, the three year rate, as per the RBA).   Their activities helped stabilise markets –  which would probably have settled down eventually anyway –  and have lowered bond yields, but the scale of the effect on rates that really matter to the wider economy is small –  and not really consistent with the scale of the Bank’s claims.

Did I mention real interest rates?  Curiously, as far as I could tell in the entire document yesterday there was not a single mention (and certainly not in the upfront material the MPC itself more clearly owned).  Here is the interest rate swaps curve for 31 Dec last year and the close of business on Tuesday (with the market then fully expecting a big expansion in the bond purchase programme).

NZ swaps

The whole curve is down about 100 basis point since the end of last year.  Unfortunately, inflation expectations have fallen about 70 basis points, so that even real wholesale rates have not fallen very much at all. In face of the biggest sharpest slump on record.

As even the Bank acknowledges –  a point I’ve made here repeatedly –  there has not been that much action on retail rates, and in particular retail deposit rates have not fallen much at all.  In fact –  the Bank doesn’t point this out –  they’ve risen in real terms.  The Bank is reduced to plaintive appeals to banks to lower retail lending rates, even as they acknowledge that wholesale term funding costs also remain relatively expensive, in turn influencing what banks are willing to pay for term deposits.

The Bank’s final argument is to claim that the large scale asset purchase programme (LSAP) has reduced the exchange rate.  The Governor made that bold claim, while the staff are (rightly) more nuanced.

In addition to lowering interest rates, LSAPs put downward pressure on the New Zealand dollar exchange rate. The New Zealand dollar has depreciated in response to the COVID-19 outbreak (see chapter 4). It is difficult to disentangle the precise impacts of the Reserve Bank’s actions from a range of other factors that influence the exchange rate, in particular the volatile swings in risk sentiment over recent months and the actions of overseas central banks.

In principle, if the Reserve Bank has bought $10 billion of so of bonds, some of the sellers will have been foreign holders.  Some of them will have been unhedged holders of NZD, and they may now have closed out those positions.   But when the Governor and Bank were making these claims, the TWI was about 5 per cent below where it had been late last year, in total, from all influences.  Perhaps the LSAP had an effect at the margin, but if so it must have been relatively small, since the overall movement in the TWI was small relative to past, less severe recessions, and our overall yield curve is still not extremely low by international standards.

To repeat, I’m not suggesting the LSAP has had no effect, just that relative to the scale of the challenge –  the collapse in economic activity, employment and prospects for inflation – what has been done is just not remotely comparable to the scale of monetary easing that a serious central bank would normally have done previously.

And, actually, once you dig just a little into their numbers, even they tell you as much.  I reckon the Bank’s baseline scenario is rather too optimistic about the extent of the economic recovery, on current policies, over the next few years.  Their view on the unemployment rate in particular seems almost incomprehensibly optimistic on announced policy as at yesterday (which is what they said they were basing things on)  But even if one takes them at their word, this is their inflation outlook.

baseline inflation

Under the Remit given to them, the MPC is required to focus on the 2 per cent midpoint of the target range.  The bottom of the target range is 1 per cent.   They now expect annual inflation to be below 1 per cent for the next two years, on current policy.  At the end of 2022, on these projections inflation is still only 1.3 per cent, about as low –  core inflation terms –  as it ever got in the last 10 years.  I’m almost certain that the Bank has never published inflation projections that have annual inflation outside the target range for so long.  And it is not as if somehow there is overfull employment during this forecast horizon –  even on the (optimistic) Reserve Bank numbers, the unemployment rate is still 5.5 per cent three years from now.

It is really pretty inexcusable.  The MPC is keen to shift responsibility onto the government, claiming that fiscal policy has to carry the load.  But MPC has been given a task by Parliament and the Minister and are just abdicating responsibility for it.

The related thing I find troubling is that while the MPC acknowledges that the risks are to the downside, there is no sustained discussion of inflation expectations at all.  Neither the word nor the notion appear in the minutes of the committee’s deliberations.  I was talking to someone yesterday who told me he’d searched the document and the word “deflation” didn’t appear at all, and there is no hint of the Committee being alert to the risks, or even highlighting the powerfully deflationary nature of this shock.  If inflation expectations have already fallen so much, and yet the Committee is now content to deliver inflation below target for several years, isn’t it likely that expectations will fall even further?  Given the self-imposed limits on nominal interest rates, doesn’t that create a risk of further retarding the recovery, by driving up real interest rates?  Whether it does or not, you’d expect a serious MPC to at least engage with these sorts of issues and risks?

The unseriousness of it all was perhaps highlighted by this new chart, showing some sense of where the OCR might go if there were no (self-imposed) constraints.

unconstrained OCR

Something like -2 per cent would certainly be a great better than we have now (0.25 per cent, with a bit of help from the LSAP), but that would still amount to only 300 basis points of monetary policy easing –  small compared to 2008/09 or to 1990/91, even though the adverse shock this time is almost certainly much larger.  As I’ve noted before there were standard Taylor rule estimates for the US in 2008/09 suggesting that even then -5 per cent interest rates would have been helpful (although clearly not critical as the economy eventually recovered without them).  And I noticed yesterday one of investment banks estimating that for Australia –  with a less severe economic shock than New Zealand –  something like -5 per cent might be a Taylor rule recommendation now.   As it is, we have a tiny –  quite inadequate –  easing in real monetary conditions.

The MPC and the Governor are simply not taking things anything like sufficiently seriously.  They’ve deferred to fiscal policy, claiming (not very credibly) no inside knowledge of today’s Budget, but (a) it is four months from an election and who knows what fiscal policy will actually be delivered over time, and (b) as noted above, even with all that support, inflation still materially undershoots the target they have been formally given.

Finally, of course, there is no suggestion that the MPC is interested in doing anything at all to ease the rules –  imposed the Bank –  that create something like an effective lower bound (modestly negative) on nominal interest rates.  That is just irresponsible.   If the MPC won’t act, the Board should insist.  If they can’t make any headway –  or, more likely, won’t even try – the Minister needs to act.  At present, the MPC appears to be frustrating the clear intentions of Parliament and the Minister –  price stability with monetary policy doing all it can to support maximum sustainable employment.  Laws are written to provide remedies for these exceptional circumstances.  If the Minister refuses to use them, he shares the blame.

For his Zoom press conference yesterday, the Governor was flanked –  excuse the grainy photo – by his billboard boasting of/aspiring to being “Best Central Bank”

orr photo

You be the judge.    But however well the people down the organisations are doing, the statutory appointees –  those we are supposed to be able to hold to account –  are again/still falling well short, led by the Governor.

Guest post by Geof Mortlock: coronavirus response

What follows is an article on various issues around the New Zealand coronavirus policy response by my former Reserve Bank colleague, and now consultant, Geof Mortlock.     The views are Geof’s alone, but I thought it was interesting and clear articulation of a case that deserved a wider audience.   Geof and I certainly don’t always agree –  sometimes we differ quite strongly.  And so it is in this article where there are bits I strongly agree with, others I’m more open-minded about, and others I’m pretty sceptical of (eg I don’t have a great deal of confidence in the value added by hands-on bank supervisors), but to repeat they are Geof’s views and not necessarily mine.

Coronavirus response: More clarity on objectives, response options and recovery strategy is needed

Geof Mortlock¹
Last week, the government released a paper that summarised its objectives for combatting the coronavirus pandemic in New Zealand. The paper, entitled ‘Written Briefing to the Epidemic Response Committee’, prepared by John Ombler, the All of Government Controller, noted that the government’s coronavirus response strategy is now aimed at ‘stamp it out and elimination’. Previously, the objective had apparently been to ‘flatten the curve’, also known as ‘mitigation’ – not that one would have known it, given the inadequate transparency and clarity in the government’s strategy to date. Despite the attempt at clarifying the objectives for the coronavirus response strategy, Mr Ombler’s paper perpetuates ambiguity, given that it refers to a strategic objective of ‘elimination’, but then goes on to suggest that the strategic objective is ‘suppression’ – i.e. keeping infection levels to a low-enough level as to minimise the risk of exceeding the health system’s capacity to deal with Covid-19.

The Ombler paper is too vague and insufficient in scope to satisfactorily explain the government’s coronavirus response objectives and the inherent trade-offs involved in different response options. The paper does not clearly explain what ‘elimination’ means. It provides no quantifications of what elimination or suppression translate to in terms of infection levels or mortality rates. It contains no information on the assumptions the government has made in arriving at these objectives. It offers no insights into the economic and wider benefits and costs of alternative objectives and associated response options.

I fully appreciate that the government – like us all – is operating in a fast-moving situation, and in the swirling mists of uncertainty. I also appreciate the immense pressures that ministers and officials are under. I have no doubt at all that their intentions are sound and that they are working extremely hard for the good of the country. I commend them in that regard. However, the lack of clarity in the government’s objectives, the lack of a clear set of graduated response options, the lack of a well-defined exit from lockdown, and the absence of meaningful cost/benefit analysis of the different objectives and response options is unacceptable. It risks imposing even greater costs on the economy and community than those that have already been incurred. If we are not careful, it risks creating a ‘cure’ that is worse than the disease itself.

The government’s decision to impose a lockdown – and especially one as relatively comprehensive in scope as the one that has been implemented – imposes massive costs on the economy and is severely impacting the livelihoods of millions of people. The costs are not likely to be short-term. We will certainly not be looking at a short ‘V’ shaped recession and recovery. The contraction in economic activity will be very deep – without precedence in living memory. A significant degree of recovery could be expected once some form of normalisation occurs, depending on the response path adopted by the government, but the reality is that this is more likely to be an elongated ‘U’ than a “V’ shaped recession and recovery. It is unlikely that economic activity will get back to pre-pandemic levels for at least a couple of years. Many businesses will fail. Many jobs will be lost.

I am not at all suggesting that these economic costs are solely, or even principally, attributable to the decisions of the government. They are not. Much of the impact on our economy arises from the actions of foreign governments and the associated contraction of economic demand, with flow-on impacts to New Zealand. Nor am I suggesting that severe economic costs would have been avoided had the government done nothing. Taking no action to restrain the spread of infection would have had a serious impact on the economy and welfare of New Zealanders through sharply reduced economic activity. And, of course, taking no action would place the health system under an intolerable strain and create an unacceptably high level of mortality. Some form of temporary lockdown was unavoidable and is necessary if we are to keep infection levels and mortality rates within reasonable bounds.

However, had the government moved earlier than it did to close the borders, and had it applied a mandatory quarantine requirement on all arrivals, then it is very arguable that the scope of the lockdown could have been much less restrictive than it is. That, in turn, would have materially reduced the damage done to our economy and the community. Taiwan is a good example of a country that imposed tight border controls early, adopted broad-based testing and tracing, and achieved a level of infection that is currently around one third of New Zealand’s, despite Taiwan having around five times the population of New Zealand. Those measures meant that they did not impose lockdown on anything like the draconian scale adopted by our government. There are salutary lessons in that for us all. I certainly hope that, once this pandemic is largely over, the government (or its successor) will hold a commission of enquiry into the response actions to draw lessons for any future pandemic response strategy.

What is needed now is a fundamental review of the existing lockdown arrangement. Keeping the basics of it in place for the remainder of the one-month period is probably justified until testing reveals that community transmission of infection is very low. However, there should urgently be a reassessment of some of the parameters within it. There is considerable scope to relax some elements of the lockdown without sacrificing the ultimate objective. In particular, the government needs to reconsider the boundary between ‘essential’ and ‘non-essential’ services. The classifications developed by the government are clumsy, arbitrary and inadequately thought-through. A good example is the very odd decision that butcher shops and vegetable/fruit shops are ‘not essential’, despite the fact that they are significant providers of staple and healthy parts of our diets. The exclusion of hardware shops is another oddity, given that they provide a wide range of items that households typically need. Similarly, the arbitrary line between ‘essential’ and ‘non-essential’ building construction is very arbitrary and hard to justify. Lockdowns in these areas could have been avoided – and economic and social costs reduced – so long as strict social distancing requirements were applied. If strict social distance requirements are maintained in businesses, there is no logical reason to keep them closed. In that regard, it is worth looking at the parameters of the lockdown arrangements in other countries to see whether some sensible relaxations can be made.

Another matter that requires attention – urgently in my assessment – is the state of national emergency (which is separate from the lockdown itself). The declaration of a national emergency, with the associated extreme powers that accompany it, goes well beyond what was needed to ensure effective lockdown. It confers extremely wide powers on the Police, with very few safeguards. The Police have been given an extensive array of powers that New Zealand has not seen since the mid-20th century. Many countries have not found it necessary to do that. This aspect of the arrangements needs to be fundamentally re-assessed. There is absolutely no justification for this country to slide into some kind of ‘police state’. The Police should be acting within tightly specified constraints to enforce lockdown arrangements. They should require a court order to enter premises. And they should be subject to additional independent scrutiny during the lockdown period to hold them to account. The very wide powers under which the Police now operate are not necessary, not justified and are a serious affront to the cornerstone of democracy – our civil liberties. The state of national emergency should be ended. That it could be invoked so easily without something like a two-thirds vote in Parliament is an indictment of the way successive Parliaments have allowed such laws to exist. No government should have the power to declare a state of national emergency without specific authorisation from Parliament and without very close scrutiny by independent parties, such as the judiciary.

Equally worrying is the extent to which this government has allowed the Director-General of the Ministry of Health to call the shots on matters that go well beyond the proper jurisdiction and expertise of the Ministry. The sweeping powers currently vested in the Director-General or medical officer of health, under the Health Act, should not rest with unelected officials. The powers exercisable by officials should be subject to approval by Cabinet or at least a Cabinet committee, with appropriate transparency, and with regular review. As things currently stand, the declaration of emergency simply leaves the powers – extreme as they are – in the hands of a few officials, without even the need for the approval of the Minister of Health.

What is needed now is a comprehensive and transparent assessment and articulation of at least the following matters:

– The objectives of the response to Covid-19. The notion of ‘elimination’ is unrealistic and inappropriate. To my knowledge, such an objective has not been adopted by other governments. It comes with huge costs, and yet the government has failed to articulate what the benefits and costs of this objective versus alternative objectives are. An objective of ‘elimination’ is a bit like saying we want to achieve a ‘zero’ road toll. That could be achieved. But it would require the virtual banning of vehicles on the road or speed limits set to 30 kph or something equally absurd. We do not pursue a zero road toll because we all know that the costs of doing so far outweigh the benefits. Likewise, we do not design building codes to achieve a zero death toll in earthquakes. To do so would impose absurdly high costs on everyone – vastly disproportionate the benefits. Instead, we accept that some deaths in a severe earthquake are unavoidable and we calibrate the building standards to achieve a low but far from zero expected death toll. We apply cost/benefit trade-offs in many aspects of public policy, such as in the funding of cancer medicines, hospital funding, education funding, health and safety regulation, and banking regulation. What we need in the case of Covid-19 is a similar approach – i.e. an objective in terms of infection levels and mortality rates that can be regarded by society as acceptable, given the economic and wider trade-offs involved. We need to see much more comprehensive and transparent analysis by the government of the alternative objectives, and the benefits and costs of each.

– Exit from lockdown. There needs to be clearly articulated forward path for transitioning from the current lockdown to normalisation, in progressive stages. This needs to be informed by a cost/benefit analysis of different transition steps. The progressive move through to normalisation should be informed by indicators that are transparent to all, such as infection levels, percentage of positive test results from wide-sample testing, and community-linked infections. One near-term option – maybe in two weeks’ time – might be to move from lockdown to a combination of requirements that would help to keep infection levels to within defined upper limits, such as:

o continued mandatory social distancing;
o businesses to operate to a maximum number of persons per defined floor area;
o businesses to continue to encourage work-from-home arrangements where feasible;
o mandatory quarantine for all arrivals into New Zealand until a reliable quick-result test can be performed at ports of entry or until global infection rates are below defined levels or vaccines are widely available in New Zealand;
o ensuring that all health workers are regularly tested for coronavirus;
o limiting and screening of visitors to medical facilities, retirement homes, hospices and other places where there are cohorts of vulnerable people;
o encouraging those in vulnerable categories to self-isolate where practicable and providing them with assistance to facilitate that, such as food deliveries and the like; and
o comprehensive testing and tracing practices on an ongoing basis.

Regional variations in the progression from lockdown to various stages of normalisation will need to be considered, based on regional infection levels.

– Extended fiscal support. The sooner we can transition from lockdown to some form of normalisation, the sooner the economy can begin the gradual process of recovery. However, it is inevitable that many businesses, self-employed and employees will be severely impacted for months to come. The government’s support package helps in some respects. However, it is narrower in scope and less generous in quantum of support than the packages put in place in some countries, including Australia and the UK. There is a pressing need to reassess the support packages going forward, including by considering a higher-level of income payment for at least six months, based on the income level of the business/person that prevailed before the pandemic. There is plenty of fiscal headroom to facilitate this. But we need to be sure that any such measures are appropriately targeted to those most in need (based on loss of income and ability to self-sustain) and monitored; this is not a time for a scatter gun approach to fiscal support. Creating new job opportunities for those whose jobs and businesses are unlikely to recover for a long time, if at all, is imperative. Infrastructure spending provides on such avenue, and is already on the government’s agenda. However, this too needs to be subject to robust cost/benefit assessment, and done in a very transparent manner. Any fiscal outlays for infrastructure projects need to satisfy meaningful cost/benefit tests if they are to proceed.

– Central bank support. We have seen some sensible moves by the Reserve Bank in response to the coronavirus situation, even if some of the rhetoric from the governor has been questionable at times. The quantitative easing program will help to keep interest rates low and facilitate bank liquidity. The encouragement of bank lending to their customers, with the backing of a partial government guarantee, is clearly desirable. So too is the relaxation of the timetable for moving banks to higher capital ratios. However, more needs to be done. In particular, it would be desirable for the Reserve Bank to finally recognise that its unjustified capital ratio requirements on banks – extremely high by international standards – has been fundamentally mis-calibrated. It will exert a very unhelpful and economically damaging procyclicality on the banking system and economy by impeding the ability of banks to lend at the very time when we want them to do so. A 12 month suspension of the transition to higher capital ratios falls well short of what is needed. A much smarter move would be to suspend the proposed increase in banks’ capital ratios completely – for at least 3 years. That would give banks greater scope to lend than the 12 month suspension permits. It would also buy much-needed time for a fundamental re-think of what is, frankly, one of the most poorly thought-through and most costly banking supervision policies I have seen from any central bank. The Minister of Finance needs to take a much more active interest in all of this. This is where there needs to be a clear distinction between preserving operational independence of the Reserve Bank for the implementation of policy, as opposed to the setting of policy. In the latter case, the high-level setting of policy should be subject to much stronger oversight by the Minister.

Monetary policy also needs to be further considered. The Reserve Bank has ruled out any further change to the OCR for 12 months. Why on earth would it do that? No other central bank on the planet, to my knowledge, has said they will not be altering monetary policy settings for a further 12 months. No sane person would. In a situation such as this, policy settings need to be kept under constant review and adjusted where appropriate as circumstances change. In these circumstances, it is highly likely that a further easing of monetary policy will be needed as part of the package of measures to support a recovery in the economy. That includes a recognition that the OCR might need to be lowered further. Negative interest rates, while possibly not yet needed, should be further considered (with considerable caution) in this context. Again, the Minister needs to be far more engaged on these matters than he appears to be. Section 12 of the RBNZ Act gives the government the power to direct the Reserve Bank on monetary policy matters. Mr Robertson therefore has the legal avenue to take action if the government (advised by Treasury) sees the need to do so. Although one would not wish to see a trigger-happy intervention by the government, it needs to at least demonstrate that it is closely scrutinising the Reserve Bank and stands ready to intervene should it see the need to do so. The Reserve Bank needs to be under very much closer scrutiny than it is.

The supervision of the banking and insurance sectors also need to be strengthened. Greatly. The Reserve Bank has still not implemented recovery planning requirements for banks or insurers. They have still not adopted a conventional form of on-site assessments of banks’ and insurers’ risk management systems. They have no comprehensive assessment framework for banks’ and insurers’ systems and controls for risk management. They are behind the eight ball on much of what is needed from a supervision authority. The IMF assessed them in 2017 with what could be described as a C- grade. In effect, we have a standard of banking and insurance supervision in New Zealand that is akin, in some respects, to something I see frequently in third world countries. Much closer oversight is needed of the Reserve Bank to ensure that it does what it is paid to do. This is especially necessary now, given the high likelihood that banks and insurers will come under severe asset quality and cashflow strain in the months and years ahead. Proactive monitoring of early warning indicators, closer scrutiny of financial institution risk management and asset quality, and the preparation of contingency plans should be key elements in the Reserve Bank’s approach to its job. Instead, it continues to place emphasis on imposing draconian capital ratios on banks when they are not needed and will badly hurt our economy. And they continue to rely on the ill-considered ‘Open Bank Resolution’ policy for dealing with failing banks, which, if it were ever used, would be like throwing a lit match into an explosives factory. It is time Mr Robertson took greater leadership in the overhaul of the Reserve Bank’s capacity and policy direction in all of these areas. The current review, which is, perversely, being co-led by the Reserve Bank itself, is simply not good enough.

These are just a few issues for the government to be looking carefully into as they develop the strategy to respond to one of the most severe crises we have faced. We need to see a much more focused, thorough, transparent and consultative approach by the government on all these issues. The Opposition also needs to play a strongly proactive role in scrutinising and putting forward its own proposals for handling the coronavirus situation. Now, more than ever, we need a whole-of-Parliament leadership on the response to one of the most damaging crises of our time.

  1. Geof Mortlock is an international financial and economic consultant based in Wellington.

Effective treatment

That is the title of a paper issued on Thursday by the New Zealand Initiative think-tank (mainly written by their chief economist Eric Crampton).  The subtitle is “Public policy prescription for a pandemic” and they range pretty broadly (although not really on public health itself) in the suggestions they offer and issues they raise.  It is well worth a read for anyone seriously interested in thinking about what policy responses the current situation demands, as well as the sorts of issues that will need to be faced when, some considerable way down the track most likely, we are in a position to think seriously about a recovery.

(By contrast, if it is political spin you want re the eventual recovery, you could try the front page of this morning’s Dominion-Post reporting and channelling comments from the Minister of Finance suggesting some sort of Bill Sutch-like pulling back from the world longer-term, insulationism, and massive public works projects.  The election campaign is clearly getting underway, and the PM and Minister of Finance have claimed to be inspired by Michael Joseph Savage, and whatever good things his government did it led us into the rocks of financial crisis and an insulationism that took decades to undo.)

There is a lot of material in the NZI paper and I don’t want to write a super long post, so what I’m going to do is to take the Executive Summary section by section and offer a few comments on each, and then pick up a few of the interesting or puzzling other ideas that didn’t quite make it up to the front of the document.

Unless effective treatment for the novel coronavirus Covid-19 emerges quickly, the world faces not only misery but economic depression. New Zealand will be immune to neither. The normal economic uncertainties of a downturn will be compounded by the uncertainties of a pandemic.

Perhaps a matter of terminology here –  and I know the first draft of the document was written a while ago – but what we already have is much more than a “downturn”.  More like a “dramatic slump”, partly a result of New Zealand government choices re the virus, but much just unavoidable whatever our government had chosen to do.  The scale of the actual quarterly fall in GDP in the June quarter is likely to be utterly unprecedented –  even if by some miracle the current partial lockdown ends 3.5 weeks from now.

The New Zealand Government’s policy needs to directly boost capabilities in the health sector while providing the kind of appropriate economic support necessary when we’re all taking a lengthy staycation and some industries are put on ice.

Uncertainty about the duration of this crisis makes deciding on the most suitable policy difficult.

Certainly agree about the uncertainty, but in a way the uncertainty is even greater, and much more constraining, for the typical business (and many households).  And that facts does point in some policy directions rather than others, given that the Crown is better placed to bear much of that risk that individual private sector operators (firms or households).

(Incidentally, I’m guessing that the huge number of people losing their jobs altogether each day aren’t thinking of this as a “staycation” but as an utterly disorienting disaster (even if, as for most of us, we know no one with the virus itself yet).

What they say on health itself seems sensible to me

The first priority must be with health.

Increasing the capacity of the health sector to deal with peaks in numbers of Covid cases is important to reduce mortality and morbidity rates. But nobody quite seems to know just where the binding constraints in the health sector are. While credible newspaper articles warn about substantial shortages in equipment and incredible pressure on staff, official statements have been far more sanguine.

If there really will be shortages of critical equipment in four to six weeks, potential suppliers should know that today. Quietly shoulder-tapping likely suppliers may partially solve the problem but won’t provide the necessary scale of response. Suppliers can come from unlikely places. For instance, Italian hospitals are reportedly trialling ventilators reconfigured from scuba diving equipment. Simply announcing a willingness to purchase equipment – and the prices the Government is willing to pay – would allow potential suppliers to identify themselves. Serious companies aren’t likely to re-tool without the certainty of a contract. But they do need to know the demand exists and that they can get essential service status to do the job.

Rapid identification of equipment and skills necessary to boost capability in the medical system, combined with a wide call for assistance, would enable people and businesses to find ways to help. If the health system is not already doing so, it should be offloading less-significant tasks to helpers with limited training, to ease the burden on key medical staff. For instance, thousands of air cabin crew have been trained in first aid and will have plenty of time on their hands. With some rapid training, they may be able to ease some of the burden.

Additionally, the Government has asked retired health workers and health workers furloughed by the current lockdown to assist in Covid-response. It should also consider those foreign-trained medical professionals already in the country who have not yet been able to secure New Zealand medical registration.

To which one could add that a commitment to utter honesty and transparency about what the government does and doesn’t know, has and hasn’t etc would help build stronger confidence.

Part of the cure for a pandemic is a sharp reduction in economic activities in areas not related either to pandemic response or critical areas like food supply. That’s why support for workers and firms is important. But the Government’s chosen wage subsidy scheme is not working well. Even if it can be extended to larger employers, it provides too little support to keep companies from laying off staff en masse.

The Initiative urges the Government to consider a version of Germany’s Short-Time Work support policy. That scheme allows firms to shift workers to a fraction of their normal hours along with an income top-up from the Government. That way, instead of laying off 80% of staff, a company could keep staff on 20% of their normal hours with little reduction in worker earnings.

This kind of scheme is better than either relying on benefits or starting up the sometimes-promoted universal basic income (UBI). A speedy reboot of the economy when this is over matters. That is much harder to do when companies must rebuild hard-earned experience and skills from scratch. The Short-Time Work support policy maintains both workers’ incomes and their links to employers. It targets support to those workers whose hours are cut, rather than spreading support broadly to those far less affected. Simply put, it works better.

I’m increasingly attracted to the Short-Time Work option.  In Germany, for example, in the last recession real GDP fell by more than in New Zealand, and yet the rise in the unemployment rate was much less in Germany than in New Zealand.  Whether or not it makes sense for a country like New Zealand in the longer-term is an open question –  I’m not yet persuaded – but….had it been in place a month ago here it would have looked quite well-suited, albeit perhaps too generous, for the situation we now face.  My unease with as proposed in the NZI paper, and given the time that has already passed, is that if we tried to adopt it as the main initiative now, it might still not do much to keep firms intact –  so severe are the losses of revenue and the extreme uncertainty about whether and when that revenue might again pick- up markedly.   And I entirely agree with the NZI that a UBI is simply not fit for purpose at present –  it does nothing to sustain firms and labour market attachments, and it provides bonus income to the large chunk of the workforce (especially in the public and agricultural sectors) that aren’t likely to be very adversely affected anyway.

Some tax provisions can also be eased. Individuals and firms should be allowed to combine the 2020/21 tax years and temporarily suspend their PAYE collection and Kiwisaver contributions. This would immediately provide more cash in hand everyone. Companies staring down provisional tax assessments based on last year’s earnings could instead defer everything to next year.

This one puzzles me a bit.  It is hard to see that it would do much harm, but it isn’t clear what good it does either.  For those still in a job, they don’t have need of huge amounts of cash right now (what is there to spend it on?). For those out of a job, they aren’t paying PAYE and Kiwisaver anyway. I guess the focus is people on reduced hours, and I don’t have much sense of how large a proportion of the labour force they might be.

Simultaneously, the Government could help reduce business’ fixed costs that otherwise might have compelled them to shut down. It could also cover Council rates bills for firms in financial distress, averting a major hit to the local government purse as well. And access to credit can be improved, especially over the longer term as wage support to employers may need to ease.

I’m a bit puzzled about the rates focus.  I don’t have the figures at my fingertips, but I would assume the business fixed costs that were typically much more substantial were rent, lease costs, and other finance costs (ie interest) –  business interest rates having hardly fallen at all.   There has been some discussion in Australia of the possibility of the government taking over not just wage liabilities but rent.   It is radical, but not out of line with the spirit of my own scheme, guaranteeeing for a year all firms and households 80 per cent of the most recent year’s taxable income.

Finally, a modified version of the New Zealand Student Loan programme should be made available to non-students to help bridge any remaining income gaps. It has the advantage of having already set provisions for income-contingent repayment when the crisis passes.

This is an idea I really quite like.  I asked Eric the other day why they weren’t including here an option to withdraw Kiwisaver funds – again done in Australia –  and he suggested that this borrowing scheme might be preferable, and avoid the risk of encouraging people to cash out of Kiwisaver at the bottom of a share price slump.   Personally, I think people should make their own judgements about that –  US share prices don’t look very low to me – but the secure access to credit (amounts capped at a moderate level) seems quite a good idea.

But financial support is not the only way the Government can and should help.

Regulations that were no real barrier to getting things done in normal times can be insurmountable in a pandemic. For example, some airline pilots require time in simulators to maintain certification, but the necessary simulators are in Australia. In normal times, this just doesn’t much matter – pilots can roster onto an Australia route when and as necessary. This doesn’t work now. But the Government can’t be expected to identify every barrier proactively. It needs to rely on business to highlight the obstacles as they come up using lines of rapid communication with regulators who can suspend or modify them during this crisis.

Sounds sensible to me.

And this is no time for policy or regulatory changes which are not related to the pandemic. The Reserve Bank and Commerce Commission have already postponed theirs. But Parliament’s Select Committees are still asking for submissions on non-urgent legislation. Doesn’t the Health Select Committee have better things to do than consider the regulatory framework for vaping? Some legislation may be urgent enough to require submissions during the Level 4 alert, but everything else should be quarantined.

Totally agree (and I could not quite believe on Thursday when someone asked me for some input on an aspect of a submission on a not-very-important-at-all bill that had submissions closing that afternoon).

Obviously, the Government should borrow the funds it needs to do all this. But this will require maintaining a disciplined approach to any spending lines unrelated to the pandemic. Entrenching new ongoing commitments would complicate a return to prudent debt levels after the crisis and make it harder to borrow the funds necessary for responding to the pandemic.

Hopefully the four weeks of Level 4 lockdown gives the Government enough time both to knock back the pandemic and adjust policy to help us through the coming economic turmoil. We need to adopt more effective treatment.

It is likely to be easy enough to borrow whatever it takes through the crisis.  Not only is the balance sheet strong, but we have a central bank, able to effectively lend into a shock that is, for the time being, powerfully deflationary.  Whatever monetary policy can do, directly or indirectly, the better.

What else struck me in the rest of the document.  Simply in the order the paper comes:

If a treatment does not emerge quickly, economic turmoil could easily last well over a year and the 2008 recession could look mild by comparison.

At this point, this is rivalling the Prime Minister for understatement. For New Zealand, what we see now is already far worse than the 2008/09 recession.

Firms that were viable during normal times and would be viable again after the crisis may nevertheless have substantial difficulty in securing credit to see them through.

The government’s small and medium business loan guarantee scheme –  details yet unknown – may well tackle this particular issue. But it is unlikely to be the main issue.  A far bigger issue is that many firms’ owners will not be willing to borrow, faced with the huge revenue loss and huge uncertainty.  If time could simply be stopped as at the end of February and resumed again 12-18 months hence, it might be one thing.  But there are real and often big costs for many firms, even if the government were to cover many of the wage costs –  and recall that at present even the government wage subsidy is only on offer for a few months, and there is no possibility of many of the adversely affected industries coming back strongly in that time.  We know that.  More importantly, owners in those sectors either know it already or will be realising it very fast.  My one year income guarantee is aimed to buy time before firms simply decide to exit.  But more will simply be exiting with each week that passes, without government action.

(Incidentally, I was a bit surprised not to see any caution in the NZI paper on one rule for the big and well-connected firms and another for the mass of companies.  Sadly, that is the way the government seems to be talking at present, and Air New Zealand already sets something of a precedent.   Quite possibly, policy will not be generous enough anyway, but it would hardly command ongoing public support if just the big-end of town is able to collect from the government.)

A post-crisis recovery period might include longer school and university hours to allow students to catch up on missed work and the temporary extension of working hours for the employed.

Quite what is going to happen, especially around school, if the situation drags on for long is hard to tell.  The current on-line model might work fine for well-motivated senior students, but I’m sceptical it can work for long.  I was a bit more troubled by the final better of the sentence: people may well want to work longer hours, and should be free to do so, but there is a tone to that sentence that almost suggests the state might direct longer hours.  And I’d be distinctly uneasy about anything of the sort.   In thinking about coming through the other side of this, it is wise to keep the overall economic losses in context.  Suppose GDP fell by 50 per cent for a year: that total loss is equivalent to 1 per cent of the total income the country and its people will generate in the next fifty years.  Even if we end this with government debt at 70 or 80 per cent of GDP – which need not happen with sensible balanced, but generous policies, in a growing economy with a balanced budget debt ratios drop away steadily without undue longer-term dislocation (as a historical reminder, the highest level of government debt on record in New Zealand was about 230 per cent of GDP).

Reckless trading provisions of the Companies Act makes directors liable for taking on more credit while insolvent. Policy may require making credit available to companies made insolvent by the crisis.
Banks may be unable to lend as needed during the current crisis if hampered by responsible lending criteria requiring assessment of future income. Relaxing these criteria will help.
Record-keeping and witnessing requirements of AML/CFT regulations currently require face-to-face processes; this may be impossible during lockdowns. Alternative compliance arrangements must be implemented.

I wasn’t quite sure of how much there was to the second point –  although would welcome any comments to elaborate-  but generally the issues raised seem sensible.

Encouraging more people to work from home may require helping individuals and firms with any unexpected costs. The Government’s decision to allow full depreciation of minor business investment will help. It may wish to go further in supporting firms providing employees with the necessary equipment if people are working from home over longer periods. Office-based workers, in the short term, can make do with a laptop but may eventually require monitors, printers and other similar equipment at home. Small condition-free grants to small business calculated by employee headcount

This one seemed like a level of specific support too far, and again would be better dealt with through my overarching income guarantee approach, which enables firms and individuals to make their own choices.

As I say, there is a lot in the paper worth thinking about and debating.  From my perspective it is mostly rather micro-focused, but in that sense much of what is good about the paper meshes quite nicely with my programme for macroeconomic stabilisation, which might usefully be read together with the NZI piece.   The proposed one-year income guarantee –  ACC for the national income, the payout of an (implicit) national pandemic insurance policy –  is at the centrepiece of that, but so too is further really major cuts in retail interest rates.  It is truly remarkable that the government can shred civil liberties, scrap Parliament in the midst of a grave crisis, close down much of the economy and almost all of society, ban funerals and so on….and yet the government, while essentially unfettered power at present, for good and ill, will do nothing to insist on such a basic aspect of responding to any large scale economic slump: much lower interest rates, and servicing costs, in a period when time simply justifies no return.

More on that issue on Monday.

 

Self-imposed constraints (the latest from the RB)

The Governor of the Reserve Bank had an op-ed in the Sunday Star Times yesterday, and I’d intended to use it as the basis for post today.   The column is quite as complacent, relative to the fast-unfolding reality, as anything we’ve had from Orr since first we heard from him on the coronavirus topic at the mid-February Monetary Policy Statement.  Even last week he was telling Mike Hosking that his level of concern wasn’t really that high (“six out of ten” was his line, and none of it sounded like simply an attempt not to spark a panic, and he told RNZ’s Kathryn Ryan that it was ridiculous to compare what was unfolding with the Great Depression (of course the specific causes are differerent, but when people make those comparisons they are typically highlighting the scale and severity of the drop in output and/or the  –  largely self-imposed –  limitations of monetary policy).  Everything Orr has said on the subject has sounded as if it might have been reasonable 10 days earlier, but not when he actually said or wrote things.   Complacency has been the best description, in a climate in which it is the last thing we can afford from our powerful, but barely accountable, head central banker.

But I’m not going to waste time unpicking the latest column, which it isn’t even clear why he wrote.

Before moving on, this is the standard real GDP estimates for New Zealand for the Great Depression (there are no official numbers that far back, although there were a lot of partial indicators).

nz depression

Real GDP in New Zealand is estimated to have fallen by about 15 per cent, peak to trough, over three years ( as a reminder it had fully regained those losses, though not got back to the previous trend, before Labour’s icon Michael Savage took office in December 1935).

Any bets on how deep the fall will be in New Zealand’s GDP over even just the first half of this year?   It depends a bit on how intense any lockdown is, but if someone forced me to put a number on the likely fall (June quarter GDP relative to last December quarter’s) it would probably be 25-30 per cent (similarly numbers are bruited about by serious people in the US, with the risks skewed to something worse.

And, reverting to the Great Depression, what got things going again then?  Well, the UK –  our major market, and less hard-hit than many countries – went off the Gold Standard in September 1931 allowing a substantial easing in monetary conditions.  And we, without yet having a proper currency of our own, further devalued against sterling in January 1933  (the US threw in some monetary policy easing later in 1933 as well).  In other words, letting off the previous self-imposed shackles of monetary policy made a great deal of difference for the better.

This is a quite different, but for now much more severe, sort of shock.    It seems unlikely that we can envisage even beginning much of any economic recovery until the virus situation is more or less sustainably under control, not just here and abroad.  Neither monetary nor fiscal policy will stop the deep drop in GDP going on right now, and probably shouldn’t even think to try right now (we are deliberately closing things down as part of fighting the virus).

But that doesn’t mean significant monetary policy easing would not still be helpful.  There are those worrying falls in inflation expectations, and more immediately there are the still-high servicing costs of a rising stock of private debt.  Public and private debt overhangs were a big issues, including in New Zealand, in the Great Depression, exacerbated then by the sharp fall in the price level.    It is pretty unconscionable that in this climate, where time has no value, floating rate business borrrowers are still paying 5 , 6 or more per cent interest rates.  That is almost solely because the Governor and the Bank refuse to do anything about significant negative interest rates possible –  it is this generation’s Gold Standard (there was a real aversion to moving away from it, and yet doing so finally made a huge difference for the better).

The Governor likes to claim that the Bank still has lots of monetary policy leeway within his own refusal to take the OCR negative (even though his chief economist told the public two weeks ago that it really wasn’t so)

yuong ha

Really just “a little”.

And I think it is safe to say that we have had fairly confirmation of Ha’s (generally not very controversial point) this morning.  The Bank and MPC issued a statement in which they committed to buying $30 billion of government bonds over the coming year.

It was a pretty feeble programme, even if the headline number was big.  A year is a very long time at present.  And whereas the RBA the other day announced an asset purchase programme centred around targeting government bond yields of three years to maturity at 0.25 per cent, it isn’t really clear what the goal of our MPC actually.  Settlement cash balances –  which is what banks get when market participants sell bonds to the Reserve Bank –  aren’t the binding constraint on anything.

And what did this large asset purchase programme announcement do?   The yield on a 10 year government bond fell by 50 basis points.  That is a big move for a single day, but……that still leaves the 10 year bond rate materially above the lows reached after the MPC’s cut in the OCR last Monday.  Quite possibly, without this action bond yields and corporate credit spreads would have spiked still higher.  So I’m not opposed to the action, but all it has done is to stop monetary and financial conditions tightening further, when what the circumstances demand is a really substantial easing of monetary conditions.    It isn’t as if there was a great deal (much at all, it seems) of an easing in the exchange rate either.   And this was the MPC’s preferred unconventional tool……as I said last week, if they are going to refuse to go negative it really is game over for monetary policy, at just the time when adjustment is most needed.  Recall the 400+ basis point cuts in retail rates we typically see in a New Zealand downturn, all of which will have been less dramatic than what we are now experiencing.  Central banks huff and puff and wave their hands to suggest lots of action, and they have done useful stuff on liquidity (again to stop conditions tightening) but the Reserve Bank of New Zealand is not alone it seems in playing distraction, to divert attention from what little monetary policy is doing given the self-imposed (wholly self-imposed) constraints.

(All of which said, even relative to the RBA, our MPC is not doing as much as they could.  As noted above, they could explicitly target and securely anchor government bond yields.  They could also still cut the OCR, even without going negative: the headline rates in both countries are 0.25 per cent, but in New Zealand that is the rate we pay banks on deposits at the Reserve Bank, while in Australia the deposit rate is lower again.   These are small differences, of course, but there is no sound analytical or systems reasons for not using all the leeway even their self-imposed constraints allow them.

Of course, the much more immediate huge issue is what the government is going to do to underpin the credit system and support a willingness of banks to lend and firms to borrow.  The only secure foundation for that remains some mix of grants and income guarantees (which will become grants).  I can only repeat that the most useful way of thinking about these thing is as the national pandemic economic policy we would have adopted twenty years ago if we’d thought hard enough, been serious enough, about what could happen: undertake to underpin all net incomes at 80 per cent of last year’s for the first year (reducing after that if the issue is still with us).    The fiscal costs are easily manageable for New Zealand: if guaranteeing 80 per cent of incomes than even if full year GDP fell 40 per cent, it would still only be a fiscal commitment of 20 per cent of GDP, and we are starting with net government debt (properly defined) of zero per cent.   It isn’t the exact dollars that really matter at this point, let alone trying to distinguish good and bad firms, but the certainty such a guarantee –  ex post insurance policy –  would provide in capping the extreme downside risks, individually and collectively for the first year.  It wouldn’t stop all exits –  some have already happened, some firms are likely to think it not viable to come back even with a grant/guarantee –  but it is the best option to help stabilise the economic damage, and to ensure that banks are able and willing to play a strongly facilitative part.

On Q&A yesterday the Minister of Finance suggested more announcements very shortly. I hope so but what worries is that once again whatever they do will be inadequate and not really get ahead of the issue. There is an opportunity now, but time is running down fast.

Another sobering chart

On Saturday I showed the then-current version of this chart.

aus 22 march

As I noted on Saturday morning

It is much the same locally-exponential pattern we’ve seen in so many other countries.  If current rates of increase continue then by the end of tomorrow Australia will have per capita numbers akin to those in the US or UK yesterday.  That is the sort of impact exponential growth has.

Australia now has as many, slightly more, cases per capita than the US and UK had on Friday.

What about New Zealand?  In this chart I’ve shown the Australian numbers divided by five (to put them on the same per capita basis as New Zealand).

nz and Aus

Perhaps at a very first glance, New Zealand doesn’t look too bad.  But look across the chart not up and down.  Our latest observations are where Australia (in equivalent population terms) was just a week ago. There is no evident or obvious reason to expect that in a week’s time we wouldn’t be something like where they are now  (or if there is such a reason no political ‘leader’ has been willing to try to articulate one).

And yet our government continues to pretend to believe there is no community transmission, confirmed or not.  It is simply extraordinary.  Reversing the presumption now – in light of what has happened in ever other similar country, but most notably in Australia with whom until almost now we’ve had a Common (travel) Virus Area –  seems much the safer option.

Sadly, it seems on a par with how the government and the Ministry of Health have treated the threat from the start.  It was, after all, only about three weeks ago that the Ministry was tweeting, on its official account, that there was more to fear from rumours, stigma etc than from the virus itself.  Nine days ago, on their website they asserted that the risk of outbreak was low.  And presumably acted/advised accordingly?

And then there is the elected government and the Prime Minister in particular (the Minister of Health has been largely invisible and apparently irrelevant).   Because it is so easy to lose track of what was said even a few days ago I went back and read the transcripts of her post-Cabinet press conferences since the start of the you (28 January was the first).  Admittedly the questioning was often equally lethargic, but it was truly startling just how complacent the Prime Minister had consistently been.  There was no apparent sense of urgency, no apparent recognition that significant spread globally was –  if not a certainty – a very high probability against which the whole of government and the private sector should be preparing, and no attempt to get out in front and alert the public to the serious threat that was looming.

Now, you might argue that our Prime Minister wasn’t much different to those abroad, and from what one sees that might be a fair comment.    But it isn’t exactly an excuse for any of them is it, with the full horror of Wuhan already in view by the end of January.   You might also argue that few/commentators were sufficiently alarmed either, which is probably also fair.   But the government is the government –  hugely well-resourced by any other standards, and fully linked in to the intelligence and threat assessments of other countries.  On the economic side, it is not much more than two weeks ago that the Prime Minister was playing down the risk of recession – laughable, if not so serious, even then –  when now we are heading into the deepest (and they are all temporary) and most sudden deep slump in New Zealand history.

When they have finally taken actions, they’ve usually been like knee-jerk reactions (often a mere day or so after denying any intention of anything of the sort, going all the way back to the first China travel ban, which they were bounced into by Australia a day after telling the Chinese foreign minister they’d do no such thing).   And, most concerningly to me, there is simply no evidence of a strategy, and no willingness to engage the public on the options, choices and risks around threats and policies that have huge huge economic, social, and civil liberties implications for us all –  not for days, but potentially for months or a year or more.  It is simply inexcusable, and almost beyond belief (even as we have to watch it day by day).    The four-stage scheme they rolled out on Saturday is certainly no strategy, and although it might have been a welcome start six weeks ago, coming out with no substance in a much-vaunted Prime Ministerial address on Saturday, it had all the feel of having been dreamed up on the back of an envelope on Friday afternoon.  There is no evident strategy.  There is no evident exit strategy for anything done so far, or anything they have in mind.   Some of the specifics even look untenable, notably the detail of their schools policies.

In fact, the more I’ve reflected on the issue over the weekend, the more I wonder how much relevant planning has been done at all.    I was recalling the huge effort that went into pandemic planning in the public sector in abour 2005/06, which I had quite a lot to do with (the economic dimensions of).   The problem with that work, as I reflect back now, is that it was mostly based on something like a re-run of 1918, where a huge proportion of the population was off work sick, or caring for the sick, but that the country was never “locked down”, and it envisaged the pandemic passing through perhaps in waves, but pretty concentrated ones, as in 1918/19.  I don’t recall anyone giving any serious thought to the idea of closing the border indefinitely (short closures sure), to locking down the economy and social interactions for many months at a time.  Perhaps in the subsequent decade, official agencies revised their planning – I hope so, but I was in public sector economic agencies until 2015, and never heard a hint of that.     And given how lethargic the whole of government was in January and February you have to worry that officials, in our greatly diminished public service are just now making it all up as they go along.

One specific dimension that got my goat was the PM lecturing (and that was her tone, repeatedly) the country about stocking up in supermarkets.   She assures that everything not only is  fine now, but always will be, no matter what stage of the crisis we get too.

First, looking backwards, one of the supermarket chain heads at the weekend said buying last week was just ahead of that in the run-up to Christmas, “but for Christmas we have a long time to prepare”.  That seemed like a fair point for him to make, but why had the Prime Minister and the government not been working with supermarkets weeks and weeks ago to emphasis the fast-building threat and urging them to increase production to cope with possible surges in demand.  Such demand was entirely foreseeable, conditioned on a recognition of the risk.  The public shouldn’t be hectored by the PM for what is her failure and that of her government.

But the bigger issue is forward- looking where she has been grossly over-promising.  It might be reasonable to suggest people slow down for a few days and let the supermarkets restock (having herself been neglectful from the start), because it probably is reasonable to assume that supermarkets will remain stocked in the early days of any lockdown.

But the Prime Minister seems not to recognise at all that in such a climate many people will prefer to avoid supermarkets if at all possible, and to have inventory in the home rather than in a public place.  That will be especially so if and when the health system becomes overloaded –  as people warn it may within a month or so –  and people reasonably fear that if they and their families get sick they may not be able to get decent treatment.

And I trust the government to keep supermarkets open in some form or another throughout, and am moderately confident the basics will be kept available –  perhaps intermittently at times, and for some goods.  New Zealanders should not starve (Irish peasants used to have adequately nutritious diets of milk, potatoes and oats).  But, frankly, most people want more than milk, potatoes and oats.  And none of us knows (a) what production the government will deem essential, (b) what factories will still be adequately staffed (and distribution channels have to hold up), and (c) what other countries will deem essential. Because, you see, although the PM talks blithely of international trade in goods continuing, that only means much if international production of things New Zealand imports continues.  As just one example, I just had a look at the back of the dishwasher powder container, and was surprised to learn it comes from……..Poland.  Hard to imagine production of dishwasher powder would be an essential in Poland if/when they are in lockdown.  It is quite plausible that lots of non-basic non-perishable goods could rapidly become quite hard to get.  Buying extra now is utterly and totally rational, whatever the Prime Minister says.  To not do so would mean putting a great deal of faith not just in the good intentions and words of the government, but in some tail-event optimistic scenario about how everything will work in a period –  that as even the Minister of Finance put it –  could last for months.

Personally, I simply have no confidence in anything they say or do anymore.

(And, please note, nothing in this is advocating any particular set of anti-virus policies now.  There are genuinely hard choices.  My kids are still at school this morning (we had the conversation yesterday).  But there is no evidence of strategy, there is no evidence of engagement with the public re what the future holds, there is no evidence they’ve thought through the limits of the state (as Matthew Hooton put it on Twitter the other day, there are some things more important than public health, but what does the PM think those are?) and so on.   It is a pretty egregiously bad performance so far, all compounded –  this is an economics blog –  by the manifest inadequacies of the economic policy response to date from government and the Reserve Bank –  and yes, I have just seen the latest RB release.)

 

 

 

A programme for macroeconomic stabilisation

On Monday afternoon I put out a post under the heading “A radical macro framework for the next year or two”.   There were four, intended as mutually reinforcing, strands to what I was proposing.  Those strands were, with a few marginal refinements relative to Monday’s post:

  • urgent action, legislative if necessary, to ensure that the OCR can effectively be cut to at least -5 per cent with substantial flow-through to retail lending and borrowing rates,
  • in the meantime, the Reserve Bank should stand in the market to buy any government bonds on offer (at 0 per cent yield for bonds with less than five years to maturity and perhaps 0.5 per cent for longer-term nominal bonds),
  • passing legislation to cut all wages by 20 per cent temporarily – at present for the next year (and probably reviewable rentals too –  the principle being fixed price contracts other than interest rates, separately dealt with above),
  •  urgent legislation (or, as a second-best, use of the Minister of Finance’s guarantee powers in the Public Finace Act) guaranteeing that all tax-resident firms and individuals would enjoy net income for 2020/21 no less than 80 per cent of that for 2019/2020. (For firms, that guarantee would be scaled to the extent staff numbers dropped below pre-crisis levels.)

Of these, right now something like the fourth measure is the single most important: to remove much of the downside income risk, in a legally-binding way, such that banks (and other financial institutions, but mostly only banks matter here) should be willing to (a) continue with current credit exposures, and (b) extend further credit as required to accommodate the net revenue shortfalls many businesses and lots of households will face.

No matter how much banks say they want to support customers, and probably genuinely mean it, banks are businesses too.  At present, there is no readily discernible date at which banks can assume either business or household net revenues will be back to normal, and no certainty about the nominal environment we/they will face at that point, having gone through a huge deflationary shock.    It won’t be problem if someone with a residual mortgage of 10 per cent of their house needs credit, or a firm with little borrowing and substantial physical assets.   I’m sure banks will be only too happy to accommodate such customers.  But plenty of household borrowers have large mortgages,  house prices will be falling (in a highly illiquid market), and many business customers won’t have much to offer by way of collateral at all.  In the latter case, the Crown guarantee would be structured to serve as such an asset.

As for really heavily indebted firms or households, some would probably just prefer to close down/liquidate and protect whatever equity the owners still have rather than take on large new debt for an indeterminate horizon of income loss.   For a firm with large fixed commitments, the need for additional credit (net cash outgoings in a climate of quite limited revenue) might be really large.  The underlying business might be sound, but it simply wouldn’t be worth it to the owners (and it isn’t as if M&A activity is likely to be buoyant in the coming months).     Banks know all this.   Bigger business borrowers will know it all.  Smaller ones will realise it quite soon.

If the goal is to avoid widespread, somewhat indiscrimate, closures and perhaps forced liquidations –  leaving the institutions of the economy not too badly positioned to pick up not far from where they left off in perhaps a year or two’s time –  the government needs to offer this sort of certainty –  ex post pandemic insurance (paid for later in higher taxes across the board).  Drip-feeding cash will not cut it, because expectations –  looking ahead –  matter to all involved.    And, of course, there is no serious way the government can directly lend, remotely responsibly, to hundreds of thousands of individual companies.

Is it ideal?  No, of course not.  But it might not be too far from the sort of model we might have chosen to pay for ex ante  had we properly faced up to the nature of pandemic risks decades ago (although even then each pandemic has its own idiosyncrasies, so I don’t really feel the need for us to lament that we did not have such established arrangements in advance).  Are their moral hazard risks?  Yes, no doubt.  There will be pandemics again, but if this one proves to have been a 1 in 100 year event, we may not need to worry too much about the moral hazard point (and frankly, I’d be more worried if what actually happened was that lots of firms went to the wall and the system just bailed out those who happened to be very politically well-connected or able to effectively play up the consequences of letting them in particular fail.)

I regard decisively dealing with the effective lower bound on nominal interest rates as also very important, but for different reasons and (in the particular circumstances of this crisis slightly less urgent).   As I’ve pointed out repeatedly in the typical recession in recent decades, the OCR (or equivalent) has been cut by 500 basis points or more, and this recession is likely to be much more severe than any of them.  75 basis points just does not cut it.  Similarly, the exchange rate usually falls deeply, and it has not moved that much at all so far –  not helped by the Bank promising not to cut further.   And, related to both of these, stabilising medium-term inflation expectations is vitally important in the face of a severe deflationary shock if we are not to complicate (perhaps greatly) the eventual recovery phase.

There are nuanced arguments about whether the limited experiments with negative policy rates in Japan and various European jurisdictions have done much good (it was surprising –  even more so in hindsight –  that the Governor did not even touch on this debate in his speech last week).   I find the fairly fragmentary evidence at best inconclusive, but more important not terribly enlightening.  These experiments have been adopted in relatively normal economic times (low interest rates to be sure, but economies have generally done okay in the last few years) and they have involved very small changes, still bounded by the risk of large scale conversions to cash.  There do seem to have been some psychological hurdles to facing retail customers with negative rates, and in many cases banks did not bother (there wasn’t that much in it).

But we are in quite different times at present.  On the one hand, depositors have few practical useful options in a climate of extreme uncertainty, high volatility, and generally declining (variable) asset prices.  And on the other, I am talking not about 25 basis points here and there, but about the ability to cut the OCR –  and comparable rates in other countries –  by another 500 basis points (and even that wouldn’t be exceptional: in the last US recessions some models suggested the Fed funds rate needed to have been able to be cut by 1000 basis points, not the 500 points the Fed actually cut by.   We need this policy leeway  –  to markedly ease servicing burdens of existing borrowers (this tends not to feature in a US context where there is so much fixed rate lending), to help drive down the exchange rate, to support medium-term inflation expectations, and (in time) to help set the scene for a robust recovery in spending and investment.     Enable the OCR to be effectively set at -5 per cent and retail interest rates will soon follow.  If necessary, given the exceptional nature of the time, I would be happy to see regulatory power used to jolt them down collectively.   If we do nothing on this front, we not only leave an enormous vacuum where stabilisation policy used to be, we really jeopardise those medium-term expectations (which appear to have been falling a lot in bond markets, overseas and in New Zealand – albeit accepting that the inflation breakevens are harder than usual to interpret).

The third strand –  assuming no instant action on fixing the effective lower bound –  would be to have the Reserve Bank standing in the market buying bonds at predetermined yields.  The main advantage of this is signalling –  absolute determination to keep medium-term inflation up in the face of the most powerful deflationary shock since the Great Depression –  but the real advantage (partly in contradiction to the first) is to demonstrate, including to the Governor, that these alternative instruments he talks up (even as his Chief Economist was talking them down) are no adequate substitute for lower interest rates, and will not do much themselves to lower private market interest rates when 0.25 per cent is a floor on the OCR.  There is no credible transmission mechanism in the current context that would make much difference, including little or no relief for borrowers –  in a climate where time has largely (and currently) lost its economic value.  But give it your best shot, quickly, and then got on with fixing the real stuff of monetary policy.

The fourth strand probably appeared rather odd, or even quixotic.  I was accused on Twitter of being some sort of right-wing stooge wanting to beat up on workers.    In a typical market economy, workers (implicitly) pay firms to accept risk.  Wages are contracturally fixed and unless you are laid off or the firm fails you can count on your wages each fortnight. Profits on the other hand are highly variable, down as well as up.  It is a good system for most of us, almost all the time.  But this year the economy is going to be really substantially smaller than anyone imagined when, for example, they contracted for a price at which they would hire/supply labour this year.    It is no one’s fault (at least from the juncture of 2019 –  who knows what could have been done differently about pandemic risk in earlier years).  We could simply let the losses lie where they (legally) fall.  In that world, lots and lots of firms will fail, and lots and lots of employees will lose all their income (and have fewer other options for the time being).  Not only that, but large chunks of their fellow citizens –  beneficiaries and NZS recipients, and public service employees face almost no income risk at all.

Part of getting through this crisis is going to require a secure (through time) sense that there is some fairness about who bears the losses –  and the losses are now large and unavoidable in aggregate.  If we’d been told three months ago what this year looks like, almost no private firm would have contracted for this year’s labour at the current price.  What I’m proposing –  a statutory wage cut of 20 per cent –  simply acts as a coordinating device, that allows everyone to lose something (and know that people in similar positions are making similar sacrifices).    Of course, in the immediate sense those who benefit from such cuts are firms –  unit labour costs are cut –  but actually it won’t generally be a transfer to capitalists because of the guarantee I promoted earlier (it is likely to be binding for a majority of firms).   In practical terms, the wage cut will probably mostly benefit the Crown finances, and enable the government to deploy resources aggressively as required at different phases of this process.   In the current phase, more private sector demand is not what is sought anyway (we are closing down much of the economy).  In the recovery phase – which might yet be more than a year away  – it will.

The wage (and rent) cut isn’t vital to the rest of the package in narrow economic terms. It is about perceived fairness and sharing the load.  I can’t see a world in which large chunks of private sector employees lose jobs, while almost all the public sector sails securely onwards (and, as I noted the other day, our household’s main income is a public service salary, so when I talk about fairness here I really mean it).

Various people who read my post on Monday –  often rather quickly –  responded by challenging me as to why we should not just adopt a temporary UBI, as even some establishment figures on the right in the US (notably Mitt Romney) have advocated.   My answer is really quite simple: in these particular circumstances, a UBI is shockingly badly targeted, and would disburse huge amounts of money while still not addressing the main presenting issues.  It would be startlingly unfair –  all those secure public servants, for example, would get even more money on top of their secure incomes, in a climate in which the whole country is quite a bit poorer.  It would discourage retained labour market attachment (this might be a marginal effect, but it still works the wrong way).  And it is focused on maintaining or boosting spending at a time –  the present –  when that is about the last thing we want to be doing.  Recall, we are deliberately shutting down much of the economy more or less rapidly in an attempt to suppress the virus –  and that includes not putting more people in shops, restaurants, theatres or whatever.  And it would do nothing for medium-term inflation expectations.

Basic income support for those whose jobs won’t exist or be able to be done should of course be provided.  That is why we have a benefit system, currently with no stand-down periods.  But for most people shortage of cash coming in won’t be the immediate issue –  they will barely be able to spend what they are getting anyway.   The big focus has to be, first, on those guarantees that keep credit going and help hold firms –  and employment –  together, reinforced by actions to stabilise medium to long term expectations.  But the focus now has to be on stabilisation and relief, not on stimulus –  trying to lift the level of activity –  per se.

Again, as I’ve said before the time for stimulus will come.  If we really fix the lower bound we might not need too much additional fiscal support –  the government accounts will have taken a deep (but appropriate) hit during the crisis itself –  but if fiscal support is helpful then, there are plenty of options, at a time when people are likely to be showing renewed interest in spending.  I’ve touted a temporary cut in GST.  I’ve also noted the possibility of a temporary cut in one of the lower income tax rates (which would deliver a similarly-sized boost to most people).  But straight lump-sum payments to individuals or households could well have a useful place then –  after all, for those who think these things are just playthings of the left, George W Bush used that approach early in the 2008/09 recession.

There are probably some other points/emphases in Monday’s post, with which this could be read together.    But action really is urgent, and that need isn’t conditioned on quite how few or many coronavirus cases we happen to have –  as I heard one smart medical-oriented person argue this morning –  but on the increasingly bleak outlook, as it will appear to banks, firms, and households.   Expectations really do affect behaviour, in economies even if not in viruses.  Providing a secure foundation for credit is vitally important.  Now.