Sometimes spotting potential bank failures must be hard. One might think of really serious undiscovered fraud, or the weak controls that enabled a rogue trader such as Nick Leeson (who brought down Barings).
But if you were given the following set of facts about a bank:
very rapid growth over a short period
a heavy reliance on deposits withdrawable on demand,
perhaps especially a heavy reliance on uninsured deposits or similar funding,
a huge (and unusually large) share of the asset portfolio made up of long-term fixed rate bonds,
a position greatly expanded at a time when short and long term interest rates were at record lows.
no sign of any extensive use of interest rate risk hedging.
then even if you had reason to believe that the quality of the loans the bank had made were fine, the alarm bells should have been ringing very loudly. It was a highly risky, nay reckless, way to run a bank.
That was, as I understand it, more or less the picture of SVB Bank, which was closed down by regulators on Friday. If, like me, you’d never heard of SVB Bank a week ago, it doesn’t really matter. It was a fairly big bank (second largest actual deposit-taking bank ever to fail in the US, even if small by the standards of JP Morgan or Bank of America) and it seems to have been boringly reckless. Perhaps when the eventual book is written – significant US bank failures usually prompt some author into print – some good stories will emerge, but on the face of it (and there are dozens of articles over the weekend you can look up) the failure was depressingly vanilla in nature. Chasing yield and coming a cropper, Since the occasional headline-grabbing bank failure is a useful reminder of risk – and that people, including very highly paid ones, make bad choices – perhaps it is not even a bad thing that it happened (and deposits of up to $250000 each are covered by insurance). Whether one goes that far or not, it is an episode that seems to reflect very poorly on the management and Board of SVB. but also on the bank’s regulators (in this case, primarily the Federal Reserve). People, perhaps fairly, note limitations in the US regulatory system (and bank accounting standards), and the lobbying SVB Bank itself had engaged in to avoid being covered by some rules that apply (in the US) only to systemically significant banks. But I am left wondering whether the relevant Fed examiners were asleep at the wheel. After all, a smart and energetic young Fed analyst who’d never gone beyond publicly available information should have been able to look at the stylised facts above and yell “whoop, whoop, pull up”. You might have hoped that when the CEO of SVB was (until Friday) on the board of the San Francisco Fed – boards that from a policy perspective are more ornamental than substantive – that that alone would have meant a more than usual vigilance by Fed staff on risks associated with that bank. But apparently not.
Anyway, my point wasn’t mainly to add to the oceans of SVB commentary, but to have a look at the big New Zealand banks. They’ve been under fire lately, and they certainly do seem to be quite profitable businesses (although I’ve always been cautious about that view, including because the NZ subs are not charged for the (considerable) implicit parental support, without which their market funding costs would be higher) but for decades none of them has failed, or even come close.
There is, of course, an old line that part of the general way banks operate is to “borrow short and lend long”. As the Governor put it in his speech a week or so back, hardly any bank in the world holds enough liquid assets that it could immediately meet all claims if they suddenly came due to today (even the ones that legally could be redeemed today). Banks hold portfolios of liquid assets – themselves voluntarily, and under regulatory duress – to limit liquidity risks, and when there is no question about the quality of a bank’s assets, banks also expect liquidity support (at a price) from central banks if they were to face unexpectedly intense liquidity pressures. The fact that lender of last resort capability is known to exist is one reason why regulatory agencies need to impose liquidity requirements (otherwise holding more higher-yielding less-liquid assets will seem attractive to some bankers).
But bank runs (a) aren’t common, and (b) don’t typically strike out of the blue on innocent well-managed banks, so typically the much more important issue is around risks which threaten to impair a bank’s capital and undermine the prospect of depositors and other creditors being able to get all their money back when it falls due. And the issue here is not so much what happens to measures of capital as regulators or accountants state them but about the underlying economic value. Accountants and regulators may not require some assets – some long-term bonds for example – to be marked to market, but whether the current market value of an asset is in the books or not does not change the facts of a potentially impaired market value.
SVB Bank seems to have been running massive and unhedged interest rate risk. They had purchased huge volumes of long-term fixed bonds (mostly federal agency mortgage securities) and had, on the other side of their balance sheet, mostly short-term deposits repricing quite frequently. You could hold a 30 year bond to maturity and know exactly what you will get back for it (assuming the issuer does not default) but it isn’t much comfort to you, or your creditors, if in the meantime your funding costs (deposit rates) have risen very sharply. SVB seems to have been an extreme example even by US standards, but holding some, reasonably material, interest rate risk position doesn’t appear to be that uncommon in US banks, especially regional ones.
But not in New Zealand. Here is the market risk note in ANZ”s latest New Zealand disclosure statement.
In the years shown ANZ took almost no active trading risk (first table) and even the second table (non-traded market risk) is very small for a bank its size. That is all summarised in the final table. A 5 percentage point parallel shift upwards in the interest rate yield curve looks as though it would make less than a 5 per cent difference to the bank’s net interest income. About 6 per cent of ANZ’s capital is held to cover market risk.
And here is the table summarising the time to reprice for both assets and liabilities
On average, liabilities do reprice sooner than assets (check the “up to three months” column as an example) but note too the use of hedging instruments (primarily interest rate swaps): the bank seems to have had a lot of mortgages repricing between 1 and 2 years from balance date and not many liabilities repricing in the same period, but used swaps to substantially reduce the scale of the interest rate risks the bank was exposed to.
I didn’t check all the other big banks – although a quick look at ASB’s disclosure statement look very similar – but I’d be surprised if there was anything very different in any of them. It is the way banking is done in New Zealand (and a product of some mix of market, self and regulatory discipline). Consistent with this, neither net interest margins nor returns on equity (with risks properly accounted for) are very sensitive at all to changes in the level of interest rates.
But if you ever have money with a bank with the sorts of characteristics I listed at the start of this post – and thus extremely exposed to any material change in the overall level of interest rates – you’d probably be well advised to get it out, very quickly.
But the other lesson from the events of the last few days is probably if you were counting on a public-spirited regulator to spot problems early and act decisively, well….at best that is quite a gamble too. But if regulators can’t do better than what seems to have been on display in SVB you do wonder quite why we pay their salaries.
Last week I reread Victoria University historian Jim McAloon’s history of New Zealand economic policymaking from 1945 to 1984, Judgements of all Kinds, first published a decade or so ago. Good works of economic history, let alone of the history of economic policymaking, aren’t thick on the ground in New Zealand, and as McAloon himself notes in a journal article published a year or two later:
“Economic history has a relatively low profile in New Zealand. Few economics programmes offer much in the way of economic history, and none of them offer courses in New Zealand economic history. Very few academics in New Zealand economics programmes publish in economic history. Victoria University, once boasting the only New Zealand chair in economic history, has largely abandoned the field.”
(Actually, when I was at Victoria in the early 80s – and not wise enough myself to have done much economic history – there were two professors of economic history)
Against this background of rather slim pickings, McAloon’s work is a useful contribution, including because he has gone back to at least some of the relevant archives. If you are at all interested in this period of New Zealand history – the backdrop in time to the post-1984 reforms and upheaval – I’d recommend the book, not because it is great or comprehensive but because it is (ie exists). In truth, although the title advertises coverage starting from 1945, there is quite a bit of material on economic policymaking in the 1930s and during the war too.
There is lots of interesting material, including about episodes few people now are particularly aware of (notably around the sterling area after the war). McAloon has his bugbears – not having much time for the British generally, or New Zealand farmers more specifically. And the phrase “the settler economy” keeps popping up, even when referring to events and developments decades after such a label had any more than rhetorical weight. I think he envisages the book as serving a somewhat revisionist purpose, in redeeming the tarnished reputation of the policymakers and advisers of the pre-1984 decades. I’m partial to a little of that sort of thing myself – for all his faults, for example, Muldoon clearly faced some of the most very adverse times to be a Minister of Finance almost throughout the 17 years that his terms spanned – but my sense is that McAloon sets himself rather too easy a target, in pushing back against some of the more florid rhetoric one still sometimes hears (from older politicians, economists, and business people) about the post-war New Zealand economy, and in the process acquits the policymakers, and most of their advisers, rather too readily. There is no doubt that the New Zealand economy in 1984 was a very different thing than it had been in 1945, and there had been plenty of sensible changes of policy made over the intervening decades. But the overall story remains one of deep relative decline, with no evident prospect of reversing that deterioration. And it wasn’t as if policymakers and advisers were innocents, unaware of the decline: by the very early 1960s serious independent reports from respected New Zealand economists were explicitly highlighting the extent of the relative productivity decline.
I’ve show numerous graphs here over the years highlighting New Zealand’s relative decline. But perhaps this simple one captures a significant aspect of what was going wrong. Read any book writing about inter-war New Zealand economic developments and it will make the point that per capita exports from New Zealand then were thought to be the highest of any country. That reflected a high level of GDP per capita and a high export share of GDP.
Consistent data over many decades is a challenge, but here are exports as a share of GDP as they were on the brink of the Great Depression (using as the GDP denominator the average of the three historical estimates on Infoshare) and by the early 1970s (using data from the OECD database).
By the early 1970s, not only had exports shrunk markedly as a share of New Zealand’s GDP, but that share was only around the median of the OECD countries (for which the OECD has data back that far), and that despite small countries typically trading more than large ones and New Zealand being in the smaller population grouping of OECD countries. One can debate the various possible causes of this steep relative decline, but New Zealand government policies did not, to say the least, help.
Anyway, the prompt to reading McAloon’s book again was that my son had been enrolled in McAloon’s second year New Zealand history course. If there are no specialist economic history courses at Victoria – which almost beggars belief given the way the university (and especially its commerce etc faculty) used to try to tout itself as preparing young people for careers in the public sector – at least there is some exposure to economic history topics in some of the history courses. Among the many essay topics students could choose from was one about New Zealand economic management from 1929 to 1975, and when my son chose to do that topic I suggested that reading the lecturer’s book might be worthwhile.
And here I divert into proud parent mode. I’ve included below the essay that Jonathan wrote on economic management over that period. I don’t agree with all of it (and had not read it until after the lecturer’s (high) marks came back) but – like the lecturer – I thought it was a pretty strong effort for a second-year student, and some of my readers may find the subject matter of interest. (And if anyone wants to hire a budding macroeconomist, he’ll probably be on the market in a couple of years.)
Controlling into Decline: Assessing government management of the New Zealand economy, 1929-1975.
by Jonathan Reddell
The period from 1929 to 1975 was an age of evolution in the New Zealand (NZ) economy. The upheavals of the Great Depression created a new consensus, while the economy continued to undergo the transition from a colonial to an independent economy. It cannot be said, however, that the period was an age of success. New Zealand’s relative decline during the period should not be understated. In 1939, New Zealand’s GDP per capita was $10,297, ahead of the Netherlands’ $7,079 and Canada’s $7,600. By 1975, both had surged ahead of New Zealand, as had others including Sweden. New Zealand’s per capita growth rate lagged about 1% behind that of other developed market economies throughout the post-war period. From 1929-1975, the performance of governments has been mixed, but that the economy was more often ill-managed than not. There are success stories, such as the diversification from Britain, and New Zealand remained one of the most prosperous countries on the planet, but on balance it was a drift into (relative) decline.
The role of the Great Depression in reshaping consensus economic thought in advanced capitalist economies is well known. The dislocations caused by the worst recession in modern history created the post-war consensus on full employment and the role of the state. This consensus would endure until the 1970s, when it was overturned by another crisis. New Zealand was no exception to this. The following paragraphs will discuss government management of the Depression, and the new economic thought that was put into practice by the First Labour Government. The essay will then discuss the post-war consensus policies and assess how well governments managed the economy to achieve them.
The Depression’s impact on New Zealand was severe. A primary exporter, New Zealand was hard-hit by a shock whose hardest blow fell on commodities. Exports fell between 55-60% between 1928-29 and 32-33. Rankin has estimated that joblessness peaked at over 35% of the workforce in 1932. To compound matters, the New Zealand economy had been weakened by Britain’s anaemic economic performance in the 1920s due to the overvaluation of sterling from 1925. Meanwhile the government’s ability to respond was constrained by the immense burden of public debt. In the 1931 Budget, public debt charges were by far the largest component of state expenditure, amounting to £10.9 million out of £24.7 million. The debt burden and global loss of confidence severely constrained the government’s ability to borrow in London, while the inelastic debt payments meant that other sources of expenditure had to be cut, as a balanced budget was considered key to stability.
While New Zealand did devalue against other currencies when Britain went off gold in September 1931, it did not devalue against sterling until 1933, prolonging the pain for exporters. From 1933, recovery was relatively rapid, as reforms including devaluation and the creation of a new monetary system under the Reserve Bank which allowed the Indemnity Act to lapse and monetary expansion while agricultural exports improved; by 1935 GDP per capita had recovered to the 1929 level. Overall, the Coalition government’s management of the Depression was mixed. Belief in the desirability of a balanced budget constrained policy, as did the debt burden. On the other hand, the recovery was eventually strong, and as Hawke notes, actions were generally “sensible and sometimes imaginative.” While it can be argued that the government could have taken more steps after Britain went off gold, overall, it is hard to argue with his judgement that, given the circumstances, the government did about as well as anyone else would have.
By the time Labour came to power in 1935, the economy had generally recovered. Members of the new government had been greatly affected by the Depression and came to believe in the importance of boosting demand and that unemployment should never be allowed to reach such levels again. Policy would be aimed at stabilisation, at security, at protecting the populace from the swings of the global economy. This would be achieved through polices such as expanded welfare and guaranteed prices for exporters. Nash wrote that the government, “intended to protect the producer…from the uncertainties of price.” For dairy, this was done through the 1936 Primary Products Marketing Act. Labour perceived that the Depression illustrated New Zealand’s excessive vulnerability to the world economy, and aimed to counteract it, to ensure long term full employment. The state would lead industrial development to achieve both full employment and a less dependent economy. Labour’s policies marked a profound departure from the pre-Depression economy and created the basis of the post-war consensus which would last until 1975. Stabilisation policy was locked in through the experiences of World War II (WW2), when the state took strong direct action and was generally successful.
The post-war economic consensus consisted of several elements. National accepted the focus on full employment, and the welfare state, with Holland professing a belief that everyone had the right to employment and necessities. A 1956 Royal Commission laid out the objectives of economic policy as: full employment, price stability, development, and promoting economic, social, and financial welfare of New Zealanders. Governments from 1935 looked to manage the economy in pursuit of these goals, particularly full employment. The following paragraphs will assess their success regarding the economy.
The 1938-39 crisis was important in setting in the controls that would characterise the economy to 1984. From 1935 recovery continued apace, with GDP per capita one of the highest in the world in 1939. This would lead to crisis. The 1938-39 balance of payments crisis was a problem of the government’s own making, and a sign of things to come. Labour’s demand policies had resulted in a red-hot domestic economy, while a slowdown in the world economy resulted in a significant fall in export receipts. The trade balance fell from £10.5 million in 1937 to £2.9 million a year later. Labour, unwilling to take actions that might harm workers like devaluation or fiscal retrenchment, opted for capital and import controls, which in some form would last until 1984. According to Hawke, the controls symbolised Labour’s move to an ‘insulationist’ economy. The story of an overheated, full employment economy leading to a balance of payments crisis would be repeated periodically throughout the consensus period, including the crises of 1957-58 and 1966-67. The controls gave rise to a distorted economy and would have significant future negative impacts. Labour’s stabilisation policies undoubtedly had some value, but the obsession with full employment resulted in mismanagement in the 1930s, as it would again.
Post-depression governments would manage the economy with full employment front of mind. For Labour, it was, according to McAloon, “not negotiable.” Speaking on the Employment Bill in 1945, Fraser said that “there is no greater tragedy than…being denied the opportunity,” to work, and being prevented from “contributing…to the production of goods and services.” This undoubtedly succeeded, at least until the 1970s. From the late 1930s, the number of registered unemployed was incredibly low, bottoming out at 38 in 1950 and 1951. While this number understates the true unemployment rate, estimates of that are as low as 1%. This was a very low number by international standards.
While other countries also looked to achieve full employment, New Zealand’s unemployment was extremely low. For example, the United States, through the 1946 Employment Act declared a goal of “maximum employment.” However, even when the 1960s governments sought to make it a reality, unemployment never fell below 2.5%. Therefore successive governments succeeded at managing the economy to achieve a level of full employment that was very low compared to other countries. A low unemployment rate has obvious benefits, but it also has costs. As was discussed, running a full employment economy with unemployment below the natural rate required import controls, to prevent domestic demand resulting in balance of payments crises. If unemployment had been allowed to rise to its natural level, which, as Gould notes, was likely quite low, the economy would have been less prone to fluctuations, whether in fiscal policy or the terms of trade, as demand for imports would have been generally weaker and there would have been less need for controls. Another negative of New Zealand’s extremely low unemployment rate was that fears of unemployment levels like other countries, particularly on the left, delayed NZ’s entry into the International Monetary Fund (IMF). Kirk exemplified those sentiments when he declared during the debate that NZ had “built up a social order that is unique,” which IMF membership would imperil. In fact, non-membership of the IMF raised the cost of dealing with crises, while it did not prevent or cause higher unemployment.
Related to the full employment goal were import controls. As has been noted, successive governments looked to defend full employment while staving off balance of payments crises with import and capital controls, which would minimise the ability for New Zealand’s foreign reserves to drain. While National attempted to liberalise after 1949, controls were reimposed in 1951-52. These stop-go policies would repeat themselves, as the perceived foreign exchange constraint remained strong. Import controls had major negative impacts. One was that import controls gave rise to import-substituting industries like textiles. These were often inefficient and misallocated resources away from potential export sectors. The high capital-output ratio of the economy through the 1950s and 1960s suggests inefficient usage, as it indicates a high level of capital was being used for low levels of output. A 1968 World Bank report argued that “import restrictions are a hidden form of protectionism, which tend to result in a misallocation of resources,” and that they have failed to result in net exchange savings. This seems believable as other sources have identified the high level of effective protection on NZ manufacturing, perhaps as high as 70% by the mid-1960s, and as a result, a functional tax on productive farmers, which weakened the NZ economy.
While some level of control was understandable, particularly after WW2 given dollar shortages, New Zealand’s controls outlasted those of other OECD countries. Australia abolished import licencing in 1961. A significant issue with New Zealand’s approach was the unwillingness to regard interest rates as a meaningful stabilisation tool. While many central banks abandoned interest rate control after WW2, New Zealand did not use interest rates even into the 1970s, while Australia had done so since the 1950s, due to factors including social credit influences and the sensitivity of farmers. This had significant drawbacks because it meant more heavy-handed, distortionary controls were necessary to manage the economy. If interest rates, rather than direct controls, had been utilised as a policy tool, it seems likely that New Zealand’s relative decline would have been less marked. Easton argues that other OECD economies suffered from high protection of their agriculture sectors. However, this mainly held up a dying industry and didn’t constrain the growth of industries like technology, while in New Zealand, controls raised the cost of inputs, effectively taxed agriculture, a growth sector, and allocated industrial capacity away from exports to import substitution.
The management of price stability is a mixed picture. An overheated economy continuously exerted inflation pressure. However, these pressures were mostly well constrained from the late 1940s. Condliffe observed that the New Zealand economy came out of WW2 “taut with supressed inflation.” As wartime controls eased, inflation picked up to about 10% in 1947-48. The government enacted several sensible measures to ease demand pressures and bring inflation down. These included a continued emphasis on national saving rather than overseas borrowing, which took money out of circulation, and the revaluation of 1948, which lowered the prices of exports and imports. The New Zealand experience continued to be shaped by global conditions, as the Korean boom drove inflation to new heights in the early 1950s. While inflation fell and was generally relatively low between 1955 and 1970 it continued to be perceived as a threat. Hawke has observed that “prices rose by 2-3% in most years…worrying to many contemporaries.” This perception is illustrated by a farmer, writing to the Press in 1961 that, “for the genuine farmer inflation is the worst thing that can happen.” Thus, to the extent that governments are responsible for assuaging the fears of their citizens, NZ governments failed in that regard.
However, from a macroeconomic perspective, inflation was well managed until the late 1960s. The breakdown of the consensus between government, employers, and unions, particularly with the Nil Wage Order of 1968 was significant. It combined with the overheated economy to produce significant levels of inflation that was managed inadequately through blunt instruments like freezes, due to ongoing full employment commitments. On balance, controlled inflation with overfull employment endured for a surprisingly long time. It is not clear, however, how much credit can be given to governments. New Zealand’s experience continued to be shaped by the global environment, and the inflation experience was similar to other countries, albeit at a lower level of unemployment. A stronger factor seems to be the enduring legacy of Depression leading to a moderation of union militancy, which constrained wage, and thus price, inflation. However, governments do deserve at least some credit for keeping inflation as low as it was.
The third objective of economic policy was industrial development, which, from the mid-1950s linked with the need to diversify export markets as bulk purchase agreements ended in 1954 and Britain desired to join the European Economic Community. McAloon notes that “industrial development, trade development…were closely related over the decade after 1957.” Industrial development was viewed as desirable from the late 1930s, as part of the quest to make New Zealand more insulated from price swings. This received greater focus under the Second Labour Government from 1957, particularly under the influence of Bill Sutch. Sutch wrote that “rapid and radical action is needed to readjust our economic structure,” towards manufacturing. Sutch’s ideas reflected the flawed but orthodox view that there was a long-term decline in the terms of trade of commodity producers relative to industrial producers, known as the Prebisch-Singer thesis. Its orthodoxy is illustrated by the World Bank’s report which argued that New Zealand’s fundamental problem was being “still too narrowly dependent on a few export commodities.” Successive governments believed that industrial development was a priority, both for reducing balance of payments difficulties and maintaining prosperity.
The success of industrial development is a mixed picture. There were successful developments, such as the Kawerau pulp and paper mill and the wider forestry industry, and the domestic economy diversified throughout the 1960s. However, as was already noted, import controls resulted in misallocation towards import substitution, and experiments such as a cotton mill in Nelson were highly problematic. The belief that too much agriculture was making New Zealand poorer seems particularly strange given that it remained the most productive industry. The dominance of sheep and cow products did decline, from 90% of receipts in the 1930s to 53% in 1977/78, as new industries picked up: manufactured and forest products made up 23.4% of exports. However, these exporters were often heavily subsidised, illustrated by the large incentives put on machinery in 1972. These subsidies created their own inefficiencies. Again, governments were deploying distortionary solutions to questionably real problems. On the other hand, management of the diversification from Britain was successful. Trade agreements were signed with Japan in 1958, and significantly, with Australia in 1965. Britain’s share of New Zealand exports fell from 51% in 1965 to 34% in 1971. While there is much to criticise governments for how they handled the economy, they managed this landmark transition well, even if Britain’s relative economic marginalisation made trade readjustment inevitable.
In conclusion, the Depression shook the New Zealand economy, establishing a new order which sought full employment, price stability, and industrial development. While these were, for a time, achieved, it came at the cost of extensive controls which were a leading contributor to New Zealand’s relative decline. While successes like trade diversification cannot be overlooked, overall government management of the economy cannot be said to have been successful. The fundamental duty of government is to deliver prosperity and while New Zealand remained prosperous, it could have been much more so.
Condliffe, J.B. The Welfare State in New Zealand. London: Allen and Unwin, 1959.
Easton, Brian. In Stormy Seas: The Post-War New Zealand Economy. Dunedin: University of Otago Press, 1997.
Gould, John. The Rake’s Progress? The New Zealand Economy Since 1945. Auckland: Hodder and Stoughton, 1982.
Greasley, David, and Les Oxley. “Regime Shift and Fast Recovery on the Periphery: New Zealand in the 1930s.” The Economic History Review 55, no. 4 (2002): pp. 697-720. https://doi.org/10.1111/1468-0289.00237
Gustafson, Barry. From the Cradle to the Grave. Auckland: Reed Methuen, 1986.
Hawke, G.R. The Making of New Zealand: An Economic History. Cambridge: Cambridge University Press, 1985.
Holland, Sidney. Passwords to Progress. Christchurch: Whitcombe and Tombs, 1943.
Kindleberger, Charles P. The World in Depression, 1929-1939. Revised Edition. Berkeley: University of California Press, 1986.
McAloon, Jim. Judgements of all Kinds: Economic Policy-Making in New Zealand 1945-1984. Wellington: Victoria University Press, 2013.
Nash, Walter. New Zealand: A Working Democracy. London: J.M Dent & Sons., 1944.
Rankin, Keith. “Workforce and Employment Estimates: New Zealand 1921-1939.” In Labour, Employment and Work in New Zealand, pp. 332-343, 1994.
Reddell, Michael, and Cath Sleeman. “Some perspectives on past recessions.” Reserve Bank of New Zealand, Bulletin, 71, no. 2 (2008): pp. 5-21.
Singleton, John, Arthur Grimes, Gary Hawke, and Frank Holmes. Innovation + Independence: The Reserve Bank of New Zealand 1973-2002. Auckland: Auckland University Press, 2006.
I don’t want to comment extensively on yesterday’s Reserve Bank announcement. It may prove to be the right call (or not), but in the data hiatus – 2.5 months since the last CPI, two months since the latest HLFS – they are to some extent flying blind (New Zealand really needs more frequent and timely key official macro data), and it would have been better to have rescheduled the announcements (adding one) as suggested in my post the other day. And the very brief, almost passing, mention of having considered a 75 basis point increase – which would have made a lot of sense this time last year – highlights again just how non-transparent and non-accountable New Zealand’s MPC is, We don’t know whether, in the end, any of the members actually favoured a 75 basis point increase, or did the Committee just toy with the idea briefly so that they could put a hawkish reference in the minutes? In places like the UK, Sweden, and the US we would have much greater clarity, and potential accountability – and potential accountability focuses the minds of decisionmakers who can, under the New Zealand system, collect their fee, turn up for lunch, and never have to do or say anything.
But looking for some other data I remembered an email from the Reserve Bank statistics group a few weeks ago indicating that they were finally going to publish some of the new data from the Survey of Expectations that they have been collecting for the last couple of years.
The survey has long asked about expected near-term policy rates (previously the 90-day bill rate as proxy, more recently the OCR) but in 2020 they added two new questions, asking respondents where they thought the OCR would be in 10 years’ time (describing that as a proxy for a neutral rate), and what they thought the average OCR would be over the next 10 years. I thought they – and especially the first question – were good additions to the survey (if we could get individual MPC members to give us their numbers, akin to the Fed’s dot-plot it would be even better).
Anyway, here are the results (despite the extraneous labels Excel added in these are quarterly data, beginning with the Sept 2020 quarter)
The blue line (expectations for the neutral nominal rate) really took me by surprise. The first observation would have been captured around the end of July 2020 (I filled mine in on 20 July), and the second three months later, about the time long-term bond yields reached their all-time lows (and talk was of a possible negative OCR in 2021). And yet responses in the last couple of surveys aren’t much different – 2.42 per cent in the September 2022 quarter and 2.43 per cent in the September 2022 quarter. If you’d asked me to guess before the question was instituted, I’d have expected a much more cyclical series of responses (consistent with the variability we see in implied forward bond yields). And since the question is about nominal rates I wouldn’t have been very surprised now to have seen expected future nominal rates rising even if the real rates respondents had in mind weren’t changing much (core inflation undershot the target midpoint for the last decade, but perhaps it won’t in future).
The orange line is much less surprising. Back in 2020 there was a general expectation that the OCR would be very low for several years. As it became apparent that wouldn’t be the case, naturally the average expected over the subsequent 10 years tend to rise (and the intense pandemic period passes out of the 10-year window too).
Both questions are about nominal rates. But the same respondents are also asked about their inflation expectations for periods one, two, five and ten years ahead. In this chart, I’ve taken the nominal responses (previous chart) and adjusted them for respondents’ inflation expectations: the 10 year ahead expectation for the blue line, and the average of the two, five, and 10 year ahead expectations for the orange line.
For what it is worth, this group of respondents still think the longer-term neutral real OCR is just barely positive, and their view has hardly changed since near the worst of the Covid shock (first observation), despite the recent huge upsurge in (core) inflation. Average expected real OCRs have increased this year as the OCR has been raised much more rapidly than was expected a year ago.
I don’t have a strong view on whether respondents are right or not (and, on checking, my own responses to the survey questions haven’t been consistently different from the average).
But…..these survey respondents seem to have very different views from the future rates implied by market prices.
In this chart I’ve taken the yields on the Sept 2030 and Sept 2035 government indexed bonds and backed out the implied real rate for the five year period between Sept 30 and Sept 35 – a period which encompasses the 10 years ahead OCR question for the period the Bank has been running the survey.
At the time of the most recent survey, respondents thought the real OCR 10 years hence would be about 0.3 per cent. At around the same time, the market prices suggested an implied future five year real bond rate of around 2.75 per cent. Sure there would usually be a term premium between OCR and a five year rate, but it wouldn’t typically be anywhere near that large. And our indexed bond markets aren’t the most liquid in the world, but the implied future rates in the chart don’t seem particularly out of line with (for example) implied future nominal government bond rates (using the May 2031, May 32, and Apr 33 bonds all currently yielding a little above 4 per cent), suggesting implied future nominal rates much higher than the 2.4 per cent (or thereabouts) survey respondents expect for the OCR 10 years hence.
I don’t have any answers to offer as to who is going to be proved right – most probably neither (there will be cycles next decade too, as well as whatever structural shocks might unfold) – but it is interesting to see such large gaps between survey responses and market prices. And kudos to the Reserve Bank for collecting (and belatedly publishing) the survey data.
I was always a bit ambivalent on the idea of a public holiday to mark the death (and life) of Her Late Majesty: there were (and are) better, cheaper, and more enduring things that could (have) been done. And the more so when the day chosen seems less to do with Queen Elizabeth (whose funeral and burial were a week ago) and more to do with the Prime Minister’s schedule. But here we are.
It seemed like a good day to potter in the old data and see how things went, in terms of relative economic performance, for the independent countries of which the Queen was monarch throughout her reign – the United Kingdom, Canada, Australia and New Zealand. Back in 1952 there were a few others – South Africa, Pakistan, and (as it then was) Ceylon. The other current realms (PNG, the Solomons, Belize, and so on) were not independent until later.
In the table below I started with Angus Maddison’s collation of historical GDP and GDP per capita (in purchasing power parity terms) estimates. I used the Western Europe and “offshoots” (NZ, Australia, Canada and the US), the east Asian countries that are now very prosperous (Singapore, Taiwan, Japan, and (South) Korea), included a few representative central European and South American countries, and included the other 1952 realms (South Africa, Pakistan, and Ceylon).
My main interest was comparing rankings from 1952 to those now. But if one starts from 1952, some people will make (not entirely unreasonable) objections about it being just after the war, and so the numbers may flatter countries that had little or destruction in World War Two, so I’ve also included 1939 numbers where (most cases) Maddison had them available. And for the most recent period I’ve included rankings for both GDP per capita and (my preferred focus) GDP per hour worked.
(UPDATE: This table replaces the original one in which I had inadvertently given Uruguay’s the US’s 2021 GDP and vice versa)
There are all sorts of extended essays one could write about relative growth performance over the decades/centuries for different groups of countries, but here my main interest is just in the four Anglo countries of which the Queen was monarch from 1952 until a couple of weeks ago. That picture is not a pretty one. 70 years ago all four countries were in the very top grouping, and these days not one of them is. Not in any way the fault of Her Late Majesty of course: she and her Governors-General act only on the advice of respective sets of ministers in each country, but a poor reflection on the countries concerned, and their successive respective governments nonetheless. New Zealand, sadly, has been by some margin the worst of them.
If I were inclined to be particularly gloomy – okay, I am – one could even note that the extent of the drop down the league tables for these stable democratic rule-of-law countries, isn’t materially different to the drop experienced by Uruguay, Argentina, and Chile, none of which enjoyed uninterrupted democratic governance over those decades. South Africa has had a similar drop down the league tables too.
I have my own stories about why most of the seven countries (Anglo and South American) have done poorly, but I don’t claim to have any particularly compelling tale about the UK and the extent of its continuing relative decline.
A couple of weeks ago I did the first couple of posts in a series looking at the Reserve Bank’s stewardship of monetary policy since the start of 2020 (and the start of Covid). That proved to be too much for my intermittent (at best) post-Covid energy levels, and although I will come back and complete the series that won’t be this week either.
But I was glancing at the Reserve Bank’s page of selected OIA releases (always interesting to see what others have asked) when I found this release last Friday under the heading “Growth of RBNZ”. The Bank appears to have adopted a new strategy where the OIA request responses it chooses to release on the website are released there on the same day the requester themselves gets the information (a strategy often intended to reduce the payoff to the effort involved in actually devising and lodging an OIA request – it has been more normal over the years to put releases on the website at least a few days after providing the information to the requester.)
Actually on checking again, I find that there were three releases on Friday, quite possibly to the same person. First was “RBNZ Brand and Design” (which request appeared to be in response to a Bank advert a couple of months ago for a brand manager), second was “Growth of RBNZ”, and third was “RBNZ media inquiries”. There is the odd amusing snippet in the first, including
In the third release, the answers aren’t very interesting (which media interviews the Bank did), but there were several questions with potentially interesting answers which the Bank claimed were dealt with in (long) documents on Parliament’s website as part of the Bank’s Annual Review last year.
But what really caught my eye was the “Growth of RBNZ” request/answers, where the requester had asked for breakdowns of staff numbers over the last 10 years. They didn’t really need to go back that far – all the 200 FTE growth in staff numbers has occurred since Orr took office (up from 255 then to 454 on 30 June 2022) but it was interesting nonetheless. One gets a very clear sense of the bloat. Here for example
(I can recall a time, 35 years ago, when the numbers were probably larger but (a) total staff numbers were even larger than Orr levels), and (b) most counted the slimming down as something much more appropriate, and appropriately concerned with a restrained approach to public spending.)
The Bank’s functions haven’t changed but – like too many public agencies – the number of “communications” staff has increased hugely
An OIA I’d lodged a couple of years ago (and written about here) gives a bit more background on that function (although numbers have grown more since).
We know there has been senior management bloat – a whole new lawyer of second tier appointees (Assistant Governors) most of whom seem to have little subject expertise to offer)
On the other hand, there are the Bank’s core economics functions. Until very recently, monetary policy was by statute the primary function of the Bank. That has changed (reasonably enough) but it is still a key core function. But here are staff numbers in the Economics Department
There are no self-evidently right or wrong answers as to how big a central bank Economics Department should be but there are few/no economies of scale, the Bank has been publishing very little serious research (or even revealing analysis) in recent years, and….inflation is through the roof. It doesn’t have the feel of an appropriate level of spending, especially when the Minister of Finance is throwing money at the Bank (all those hugely increased “support” functions above). But it is consistent with the stories one hears, at second hand but from inside the institution, suggesting that the Governor has little interest in monetary policy or the supporting macroeconomics. The Bank also released some salary data by function and it is striking that in 2021/22 the total salary spend on the Economics Department was almost 10 per cent lower than it had been in 2012/13.
The Financial Markets Department has usually been seen primarily as an element of the Bank’s monetary policy function (implementation etc), so it looks somewhat odd to see a huge increase in staff numbers there even as the economics function has been flat or falling. These were the operational people who, on the Governor’s instructions, lost the taxpayer billions and billions of dollars through the LSAP (so it isn’t even as if market functions were paying for themselves).
The other obvious area of growth – but harder to illustrate given the changing definitions/structures, so that numbers for the earlier period aren’t readily comparable to those now – is around the Bank’s financial stability functions. Some will welcome this growth, citing recommendations from the (fellow supervisors who did the) IMF’s FSAP a few years ago. Count me sceptical. For example, as at 30 June 2022 the Bank now has 38 people doing “Prudential Policy”, which feels large not just by historical Bank standards (there was a time 20 years ago when, perhaps going through the other extreme, all the prudential functions, not just policy, had about 10 people) but by comparisons with the policy functions for specific areas of policy in other ministries. It is, for example, more than the total staffing in the Economics Department. Oh, and they also have 22 staff doing “Financial Stability Assessment and Strategy” and yet the Bank publishes nothing particularly insightful and no research relevant to the prudential or financial stability functions. As best I can tell from this release, total staff numbers in the financial stability functions have more than doubled since 2018 when Orr took office.
Orr has long had something of a reputation as an empire-builder, and in his first four years at the Bank that seems to have been amply warranted again. This is scarce taxpayers’ money and yet Orr (facilitated by the Minister and the Board) flings it round with gay abandon……without even the consolation of better quality research, analysis, policy design, let alone policy outcomes. But it has been a windfall for HR people and former journalists.
I will resume my series of posts reviewing Covid monetary policy next week.
This post will be primarily of interest to former Reserve Bank staff, although may also interest those who are now, or were previously, charged with monitoring and holding to account the Reserve Bank. Most regular readers of the blog are likely to want to stop reading here.
I have set out below, without further comment, a significant chunk of the latest Annual Report of the Reserve Bank of New Zealand Staff Superannuation and Provident Fund. I am both a member and a long-serving trustee of the scheme. The report is now in the hands of members, but is also a public document (readily available on the Disclose register at the Companies Office). The material in the extracts below may also be of interest and relevance to former staff who were once members of the scheme but are so no longer, and whose financial interests may have been affected by (contested) rule changes made some considerable time ago.
The Minister of Finance yesterday afternoon finally announced the rest of the members of the new Reserve Bank Board that takes office, under its new authorising legislation, today. In my post earlier this week, I highlighted a number of weaknesses in the legislation around the (dis) qualifications of the Governor and other Board members. None of the appointments to the Board appear to be in breach of the Act, but several are questionable on various counts, and taken together (and one should think about the composition of the Board as a whole) the new Board represents a poor, and grossly inadequate, start to the new regime. It could have been a great opportunity for a really impressive fresh start for the governance of the Bank. Instead, the Orr-Robertson degrading of the Bank continues.
As one gets older, rose-tinted glasses about aspects of the past are a risk. I do recall a time when the Reserve Bank Board had some really impressive people on it (mostly credit to Roger Douglas). But the dominant story over the almost 90 years the Bank has existed hasn’t been of impressive people being appointed to non-executive roles on the Board. In making appointments, at least since the government took full ownership of the Bank in 1936, political debts have always been paid or political loyalties rewarded – at times, past, present, and future overtly political figures have been appointed (and I even found one member who’d been a Communist Party donor), and the general quality has ebbed and flowed. One member I’m aware of – whom I gather turned out to make a reasonable contribution – was appointed mostly to spite a then Governor who vehemently objected to an economist the Minister wanted to appoint. There have been a handful of people with relevant subject expertise, some people good at asking (awkward) questions, and the time-servers and middling sorts who populate the myriad of boards and committees governments have to fill.
But – and it is an important but – none of them ever mattered very much. From the late 30s to 1990 it was clear that if the Board was the governing authority of the Bank as an entity (“the Board was the Bank” was used to say), most everything that really mattered about what the Bank did was decided – quite properly under the then-legislation – by the Minister of Finance and/or the Cabinet. That included policy, implementation, and key personnel (Governor and Deputy Governor). No doubt there were plenty of things for the board to do in that era – administration, buildings, staff etc – but it wasn’t the stuff we set up the central bank for. And from 1990 to yesterday, the Board had little say over anything much (not even the pay and rations stuff) but established as an monitoring and accountability body almost exclusively. It wasn’t quite that narrow, in that a person could only be appointed or reappointed as Governor if recommended by the Board.
As the overhaul of the legislation got underway, more recently people could only be appointed to the MPC on the recommendation of the Board, but OIA documents show that when the MPC was established they did not recommend names to the Minister but presented a list and said to Robertson “you pick”. This was the same Board that had got together with the Governor and Minister and put in place a blackball on the appointment to non-executive positions of anyone with actual hard expertise in monetary policy.
What of the new legislation. There have already been attempts at spin.
Thus, we have this from the Minister of Finance
The Board’s remit does not cover monetary policy, which remains solely the role of the Monetary Policy Committee.
And it is certainly true that the Board members do not get to set the OCR or publish projections. But as the Bank now points out on its website. “collective duties of the Board” now include
reviewing the performance of the Monetary Policy Committee and its members.
And it is the Board that has to recommend a person to be appointed (or reappointed) as Governor, and has to recommend appointees for the Monetary Policy Committee. It also has the responsibility to recommend removal of these people if they are not adequately doing their jobs.
In the Bank’s Annual Report (sec 240) they are specifically required to include
(m) a statement as to whether, in the board’s opinion, the MPC and the members of the MPC have adequately discharged their respective responsibilities during the financial year (seesection 99); and
(n) a description of how the board has assessed the matter under paragraph (m)
And that is just monetary policy. The Board also now has all the powers the Governor previously had on prudential regulatory matters (mostly banks, but including non-bank deposit-takers, insurers, payment system infrastructures), New Zealand’s physical currency, a large balance sheet. And there are a number of grey areas in the Act of matters which in my view really should be matters for the MPC, but seem to be matters for the Board. You will recall the big disputes a few years ago about the Governor’s ambitions to dramatically increase capital ratios: such things are now the responsibility of the Board. And recall that the whole point of the new Board model was to reduce the single-person risks inherent in the previous legislation (so don’t anyone think about running a “oh, none of this matters as the Governor runs things” response).
So lets look at the make-up of the Board.
Take the Governor first (and note the oddity of the new legislation where on paper the Governor is a totally dominant figure on monetary policy, but just another board member on the Bank’s other major policy/regulatory functions). With the best will in the world, no one would argue that Adrian Orr is a leading figure in either monetary policy or financial stability functions. With a really really impressive chief executive, the rest of the Board can matter a little less – but the best people need hard and informed questioning. All the signs suggest an undisciplined and petulant figure who just isn’t overly interested in the core responsibilities of the Bank – and that would be consistent with his record of speeches over his four years in office.
Then we have the chair, Neil Quigley, who was an economics academic and is now Vice-Chancellor of Waikato University. Quigley has been on the Board for more than a decade, has been chair since 2016 (and thus presumably bears the greatest responsibility for Orr, and what followed). But as I discussed yesterday in all those years on the Board there has been little sign of serious and hard challenge and scrutiny, and despite Quigley’s academic background there isn’t much sign these days of someone devoting a lot of time to keeping abreast of the literature on financial stability and regulation. How could he? Most would have thought a university vice-chancellor role in these difficult times would itself be at least a fulltime job. Quigley’s appointment appears to be a transitional one (to 30 June 2024), and his replacement would be a key opportunity for any new government taking office after next year’s election that was serious about restoring the authority, reputation etc of the Bank.
It is downhill from there with the rest of the Board. Taking them in alphabetical order
All laudable no doubt, but not a shred of a sign of suitability to be a board member of New Zealand’s prudential regulator or to be choosing appointees to the MPC and evaluating the performance of the MPC.
I’ve discussed Finlay previously. We can be relieved that his terms as NZ Post chair (owning Kiwibank and Kiwi Wealth) ended yesterday. He should never have been actively involved in Reserve Bank affairs while chairing the owner of a major bank. But that is now over, and we are left with someone who looks like a pretty generic professional director and accountant. Perhaps, and despite his past (what ethics does he display in having accepted the RB/NZ Post conflict), he could be a perfectly adequate director of yet another government body. But it isn’t evident there is any expertise or experience in monetary policy, prudential regulation, financial stability etc.
Higgins appears to be wholly and solely a diversity hire. Her background is all very interesting, perhaps even laudable, but…..this is the central bank and prudential regulatory agency, and there is not a shred of relevant background or qualifications – any more than a professor of Latin and university bureaucrat would typically have.
Paterson is another carryover from the old board. Perhaps she is just excellent (but remember all those questions we didn’t find in the Board minutes to now) but she is a pharmacist turned generic company director. There is a place for such people, perhaps even a couple on a central bank board, but subject matter expertise and energy on such matters seems less than evident.
Pepper seems to be the only appointee with recent practical exposure to financial markets. On paper he looks like he could be quite a reasonable appointment to the FMA Board (perhaps a swap with Professor Prasanna Gai who is on the FMA but has expertise and experience that would be very valuable on the Bank’s Board or MPC). But the Bank’s Board is more about financial institutions than about wholesale markets and it isn’t evident he has much knowledge about institutions, the sort of risks that threaten them, or about financial regulatory policy – let alone being particularly fit for evaluating MPC members.
And then there is that insurance company he recently became a director of. According to the Minister
Mr Pepper is a director at Ando Insurance Group Ltd, but that role is not expected to create a conflict of interest as Ando is a non-regulated company.
The problem is that when you look up that company it is described as almost 40 per cent owned by a foreign insurer which is regulated by the Reserve Bank, and Ando describes itself as writing its insurance business for that regulated company. I don’t know either the business or the law enough to know why Ando itself is not regulated by the Reserve Bank, but on what we do know the appointment, while lawful, seems pretty questionable, and not (especially after Finlay) a great way to start a shiny new Board and governance model. One wonders what Treasury made of it when they provided advice to the Minister on appointees. (Or, indeed, the other political parties when, as the law now requires, they were consulted.)
Raumati-Tu’ua (who seems to be a qualified accountant) is another of those generic professional directors. As I said earlier, there is a place for a couple of them on the Board, but there is no relevant subject matter expertise at all.
For the most part I am not suggesting that as individuals these people are unsuited to being on a mixed Board (although Higgins appears utterly unqualified, and Pepper questionable on ethical grounds), but what you end up with is a Board that is deeply unimpressive and really unfit for anything like the role the legislation envisages for the Board of the Reserve Bank. There is no one with any real expertise or authority in banking, no one with any real expertise on financial regulatory matters, no one who really seems fit (or ready) to be holding the MPC to account or making good choices about who should go on the MPC in future. And, perhaps a little surprisingly given the limited pool of expertise locally and the risks of too inward loking an approach, there is no one from abroad. As a group – however nice, and perhaps able they each are in their own fields – they simply aren’t up to what the job should entail, and that against the background on an inexperienced and underqualified senior management team. One can only imagine the Australian Prudential Regulatory Authority people reading of these appointments with some mix of despair and bewilderment while – condescendingly, but as they are prone to – suggesting that fortunately it doesn’t matter too much as APRA does the prudential supervision that really counts for New Zealand. That model – wind up and turn things over to APRA – was rejected (and rightly) by Michael Cullen almost 20 years ago, but his successor seems to be going for the worst of all worlds -a a bloated and expensive central bank of our own, led by people who do not warrant any great level of confidence in their individual or collective capabilities in the role they have taken up.
If there is a National/ACT government after the election it will have to make it a matter of priority to begin a far-reaching overhaul of the Reserve Bank (management and governance) to reverse the increasingly embarrassing spectacle of sustained institutional decline.
Meanwhile, of course, under the new law, the Minister of Finance was required to consult with other political parties on proposed appointees. It is a relatively unusual provision which Labour chose to put in the law, presumably intended to single their seriousness about a high quality Board that was broadly not too unacceptable across party lines (consistent with that, these appointees do not serve at will and can be removed only for cause – not including being ill-qualified in the first place). One wonders what National and ACT (in particular) said when the Minister consulted? Perhaps there were worse names on an original list. Perhaps the parties never bothered objecting, or perhaps they did object and Robertson just pushed on through anyway. Perhaps the relevant spokespeople could tell us?
I have lodged a series of OIA requests with the Minister, The Treasury, and the Reserve Bank to get a better insight on the process leading to those appointments, including the consultation with other parties.
My last short post was a month ago. At that stage post-Covid it was seriously taxing to read anything more demanding than Trollope, let alone even think about writing anything.
But with time, things improve. I had even harboured thoughts of a serious post this week – the one I’d like to write is about how we assess the culpability of central banks for the current and prospective inflation outcomes.
But….I had a commitment to write a 1000 word book review for a publication I write for. I did a draft of that yesterday, and doing so so badly knocked me back I won’t be trying anything similar for a while yet.
The gist of the post would have been:
Based on the information, understanding, and risks at the time, interest rate cuts in early 2020 were well-warranted.
(Core) inflation outcomes (globally) are largely the outcome of monetary policy choices 12-18 months previously.
12-18 months previously no one was forecasting inflation (or unemployment) outcomes akin to what we actually now see (check RB forecasts, NZ private sector forecasts, or overseas official or private forecasts).
That was a huge forecasting/understanding error, but……it is hard to hold central banks very culpable when no one much else saw the outlook any better (even if it is their specific job).
There is much more culpability about sluggish policy responses (or lack of them) from about a year ago, as the upside risks became increasingly apparent. Central banks took a punt, which hasn’t worked out, and we are all paying the price (in NZ it wasn’t until February that the OCR got to pre-Covid levels and the Funding for lending crisis programme is still running).
Serious scrutiny of central bank policymakers is now warranted, with a presumption against reappointment (but here two were just reappointed).
Oh, and the massive losses to the taxpayer from the bond buying programmes – purchases often occurring well after it was clear worst-case downside outcomes were no longer likely – are something central bankers are entirely culpable for.
And the book? Two Hundred Years of Muddling Through: The Surprising Story of the British Economy by UK journalist Duncan Weldon. It is short (300 pages), accessible (even chatty), judicious, informed by the literature, and strongly recommended (especially for the period up to about 1950) for anyone who wants to know a bit more economic and economic policymaking history. I’ve read a lot in that area, and so probably didn’t learn a lot new, but was interested to learn that on the eve of World War One, not only was the UK “the dominant manufacturer of exported goods, the centre of international finance” but also “the world’s largest net energy exporter” (that was the coal).
Three weeks ago I last wrote here, in a blithely optimistic tone
No posts last week between some mix of the war news (including related economics and financial markets news) being more interesting, and Covid – in our house that is. Not being too sick, but not being entirely well either I wasn’t concentrating very hard for very long. Fortunately, the isolation is now half over and no one’s health is particularly concerning. So back to some domestic economics and policy.
When our isolation began I’d picked off the bookshelves the first of the six of Anthony Trollope’s Palliser novels. Having been on the shelves for almost 20 years it seemed like a good opportunity to make a start on the series.
Unfortunately, although the whole family got Covid to one degree or other and all of them recovered fully, I – quite a bit the oldest, and perhaps previously prone to slow recoveries – did not.
And this morning I’ve just finished the last of the six Palliser novels (an enjoyable read if, perhaps, not as good as his Barsetshire novels).
As those who follow me on Twitter will know, it is not as if I have lost all interest in economic policy etc, but have just lost the ability to concentrate on anything more taxing than Trollope for more than perhaps 10 minutes without feeling really quite unwell and needing to lie down. Reading one 8 page memo bright and early yesterday morning completely did me in for the day.
There are many people much less well positioned than I am (including that I have an ample supply of novels etc on the shelves), so this is really just an advisory that it seems likely to be a few weeks at least before there are any other posts here. Which is a shame, as interesting issues abound (should, for example, the MPC consider a 75 or even a 100 basis point increase in the OCR next month?), but for now it is the way things are.
The National Party, in particular, has been seeking to make the rate of inflation a key line of attack on the government. Headline annual CPI inflation was 5.9 per cent in the most recent release, and National has been running a line that government spending is to blame. It is never clear how much they think it is to blame – or even in what sense – but it must be to a considerable extent, assuming (as I do) that they are addressing the issue honestly.
I’ve seen quite a bit of talk that government spending (core Crown expenses) is estimated to have risen by 68 per cent from the June 2017 year (last full year of the previous government) to the June 2022 year – numbers from the HYEFU published last December. That is quite a lot: in the previous five years, this measure of spending rose by only 11 per cent. Of course, what you won’t see mentioned is that government spending is forecast to drop by 6 per cent in the year to June 2023, consistent with the fact that there were large one-off outlays on account of lockdowns (2020 and 2021), not (forecast) to be repeated.
But there is no question but that government spending now accounts for a larger share of the economy than it did. Since inflation was just struggling to get up towards target pre-Covid, and I’m not really into partisan points-scoring, lets focus on the changes from the June 2019 year (last full pre-Covid period). Core Crown expenses were 28 per cent of GDP that year, and are projected to be 35.3 per cent this year, and 30.5 per cent in the year to June 2023 (nominal GDP is growing quite a bit). That isn’t a tiny change, but…..it is quite a lot smaller than the drop in government spending as a share of GDP from 2012 to 2017. I haven’t heard National MPs suggesting their government’s (lack of) spending was responsible for inflation undershooting over much of that decade – and nor should they because (a) fiscal plans are pretty transparent in New Zealand and (b) it is the responsibility of the Reserve Bank to respond to forecast spending (public and private) in a way that keeps inflation near target. The government is responsible for the Bank, of course, but the Bank is responsible for (the persistent bits of) inflation.
The genesis of this post was yesterday morning when my wife came upstairs and told me I was being quoted on Morning Report. The interviewer was pushing back on Luxon’s claim that government spending was to blame for high inflation, suggesting that I – who (words to the effect of) “wasn’t exactly a big fan of the government” – disagreed and believed that monetary policy was responsible. I presume the interviewer had in mind my post from a couple of weeks back, and I then tweeted out this extract
I haven’t taken a strong view on which factors contributed to the demand stimulus, but have been keen to stress the responsibility that falls on monetary policy to manage (core, systematic) inflation pressures, wherever they initially arise from. If there was a (macroeconomic policy) mistake, it rests – almost by definition, by statute – with the forecasting and policy setting of the Reserve Bank’s Monetary Policy Committee.
I haven’t seen any compelling piece of analysis from anyone (but most notably the Bank, whose job it is) unpicking the relative contributions of monetary and fiscal policy in getting us to the point where core inflation was so high and there was a consensus monetary policy adjustment was required. Nor, I think, has there been any really good analysis of why things that were widely expected in 2020 just never came to pass (eg personally I’m still surprised that amid the huge uncertainty around Covid, the border etc, business investment has held up as much as it has). Were the forecasts the government had available to it in 2020 from The Treasury and the Reserve Bank simply incompetently done or the best that could realistically have been done at the time?
Standard analytical indicators often don’t help much. This, for example, is the fiscal impulse measure from the HYEFU, which shows huge year to year fluctuations over the Covid and (assumed) aftermath period. Did fiscal policy go crazy in the year to June 2020? Well, not really, but we had huge wage subsidy outlays in the last few months of that year – despite which (and desirably as a matter of Covid policy at the time) GDP fell sharply. What was happening was income replacement for people unable to work because of the effects of the lockdowns. And no one much – certainly not the National Party – thinks that was a mistake. In the year to June 2021, a big negative fiscal impulse shows, simply because in contrast to the previous year there were no big lockdowns and associated huge outlays. And then we had late 2021’s lockdowns. And for 2022/23 no such events are forecast.
One can’t really say – in much of a meaningful way – that fiscal policy swung from being highly inflationary to highly disinflationary, wash and repeat. Instead, some mix of the virus, public reactions to it, and the policy restrictions periodically materially impeded the economy’s capacity to supply (to some unknowable extent even in the lightest restrictions period potential real GDP per capita is probably lower than otherwise too). The government provided partial income replacement, such that incomes fell by less than potential output. As the restrictions came off, the supply restrictions abated – and the government was no longer pumping out income support – but effective demand (itself constrained in the restrictions period) bounced back even more strongly.
Now, not all of the additional government spending has been of that fairly-uncontroversial type. Or even the things – running MIQ, vaccine rollouts – that were integral to the Covid response itself And we can all cite examples of wasteful spending, or things done under a Covid logo that really had nothing whatever to do with Covid responses. But most, in the scheme of things, were relatively small.
This chart shows The Treasury’s latest attempt at a structural balance estimate (the dotted line).
In the scheme of things (a) the deficits are pretty small, and (b) they don’t move around that much. If big and persistent structural deficits were your concern then – if this estimation is even roughly right – the first half of last decade was a much bigger issues. And recall that the persistent increase in government spending wasn’t that large by historical standards, wasn’t badly-telegraphed (to the Bank), and should have been something the Bank was readily able to have handled (keeping core inflation inside the target range).
The bottom line is that there was a forecasting mistake: not by ministers or the Labour Party, but by (a) The Treasury, and (b) the Reserve Bank and its monetary policy committee. Go back and check the macro forecasts in late 2020. The forecasters at the official agencies basically knew what fiscal policy was, even recognised the possibility of future lockdowns (and future income support), and they got the inflation and unemployment outlook quite wrong. They had lots of resources and so should have done better, but their forecasts weren’t extreme outliers (and they didn’t then seem wildly implausible to me). They knew about the supply constraints, they knew about the income support, they even knew that the world economy was going to be grappling with Covid for some time. Consistent with that, for much of 2020 inflation expectations – market prices or surveys – had been falling, even though people knew a fair amount about what monetary and fiscal policy were doing. In real terms, through much of that year, the OCR had barely fallen at all. It was all known, but the experts got things wrong.
Quite why they did still isn’t sufficiently clear. But, and it is only fair to recognise this, the (large) mistake made here seems to have been one repeated in a bunch of other countries, where resource pressures (and core inflation) have become evident much more strongly and quickly than most serious analysts had thought likely (or, looking at market prices, than markets themselves had expected). Some of that mistake was welcome – getting unemployment back down again was a great success, and inflation in too many countries had been below target for too long – so central banks had some buffer. But it has become most unwelcome, and central banks have been too slow to pivot and to reverse themselves.
Not only have the Opposition parties here been trying to blame government spending, but they have been trying to tie it to the 5.9 per cent headline inflation outcome. I suppose I understand the short-term politics of that, and if you are polling as badly as National was, perhaps you need some quick wins, any wins. But it doesn’t make much analytical sense, and actually enables the government to push back more than they really should be able to. Because no serious analyst thinks that either the government or the Reserve Bank is “to blame” for the full 5.9 per cent – the supply chain disruption effects etc are real, and to the extent they raise prices it is pretty basic economics for monetary policy to “look through” such exogenous factors. It seems unlikely those particular factors will be in play when we turn out to vote next year.
Core inflation not so much – indeed, the Bank’s sectoral core factor model measure is designed to look for the persistent components across the whole range of price increases, filtering out the high profile but idiosyncratic changes. Those measures have also risen strongly and now are above the top of the target range. That inflation is what NZ macro policy can, and should, do something about. But based on those measures – and their forecasts – the Reserve Bank has been too slow to act: the OCR today is still below where it was before Covid struck, even as core inflation and inflation expectations are way higher. Conventional measures of monetary policy stimulus suggest more fuel thrown on the fire now than was the case two years ago.
When I thought about writing this post, I thought about unpicking a series of parliamentary questions and answers from yesterday on inflation. I won’t, but suffice to say neither the Minister of Finance, the Prime Minister, the Leader of the Opposition, or Simon Bridges or David Seymour emerged with much credit – at least for the evident command of the analytical and policy issues. There was simply no mention of monetary policy, of the Reserve Bank, of the Monetary Policy Committee, or (notably) the government’s legal responsibility to ensure that the Bank has been doing its job. It clearly hasn’t (or core inflation would not have gotten away on them to the extent it has). I suppose it is awkward for the politicians – who wants to be seen championing higher interest rates? – and yet that is the route to getting inflation back down, and the sooner action is taken the less the total action required is likely to be. With (core) inflation bursting out the top of the range, perhaps with further to go, the Bank haemorrhaging senior staff, the recent recruitment of a deputy chief executive for macro and monetary policy with no experience, expertise, or credibility in that area, it would seem a pretty open line of attack. Geeky? For sure? But it is where the real responsibility rests – with the Bank, and with the man to whom they are accountable, who appoints the Board and MPC members? There is some real government responsibility here, but it isn’t mainly about fiscal policy (wasteful as some spending items are, inefficient as some tax grabs are), but about institutional decline, and (core) inflation outcomes that have become quite troubling.
Since I started writing this post, an interview by Bloomberg with Luxon has appeared. In that interview Luxon declares that a National government would amend the Act to reinstate a single focus on price stability. I don’t particularly support that proposal – it was a concern of National in 2018 – but it is of no substantive relevance. Even the Governor has gone on record saying that in the environment of the last couple of years – when they forecast both inflation and employment to be very weak – he didn’t think monetary policy was run any differently than it would have been under the old mandate. That too is pretty basic macroeconomics. It is good that the Leader of the Opposition has begun to talk a bit about monetary policy, but he needs to train his fire where it belongs – on the Governor – not, as he did before Christmas, forcing Simon Bridges to walk back a comment casting doubt on whether National would support Orr being reappointed next year. In normal times, you would hope politicians wouldn’t need to comment much on central bankers at all. But the macro outcomes (notably inflation), and Orr’s approach on a whole manner of issues (including the ever-mounting LSAP losses) suggest these are far from normal times. Core inflation could and should be in the target range. It is a failure of the Reserve Bank that it is not, and that – to date – nothing energetic has been done in response.