Threadbare analysis and ideological causes

Last week a group calling themselves the Sustainable Finance Forum –  itself a creation of the self-selected left-wing environmental/political lobby group The Aotearoa Circle –  published an interim report.   The report is 70 pages long, but don’t let that deter you as there really isn’t much there.

Of course, this is not just any lobby group.  On the board of the Aotearoa Circle, for example, sits Vicky Robertson, chief executive of the Ministry for the Environment, and supposedly an apolitical public servant, advising ministers of whichever political stripe.  Oh well, never mind those old conventions…..   And one of the two co-chairs of the Sustainable Finance Forum is Matt Whineray, chief executive of the New Zealand Superannuation Fund, and supposedly an apolitical public servant charged with managing a large pool of taxpayers’ money from one government to the next.   Somewhat surprisingly (but welcome) the Reserve Bank Governor isn’t a full participant in this body –  although we’ve been left in no doubt of his ideological/political colours –  but the Bank (together with the FMA and the Ministry for the Environment itself) is described as an observer.

Of course, the participants aren’t all (or even mostly) public servants.   Woke left-wingery isn’t confined to the public sector and the second co-chair is a senior manager at Westpac, a bank which goes out of its way to advertise its enthusiasm for all such modern “worthy causes”.  There is a “technical working group” of 33 people and probably 85 per cent of them are employed in the private sector (it does seem rather a large technical working group for a report with only about 50 pages of text).

What there isn’t is much substance or much rigour.  There are dozens and dozens of grab-bag factoids –  some real, some not –  but little context.   There is no sense, for example, that these people have any real understanding of how our current levels of prosperity were achieved.  Perhaps more concerningly, given their breathless enthusiasm for stuff to be done, is that they demonstrate no awareness of the limitations of knowledge, the pervasiveness of uncertainty, or of the well-demonstrated capacity for governments to get things badly wrong.  There isn’t much sign either that they have read any economics beyond Kate Raworth.  And there is no sign either that they’ve engaged with Chesterton’s fence

In the matter of reforming things, as distinct from deforming them, there is one plain and simple principle; a principle which will probably be called a paradox. There exists in such a case a certain institution or law; let us say, for the sake of simplicity, a fence or gate erected across a road. The more modern type of reformer goes gaily up to it and says, “I don’t see the use of this; let us clear it away.” To which the more intelligent type of reformer will do well to answer: “If you don’t see the use of it, I certainly won’t let you clear it away. Go away and think. Then, when you can come back and tell me that you do see the use of it, I may allow you to destroy it.”

Perhaps the zealots are right and the end of the world is nigh, all that we have known must be up-ended etc, but it would be more reassuring if they showed signs of actually understanding why things are as they are.

The bottom line goal seems to “the transition to a sustainable economy” and yet this goal is simply not defined.   Since these peope are from the financial sector, they talk a lot about a “sustainable financial sector”.   In the media coverage of the report there was some coverage to the factoid that 95 per cent of respondents believed that the current financial system was not sustainable.  I was one of the people interviewed as part of the project and I was one of the 5 per cent –  partly perhaps because I was taken aback by the question: what on earth did “a sustainable financial system” actually mean?    As the financial system didn’t seem likely to fall over (even the Reserve Bank used to tell us that before the Governor when chasing capital whims), it had been with us in much the same form for a long time, and had proved adaptable as market demands and regulatory structures changed, it seemed a pretty obvious answer to me.   But clearly I wasn’t part of the inner sanctum, because in the report itself defines “a sustainable financial system” rather idiosyncratically as one that serves the ends favoured by the authors:

The aim of the project is to produce a Roadmap for Action on how to shift New Zealand to a sustainable financial system – from one which focuses primarily on (often shortterm) financial wealth creation, to one that supports long-term social, environmental, and economic wellbeing and prosperity for all  New Zealanders, protecting natural resources for future generations.

Strangely, there is no mention of the fact that –  relatively poor as New Zealand’s performance has been –  material living standards here are hugely higher than they were 100, let alone 200, years ago, and for most people the day-to-day experience of pollution is also much less serious than it was 100 years ago.  Technology, innovation, and finance have all contributed to those outcomes.   There is lots and lots of talk in the report about Maori perspectives and ways of thinking –  a better economic model we were told, one with no externalities apparently……. – but no apparent recognition –  or concern –  that Maori systems and worldviews (pre Western contact) had not exactly been tending towards the sort of high material living standards, and functioning financial system, that we take for granted today.

None of which is to be cavalier about where we stand now.  There are outstanding issues around water, for example. But it isn’t obvious what role the financial system has to play there –  regulatory issues around pricing, definition of property rights, access etc provide the backdrop against which borrowers/investors raise funds and other provide them.    And, of course, there is a climate change, but if anything is characterised by uncertainty it has to be that area.  One of the bugbears of the SFF (and the Reserve Bank Governor) is the (alleged) short-termism of the financial system, but they never seem to grapple –  including in this report –  with the fact that a relatively short-term approach is a prudent response to the risks created by uncertainty.

Pretty much every left-wing cause of the decade gets reference in the report.  Inequality is a big one for them, but with no substantial analysis one is left with the impression that it is mostly for effect, and mood affiliation.   Early in the report there was a referenced claim, for example, that  “New Zealand’s income inequality gap has impacted GDP by more than 15%”, but when I looked up the reference it was to a North and South article which itself claimed –  without a citation –  that

OECD researchers have suggested our gap has hobbled GDP by more than 15 percentage points in recent decades, largely because of disadvantaged families bailing out of education.

Well, perhaps….but since OECD statistics also show that New Zealand employee skill levels are among the very highest in the OECD it seems unlikely.  Oh, and returns to education in New Zealand appear to be quite low.  And what it had to be with a “sustainable financial system” wasn’t clear at all.  Being, apparently, a bunch of lefties they want a “comprehensive response to inequality” but what they mean, or what (if anything) it has to do with the financial system is left totally unspecified.   It was the feelings that mattered apparently.   They do claim the “current financial system” is contributing to “growing inequality”, but make no effort to justify either limb of that claim.

We got similarly feeble references to the so-called “gender pay gap”.  There was a whole page on modern slavery and labour exploitation, some of which was interesting, some of which was fair, but none of which had any discernible relevance to the New Zealand financial system.  Hard to disagree, I suppose, with the banner quote on that page that “a financial system cannot be sustainable if it undermines the basic human rights we all hold dear” but even if true –  and I’m thinking of exceptions as I type –  it isn’t overly helpful or offer any great insight on how the financial sector should adjust/evolve.

At the very front of the document the Aotearoa Circle told us about their vision which includes

They aim to achieve this by reversing the decline of our natural resources.

Which also seems pretty incoherent. I get the impression they have waterways in mind –  which is fair enough I suppose, within limits (the benchmark can’t be say pre-1000AD conditions) –  but natural resources include coal, gold, oil and gas, timber, ironsands and so on.  Did they not notice?   Are they proposing to put the coal back in the mountains –  the same coal burned in the process of generating the living standards we have now, and the potential to move towards newer (cleaner) technologies?    It is a small point in a way, but it is the sort of thing that is likely undermine any good a report of this sort might do among those who aren’t uncritical “true believers” to start with.

There is all the talk about rising sea levels and what this might mean.  That partly involves using scary numbers about the value of affected buildings, but without any reference to the twin facts that (a) the dates they are quoting are mostly many decades away, and (b) existing structures depreciate.   And then, of course, there is the talk about access to finance and insurance.  Which are real issues no doubt, but they don’t unfold overnight –  they are some of the better-foreshadowed risks companies have ever faced –  and no reason (identified in the report) why existing market participants (and perhaps new entrants) can’t/won’t respond and adjust, in response to their own incentives, as they’ve always done.     Same goes for wider climate change issues: the report claims ‘financial markets in New Zealand..are still largely misaligned with climate change and other sustainability imperatives”, but they offer no evidence for this –  not a shred.

These people also have a bunch of other ideological causes.  They appear to champion the Living Wage as a policy response to New Zealand’s poor productivity.  Not only is that incoherent, but there is no obvious connection to the financial system (“sustainable” or otherwise)     They rightly lament the high cost of housing –  although never point out that were these government-driven distortions ever to be reversed and the market able to function well that housing finance would be a much much smaller part of bank balance sheets in future.  Oh, and they are dead keen on Australia’s compulsory private superannuation system –  but I guess we should mostly just put that down to (consciously or unconsciously) pure self-interest (it is a great system for financial industry service providers, while our own retirement income system generates very low rates of elderly poverty with a pretty modest fiscal burden).

And we get the best part of a full page on the Reserve Bank/FMA crusade around bank culture and conduct, all of which skated over the fact that when those agencies reported back (on their largely ultra vires activities) the bottom line was that there was little evidence of any sustained problems.  But I guess that wasn’t the narrative these left-wing crusaders wanted to channel.

Buried amid the blather there are probably a few sensible paragraphs on a few specific regulatory issues, but what might be valuable is largely lost amid the rhetoric, and the rhetoric itself is of much-diminished value because there is so little hard-headed substance.  We know for example that the Orr/Whineray NZSF could get away with making a big active punt on climate change, and so mask the punt that we can never properly hold them to account for it.  But that is the weakly-accountable government for you.  Most investors, most savers, want more than idle calls for the financial system to work for the “good of society”, however ill-defined that may be.    All manner of chancers and opportunists  (public and private sector) will tell you their project, their plan is “the one”.  The challenge of anyone –  especially anyone investing other people’s money –  is to be able to recognise the good from the bad, manage the risks etc.  And none of that is easy.  None of us knows what the economy will look like 30 years hence, let alone this time next century.  Not even Whineray and Silk.

There is an opportunity to submit on the interim report (link here). I’m not sure I’ll even bother.  It is so bad (and so ideological) they’d really be better off ripping up the report and starting from scratch with a much more hard-headed approach to thinking through the issues and challenges, constraints and opportunities, including demonstrating a thorough understanding of the strengths and weaknesses of the current system   But I guess that wouldn’t suit their mates in the Labour and Green parties, for whom reports like this help provide cover, even when largely devoid of substance, insight, or sustained robust argument.

 

2019 vs 1969

I was listening to a thoughtful podcast discussion yesterday between one of my favourite US commentators, Jonah Goldberg, and Marian Tupy of the Cato Institute (where he a responsible for the Human Progress website)    This morning I read a column by economist Noah Smith along very similar lines.   The bottom line: life just gets better and better (the podcast discussion was more wide-ranging, across history and across countries, and somewhat more reflective, while Smith’s –  much shorter – piece was comparing life in the US in the 1950s and now).

I’ve read numerous books and articles along similar lines: as just two examples, Steven Pinker’s Enlightenment Now and Matt Ridley’s  The Rational Optimist. I’ve even run some of these arguments myself in a New Zealand context, illustrating just how different material living standards are now relative to those 100 years ago.

You won’t get any disagreement from me to the proposition that a market-oriented economy is the best mechanism known to man –  although its innards, which bits matter most, still have elements of mystery –  for generating material prosperity.  You also won’t get any disagreement from me that some times/places in human history have been better than others (on almost any aspect conceivable).  Then again, there have been times and places worse –  sometimes materially so – than those that went before.   Any society in the midst of a civil war is almost inevitably in a particulary undesirable situation.   1970s Cambodia was almost certainly worse than, say, the colonial era, 1940s Germany worse than most times in German history (notwithstanding the fruits of material progress), and so on.

Material gains –  whether things, life expectancies, or whatever –  aren’t everything but they aren’t nothing either.   Even abstracting from the war going on at the time, I was sympathetic to the proposition that no amount of money would make any modern American change places with John D Rockefeller 100 years earlier (except of course that some things of value have no price). I don’t even suppose there are too many takers for 1969 Czechoslovakia (Tupy is of Slovak ancestry) over today’s Czech Republic or Slovakia (not even all those US millenials who answered a recent survey suggesting they had a favourable view of communism).

But some choices –  not ones actually open to us, of course, but thought experiments –  are much less clear-cut.   I got to reflecting on life in New Zealand 50 years ago and that now.

At a material level, even as a woeful underperformer on the productivity front (although yesterday’s release from SNZ suggests they may have found another 1-2 per cent of productivity –  level, not growth rate), real GDP per capita or per hour worked are significantly higher than they were 50 years ago.  But to what end is less clear.

Fifty years ago I lived in Kawerau, which was probably as prosperous a town, if new and a little raw, as could be found in the country –  fruit of the Think Big project of the 1950s.  (From all I’ve seen and read, life in Kawerau today is probably worse than it was then.)  But that isn’t really my comparison.   We didn’t have a great deal –  my father had just taken up a role as pastor of the local Baptist church –  but two of my uncles were partners, apparently reasonable successful, in professional practices in central Christchurch (one law, one accounting).   And if I contrast the lives they, and aunts and cousins, had then with the life my family lives now –  I was a well-paid public servant for decades, my wife now is a well-paid senior public servant –  it is hard to spot the nature of the substantial gains (which isn’t a complaint at all).  That is probably even more true if I contemplate the prospects for my children, given what successive governments have done to the housing market.

Perhaps it is something about my/our tastes, and I’m certainly not suggesting the average material standard of living is worse than it was, just that the gains don’t count for that much with me (unlike, say, the gains in the 50 or 100 years prior to that) –  mostly nice-to-haves rather than things which have me celebrating leaps and bounds in human progress.  Are the cars fancier?  Well, yes of course, but I’m not one of those who greatly values cars.  Is the internet nice to have?  Well, of course (and I’d not be writing this without it), but in what ways would we be substantially poorer without it (it offers an improvement on weekly news magazines and newspapers, but not that much of one most of the time)?  Mightn’t most parents prefer a world in which schools weren’t pervaded by smartphones and their distractions.   There is immense choice of eating out options I guess, but frankly I like to cook, as did my mother.  Again, perhaps it is a matter of tastes.   But the proposition of the evangelists of “progress” is that even the material gains are self-evident and (at least by implication) substantial.  I’m not disputing there are gains, but how much weight one might put on them is another matter.  For materialists, I guess quite a lot, unless diminishing marginal utility sets in for them as well.

(This isn’t, of course, an original point, and is –  among other things –  something of a variation of the story US economist Robert Gordon tells, in suggesting that the real lifestlye-improving gains happened decades ago.)

Perhaps the gains in life expectancy for those born seem less arguable.  And I’m certainly not going to dispute that they are real.  But it brings us closer to the deeper questions about the purpose of life. And about which lives.  And what life.

As compared to 1969, New Zealand now legalises –  and has the taxpayer fund –  13000+ abortions a year, and this ability to have one’s own child put to death is deemed by our leaders some sort of basic human right, a matter of “health”.

As compared to 1969, our society grapples with disconcertingly high suicide rates, especially among some of our young people.

And, as compared to 1969, our system is on the brink of legalising assisted suicide.

In some parts of other Western societies, even adult life expectancies are falling, fruit of some mix of drugs, isolation, despair or whatever.

And for any Christian –  and Christianity has shaped the culture from which the bulk of our population comes for perhaps 1500 years –  this earthly life is just the foretaste, the preparation, for eternal life with God.  That doesn’t make life on earth unimportant –  far from it –  but creates a different perspective on the value one might attach to a few more years here.    Societies in which there is nothing more are also ones in which it is much harder to envisage a cause, a choice, worth dying for.

Why else might one legitimately be underwhelmed by what has become of the country since, say, 1969? I could list:

  • the rise of welfarism,
  • the normalisation of birth outside marriage,
  • the abandonment of any societal recognition of the importance of marriage as a bedrock institution of society.
  • the coarsening of our culture (each Saturday I’m still astonished that the Herald runs a column celebrating what were once vices, in some traditions even “deadly sins”,
  • easy and extensive access to pornography (flip side of the advantages of the internet), that degrades all those involved,
  • the normalisation –  nay celebration – of the vice of homosexual practice,
  • the current transgender mania,
  • the loss of any sense of a unifying day of rest.

And, at the heart of it, the decline in Christian faith and observance (there were never “golden days”, but everyone recognises the difference between then and now.  Every society has a “religion” of sorts –  the taboos and understanding by which societies operate and people interact –  and I find almost nothing appealing about modern New Zealand’s provisional replacements for Christianity.

I could go on and add that in 1969 our main political parties and their leaders were pretty clear about the nature of Communism and the evil represented by the regimes in the Soviet Union and the People’s Republic of China.  The Soviet Union has, mercifully, gone, but the evil represented by the PRC/CCP is as real as ever, and more threatening to us, since our “elites” have abandoned all sense of right and wrong where the PRC is concerned, pursuing (it seems) only money, whether through trade or party donations.

And there is the increasing power of the state, enabled by technology.  Surveillance, and coercive, states aren’t just a threat in China.

And so on and so forth.

Are there alternative perspectives?  Well, of course.  Perhaps as many as there are “religions” or world views.   Some will regard where we’ve got to in the last 50 years as a giant step forward.  For all the material and (often double-edged) technological advantages, personally I’d exchange 2019 New Zealand for 1969 New Zealand.  It isn’t a choice or an option, but to me what we’ve gained is small compensation –  not even really directly comparable –  to what we’ve lost.

Monetary policy communications and the lack of transparency

The Reserve Bank’s Assistant Governor for monetary policy and financial markets, Christian Hawkesby, went off to Sydney earlier this week to talk to some investors about New Zealand monetary policy communications.  Hawkesby now has tenure and independence –  at least in principle – as a statutory officeholder, a member of the Monetary Policy Committee, appointed directly by the Minister of Finance.

It was perhaps telling that (a) the speech was delivered on a New Zealand public holiday, (b) the text wasn’t released for another 24 hours, and (c) we have no record of what Hawkesby actually said, including in response to questions.  That is no way to do monetary policy communications.

Perhaps while he was in Sydney Hawkesby dropped in on his peers at the Reserve Bank of Australia.   The RBA has about 45 speeches/presentations from senior managers showing on its Speeches page for 2019.   For all but three of them –  and none of those three on topics that appear market-sensitive –  there is video, audio or a Hansard transcript (several of the Governor’s appearances were to parliamentary committees).  It doesn’t seem to make any difference to the RBA whether the speeches etc are given overseas, out in the provinces in Australia, or in downtown Sydney or Melbourne: the standard they set for themselves is that when they say something, it is made generally available.    Anything else poses a risk –  actual or in appearances –  of unequal access to potentially market-moving, or just insightful, official information and perspectives.  That is just one aspect of communications on which the Reserve Bank of New Zealand falls a long way short of best practice.  There are 12 speeches from senior managers on the Reserve Bank of New Zealand’s Speeches page for 2019, and for only of them is there video footage (that a puff piece by the Governor –  which I wrote about here).

Hawkesby’s speech came in two parts.  The first was devoted to repeating longstanding Reserve Bank spin about how transparent it is, supplemented by some Orr-esque lines about how surprising the market is no bad thing (the second part was defensive play around the surprise August 50 bps OCR cut).  There were no fresh insights or arguments, which in itself was a bit disappointing from so senior a figure, relatively newly returned to the Bank  –  despite the relatively junior-sounding title, Hawkesby is, in effect (and in Wellington public service lingo) a deputy chief executive responsible for half the Bank’s core functions.  Anywhere else in the world he’d carry a Deputy Governor title.   Those are the standards his speeches should be held to.

The Reserve Bank (longstanding) main claim to being highly transparent is that it publishes a future track for the policy interest rate (the OCR) for a period two to three years ahead.  We were the first central bank to do so, in 1997.  As Hawkesby notes, despite 22 years experience, only a handful of other central banks  (four small advanced country ones) have followed our lead.  Reasonable people can debate whether publishing a forward interest rate track is the best way to do things (I’ve never been convinced myself) but when none of the world’s leading central banks have taken that path –  and all will, quite seriously, proclaim a commitment to transparency –  it probably isn’t something to put quite as much weight on as the Bank has done (through successive Governors/staff).

I’ve characterised the publication of the forward interest rate track as being highly transparent about something the Bank (now, at least formally, the MPC) knows almost nothing about.  Economic forecasting is a mug’s game, and there is little evidence that anyone can usefully forecast economic developments more than perhaps a quarter or two ahead….and yet, monetary policy works with a lag, so a medium-term OCR projections (for, say, 2.5 years ahead) implicitly requires –  to be meaningful – some intelligent view of inflation prospects perhaps four years hence.  No one can do it in a way that has any useful substantive information.

And if the Reserve Bank is pretty transparent about the stuff it knows almost nothing about –  and has to divert scarce resources to generating such tracks –  it is really quite strikingly non-transparent about the stuff it does know more about.  For example:

  • we have a Governor, clearly the most important player in the system, who has not yet given a particularly substantive speech on monetary policy, the economy, and inflation (which would otherwise offer insights on his thought processes, his mental models, his ability to process and analyse data etc),
  • we have a Chief Economist –  also a statutory appointee as member of the Monetary Policy Committee –  who has not given a speech or said a substantive word in public since he was appointed,
  • as above, the Bank isn’t particularly transparent around the speeches it does give (and especially around answers to questions),
  • we have three non-executive members of the Monetary Policy Committee from whom not a word has been heard since they were appointed.  We know nothing about how any of them think about the policy targets towards which they are working, about how economic developments are unfolding, or about the “reaction functions” they use  (and this is so even though the rules allow them to speak), and
  • the Bank is totally untransparent about the background analysis produced to support monetary policy decisionmaking.   The current government –  not naturally particularly transparent –  has adopted a practice of pro-active release of Cabinet papers, many Budget-related papers have long been pro-actively released, but ask for any background papers re monetary policy decisions –  even with quite a lag –  and the Bank will simply refuse (and, sadly, they have the ineffectual Ombudsmen –  over several appointees – wrapped around their little finger in clasping this taxpayer-funded analysis tightly to their chest).  Perhaps it is lawful, but it simply isn’t transparent.   (A few years ago, after many months of trying, I managed to get them to release background papers for an MPS from 10 years previously –  but no one supposes they would release such material from, say, two years ago.  If there is a decent argument for any confidentiality around this material, it could only credibly mounted for the period from one MPS to the next –  ie three months or so – at most.)

That isn’t good monetary policy transparency, nor is good open government (the latter not being a consideration that ever weighed much with the Bank).

Hawkesby attempts a defence of the Bank’s preferred practice, in which only the Governor speaks about monetary policy (no speeches of course, just MPS press conferences) and to the extent that underlings like Hawkesby speech they largely parrot the Governor.   This is the best he can manage

A third limitation of transparency is the noise that it can create – an example of this is how to capture the diversity of views of individual members of a committee tasked with setting interest rates.

An example of this is how to capture the diversity of views of individual members of a committee that sets interest rates. Each individual member regularly sharing their views on the economic and policy outlook can make it harder for financial markets to interpret the reaction function of the collective group. While I worked at the Bank of England, I always remember the head of communications bemoaning the cacophony of voices. More transparency around the perspectives of individual members could also create incentives for those individuals to hold on to a previously published position even as new information emerges, for fear of being seen as ‘conceding’ their position.

A paradox of these limitations is that greater transparency does not necessarily equate to increased clarity for market participants and the general public. Just because more information is available does not necessarily mean the audience will have a greater understanding of how and why central banks make decisions.

But there isn’t much there.  Of course Communications managers are keen on message discipline –  always have been, always will be –  and at the Bank of England management was long not very keen on the independence of the external MPC members anyway.  But isn’t it striking that whereas the Reserve Bank seems to believe that New Zealanders –  public, markets –  can’t cope with a diversity of views (about a highly uncertain business), the national central banks for the largest advanced economies –  the US, Japan, and the UK –  in fact do cope quite well with having MPC members explicitly voting against a majority view, or articulating a model or analytical insights a bit different from that of others on the relevant committee.   Sweden is a succesful small country example.  The ECB is a bit different –  and there are some reasons why, around minimising pressure on members to act for their own country’s national interests –  but even in the ECB there is plenty of open recognition of differences of view among the monetary policy decisionmakers.   It isn’t as if central bankers know from year to year –  often not from quarter to quarter –  what they are going to do: events happen, interpretations evolve, and particular hypotheses are openly challenged and scrutinised (including those of monetary policy decisionmakers, when we are allowed to see them).

So, no, the Reserve Bank of New Zealand really isn’t particularly transparent at all.  And the newly published minutes really represent not much of a step forward at all.

One of Hawkesby’s points is that the Bank is keen to learn from outsiders –  yes, even “bloggers”.

When private sector economists, analysts, commentators or bloggers don’t agree with our policy decisions or our projections for the economy, it can be an uncomfortable message to hear. But it is an invaluable exercise to test our assumptions and reasoning, even if we don’t agree with their conclusions, we inevitably learn something along the way and strengthen our analysis of the issues.

Good to know (although it is a bit to take seriously when we see how the Governor responds to challenge, criticism, or alternative perspectives on another of those highly complex and uncertain issues –  appropriate bank capital requirements).

But this line is really used to buttress a rather silly line the Governor has run on a few occasions about the (alleged) dangers of the markets paying too much attention to trying to guess what the Bank is up to, in turn (allegedly) reducing the information the Bank itself can get from market prices.   This is, we are told, one reason why it is just fine for the Bank to do things that take markets totally by surprise (notably, the 50 basis point OCR cut in August).

It really is a nonsense argument, even if he can find a couple of footnotes to attempt to buttress his case. In fact (and in effect) he more or less concedes later in the speech when he highlights things like falling medium to long-term inflation expectations (including from the indexed bond market –  a welcome Hawkesby innovation to have the Bank even acknowledge the indicator) that were concerning the MPC when they made their decision.  Almost certainly those indicators –  eg from 10 year bonds – would have been just as they were whether markets thought the Bank was going to cut 50 bps in one go, surprising almost everyone, or (say) spread the cuts over two 25 bps cuts.

I’m not one of those who think that monetary policy decisionmakers should always deliver on market expectations. But usually if market expectations are very wrong (not –  eg –  just 10 expected a cut, 12 expected no change) it is the fault of the monetary policy decisionmakers themselves.   In those circumstances, they add noise and volatility that is simply unnecessary and has no redeeming societal merit.

And as I noted at the time of the August MPS, the 50 point cut looked a lot like a rather rushed last minute decision, that wasn’t really supported by other the numbers (they themselves produced) or the MPS text.

And what makes it a bit more concerning is that it is pretty clear the Bank itself wasn’t intending to move by 50 basis points even a few days ago.  The projections they published yesterday were finalised on 1 August (last Thursday).   On those numbers, the projections for the OCR (quarterly average) were:

September quarter 2019    1.4 per cent

December quarter 2019     1.2 per cent

March quarter 2020            1.1 per cent

With the next OCR review in late September and the following one in md-November, those projections –  adopted by the whole MPC – clearly envisaged not getting to a 1 per cent OCR even by the end of the year.

The bulk of the Monetary Policy Statement itself is written in the same relatively relaxed style, with no hint of a change in policy approach, and thus no proper articulation of the reason for it, or (hence) for how we should think about how the Committee will react, in principle, at future OCR reviews.   The Bank has added to uncertainty around policy, not reduced it.    In a similar vein, there is a new two page Box A in the statement on “monetary policy strategy”, intended to run each quarter, which is so general as to add nothing to the state of understanding of what the MPC and the Bank are up to.

And you will look in vain for any real insight from the minutes of the MPC meeting.   We are told

The members debated the relative benefits of reducing the OCR by 25 basis points and communicating an easing bias, versus reducing the OCR by 50 basis points now. The Committee noted both options were consistent with the forward path in the projections. [a claim that demonstrably isn’t true –  see above] The Committee reached a consensus to cut the OCR by 50 basis points to 1.0 percent. They agreed that the larger initial monetary stimulus would best ensure the Committee continues to meet its inflation and employment objectives.

But nothing about the considerations Committee members took into account in belatedly lurching to a 50 point OCR cut, or how they think about the conventions and signalling around using 25 point moves vs 50 point moves (when things aren’t falling apart here –  and it was the Governor yesterday who announced, oddly, of New Zealand that “the country is in a great condition”).

That wasn’t good or effective monetary policy communications.  It wasn’t a transparent insight on how the Committee is operating, the sort of reaction functions members are using, their view of MPS reviews vs the other OCR reviews.    It was –  or came across as –  a lurch (even if, like me, you thought that the OCR needed to come down quite a bit, quite quickly).

I’m going to end with two more examples of a lack of serious transparency.  Near the end of his speech Hawkesby observes

There are plenty of communication challenges ahead, especially if monetary policy in New Zealand moves into a less conventional territory, and we end up adopting new tools and approaches.

These will need to be explained clearly to both financial markets and the people of New Zealand.

No doubt, but would be an open and transparent central bank, wanting to build and maintain confidence in (a) its potential instruments, and (b) its actual decisionmakers and their advisers want to be much more open than the Reserve Bank has actually been?  Wouldn’t discussion documents outlining potential issues and options be a good idea?  Wouldn’t seminars and workshops with outside experts and market participants be a good idea?  Apart from anything else, at least in principle (as the Assistant Governor said) the Bank learns something from such engagement, challenge, and critique and in the process improves its own understanding and analysis.  It isn’t as if anyone is suggesting they pre-commit to when particularly instruments might be used, so this stuff shouldn’t really be market-sensitive, but it is quite important, potentially to us all (and was we know the Bank’s own research capability has been gutted this year).  And it isn’t as if the Bank’s background analysis on other matters –  bank capital again –  should fill us with confidence and willingness to simply “trust us, we know what we are doing”.

And on a smaller note, the next Monetary Policy Statement  and OCR decision is on 13 November.  As the Assistant Governor highlighted, inflation expectations are quite a significant influence in Bank thinking at present (rightly or otherwise).  And yet the main inflation expectations series –  the two year ahead measure in the Bank’s own survey –  isn’t scheduled for release until 12 November.   I participate in that survey.   Responses were due by midday last Tuesday (22nd). It is an electronic survey and if the results are not already in the Bank’s hands, they assuredly could be (it is pretty simple survey with fewer than 100 respondents, taking a matter of hours to compile at most).  And yet the Bank is sitting on this information until the very last minute.  By the time we get it, their decision will have been all-but-finally made, their MPS document completely written. If they were really serious about the desire to listen and learn, from markets, commentators, nay even “bloggers”, they’d have made sure the information was compiled and published quickly, allowing the Bank itself to listen to the response of outsiders in processing the significance of such important (to them) economic data.

If they were really serious…..instead, they mostly seem interested in fending off critics and keeping to themselves the stuff they know, while distracting us with their transparency about the stuff they don’t know much about at all (and where most central banks have not thought it advisable to follow the New Zealand lead).

 

 

Two years on

The weekend newspapers had several articles highlighting the second anniversary of the New Zealand First choice that led to the creation of the current government.  There was, for example, the double-page spread  in the Herald devoted to a not-at-all-searching interview with the Prime Minister and the Minister of Finance.  And there was another double-page article in the Dominion-Post looking at the government’s performance under a range of policy headings.  Since the government’s term is now two-thirds over –  likely to be in full campaign mode (say) nine months from now –  it seems not unreasonable to take a look at performance.

The Stuff political stuff divided up nine policy areas between them and wrote short reviews of the government’s performance in each of them.  On my reading, they tended towards a generous assessment.  All governments do stuff –  sometimes even just things in the works under a previous government – and where this government has done most (education notably) there isn’t a huge amount of evidence that there were real problems that needed fixing, or that their fixes were dealing with whatever real problems there were.

Take housing, for example, where the Stuff journalists summarise thus

Two years into the Government’s term, housing is far from Labour’s strong point, but it is not an area of total failure.

So house prices are still rising, rents are still rising (even in a low-interest rate world in which provision of rental housing could/should have been cheaper than ever) and there has been no legislation to free-up urban land markets, or to compel local authorities to operate a more liberal approach.   Set against that, a foreign buyers’ ban was largely irrelevant, and there is little reason to suppose that building a lot more state houses will increase the overall effective supply of housing (certainly won’t deal with the land issues).  For what was declared to be a “crisis” –  I’ll just settle for disgrace –  what has been done, or accomplished, is astonishingly little.  And it isn’t as if markets are pricing in better outcomes in future either.

But what really caught my eye was that there was no discussion of the government’s economic policy performance.  One might reasonably grant them a pass mark on fiscal stewardship –  but on anything beyond that the best reason why Stuff might have chosen to overlook this key area of policy is that there just isn’t much there at all.

Back when they were in Opposition we would, occasionally, here about the lack of any decent productivity growth, talk about growing export sectors, and so on.  Even today, the mantra of a “productive and sustainable” economy gets rolled out from time to time…..but with almost nothing to back it.

Actual productivity growth still languishes – running at no more than 0.5 per cent per annum, slower than in most other OECD countries. (It is fair to note here that there could be material revisions to a large number of macro series over the next couple of months, consequent on the census (and subsequent creative efforts) results, but there is no obvious reason to anticipate material improvements.)

There is no sign that the external orientation of the economy has strengthened (eg exports and imports as a share of GDP). no sign of robust business investment, and of course we all know that business confidence results are in the doldrums.  Interest rates have had to be cut further and the real exchange rate remains pretty high.

And what response has government policy made?   The government seems to have made quite a fuss about the new research and development tax credit. But they’ve produced no sustained analysis illustrating why this will make a great difference – and no sustained either looking at why firms didn’t regard higher rates of R&D spending here as offering attractive risk-adjusted returns.  And that really is about it.

And on the other hand, we have the government sitting idly by while the Reserve Bank Governor pursues his whim of making credit less readily available and more expensive, a halt to most new road-building even as the population continues to increase rapidly (and not, even, say, a congestion-pricing regime that might help reconcile the two), a ban on most oil and gas exploration, looming new regulatory restrictions around water.  Oh, and immigration policy –  for which there is no evidence of systematic economywide gains, in a country where (fixed) natural resources underpin prosperity –  is, if anything, becoming more liberal.

The government keeps telling us it has a plan.  I wrote here at the start of the year about an economics speech the Prime Minister gave, concluding

If there is any sign of a plan, it isn’t one that is going to do anything to lift our economic performance, in the short or longer-term.   All indications are that the Prime Minister doesn’t care. 

And then last month the government released something they did call an “Economic Plan” – in fact a thirty year one.  Notwithstanding all the glossy pictures and long lists of points, it sank without a trace, barely even reported at the time, even with a supporting op-ed from the Prime Minister herself (my take was here).

Once upon a time, I wondered (perhaps naively) if perhaps they –  upper reaches of the Labour Party – really did care.  They should.  After all, it is their traditional voters –  the poorer people, the working classes, the younger –  who suffer most from the decades-long failure of successive governments to improve New Zealand’s woefully poor productivity performance.    But all the evidence from their time in office is that any care is superficial at best.  Sure, they’d probably welcome a much better performing economy if it suddenly dawned fresh and shiny.  But they seem to have no real ideas, no compelling narrative, for how to markedly re-orient our economic performance, and they is no apparent interest in finding answers, or ensuring that our economic policy and analytical institutions are delivering them serious advice, grounded in the actual experience of New Zealand, on policy approaches that might really make a difference.

It is an utter abdication of responsibility.  No one made them run for office, no one forces them to stay in office, but when they take office they have responsibilities for the future prosperity of New Zealanders that they show no sign of taking at all seriously.

An academic economist left this comment on one of my weekend posts

With this in mind, I must confess that I always threaten to fail my Otago students if they don’t migrate to Austalia, because it shows they haven’t learnt anything from me; but the university doesn’t allow me to deliver on the threat. Still, most would be financially better off if they took this advice, and migrated to a place where better firms are located, and sought jobs there.

Sadly true.  And what a sad commentary on decades of policy failure here: Labour ministers currently hold all the key portfolios (Prime Minister, Minister of Financem Minister of Economic Development) and it is their failure now.

 

Prosperity then and now

I have a few other things on today, so these are just a couple of charts that are background for a post I may write tomorrow, prompted by this article.

The first shows the countries with the highest GDP per capita in 1900, expressed in international dollars, and taken from the Maddison project database.  Where I stopped is a bit arbitrary, but there is a reasonable step down from Chile to the next group of countries (ones in Europe).  Which countries make the list doesn’t depend on the precise choice of year (I checked 1913 and got the same list).

1900 GDP pc

I’ve also marked, in red, the countries that wouldn’t make a top-tier grouping today.

And here is the top tier of countries now, ranked by real GDP per hour worked (a better indicator of the capacity/possibilities of an economy, but for which there isn’t data for the earlier periods).   I’ve included a slightly larger number of countries, recognising that some of the very small ones (notably Luxembourg and Iceland) weren’t in the 1900 database.  For Ireland, I have followed the local authorities’ guidance and used their “modified GNI measure”.

GDP phw 2018

I find both the similarities and differences striking.

Most of the top-tier countries in 1900 are still there now.  Most of today’s top-tier countries (recognising that the oil exporters generally aren’t in the database) were there in 1900. Long-term persistence in prosperity is well-recognised in the literature.

But there are differences too.

In 1900, four Anglo countries topped the chart.  These days, only the United States is anywhere near the top.

And of the five southern hemisphere countries on the list in 1900, only one (Australia) is still there today.  All of the four who have dropped off the list are well below the lowest country on it (Ireland).

And the only Asian country that yet makes the list is Singapore (although Taiwan and Japan would take two of the next three places).

 

Portrait of a strongman

It didn’t seem like the best weekend for Reserve Bank Governor Adrian Orr.

First, there was Radio New Zealand’s Insight documentary on the Governor’s bank capital plans, and other possible new regulatory burdens.  I was impressed with the huge amount of time and energy that was put into the programme, although inevitably there are limitations in what a programme designed for a mainstream Sunday morning audience can deal with.     In some ways, the best public service now would be if Radio New Zealand and/or the Reserve Bank agreed to release the full interview Guyon Espiner did with the Governor –  we were told it was an hour long, but no more than five minutes would have been used in the programme (I presume this was par for the course on Espiner’s background work, as I did an interview with him that went for perhaps 40+ minutes).

In commenting on the substance of the programme one then has to be a bit careful.  The selection of quotes and the framing is Espiner’s (and I did notice a couple of small errors) and although he is a responsible senior journalist, the way he presented material isn’t necessarily the way the Governor himself might have chosen to.  Then again, the Governor has plenty of communications media open to him and after 18 months in the job still hasn’t given a speech about financial regulation topics, for which he personally has huge personal policy freedom.

But as RNZ presented the Governor’s arguments, they were less than impressive.  They seemed to be playing distraction more than engaging with what should be the core issues.  Not once, at least according to my notes, did he engage on the possible costs and distortions his proposals would introduce (whatever the possible benefits). Not once, for example, did he engage with how comparable his proposals are to the regime that will apply in Australia to the respective banking groups (hint, Orr’s are much more onerous).

Instead, we got irrelevancies.  The Governor decreed that banks were earning too much money in New Zealand.  Not only that, in his tree god and garden imagery, the (Australian) banks were “darkening the garden”, such that the market was not as competitive as it should be.  Perhaps there is something to those arguments, but they are simply not the Governor’s job and should be irrelevant considerations in proposing to exercise regulatory powers under the Reserve Bank Act (directed to promoting the soundness and efficiency of the financial system).  We have a Commerce Act, there are powers now for the Minister of Commerce or the Commerce Commission to initiate a market study.  But that has nothing at all to do with the Reserve Bank, the prudential regulator, not the competition authority.

Orr came a little closer to his own ground, and to respectable arguments, when he suggested that existing capital (and leverage) ratios were just too low, and thus that banks were “too risky”.  That might have been a touch more persuasive if, for example, he’d engaged with the standalone credit ratings of the banks operating here, or talked about the differences between a strongly-diversified big bank and an individual borrower (instead he tried to imply that the risks, and hence appropriate capital, were much the same).  There was the rather weak claim that “at times” housing crises have led to banking crises, but no attempt to unpack that claim, or to engage with the repeated stress tests his own institutions has done this decade.  Let alone, to consider the experiences of banking system like our own (or Australia’s or Canada’s or Norway’s) that with floating exchange rates and governments out of the housing finance market have proved resilient over many decades.

Instead we got another attempt at distraction, suggesting that the New Zealand experience in 2008/09 was really rather a close-run thing.  He knows it wasn’t so. He knows that the issues the New Zealand banks (and their parents) faced in 2008/09 were about liquidity, not about credit quality or loan losses.  There had been a degree of complacency among the banks about liquidity in the 00s –  I recall one discussion with the head of risk at a major bank in about 2006 who simply could not conceive of a world in which funding liquidity markets would dry up almost completely.   But liquidity is a different issue than loan losses –  which were modest in a fairly deep recession after a period of very rapid credit growth – and even the liquidity/funding issues New Zealand banks faced never threatened to bring any of them down.  And the Bank addressed the funding/liquidity issues almost a decade ago, with much more stringent policy requirements.    And risk-weighted capital ratios are already higher than they were going into the last recession  –  partly under regulatory pressure, partly market pressure  –  a recession when (to repeat) the loan losses were pretty modest and not at all threatening.

Then we had more rhetoric about how the Bank was not going to “keep falsely subsidising bank businesses”, although the nature of any such “subsidy” was never clear given (a) the resilience of banks to the Reserve Bank’s own stress tests, and (b) the central place the Bank has long argued OBR should have in handling any bank failures in New Zealand.   But it probably sounded good.  And then he fell back on attempts to exaggerate the costs of financial crises, with talk of “generations of lost employment opportunities”, mental health failures, and vague allusions to various “challenges” of the world right now –  the Brexit, Trump duo again I suppose – being down to insufficient bank capital.    Evidence and sustained argumentation would help –  if not on a short radio programme then, for example, in speeches and robust consultative documents and –  perish the thought –  upfront cost/benefit analyses (as distinct from the ex post one they might eventually show us).

There was some discussion of dairy lending.  As the Governor fairly noted there had been some fairly aggressive and unwise lending to that sector over the last 15 years (in the early part of that period the impression was that the offshore parents had little real idea of what the subsidiaries were doing in that sector).  Dairy farm economics doesn’t look as it once did, for various market and (actual/proposed) regulatory reasons, so no doubt there isn’t the same bank risk appetite there once was.  But it is quite unconvincing for the Governor to try to pretend his capital proposals won’t exacerbate pressures in that sector, or in other sectors where specific hard-to-extract and manage  knowledge/experience is key to good lending.  Big corporates, for example, who can simply turn to banks not affected by the Governor’s proposal (overseas-based banks, and even the parents of the NZ locally-incorporated banks).  I doubt credit supply will be too adversely affected for residential mortgage finance either.  But for other sectors, including dairy, who does the Governor expect to step into the gap?  Wasn’t he talking (see above) about insufficient competition?  Won’t these proposals weaken that competition, especially as all the locally-owned banks are themselves capital constrained?

The Governor also tried to claim that the Bank’s existing capital rules had somehow “caused” the banks to run into problems on dairy lending, citing differences in risk weights used by various banks for apparently similar lending.   Even to the extent there is an issue there, it is worth remembering that (a) by far the biggest increases in dairy lending occurred (last decade) before the advanced models approach came into effect, and (b) good banks get things wrong from time to time, and none of the actual or stress-tested dairy losses pose any threat to systemic stability.  The Governor’s numbers tell him so.   We want banks to lose money from time to time –  were they not doing so the Governor (on another day, another trope) would probably be complaining about them taking insufficient risk, holding back opportunities etc.

And then, of course, there was the cavalier line I wrote about on Friday: the Governor in essence telling the banks that if they don’t like his rules (and him as prosecutor, judge and jury in his own case) they can just take their money and go.  I wrote about this  irresponsible line on Friday.

Perhaps we should see his talk –  all it appears to be at present – about banning people from serving on both the boards of parent and New Zealand subsidiary at the same time, as all part of that same mentality of suspicion of Australian banks.  The Governor shows little or no sign of appreciating the value New Zealand, and New Zealanders, get from having banks that are part of much larger banking groups, from a country with a track record of a stable and well-managed banking system.  He talks a lot about the standalone capacity of New Zealand subsidiaries in a crisis, but very little about the benefits of integrated banking operations in more normal circumstances (ie at least 99 per cent of the time).  He seems to be hankering for the Australian banks to sell down their shareholding in the New Zealand subsidiaries –  acting as, in effect, an agent for NZX and the New Zealand funds management industry – while showing no sign of recognising that a more arms-length New Zealand operation might also be one less well-placed to receive parental support if something ever does go wrong.

All in all, I just wasn’t persuaded that Orr was even trying to make a serious sustained analytical case for the specific policy he is pursuing.  Playing distraction seemed to be more the style.  (Perhaps I’m wrong and the tape of the full interview would no doubt tell us more.)  That, after all, is the problem with the regime: at least formally, under the law, having dreamed up this proposal all by himself, the only person he actually has to convince of its merits is….himself (final decisionmaker).

Oh, and I almost forgot to mention Auckland University economics professor Robert MacCulloch’s comments.  He highlighted the “sheer lack of raw intellectual firepower” at the Bank, and claimed that neither the Board nor the senior management were really up to the job.  I probably wouldn’t have put it quite that strongly –  there are still able people but in the Board’s case they seem to have no interest in doing anything other than covering for the Governor, and in the staff’s case, personal self-protection –  with a Governor who does not welcome challenge –  is a deterrent to people speaking up even if they have (a) stayed on, and (b) disagreed.      The Bank has lost a lot of good people this year, for various reasons, but few would have had much involvement in the bank capital issues.  MacCulloch’s other comments resonated more strongly with me: there is no history of extreme fragility in the New Zealand banking system (“rather the opposite in 2008”) and that the Governor’s style is undermining confidende in the Reserve Bank, at home and abroad.

Of course, only a few geeks would try to unpick the Insight programme.

But the Sunday Star Times did us a public service with a big double-page article on the Governor that was distinctly less than flattering.  The online version ran under the title “Portrait of the Governor as a strongman”.  I’d encourage you to read the article. Several critics were actually willing to go on the record –  not, of course, ones from among the banks (the “strongman” has a lot of power over them).

Here is an extract, starting with reference to the heavyhanded stance Orr took with veteran and highly capable journalist Jenny Ruth at a recent press conference

The video of the conference remains on the Reserve Bank’s website. Some reporters said they were stunned Orr would air his anger so publicly and called it bullying.

But other observers were not surprised. Details of Lubberink’s experience were already circulating in Wellington and industry sources say they match a pattern of hectoring by Orr of those who question the Reserve Bank’s plan.

“There is a pattern of [Orr] publicly belittling and berating people who disagree with him, at conferences, on the sidelines of financial industry events,” said one source who’s been involved in making submissions to the Reserve Bank on the capital proposal.

There have also been angry weekend phone calls made by Orr to submitters he doesn’t agree with.

“I’m worried about what he’s doing.”

The source said some companies have “withheld submissions,” for fear of being targeted by Orr.

“They’re absolutely scared of repercussions. It’s genuinely disturbing,” he said.

(Orr told someone recently he didn’t read what I write –  his perfect liberty of course –  so I guess I’m safe from the “angry weekend phone calls”.)

Sadly, one can’t really say it is shocking.  It is, more or less, what one might have come to expect.  But it is appalling, and a far cry from the sort of standard the public has a right to expect from such a powerful public servant.  Wielding so much power singlehandedly, with few checks and balances, we need someone with a judicious and calm temperament, happy to engage openly and non-defensively, and so on. Instead we have Adrian Orr.

The article reports that Orr refused to be interviewed.  But perhaps the bigger question is why the journalist responsible –  for a very useful and courageous article –  showed no sign of having sought comment from Neil Quigley, the chair of the Bank’s Board who is paid to hold the Governor to account.  And there was no sign either of having sought comment from Grant Robertson, the person who actually has the power to dismiss the Governor and whom –  as voters –  we might expect to be visible when concerns like these are raised.  (And if the Minister of Finance isn’t visible, why isn’t the Prime Minister insisting that her Minister do his job?)  The behaviour as reported should be unacceptable in a democratic society governed by the rule of law and conventions of acceptable conduct.

Another quote from the article

In the cut and thrust of the debate, Orr’s jokey style and everyman charisma fell away. In recent months he’s dogmatically insisted the cost of his plan would be minimal and has picked personally at critics in the media, academia, and the financial services industry.

He’s been variously described as defensive, bullying, and perilously close to abusing his power.

“He’s in danger of bringing scorn on his office,” said long-time industry watcher David Tripe, professor of banking at Massey University. “I used to know him well. I no longer feel so confident.”

I was exchanging notes last week with someone about comparisons between Graeme Wheeler and Adrian Orr.   The SST article reports insiders claiming that Wheeler had not been keen on the idea of big increases in capital requirements for locally-incorporated banks.  If so, that is to his credit.

Not much else was. I’m not going to repeat his failings, but recall just how unpopular he had become with key stakeholders by late in his term (the survey the New Zealand Initiative undertook). By the end, his departure was almost universally welcomed, and must almost have been a relief to him too, as someone never at all comfortable in the public spotlight.

Orr is more a polarising figure, in that he does still have some supporters, but they must be getting quite uncomfortable with his style, even if they are sympathetic on substance.  But a rerun of that NZI survey would be unlikely to show up the Bank in a good light.  The more time goes on the more unsuited Orr appears to be for the office to which the Bank’s Board and the Minister of Finance appointed him.     He degrades the standing of the Bank here and abroad, as well as eroding its internal analytical capability and whatever spirit of robust internal debate was left after Wheeler, and undermines confidence in the institution’s ability to manage real threats.  It is rather sad to watch, but perhaps only a slightly more extreme example of the sustained degradation of policy capability and leadership in New Zealand public life and public sector this century.

 I hear on RNZ this morning the Governor was quoted as pushing back – I think mainly against MacCulloch – suggesting that criticisms were “narrow nitpicking”.  But there is a long list of sceptics, and of reasoned critical submissions on what is proposing, and how he is doing it. For anyone interested, here was my formal submission

Revisiting some RB history

One of Stuff’s political correspondents, Henry Cooke, had a column in this morning’s  Dominion-Post about Adrian Orr and the power he wields, single-handedly, around banking regulation.

The column starts with some comparisons with some other senior public servants

Think Police Commissioner Mike Bush, former Treasury boss Gabriel Makhlouf​, or State Services Commissioner Peter Hughes. These three have had more influence over the way this country is run than all but the most powerful MPs.

Yet that trio can technically be called to heel by their ministers, even if doing so will probably result in a serious headache for the minister in question. Not so for Reserve Bank governor Adrian Orr, whose independence is enshrined in law.

Not probably company most would want to be numbered with.  A Police Commissioner who gave a eulogy at the funeral of a former policeman widely accepted as having planted evidence in a murder case, who seems to be counted on not to make trouble for whichever party is in power, and who is only too happy for the NZ Police to cosy up to, and assist, the PRC security forces.  A now-departed Treasury Secretary who presided over the decline of his own institution, and then flitted the country refusing to accept any serious responsbility for his own conduct over the “budget hack” affair.  And so on.     Whatever influence these people might have – not much I’d have thought in the case of the Police Commissioner – they have no policymaking powers themselves.

By contrast, when it comes to banking regulation, the Reserve Bank Governor enjoys a great deal of formal power, with little accountability and no rights of appeal against his policy decisions.   They are powers which should be reined in, by MPs and ministers, and which while they exist need to be used with the utmost judiciousness and care.  Under Orr, it is more like a bull in a china shop, pursuing personal whims, perhaps political agendas, all supported by not very much robust analysis at all.   I’ve written about all that previously and am not going to repeat it today.

Cooke notes the suggestion by Paul Goldsmith that the Governor should have fewer policymaking powers, with big policy calls in banking regulation being made by ministers and MPs, as big policy calls in most other areas of public life are.  But then follows a strange end to his article, which is the point of this post.

Goldsmith knows all about how the Reserve Bank can set off real political fires. He wrote the book about the last Reserve Bank governor to step so seriously into the fray: Don Brash. Way way back in 1990 the then-Labour government’s election-year Budget was utterly blunted when Brash decided to immediately hike interest rates in response. Brash was drawn into the bitter debate between David Lange and his own finance minister, and the whole thing was extremely public.

We are nowhere near that level of chaos yet. But things sure are starting to get interesting.

I guess it is what comes of middle age, but the events of 1990 still seem to me not much further back than yesterday (not “way way back”), but I suppose the typical journalist is young.  Even so, it isn’t hard to have checked that the Prime Minister in question was Geoffrey Palmer  (and, unless I’ve missed something, the Goldsmith book doesn’t seem to deal with the episode in question at all).

And there are a few things to bear in mind as institutional context to that episode:

  • the Reserve Bank had received statutory operational independence only a few months earlier, under legislation initiated by the government in question (4th Labour government,
  • under that legislation, the Bank was responsible for pursuing an inflation target, primarily set by the government but formalised in a Policy Targets Agreement between the Governor and the Minister.  That agreement had been signed as recently as March 1990 and required as to get to price stability (0 to 2 per cent annual inflation) by the end of 1992,
  • at the time, the Labour government was miles behind in the polls, in an FPP electorial system, and generally expected to be thrashed in the polls later that year (I see in my diary that in the week in question I observed that “the only question seems to be whether Labour will hold St Albans and Christchurch Central”, two of Labour’s safer seats, held by Minister and PM respectively,
  • while National had supported the Reserve Bank Act (a) it was promising to push the target date further out (to 1993) and (b) that was with the Richardson camp dominant, but there was a fear that a less “hardline” strand within the caucus might prove dominant (eg, as it was thought at the time, the popular Winston Peters and Bill Birch),
  • the reform programme had already ripped apart Labour, the economy was in the midst of a difficult adjustment, and privately even someone as mainstream as the Minister of Finance was saying privately (in a meeting with officials), “we all know that if we don’t get to 0 to 2 per cent, we’ll just change the target”.

All of which could be summed up in the idea that there was not yet a great deal of credibility attached to the notion that inflation was actually going to be securely lowered into a 0 to 2 per cent range.  People, including markets, were searching for signals and signs that might buttress or undermine confidence.  And yet it was the Bank’s job –  mandated by Parliament and the Minister – to deliver that price stability outcome, and to do so at least transitional economic cost.

So what happened?   On 24 July 1990 the government brought down a Budget that was treated by financial markets as something of an election giveaway.  Under the rules at the time, they posted a surplus, but only by including what was in effect a large expected asset sale proceeds as revenue, and significant deficits were again forecast in the out-years.  It was widely viewed as a reversal of direction after five years of sustained fiscal consolidation.  There were a number of measures in the Budget (reductions in government price/fees/excises) which would have the effect of lowering the headline inflation rate for one year, but those weren’t really the focus of either the Reserve Bank or the financial markets.

Bond yields rose in response, and as market participants reflected a bit further the exchange rate fell.    It was that move, rather than the Budget itself, that prompted a reaction from the Reserve Bank.  Until the exchange rate fell, we had planned only a mild passing comment –  about the importance of ongoing fiscal discipline –  in the next Monetary Policy Statement.

At that time, we did not set an official interest rate (the OCR wasn’t a thing until 1999).  And the conventional view, not just at the Bank, was that exchange rate changes had a big short-term effect on domestic prices (whereas these days the short-term effects are roughly a 1 per cent change in the CPI for a 10 per cent change in the exchange rate, in those days empiricial estimates suggested anything up to a 4.6 per cent change in the CPI for a 10 per cent change in the exchange rate).  And so, roughly speaking, we ran policy with (unpublished) ranges in which the TWI could fluctuate, which were reset each quarter in light of the inflation outlook and changes in economic data.  If the exchange rate looked to move through the bottom of the range, we made a statement (‘open mouth operations’) and usually the statement itself was sufficient for interest rates and the exchange rate to adjust (the latter back into the range).

On Tuesday 31 July – thus a week after the Budget –  the exchange rate had fallen throught the bottom of our indicative range, and the Governor agreed to tighten monetary policy (it was a decision made a bit more easily than usual because all three of the more dovish senior officials were all away that week, but it was entirely in line with our standard operating framework).  We knew it wasn’t going to be popular – I noted in my diary that evening the question of whether it would spark a confrontation with the government – but the point of an operationally independent central bank was to be willing to be unpopular, especially in the run-up to elections.  There was a bit of a sense that it would not look good for the case for operational autonomy if we did nothing when first market doubts arose.  (Some years later David Caygill confirmed to me that the government had not expected any adverse reaction.)

We made an initial statement the following morning, which pushed interest rates up but didn’t do much to the exchange rate.  The statement was well-received by market economists (“who seemed surprised that we had the backbone – an NBR article this morning openly suggested that we want to back away”) and the Opposition finance people “who are impressed with the explicitness and clarity of the statement” (they had been criticising us for oblique communications), and even the media coverage wasn’t bad.  The Minister of Finance was not terribly supportive, but the Prime Minister was overseas.

On the following day, we were pondering whether we needed to make another statement –  to get the exchange rate back within the range.    Those with a particularly good memory may recall that this was also the day (2 August) Iraq invaded Kuwait, which pushed oil prices sharply upwards.  At the time –  although we weren’t knee-jerk reacting to oil prices –  our stance would have been that first round oil price effects were to be looked through, but that much higher oil prices would create risks of higher inflation expectations and a spillover into holding underlying or core inflation above target.

And so we made another statement the following morning.  For a time that day we thought we’d completely botched things because there were wire service reports that Iraq had gone on to invade Saudi Arabia too, but of course that was soon proved false.  Interest rates rose quite a bit, and the exchange rate also edged higher.  Banks began raising mortgage rates prompting the Minister of Finance to come out with rather silly comments (“presumably under Palmer’s orders”) about the banks being mean and out to get the government.  With the Prime Minister’s return both he and the Minister were out with further critical comments –  recall that they were less than three months out from an election thrashing .  The comments were aimed especially at the banks, while noting that there was nothing the government could do (monetary policy operational decisions having been handed to the Bank).

It wasn’t as if the Bank itself was totally blinkered and doctrinaire during this period.  In the days following this episode we discussed ourselves at senior levels whether we should consider recommending pushing back the target date (to, say, 1993) but on balance decided not to do so just yet.

That specific controversy died down pretty quickly, and to my mind remains an example of the system working as it was supposed to.  We were doing our job, and the government was doing its (setting fiscal policy, having initially set the inflation target itself).   I haven’t checked with Don Brash but I’ve never heard a suggestion that the framework, the target, or Don’s position was then in jeopardy.  In fact, a month or so later, Don was upsetting the Opposition by making himself somewhat party to the “Growth Agreement” the government and the unions reached –  in our terms, what that amount to was simply restating that if inflation pressures (this time wages) were lower then all else equal monetary policy would be able to be easier and interest rates (and the exchange rate) lower.

With the benefit of hindsight one can argue about whether the Bank’s monetary policy tightening was really necessary. In some respects, the market reaction post-Budget was a confidence shock and demand might have been expected to weaken anyway.  Moreover, actual exchange rate passthroughs were to prove weaker in future than had been the case in the past.   With better analysis might we have realised that sooner? Perhaps.  But as I noted, the Bank’s reaction was wholly consistent with the Policy Targets Agreement, signed only a few months earlier, and with our best understanding then of how the economy worked, in the midst of a highly contentious and uncertain disinflation, and was supported by the bulk of private market economists.

I’m not sure where Henry Cooke got his story, but it just wasn’t “chaos” then, and to the extent there was any, it wasn’t Bank-initiated.

In fact, that episode wasn’t even close to the toughest political challenges for the Bank.   Only a few months later, National was in power and Jim Bolger in particular was very unhappy with some of the choices the Bank was making.  Goldsmith records Ruth Richardson warning Brash, as she was about to leave for an overseas trip, not to “make waves” as his “best friend at court” wouldn’t be around to provide cover.  That angst went on for months, and even culminated in pressure on the Bank from senior Treasury officials to ease monetary policy specifically to assist Richardson’s own political position.  (I am less confident that we handled 1991 that well, even on the sort of information we should have used at the time).

And then, of course, a decade later there was Don Brash’s infamous Knowledge Wave conference speech –  given rather against the advice of various of his closer advisers – which, whatever its substantive merits, did involve stepping well outside his statutory role, and greatly irritated the then Prime Minister, in turn poisoning the prospects for any internal candidate succeeding Brash when he left for politics in 2002.

The point of this post is really twofold.  I quite like delving into the monetary policy history, much of which isn’t that well or readily accessibly documented.  But I was also keen to differentiate that episode from the current controversy around Orr.  In 1990 the government set the mandate –  and was free to change it at any time –  and we were simply doing our best to implement that mandate, in a climate of huge political and economic uncertainty.

By contrast, when Adrian Orr is proposing banning people from serving on the boards of bank parents and subs or –  much more radically –  proposes that he should more or less double how much capital locally-incorporated banks would need, he isn’t following some clear and specific mandate set by Parliament or the Minister, against which he can readily be held to account.  He is pursuing a personal whim.  His stated goal –  reducing the risks to the soundness of the financial system –  is certainly an authorised statutory goal, but there is no professional consensus on what level of risk is appropriate, or what policy steps might deliver that level of risks, or what costs might be imposed in the transition or the steady-state.  And there are no effective rights of appeal, no override powers, to his one-man exercise of his personal preferences.     That simply isn’t appropriate.  With superlative supporting analysis, and a long and open period of real consultation –  before the Governor nailed his colours to the mast, as prosecutor in the case he himself will judge –  it might be one thing (still not ideal).  What we’ve actually had in the past year falls far short of that sort of standard.  It is a much more serious situation –  including because there are no self-correcting mechanisms (eg inflation falling below target, telling the Bank it has things a bit tight –  than a one-week flurry around a modest monetary policy adjustment implemented in pursuit of a goal the government itself had explicitly set.

The Minister of Finance and the Board do not have formal override powers.  But they could, and should, be using the leverage they have to insist on a much more compelling case being made for any actual policy adjustment (and not for that case to be published only after the decision itself has been made).  Cooke’s article quoted a submission suggesting annual GDP costs of up to $1.8 billion a year, but the Governor’s own deputy has quite openly suggested that the policy will cost the economy $750 million a year.  For gains –  in a sound and well-managed banking system – that are far from evident, in an economy where tightening credit conditions, even just in a transition, are about the last thing that is needed.