Graeme Wheeler indicated yesterday that he will shortly be giving a speech offering some reflections on his time as Governor.    It is a good idea, at least in principle.  Wrapping up his 10 years as RBA Governor last year, Glenn Stevens gave a thoughtful speech along those lines (which I had intended to write about, but never got round to).   Wrapping up his 10 years as Governor of the Reserve Bank, Alan Bollard did an interesting interview with one of the editors of the Bulletin – he even acknowledged having made a mistake early in his term.

It is hard to be very optimistic about the forthcoming Wheeler speech, but ….. perhaps……this time.  Someone emailed me last night, after my comments on yesterday’s news conference, suggesting that

surely at heart you would have been more disappointed if Wheeler had finally answered questions in a meaningful way.  Would have made the past 5 years of communication even more painful.

I’d have been astonished certainly, but I have a naively optimistic streak and I’d like to  be pleasantly surprised, even this late in the game.  When he was appointed, I had had high hopes for the Governor.

But the promise of a forthcoming review speech, and an exchange with someone yesterday about the relative performance of the three Governors who have operated in the inflation-targeting era (in which I found myself defending Graeme), got me reflecting on how one might do those comparisons, at least in respect of monetary policy.

One could simply look at deviations of inflation from target.   Using headline CPI inflation wouldn’t help much there –  the CPI in the 1990s was constructed materially differently than it is now.  And when Don Brash took office there wasn’t an inflation target at all.  But the Bank is fond of its sectoral factor model measure of core inflation.  That measure has only been around for the last five years or so, but the Bank has calculated the series back to September 1993.   And as it happens, the first inflation target that last long enough for performance to be measured against it was the one adopted by the incoming National government in December 1990 –  inflation was to be 0 to 2 per cent by December 1993.

So here is the sectoral factor model measure graphed against the midpoint of the successive target ranges.

There are several things to notice:

• this measure of core inflation has been much more stable in the Wheeler years than in any previous five year period,
• none of the three Governors kept sectoral core inflation (or any other measure) close to the midpoint of the target range, and
• the biggest deviations were in the last years of the previous boom, when this measure of core inflation was actually outside the target range.

In terms of average deviations

But the Bollard decade was a tale of two halves: far above the target midpoint for his first six years or so, and then increasingly below the midpoint by the end of the period.

All this said, I wouldn’t want to put too much weight on those numbers, for various reasons including:

• monetary policy works with a lag.  One can’t blame Graeme Wheeler for the first 12-18 months’ outcomes during his term.  Then again, the last three or four years’ numbers aren’t much different from those early in his term,
• this measure didn’t exist, and certainly wasn’t being used, in the Brash or Bollard years (that said, no one disputes that inflation ran above the target midpoint during their terms, for various –  different –  reasons),
• only since Wheeler took office has the target midpoint had any formal status.  In practice, Don Brash did aim for the midpoint, and often referred to it in public communications.  Alan Bollard didn’t regard the midpoint as being particularly important, and thought (and talked) in terms only of being comfortably inside the target range (thus at times we published projections with inflation settling back to around 2.5 per cent).

The fact that inflation averaged well above the target midpoints during the Brash years often surprises people.  Don had a reputation as an inflation-hating hardliner (an “inflation nutter”), which was –  at least in some respects –  well-warranted (he could also, at times, be a political pragmatist, to the dismay of the real hardliners).   He took the targets, and the midpoints, seriously.  So why was inflation averaging persistently above target?  My story is that he – we –  never quite realised how much higher than international interest rates New Zealand interest rates needed to be to keep inflation here in check.  In today’s terms, we underestimated the neutral interest rate.  In a way that wasn’t surprising.  After the great disinflation, we expected our interest rates to converge to those of the rest of the world –  and international visitors encouraged us in that view (I well recall the day a visiting senior Australian sat in my office trying to argue that we must have policy wrong because interest rates were still so much higher than those in Australia).    That convergence has simply never proved possible –  I argue because of the interaction of high immigration and low savings, but the “why” is a topic for another day.  Everyone realises that now, but we didn’t in the 1990s.   It led us to forecast lower inflation rates than we ended up achieving, and because – in effect – we believed our model we kept making what amounted to the same mistake.

Alan Bollard’s “mistake” was different.  He came into office with a sense that Don –  and those around him –  had been too hardline, and that if only we “gave growth a chance” we could get better outcomes all round.  I suspect he really did care about unemployment. He certainly cared a lot about the tradables sector, and the rising and high exchange rate quickly became quite a constraint on what he was willing to do with the OCR  (it was something of a political constraint too).  He was probably less willing to tighten than the median of the staff advice would have been, but actually staff advice also had something of the wrong model.  People just didn’t realise how much momentum there was behind the boom, or how structural (to the interaction of population and land use regulation) the lift in house prices was.   Because of the exchange rate, Alan was unwilling for too long to contemplate taking the OCR anywhere near the (real) peaks of the 1990s, even though by most measures –  whether unemployment or capacity utilisation –  the pressure on resources was much greater.

All three Governors made what would now be generally recognised as mistakes.  Some lasted shorter than others.  We held off adopting an OCR for years too long.  In 1991 we made the now-incomprehensible mistake (I strongly supported it at the time) of trying to hold up interest rates even as the economy was falling away rapidly into a recession, on some misguided view around the interpretation of the yield curve slope.  That lasted only a matter of months.  Then there was the MCI debacle in 1997 and 1998.  And scarred by that experience, we were too quick to cut the OCR in 2001 –  responding to a US recession that never much affected us.

Alan Bollard later openly acknowledged that his interest rates cuts in 2003 had been a mistake (at the time I’d thought at least the first one was appropriate).  And in 2010 the Bank was too quick to start raising interest rates, and had to reverse itself quite quickly.

As for the (single) Wheeler term, it was dominated by the mistake of promising to raise the OCR a lot, actually raising it by 100 basis points, and then the Bank only slowly and reluctantly having to more than fully reverse itself.     Perhaps more seriously still, there has been no apparent effort to position New Zealand for the next recession, when the OCR won’t be starting at 8.25 per cent.

Some of the mistakes the Reserve Bank has made have been in company (other central banks doing similar things).  Most haven’t.  In some cases, it has been a clear example of the Governor imposing his will on the organisation –  those 2003 OCR cuts were over the advice of a majority of OCRAG –  but most haven’t.  Then again, chief executives shape organisations, recruit people they are comfortable with, and sometimes don’t really welcome the airing of alternative views.  I don’t think, with hindsight, the institution’s record has been particularly good –  and I say that as someone who was heavily involved, at times at very senior levels, for a long time.  Sadly, it doesn’t seem to be improving.

I’m reluctant to try to reach a view on whether, overall, Wheeler has been worse than his two predecessors.     After all, the circumstances the three men faced were very different:

• Don Brash was in charge during what we liked to think of as the “heroic” phase, slaying the inflation beast that ravaged New Zealand for the previous 25 years.  But, beyond that, he –  and we –  were learning what it meant to run monetary policy in a low inflation environment.  We had few effective yardsticks –  although we were probably more reluctant than we should have been to have consulted other countries’ practices and experiences.
• On the other hand, Don presided over monetary policy through probably the most stable period ever in New Zealand’s terms of trade.
• Alan Bollard presided during the most dramatic financial crisis the world had seen for decades –  perhaps since 1914.  I didn’t agree with all his stances in that time –  some he himself changed quite quickly –  but in many ways that 18 months or so was his finest hour: the willingness to improvise liquidity policies and to cut the OCR again and again, in large dollops.
• Recessions: Bollard and Brash had to cope with them (ie externally sourced ones –  1991, the Asian crisis, the dot-com bust, and 2008/09). and Wheeler simply hasn’t.
• Different shocks: Brash presided over the period of wrenching fiscal and structural adjustment, which made much of the data harder to read.  Bollard presided during a whole new period of persistent and unexpected strength in the terms of trade (we hadn’t paid them much attention until to then) and the Canterbury earthquakes.  All three Governors have had to grapple with the toxic mix of population growth and land use regulation spilling into rising trend house prices –  but it was the Bollard years that saw the largest, and most widespread, increase in debt/GDP ratios and private sector lending more generally.
• In his early years, Brash had to deal with a severe domestic financial crisis and the aftermath of a very damaging credit, equity and commercial property boom.  Neither Bollard (despite the finance companies) nor Wheeler had to face something similar.

But, in many ways, I’d argue that Graeme Wheeler, and the Bank he presides over, have had it relatively easy.    Over his period there has been:

• no international recession,
• no major overseas financial crisis (the euro crisis transitioned into chronic state around the time Wheeler took office),
• no deeply dislocative domestic shocks,
• a stable backdrop of global inflation,

And unlike many of his international peers, he has always had total flexibility to adjust the OCR as required (the near-zero bound simply wasn’t an issue) and there were no looming fiscal crises in the background either.

You might be surprised by the comment about stable global inflation. But here is the OECD’s measure of G7 core inflation (ie CPI ex food and energy).

Pretty stable for almost 20 years now.  Of course, within that some countries have done better than others.  And the interest rates that have been consistent with keeping inflation around these levels have fallen a long way.  But there aren’t huge inflationary or deflationary shocks from other advanced economies.  Contrast this chart with the New Zealand core inflation chart above.    And recall that, unlike New Zealand, most of the G7 countries were pushed to the absolute limits of conventional monetary policy.

It is fair to acknowledge that the recent swings in the terms of trade have been quite large –  so I’m not trying to suggest that getting monetary policy just right was easy (if it were that easy, we wouldn’t be paying a lot of people a lot of money to get it right).    But broadly speaking, a lot of things have been working in the Reserve Bank’s favour in recent years, that their peers in other countries haven’t had:

• as already mentioned, the Reserve Bank had full OCR flexibility, and
• an unemployment rate persistently above their own estimates of the NAIRU (a basic pointer to a demand shortfall, something conventional monetary policy can remedy),
• high terms of trade (on average), supporting demand overall,
• the effects of Canterbury earthquakes were quite disruptive late in Bollard’s term, but ever since Wheeler took office, they’ve been a consistent source of demand growth [NB I’m not suggesting earthquakes make us richer, but the reconstruction is a significant source of demand –  helpful if demand is otherwise scarce.] and
• really rapid population growth (hard to forecast, but persistently surprising on the upside throughout Wheeler’s term –  the last quarter of net outflows, seasonally adjusted, ended a few days after he took office), and
• although fiscal policy was net contractionary at the start of his term, even that has swung round to neutral or mildly expansionary more recently.

There is no reason to think it has been any harder to get things right –  forecasts and reality – than in the earlier years, and some reasons why it should have been easier to keep inflation up near target.

Non-tradables inflation, the bit the Reserve Bank has most medium-term influence over, should have been relatively easy to get up to levels more consistent with meeting the overall inflation target.  And yet, the Bank’s sectoral factor model measure of non-tradables inflation is no higher now than it was when the Governor took office.

Arguments about technological change, structural changes in labour demand, or whatever simply aren’t relevant to this conclusion.  They provide opportunities for faster growth without unduly fast inflation –  surely, broadly speaking, the goal of economic policy?  They provide the oppportunity to run the labour market a bit harder and get more people –  often people who find life a bit difficult – into employment.   In such a world, one does well –  getting inflation back to target –  by doing good.    Instead, all too often it has come to seem as though the Wheeler Reserve Bank is more concerned about house prices –  especially in Auckland – than it is about inflation or unemployment, even though –  when pushed –  they will acknowledge that monetary policy can’t do much about house prices.  And all this with no good model of house prices, and the failures of land use regulation.

So, yes, we’ve had stable (core) inflation in the Wheeler years, but stable at too low a level –  in his own words, an “unnecessarily” low levels.  He agreed to deliver it higher, and had a lot of things working in his favour to get it higher.  He wasn’t faced with rapid productivity growth –  driving prices down  –  rather the contrary.  And he was never faced with a fully employed labour market.    He simply didn’t do his job, when he easily could have.  He seemed to allow himself too readily to believe that somehow he faced the same challenges some of his peers bemoaned at BIS meetings –  when the preconditions for rapid (per capita) demand growth, a strong labour market, and inflation around target were much different here.

Would another Governor faced with the same circumstances have done differently in recent years?  We can’t really know.  There have always been some economists and commentators running a different tack but (a) as far as we can tell, most of the rest of the Reserve Bank senior officials have supported the Governor’s approach, and (b) most domestic market economists have done so most of the time as well.     It was the sort of defence we used in the Bollard and Brash years –  few ever consistently argued for tougher policy.  But it isn’t that persuasive an argument –  we charge the Reserve Bank Governor, resource him, and pay him well, to do better.

Where I suspect we can conclude that a different Governor would have done better is in perhaps the more peripheral aspects of monetary policy:

• it is hard to believe that any other Governor would have been so reluctant to acknowledge a mistake.  Even if reluctant to accept the fact, most would have found more effective, appealing, lines to use,
• Most possible Governors would have been much more willing to open themselves up to serious scrutiny, especially when questions around performance started arising.  Good ones would prove their competence and capability in part by their ability to engage with and deal with alternative perspectives.
• Surely no other possible Governor would have taken the pursuit of Stephen Toplis to quite such lengths.  We know other Governors have at times expressed irritation with particular views, but that is very different from deploying your entire senior management team to attempt to close a critic down, and then when that failed  writing to Toplis’s employer – an institution the Bank actively regulates – to attempt to have him censored,
• (oh, and other possible Governors probably wouldn’t have attempted to tar publically, in the cool light of day, someone who highlighted a serious weakness in the Bank’s systems).

It is hard not to think that a different Governor wouldn’t have produced stronger speeches – more akin to the quality one finds from Governors in other advanced countries –  or demanded, and received, more consistent depth and excellence in the quality of the analytical work underpinning the advice on monetary policy.

I’m not going to conclude that Wheeler did monetary policy worse than his predecessors –  and I will be interested to see his own arguments in his forthcoming speech –  but even considered in isolation it doesn’t look to have been a creditable record, whether on substance or on style.   That is something the Bank’s Board –  and whoever might shortly be Minister of Finance –  need to reflect on seriously, not just in identifying a specific successor, but in strengthening the institution as a whole.

Consistent to the end, the outgoing Governor of the Reserve Bank today both refused to accept that he’d made any mistakes, while refusing any comment at all on some of the more searching questions.

The news conference was on the occasion of the release of his statutory monetary policy accountability document, the Monetary Policy Statement.    It was the last opportunity journalists will get to question him.  And yet faced with questions about the Toplis affair (his use of public resources, including his senior managers, to attempt to close down critical commentary from an employee of an organisation the Bank regulates), he simply refused to comment.   I’m sure he is now feeling quite embattled and defensive, but surely it should be unacceptable for a powerful public official to simply refuse all comment on such a chilling example of abuse of executive office?   If he doesn’t think it is an abuse, and thinks somehow people shouldn’t be allowed to aggressively criticise him, he should at least have the decency to say so openly.   I hope members of Parliament use their opportunity this afternoon to ask questions on this matter, and to insist on answers.

The Governor also tried to avoid most questions about his term in office (but was happy to provide a long answer to a curious question about risks around North Korea, on which he has (a) no accountability, and (b) no more knowledge than the rest of us).  Apparently there is a speech coming –  which may be interesting, but it provides no opportunity for follow-up challenge or scrutiny.   Asked if his critics have been fair, and if at times their criticism may have clouded his judgement in decisionmaking, he claimed he will cover that in his speech.  If so, that should be interesting.      Asked also about:

• what surprised him about the economy in the last five years,
• about his inflation record in the last five years, and
• what his successor should worry about

he refused to provide any answers, and simply referred everyone to the forthcoming speech.

One journalist finally voiced a widespread concern and asked if the Governor had been open enough with the media, noting that the Governor appeared not to have given a single live interview in five years.     The Governor claimed to have been pretty open, citing the press conferences he holds.  He also claimed that his colleagues do interviews, but simply never engaged with the fact that he personally is legally responsible for the exercise of a great deal of power –  not just monetary policy, but in regulatory policy areas –  and simply doesn’t face up, ever, to anything but soft-ball interviews.  A press conference, with 20 other media and where the Governor gets to decide whose questions to take when, is simply very different from a sustained searching interview –  whether on Morning Report or one of the TV current affairs shows.

Towards the end of the interview, the Governor seemed to change tack a little.  After repeated questions about his stewardship, he came out claiming that things have actually gone pretty well really over the last five years, and that the Reserve Bank deserves credit for that.   It was like a performance straight from the National Party advertising unit.  Growth had, we were told, averaged 3 per cent and there had been plenty of employment growth.  Even house price inflation was somehow claimed as to their credit (I think the fact that it is temporarily low in Auckland).   Oh, and core inflation averaging 1.5 per cent –  when he had explicitly accepted a task of keeping it around 2 per cent –  was also apparently just fine.    These results should, apparently, dispel any suggestion that, even with hindsight, monetary policy had on average been too tight.

He did acknowledge in passing that there hadn’t been much productivity growth –  which isn’t his fault –  but there was no mention at all of the weak per capita GDP growth (by comparison with earlier recoveries), no mention of an unemployment rate that has been above even the Bank’s too-high NAIRU estimate for eight years now, and no mention of a very high labour underutilisation rate.   And even on the inflation front, he seemed to want to blame all the problems on the rest of the world: low tradables inflation, as if a persistently high exchange rate had nothing to do with that.  He attempted to claim that non-tradables inflation (averaging around 2.2 per cent) had been just fine, when everyone recognises that getting core inflation near 2 per cent would have required non-tradables inflation rather nearer 3 per cent (which shouldn’t really have been hard amid a big building boom).  And non-tradables is what the Reserve Bank has the greatest degree of medium-term influence over.  If the Bank deserves credit for the last five years –  whether for style and communications, or for specific policy – it can only have done so relative to a particularly low benchmark.

Even now, said the Governor, he was quite comfortable with his decisionmaking in 2014 and 2015 –  when he unnecessarily raised the OCR by 100 basis points, and then was slow and reluctant to reverse those cuts.    I’m not sure what he thinks he gains by never ever conceding any mistakes.  He’s human surely.  We all make mistakes.

All in all it was a pretty disappointing, if not overly surprising, performance.  Whoever takes up the job of Governor next year will surely face a huge challenge, in shifting the organisational culture –  which must have been infected by Wheeler’s approach –  and lifting performance.

And all that was before even getting to the content of this Monetary Policy Statement.  

There was the odd good thing I noticed.  LUCI, the ill-fated Labour Utilisation Composite Index –  sold for a year or so as a measure of absolute tightness in the labour market, before they finally realised that it was mainly an indicator of changes in that tightness (a difference that matters quite a lot) –  seems to have quietly exited the stage.

But there were various more troubling points:

• they were at pains to note that their estimate of the neutral OCR has carried on falling.   But, as in the chief economist’s speech a couple of weeks ago, there was no attempt to translate that into estimates of how neutral mortgage rates, or neutral deposit rates have changed.  As I noted then, widening spreads between the retail interest rates and the OCR suggest that if we take the Bank’s neutral OCR estimates seriously, their implicit estimates of neutral retail rates have been rising.   That seems seriously implausible.   It matters because the Bank keeps talking –  and forecasting –  on the basis that monetary policy is highly stimulatory. It almost certainly isn’t.
• and although they did note that mortgage interest rates are higher than they were last year, there was no attempt anywhere in the document to explain why the Bank considers that monetary conditions need to be tighter now than they were last year (especially as growth and core inflation have been surprising on the low side).
• it was quite surprising how upbeat they appeared to be on the global economy.  In fact, their upside scenario is one in which global inflation picks up quite a bit.   That migth have seemed a plausible possibility a few months ago, but with US inflation ebbing and no real signs of any increase in core inflation anywhere else, it looks (frankly) a little desperate.  Perhaps it is a reflection of the Governor’s continued conviction that global monetary policy is highly accommodative/stimulatory?   Were it actually so, one might have expected an increase in inflation before now.
• the Bank seems focused on the idea that the labour market is almost at capacity.  Their projections have the unemployment rate levelling out at 4.5 per cent, suggesting that is their estimate of the NAIRU.  Between demographic factors on the one hand, and wage inflation outcomes on the other, that seems unlikely.

But perhaps my biggest puzzle is where all the forecast growth is coming from.

Over the next six quarters, the Bank projects that quarterly GDP growth will average just over 0.9 per cent. This chart shows six-quarter moving average of GDP growth (in turn, averaging the production and expenditure measures).

The orange dot shows the forecast for the next six quarters.  Their projections suggest that the economy will grow more rapidly over the next 18 months than it has managed on a sustained basis at any time in the current recovery.   You might not think that the difference looks large, but:

• the Bank already recognises that monetary conditions are tighter than they were last year,
• the Bank is forecasting a substantial reduction in the net migration inflow, and no one seriously doubts that unexpectedly rapid population growth has been the biggest single driver of headline GDP growth in recent years.  However much immigration adds to supply, it adds a lot to demand.

So why are we to expect a sustained growth acceleration from here?   Although it isn’t stated in the document, I hear that the Bank is invoking the expected fiscal stimulus (from promised measures announced in the Budget).  In isolation that might make some sense, but against the projected halving in the net migration inflow and the actual tightening in monetary conditions, it doesn’t really ring true.     If anything, the risk now has to be that over the next 18 months, headline GDP growth averages lower than we’ve seen in the last couple of years.

In many respects, the MPS is just another production in the long line of Reserve Bank documents that hold out the promise of higher medium-term inflation, but with little reason to expect it to happen.     But I was interested in one line in the policy section of the document. Often the Bank sounds quite complacent about non-tradables inflation, suggesting that everything is under control.  But this time they explicitly note that “a strong lift in non-tradables inflation is necessary for inflation to settle near the target midpoint in the medium-term”.   That, for central-bank-speak, is a pretty strong statement.    It might seem to argue for a more aggressive easing.

But they seem torn.  On the one hand, they go on to note that even “higher levels of growth may not be accompanied by significant increases in inflationary pressure”.   On the other, there is another strong statement about wage inflation: “increasing capacity pressure is likely to support wage growth in the near term“.    I guess that is quite a benchmark they’ve set for themselves –  and quite a surprising one after all these years of one-sided forecast errors.  If it doesn’t happen, and there seems little obvious reason why it should start now, I hope the Governor’s successors will be revisiting the stance of policy.

You might be wondering, so why not just cut the OCR and “give growth a chance”?  The Governor’s response to that is

an easing of policy, seeking to achieve a faster increase in inflation, would risk generating unnecessary volatility in the economy

I’m not quite sure what standards he is judging “unnecessary” by here?  It isn’t as if growth has ever been particularly rapid in this recovery (see chart above).  It isn’t as if unemployment has ever dropped, even temporarily, below the NAIRU.  It isn’t as if inflation has been surprising on the upside.  It isn’t as if productivity has been rocketing away.   It is as if the Bank is simply allergic to taking any steps that might possibly run a risk of (core) inflation going over 2 per cent, after all these years below.  In practice, it looks a lot like 2 per cent inflation represents a practical ceiling, rather than a target midpoint.

The Governor concluded his press release claiming that “monetary policy will remain accommodative for a considerable period”.  Fortunately, he will have no say in that matter.  Unfortunately, since we know neither who will be making the decisions, or what PTA they will be working towards –  recall that Labour, with the support of eminent economists like Lars Svensson, favour adding an explicit unemployment objective (to help make clear why we have active monetary policy in the first place) –  there isn’t really much information in that statement at all.   Much of the uncertainty is inevitable –  no one knows the future –  but quite a bit would be avoidable if we had a better statutory mechanism for Reserve Bank decisionmaking.

The search for the new Governor presumably goes on (the Reserve Bank Board would, on normal schedule be meeting next week).  Should the Opposition parties win power, I hope that one of their first actions (because time is pressing) will be a quick amendment to the Reserve Bank Act, to give the Minister of Finance the power almost all his overseas peers have, to appoint directly as Governor someone with whom he is comfortable, not someone the outgoing government’s Board delivers up to him.  In fact, it would be a sensible change whichever group of parties forms the next government.