(This isn’t the follow-up post on real interest rates.)

A commenter on interest.co.nz , referring to my piece on the exchange rate the other day, posed the following question:

Last week the Reserve Bank released the latest issue of the Bulletin.  This issue, by Head of Communications, Mike Hannah, ran with the slightly twee title of “Being an engaging central bank”.   The article consisted of two things:  it reported the results of a fairly extensive survey of the Bank’s engagement with the public and other so-called stakeholders, and articulated and  defended the Bank’s communications approach.  Appended to the article was the 80 page report from the consultants the Bank hired to do the engagement study. I haven’t seen  any  media coverage of article, so perhaps this mention will help generate some readers.

The Reserve Bank has long had a self-image of being quite a transparent organisation.  And it has made significant efforts in that regard.  Fifteen years ago, the Bank might reasonably have been considered a leader.  The Bank makes much of the modest increase in the number of speeches it is doing, but older readers may recall Don Brash’s roadshows around the regions in earlier years.  There isn’t anything very new about what has happened in the last year or two.

As readers will know, I have highlighted a number of areas in which the Reserve Bank is currently very far from best practice when it comes to transparency, around both monetary policy, financial stability, and the Bank’s market operations.  I have also pointed to areas where they don’t even seem to comply with the provisions of their Act as regards communications (re both the Monetary Policy Statement and the Financial Stability Report) and, as recently as this morning, I have highlighted the Bank’s cavalier attitude (in common with many other public agencies) to the provisions of the Official Information Act.  So, I thought I really should read the Bulletin article.

There is interesting material there and (as often with these sorts of things) the research report is more interesting than the Bank’s public take on it.  It was nice, for example, to learn how many visitors the Bank’s website gets (just over 2000 a day last year, which frankly seemed surprisingly low).  Both bits, however, are riddled with PR-speak (“future-state” vision,  “a partner in the economic infrastructure space” , “further inside the future-vision tent”).

On the questions posed, the Bank emerges relatively well –  if the general public (a rather important group) don’t have much trust in the Bank, those who are closer to the institution appear to, and to generally be reasonably positive about the Bank’s engagement with them.  That covers modest samples of people from regulated entities, the business community, researchers, the media, and other government agencies.    The results are good news, as far as they go.

As regards, the Bank’s relationship with central government, both the consultants and the Bank seem a bit confused, describing the Bank as “both a partner and a constituent”.  Surely, most of all, the Bank is a creature of Parliament, funded by Parliament, and directly accountable to Parliament and to the Minister of Finance?    If one wants to adopt the jargon, perhaps “adviser” and “service provider” might better describe the Bank’s relationship with central government.  Perhaps the authors only had other government departments in mind, but part of effective engagement is clear communication.

As I noted, the article also engages in a bit of defence of the current limits of transparency.    One line that was a little concerning was the suggestion that “different degrees of transparency are appropriate for different stakeholder groups”.  I think I understand what they are trying to get at, but this expression of the point seems really quite dangerous.  We will be more transparent to the people who get on with us?  To people who agree with us?  To “people like us”?  To economists in lock-ups, more than to the public?  It is quite a dangerous path to go down, and is part of the reason why the country needs an effective Official Information  Act.  Transparency is not just about what a government agency wants to communicate –  which, in fairness, is probably the focus of the external engagement work –  it is about the ability to scrutinise public agencies even when they don’t want to be scrutinised, or when it is uncomfortable or even embarrassing to be scrutinised.  That is the difference between, say, a private firm, and a government agency.

The article also suggests that publication of interest rate projections is as informative as “the minutes of our monetary policy meetings”.  That may well be true, although since no one has seen the minutes of the Governing Committee or the Monetary Policy Committee they have no way to know.  More to point, those documents are about two quite different things.  Interest rate projections are the Governor’s current best view of where interest rates are likely to go in future.  Good monetary policy minutes abroad convey much more of the richness of the sorts of factors, and debates,  that went into reaching the current OCR decision.  Given a choice, good minutes offer more real information than projections  –  it is that distinction between things we know very little about, and things we know a lot about, that I wrote about a couple of weeks ago.  The Bank is quite good on the former, but very weak on the latter.

Which brings me to my final point.  The consultants use, and Hannah picks up, the phrase “the paradox of transparency”, in which allegedly too much transparency by the Bank could “threaten  the certainty” that respondents value.    It is a convenient phraseology but it is largely misguided.  The Governor does not know where interest rates will be year from now.  He does not even know what lending controls might be in place by then.  There is very little certainty in anything around this business.  Greater transparency (both historical transparency OIA style), and perhaps a range of public views from members of a formal decision-making committee, would be likely to reflect the real uncertainty we and they face, rather than create it.

I could cover a lot more points, but you might consider reading the material yourself and seeing what you think.   I’m not sure that in good conscience I could recommend it as a wise use of anyone’s time, but more data is almost always better than less.  It is great that the Bank has pro-actively published the material, although I am left wondering how long it might have taken to get it out of them under the OIA had the results been seen by Bank management as less favourable to them.

In recent years a practice has grown up of government ministers writing to agencies (Crown entities and the like) in a “letter of expectation”.  These are formal documents, but they are not legally binding.  They do not replace, or in any way either reduce or extend the obligations of the agency concerned under either its own legislation, or under any relevant provisions of other legislation (eg the Public Finance Act or the State Sector Act).  But they can still play a useful role in setting out things that are particular priorities for ministers, and particularly aspects around the engagement of the agency with the minister concerned and the minister’s office.

For some time, the Minister of Finance has been sending an annual letter of expectation to the Reserve Bank.  I asked for copies of those the current Governor had received from the Minister of Finance  and –  after pretty well the full extent of the lawfully available time had been used, including extending the deadline by transferring the request from the Reserve Bank to the Minister of Finance –  I received copies in the mail the other day (the technology was a little surprising in this age of e-government, but still….).

The first thing to note is that letters of expectation to the Reserve Bank Governor are not routinely published.  A quick search suggests that those to many other government agencies are.  There are pros and cons to routine pro-active publication.  Do so, and any really sensitive points won’t be included in the letter, unless the minister concerned particularly wants to make a public point.  Then again, these are public agencies, and letters like these can affect the emphasis that agencies put on various aspects of their statutory powers and responsibilities.

These documents can be a bit of a grab bag.  Sometimes the minister himself really does have a point to make, about something in the relationship that isn’t working that well.  Sometimes the contents might just reflect a hobbyhorse issue of people in the relevant policy ministry (when I was at Treasury I made a few comments on draft letters of expectation to the then Reserve Bank Governor).   And a letter of a couple of pages can’t capture everything about the dynamic of an ongoing relationship.  But the letters do go out under the signature of the minister, in this case a long-serving senior minister, and the contents should tell us something interesting about what Bill English is looking for from the Reserve Bank.  The Reserve Bank is an interesting mix – an institution with a very high degree of operational independence in most of its function, but with some key powers reserved to the Minister of Finance.

Graeme Wheeler has received three letters of expectation from Bill English since becoming Governor.  The most recent was sent on 2 March 2015.  A copy of it is here:

letter of expectations

A few things struck me as interesting:

• The focus is almost entirely on the regulatory functions of the Reserve Bank.  One senses that these must be where the pressure points in the relationship have been  –  around advance consultation and around the analysis underpinning regulatory and legislative proposals.
• No questions at all are raised about the way that inflation has consistently undershot the midpoint of the inflation target range, even though the target is a formal agreement between the Minister and the Governor, in which the Governor has the operational freedom to adjust policy to meet the target, but the Minister has the prime responsibility for setting the target, and holding the Governor to account for his performance in achieving it.  I was a bit surprised by this omission.  It may reflect some sense, whether in the Minister’s office or in Treasury, that the Minister should avoid being seen putting pressure on the Governor in respect of specific OCR decisions.  That is fine, but the Minister is responsible for how the Governor exercises his considerable powers in this area, and the surprisingly weak inflation has now been around for a long time.  And there was that curious comment in the newspaper a few weeks ago about the Minister’s apparent concerns.
• The Minister is formally asking the Bank to supply him with advance information on any significant institution regulated by the Reserve Bank “that faces a material risk of financial difficulty”.  At one level, one can understand this request – ministers don’t like being surprised –  but the administration of prudential policy is typically put at arms-length from ministers for good reason.  In many countries (perhaps especially less developed ones), ministers (and their friends and donors) have been too close to major financial sector participants.  Knowing that an institution is at risk –  because sensitive information about its finances has been disclosed to the Minister – does not give the Minister power to intervene, but it does increase the risk of political pressure being brought to bear on the Bank in respect of how it handles an institution in difficulty.    There are no easy answers to where the line should be drawn, but this feels like one of those situations where what is written down goes a little far.
• 2015 is the first time that the letter of expectation has been copied, formally at least, to the Chair of Reserve Bank’s Board of Directors.  The Board exists largely as the monitoring agent for the Minister of Finance, and it must be helpful for them to have formally the document recording the Minister’s expectations of the Governor.
• In the last two letters the Minister has noted that “I also look forward to the Reserve Bank’s analytical contributions to deepen our understanding of New Zealand’s economic performance and macroeconomic imbalances”.  Perhaps this is now meant largely as a ritual incantation.   There has been little sign of such analysis in the last couple of years and given the Bank’s apparently much tighter funding constraints (in the forthcoming Funding Agreement) it may not be realistic to expect that they will have the resources to make much contribution in this area.
• In each of the three letters, the Minister has highlighted his desire to reduce the contingent fiscal risks associated with the banking sector.  He notes the existence of the OBR tool but wants to better understand “opportunities to reduce these risks further”.  At one level, that prompts a reaction of “just say no”.  Ministers, not central banks, make the choices in which banking failures become direct fiscal risks.    But there is also a balance here.  Even under OBR, it is generally accepted that for the tool to work the non-written-down component of the failed bank’s liabilities will need to be government guaranteed.  Many (including me) would argue that, in most circumstances, when a major bank failed the liabilities of the other banks would also need to be guaranteed.  Eliminating fiscal risks associated with bank failure –  or even reducing them much further from the already very low levels (see the Bank’s work on the implications of Basle III) –  would require either a rock solid political determination to let a failed bank fail (and either close, or be taken over quickly)  –  unlikely ever to be a time-consistent strategy –  or even higher  minimum capital requirements.  I think that, at current capital levels, the Modigliani-Miller proposition would hold, and higher capital requirements would not raise overall bank cost of capital.  But I’m sure the banks wouldn’t see it that way.  The Reserve Bank itself can’t quite make up its mind what it believes on that score, but I can imagine a great deal of lobbying of ministers (here and in Australia) if the Reserve Bank were to respond by looking to materially raise required capital ratios.

It was interesting to have the material.  It does add a little to our ability to understand the Reserve Bank and its relationships with the Minister (and Treasury).  Perhaps they could at least consider routine publication in future, as part of enhancing the transparency of the Reserve Bank.

(If anyone does want the letters from 2013 and 2014 they can email me.)

That was the title of an address I did to a group of several hundred investment management professionals in Auckland this morning.  The organisers wanted snappy titles: mine was inspired by the book, The Blunders of our Governments that I wrote about a few weeks ago.

The essence of my story is in this summary I gave them for the programme.

High and rising house prices in Auckland hog the headlines.  The tax regime and bank lending practices are largely irrelevant to what has gone on.   Instead, increasingly unaffordable house and land prices result from the collision of two, no doubt individually well-intentioned, sets of policies.  Tight restrictions on land use crimp the supply of the sort of properties most people want to live in, while very high target levels of non-citizen inward migration persistently boost demand for housing.  One or other policy might make sense, but together they represent a blunder that is enormously costly to the younger generation of Aucklanders.

I only had 20 minutes to speak, but a fuller version of my story, with a few more of i’s dotted and t’s crossed, is here.

High house prices a blunder of our governments

In a slightly intimidating approach (at least for the speaker), each presentation was rated electronically by each member of the audience as soon as it ended.  93 per cent of the audience claimed to “largely agree” with my story.  I’m sure that won’t be the general reaction, and as ever I’m interested in thoughtful comments etc.

I’m a bit pushed for time today, so just a fairly quick post on the latest housing “patent remedy”.

I was quite critical last week of the Reserve Bank’s latest proposed regulatory intervention in the housing finance market.  I noted that

The Auckland housing situation (a social and political scandal, as I’ve said before) calls for careful diagnosis, informed by experience and insights from the rest of the country, and remedies that deal effectively with the underlying issues and causes.

The Government’s proposed new  tax measure –  a brightline test in which gains on (almost) any sale of a non-owner-occupied house held for less than two years will be liable for income tax at the seller’s usual marginal tax rate-  doesn’t seem to fit the bill much better than the Reserve Bank’s new intervention.  It is also unrelated to the basic causes of the problem – laws and regulatory practices that impede the responsiveness of new supply, while at the same time other policy instruments actively drive rapid population growth in Auckland.  (Taking a medium-term perspective, almost anything else is largely irrelevant.)  It will be interesting to see what Treasury’s advice on the proposal was –  they have long-favoured a capital gains tax, but it would be surprising if they thought this was either good tax policy, or something well-targeted at the housing market issues[1].

Last week’s Reserve Bank announcement drew editorials praising the fact that someone, anyone, was doing something, anything.  There doesn’t seem to be anything similar this morning, but perhaps that is the nature of politics.

In fact, relative to the Reserve Bank’s announcement, there are some things to be said for the government’s announcement.

• Neither announcement has an electoral mandate – and it is only eight months since the General Election –  but at least the latest announcement was made by Ministers, who are elected members of Parliament.  The public can oust MPs, and as Australia illustrates leaders (and ministers) serve only at the pleasure of governing party caucuses.
• Whereas it is virtually impossible to mount a credible argument that not a cent can safely be lent, at any interest rate, to Auckland investor property purchasers at LVRs over 70 per cent, at least the two year bright-line test can defended as reducing the weight the tax system places on establishing intent.  Taxes should be levied based on actions (or even assets), not on highly intrusive bureaucratic assessments of intent.
• The government’s announcement yesterday will require legislation, and media report that there will be Select Committee scrutiny.   Elected representatives will scrutinise the proposal, and the media will report on the process.  Contrast that with the Reserve Bank’s proposal, which will be shoehorned in under legislative provisions that were never intended for the purpose.  Submissions will be invited, but (unlike Select Committee submissions) we will see those submissions only after the final decisions have been made, and the unelected Governor will be judge and jury in his own case.  Yes, it is probably lawful, but it lacks some legitimacy.

But in addition to being ill-targeted, yesterday’s announcement looks as though it will add to the pro-cyclicality of government revenue.  In other words, more revenue will flow into the government’s coffer at the peaks of booms (when it shouldn’t need extra revenue) only for that source to dry up when downturns happen.  Pro-cyclical discretionary fiscal policy is something to avoid as far as possible –  see, for example, Anne-Marie Brook’s work –  and this change will only (slightly) worsen the problem.  On a much larger scale, this issue was a major problem in Ireland.

I’m not close enough to tax administration to know quite how this will work if house prices ever fall sharply, but if people can offset losses on a house sale against other income, it would be quite an incentive to realise one’s loss quickly (inside the two year window when one can avoid the intent test), potentially exacerbating the speed of a correction.  So in a severe housing downturn, will the government be writing cheques to housing investors who’ve punted and lost?  Even if losses can only be carried forward to be offset against any future gains, the procyclicality of revenue will increase and the risk of more procylical discretionary policy will rise.

Capital income is generally overtaxed.  That said, I’m not resolutely opposed to a theoretically pure capital gains tax.  With efficient asset market pricing, there are no rationally expected real capital gains.  Any actual gains and losses (of which there will be many) are then just windfalls.  One can treat them as taxable income/losses or not, and it is mostly just a distributional issue with no very material efficiency implications.  But that assumes:

• All assets are subject to tax (not some assets, held by some types of people)
• Gains and losses are treated symmetrically
• Only inflation-adjusted capital gains (losses) are taxed
• The CGT applies based on changes in market values, not realisations

I’m not aware of a single capital gains tax anywhere, ever,  that has met those tests.  Real world CGTs are distortionary in a whole variety of ways, including discouraging turnover and encouraging assets to be held not by those who can most efficiently hold and manage them, but by those who are at least risk of having to trigger a transaction.  Big investment funds might never need to trade a property, but an individual small business operator (eg a family with a single investment property) can face many possible changes in life circumstances which could compel a sale – including, but not limited to, redundancy or job relocation.  The PIE regime already started to skew the ground against individual holders of investment properties, and this measure will skew it a bit further.

In the end, yesterday’s announcement looks a lot like political theatre.  As ministers, and the Reserve Bank, have rightly noted previously, CGTs don’t change the character of house price cycles, and attenuated ones like this are even less likely to.  Some will feel better that “something is being done”, but it will just divert attention, and policy and legislative time, away from measures that grapple with the real issues.  My first reaction yesterday when I heard the announcement was to think of the Third Labour Government’s Property Speculation Tax in 1973, introduced at the height of an earlier house price boom.   We had a look at it when we did the Supplementary Stabilisation Instruments Report in 2005/06.  It also made good political theatre, distracting from the real issues.   Every asset price boom is a little bit different.  But like this proposal the Property Speculation Tax attacked symptoms and was largely irrelevant to ending the 1970s house price boom (which was followed by a multi-year very deep fall in real house prices).  Marked changes in immigration policy, and a collapse in the terms of trade which helped prompt an exodus of New Zealanders to Australia, had much more to do with that.  House prices are influenced by a whole variety of factors, but Auckland prices are only likely to fall very much very sustainably if there is some combination of a far-reaching freeing up of restrictions that impede supply and an end to the policy-fuelled population pressures.

UPDATE:  This article is interesting in light of the Reserve Bank’s response to my OIA last week in which the Bank confirmed that it had done no substantive analysis of capital gains taxes, and had provided no advice on such issues to a variety of ministers or agencies.  Since I inadvertently omitted the Prime Minister from the list, it is possible they may have given such advice directly to him, but it would be surprising then that nothing had been provided to Treasury (or IRD).

[1] The brightline test idea has been around for a while.  I found that it was referred to in the Supplementary Stabilisation Instruments Report the Reserve Bank and Treasury prepared at the request of the then Minister of Finance in 2006.

I have been making the point (ad nauseum perhaps) that it is hard to reconcile the Reserve Bank senior management’s public anguishing about the threat house prices allegedly pose to the soundness of the New Zealand financial system with the results of their own 2014 stress tests, reported in the November 2014 Financial Stability Report.   The latest FSR does not even mention the earlier stress tests, despite the new regulatory controls the Bank is planning.

But in the Herald this morning –  not the Bank’s own statutorily-required accountability document – we find an official Reserve Bank spokeswoman quoted on the very topic.  Mary Holm, the Herald’s personal finance columnist had had a question from a reader about what would happen if house prices dropped sharply.  Surely, the reader suggests, banks would collapse?  So Holm went to the Reserve Bank for comment:

What does the RB think about the possibility of a property plunge. “Whether property prices could drop by half from today’s values is purely speculative,” she says. “Nevertheless, a 50 per cent drop matches some of the more severely affected economies in the global financial crisis such as Ireland.”

So they’re not ruling it out. But would such a drop cause banks to “collapse”? “The short answer is no, we do not believe so,” she says.

“The Reserve Bank conducts regular bank stress tests in collaboration with the Australian Prudential Regulation Authority. The most recent one was last year, and the results of it are featured in the November 2014 Financial Stability Report, pages 9 to 11, on our website.

“This stress-test exercise featured two imagined adverse economic scenarios over five years, one of which involved a sharp slowdown in economic growth in China, which triggered a severe double-dip recession in New Zealand. Among the impacts were house prices declining by 40 per cent nationally, with a more pronounced fall in Auckland – similar to your reader’s worst case scenario.”

So how would our banks fare?

“The Reserve Bank was generally satisfied with how the banks managed their way through the impacts of these scenarios, and we are comfortable that the New Zealand financial system is currently sound and stable, and capable of withstanding a major adverse event.”

So our own Reserve Bank, required to run prudential regulation to promote the soundness and efficiency of the financial system, is quite comfortable that, based on the asset structure of the major banks last year, our banks and our financial system would come through just fine if (Auckland) house prices were to fall by 50 per cent.

Note carefully, I am not misreading them as suggesting that our banks would always be robust to any such collapse in asset prices.  In other circumstances, with a different mix of loans on the books, the threat could be much much greater.  But as things stood last year –  and bank loan books haven’t changed much since then – the New Zealand financial system would be fine.  Recall that it is not residential mortgage loans that typically threaten banking systems, but construction and commercial property exposures.  The Reserve Bank spokeswoman mentioned the Irish case, but in Ireland it was reckless lending on a huge property development boom (commercial and residential) that played the central role in undermining the health of the Irish banking system, and in particular which brought down their most egregious lender , Anglo Irish Bank (read about it here).  We don’t have any such large scale credit-financed property development boom in New Zealand.

Which brings us back to the question, what does Graeme Wheeler think he is doing with his proposed new restrictions on banks lending to small businesses in the rental property market?  His spokeswoman just told us that the financial system was likely to be robust even if house prices fell 50 per cent, and his only statutory mandate is about the soundness and efficiency of the financial system.  His proposed new controls will impair the efficiency of the financial system, and his own spokeswoman says (what his FSR opened by saying as well) that soundness is just fine.  Dampening house prices temporarily just does not, and should not, figure as an objective in the Reserve Bank Act.

Just one other quick point on the Bank spokeswoman’s comments.  Holm reports her as saying:

“In the extremely unlikely event of a bank failure, our Open Bank Resolution (OBR) policy would apply. The aim of OBR is to allow a distressed bank to be kept open for business while placing the cost of its failure primarily on the bank’s shareholders and creditors rather than the taxpayer.

The first sentence of that statement is just wrong, as I’m sure the Bank now recognises.  Any decision to use OBR will not be a matter for the Reserve Bank, but for the Minister of Finance.  The chances of OBR being used in respect of a major bank have always seemed to me quite small.  It is a good tool to have available, and might be a credible option for the failure of a small New Zealand bank, but it has always only been one option to have in the toolkit (as the Bank reports here) , to present to the Minister of FInance at the point when a bank fails.   For the major banks, it is good to be able to scare the Australian authorities that we just might use it, but in most plausible failure scenarios OBR is much less likely than a government bailout.  And that is partly because New Zealand has not yet come to grips with deposit insurance.  Deposit insurance is  not an ideal policy by any means, but without it the chances that a Minister of Finance and his Prime Minister will agree to allowing widespread losses for retail investors seems vanishingly small.  That is a general proposition, not specific to the current government, but having bailed out every creditor of AMI this particular government does have form.

The Reserve Bank makes much of its transparency around monetary policy.  A good example was this speech by central banking newcomer, Deputy Governor Geoff Bascand, which invoked a recent academic study by Dincer and Eichengreen, in which the Reserve Bank of New Zealand scored second on transparency, behind only Sweden’s Riksbank.

There is a range of different dimensions of transparency.   Central banks and monetary policy are generally materially more transparent, and open to scrutiny, than they were in the early post-liberalisation years.   But things aren’t necessarily so much more transparent than they were in earlier decades.  A fixed exchange rate, such as New Zealand had for many decades, was very transparent – probably easier to understand, and benchmark performance against, than the inflation target (with all its caveats and exclusions).  Reserve requirements on banks, and regulated interest rates were also very visible and open.  Price freezes were also transparent and, like them or not, LVR restrictions are rather more transparent than adjustments to minimum risk weights in bank regulatory capital frameworks.  More transparent policies are not always better policies than less transparent ones, but in respect of any particular type of policy more transparency will generally be better than less.  That is more about democracy, open government, and substantive accountability than it is about the ability of transparent policy to influence behaviour towards government ends.  On that latter score, the benefits of transparency are typically oversold.

Perhaps a useful distinction for thinking about the transparency of New Zealand monetary policy is between transparency about stuff one knows little about, and transparency about stuff one knows a lot about.  The Reserve Bank is very good about the former, and quite poor on the latter.

Let me explain.  Since the 1980s (and initially under the influence of the new Official Information Act) the Reserve Bank has been publishing economic forecasts.  No other central bank did so at the time.  For a long time the forecasts didn’t mean a great deal – I once sat in a meeting with Roger Douglas in which the then Deputy Governor memorably disowned the forecasts as “just those of the Economics Department”.  But by the mid- 1990s, as inflation targeting bedded down, economic and inflation forecasts became the centrepiece of how the Reserve Bank formulated, and talked about, monetary policy.  From 1997, and almost by accident, the Bank started publishing forecasts of its own actions.  A new model had a policy rule embedded in it, in which the interest rate adjusted to keep inflation, over the medium-term, near the midpoint of the target range.  The Reserve Bank of New Zealand was the first central bank to publish such endogenous interest rate projections.  It is still in a minority in doing so.  If one is going to publish forecasts, there are pros and cons to publishing an endogenous interest rate track (rather than, say, publishing economic projection based on current interest rates, or using market implied future rates).  My bias has always been not to have done so, but reasonable people can differ on that.

Economic forecasts take a lot of effort to put together, and a lot of effort to burnish and refine for publication.  They remain at the heart of the Reserve Bank’s Monetary Policy Statements, and interest rate announcements, more so than in many other countries.  And yet they contain almost no useful information.    The Reserve Bank publishes projections two to three years ahead, which in the case of the interest rate projections involves looked four to five years ahead (since interest rates work with a lag and are, in principle, set in response to the outlook for inflation pressures).  But no one knows anything very much about what will happen to the New Zealand economy, or that of the wider world.  Perhaps there might be a little bit of information in economic projections three to six months ahead, but beyond that the Reserve Bank has no useful information, and so can convey no useful information to the public or to markets.    The Governor might have a policy reaction function in mind (ie how he might react if things turn out the way the projections suggest) but that reaction function has never been disclosed and has probably changed over time (perhaps from quarter to quarter).

Suggesting that central banks don’t know much about the future should never have been a controversial proposition, but the last decade makes the point very starkly.  The Reserve Bank (like everyone else) was totally wrong-footed by the recession of 2008/09, and then has been consistently wrong about the outlook for inflation and interest rates since then.  I’m not particularly critical of them for that (after all, markets have mostly been more wrong, and other central banks almost as wrong).  It is the way the world is.  My point simply is that there is not much more information in a central bank’s medium-term economic forecast than in a horoscope.  And the horoscope takes a lot fewer expensive (and scarce) real resources to generate.

For all the rhetoric about forecast-based policies, the success of the Taylor rule in describing how central banks operated, across many countries and several decades, also illustrates that central banks mostly adjust policy by “looking out the window”.  Even contemporaneous data are ridddled with uncertainty and scope for revision, but looking at what is going on today and responding to that is about as good as it gets.  It might not be “optimal” in some models, but such models typically won’t capture the degree of uncertainty in the real world.

So our Reserve Bank –  like many of its peers –  is quite transparent about the stuff it knows almost nothing about, but it is really not very transparent about the stuff it knows a lot about.  Open government and accountability are more about those latter things.

Let me illustrate:

• The Reserve Bank’s main forecasting model is still not public.  I gather the intention is to publish it (they keep referring to it as “forthcoming”) but it has now been in use for a couple of years, was put together at significant public expense (replacing a predecessor compiled at even greater expense), but is not public, and certainly not in a useable form.  Why not?  Similar concerns have been raised in the UK about the non-disclosure of the Bank of England’s model.  The point here is not that the model itself will offer any great insights to future policy, but that it documents the understanding of the Bank’s economic staff as to how the economy works, and what the key relationships are.  Those are insights we should have direct access to –  apart from anything else, we paid for them.  Similarly, it would be useful for observers to know what policy reaction function the Bank uses as the baseline in its model.   It is one benchmark which observers could use to pose questions about the Governor’s actual interest rate decisions.  And it would be useful to know whether, eg, changes in the PTA changed the reaction function staff used to describe policy.
• The Bank does not publish any minutes of any of its monetary policy meetings (or those in other areas of policy, but that is a topic for another day).  The standard argument has been that the MPS itself is the New Zealand equivalent – it lays out the conclusions of the single decision-maker.  But that argument won’t wash.  Successive Governors have stressed that they operate collegial processes, seeking advice from a range of internal and external advisers. The current Governor says he makes major decisions in the forum of a Governing Committee.  Especially in an area as riddled with uncertainty as monetary policy, citizens should be entitled to understand the range of competing considerations and arguments that went in to shaping particular policy decisions.  Submissions to Select Committees on draft legislation are public, and private citizens’ submissions on public sector consultative documents are typically published, so why shouldn’t we, after the event, be able to see the range of perspectives that went into setting a particular interest rate?  Reasonable people can disagree on how full such minutes should be, and how quickly they should be released, but the Reserve Bank of New Zealand has refused to release such material at all.  Are substantive minutes being made at all of meetings of the Governing Committee?
• The Reserve Bank does not release, even with a considerable lag, the key background papers considered by the Governor in preparing each quarter’s forecasts and MPS.  As regulars readers will know, when I recently requested these documents from a forecast round ten years ago (about which there can be no market sensitivity, and no difficulty around free exchange of views), I was fobbed off with the claim that they could not process the request in the standard 20 working days.  I’m still awaiting the final response.  I hope the Bank is thinking seriously about a new standard release policy for all these background papers –  perhaps releasing all them with a lag of no more than one OCR review after the decision to which they related.  Pro-active release of background documents is a growing practice in other areas of government (and has been around Budget papers)  but it has not yet come to the Reserve Bank.  This is hard information, generated at public expense, and yet there is no openness or transparency in making the material available.
• There is little or no openness around the process for negotiating Policy Targets Agreements.  In Canada, several of the five yearly inflation control agreements (and these are not legally binding documents, just statements of shared understanding) have been proceeded by an extensive programme of research and debate on possible areas of change.  There has been nothing similar here, ever.  In New Zealand’s case, the possibility of ex ante transparency is not helped by weaknesses in the legislation: a PTA must be signed by the Minister and Governor before a new Governor is formally appointed.  If, by contrast, a Policy Targets Agreement were reached with the Bank – not an individual – at a time not tied to the appointment of the Governor, it would be much easier to run an open process.  Perhaps a year out from the expiry of a PTA, the Minister of Finance or Treasury could invite submissions. A workshop could be held to explore alternative proposals, even if the final result was simply to reaffirm the status quo.     But even now, there is no good grounds for an ex post lack of transparency.  What stops the Reserve Bank, the Treasury, and the Minister of Finance publishing all significant documents generated in the course of negotiating a new PTA once it has been published?  I recently asked for copies of the background documents to the 2012 PTA (something signed almost three years ago).  I didn’t want them to find out stuff I didn’t know –  I had some involvement in the process, and so had a fair idea of the issues that were discussed etc  –  but to serve the interests of public transparency, and to enable people to see how, if at all, risks like the zero lower bound were taken into account.  I was presented with a large bill that would have to be paid if I wanted to pursue the matter.  The Bank is probably within its legal rights to do so, but what does it say about the transparency of the institution and monetary policy that it does so?
• The Reserve Bank’s Board exists to hold the Governor to account.  And yet papers that go to the Board, and the conclusions of the Board on monetary policy, are not published.  The Green Party was, for a while, routinely requesting Board papers, as much as anything to make a point about lack of transparency.   It is certainly true the the Board now publishes an Annual Report, but it is an anodyne document offering no real insight into the processes or debates the Board might have had, in assessing the Bank’s conduct of monetary policy.  Again, no doubt release would need to be with a lag.    For some other work I have underway, I recently obtained Board minutes from 20 years ago, unexpurgated.  But I wonder how someone would get on asking for material the Board considered on monetary policy perhaps one to two years ago?
• Another aspect of monetary policy where the Bank is not very transparent is foreign exchange intervention.  Best practice internationally is to disclose such intervention within a few days. In the Reserve Bank of New Zealand’s case, there is no disclosure until the end of the following month (ie the lag can be as long as two months) and even then we are only left to deduce the size of the intervention from tables that have not changed since the intervention policy was introduced.  Again, best practice would make available, with a modest lag, daily data on the Bank’s intervention positions.  Doing so would enable people to better assess any impact of the intervention, and to better hold the Bank to account for the profits and losses on intervention (its large wager at our risk/expense).
• The Bank also isn’t very good about transparent self-critical analysis of its own performance.  The provisions of the Act around Monetary Policy Statements are awkwardly worded, and need updating, but they actually require the Bank to provide a regular “review and assessment” of its own past policy.  That is difficult to do well, and there are inevitably lags involved, but it just isn’t done very much at all.  “Assess” means more than “describe and defend”.    Perhaps, for example, they could take the opportunity every two years or so to do a special chapter in an MPS self-critically reviewing their own performance.  The idea isn’t about a public whipping – monetary policy is one of those areas where everyone faces huge uncertainty.  We have live with the mistakes and misjudgements central banks make, but there needs to be a strong commitment to learn from those inevitable mistakes and account for them to citizens.
• And finally, the Reserve Bank does not typically release its MPS OCR decisions until almost two weeks after they are made.  This is less an issue of transparency than of risk, but is out of step with practices anywhere else in the advanced world.

In each case, no doubt arguments can be made that particular items on my list should not be disclosed, or should only be disclosed to researchers years later.  My point is simply that the Reserve Bank is not very transparent, or committed to open government, on things it actually knows about –  its own operations, its own analysis, its own deliberations.  It is pretty transparent about what it thinks might happen in the future –  but that isn’t much use to anyone since the Reserve Bank knows no more than anyone else about the future, and “anyone else” knows almost nothing.

And the benchmark here is not just about what other central banks do.  It should be about a strong commitment to open government and substantive accountability.  To, for example, the principle in the Official Information Act –  one of the surprising legacies of the Muldoon government –  that

The question whether any official information is to be made available, where that question arises under this Act, shall be determined, except where this Act otherwise expressly requires, in accordance with the purposes of this Act and the principle that the information shall be made available unless there is good reason for withholding it.

A much more pro-active approach from the Reserve Bank would, over time enhance its own reputation, for good quality policymaking and for a commitment to recognising the obligations powerful government agencies should have in an open democracy.

A few more points struck me about the Reserve Bank’s latest FSR.  This longer post is about housing, and later in the day I’ll touch on another couple of issues.

There seems to have been a knee-jerk reaction, including in newspaper editorials this morning, that we should be grateful to the Reserve Bank that “something is being done” by someone, anyone.  That is a terrible way to make policy.  If a child is drowning no one cares who jumps in to rescue the child so long as someone does.  But if a child has a serious illness the last thing we want is random enthusiasts (let alone powerful government agencies with the coercive force of law behind them) jumping in with their own patent remedies.  The Auckland housing situation (a social and political scandal, as I’ve said before) calls for careful diagnosis, informed by experience and insights from the rest of the country, and remedies that deal effectively with the underlying issues and causes.

Banning banks from lending a cent over 70 per cent of the assessed value of a property to “investors” in “Auckland” is a solution in search of a real problem.  What makes the Governor so sure that 10 per cent of Auckland mortgage lending can safely be made in loans over 80 per cent of the value of the property if the buyer is an owner-occupier (or, apparently, some classes of bach owner), but that not one cent can be safely advanced to “investors” for more than 70 per cent of the value of the property? On the evidence of the FSR, there is nothing solid to provide that confidence, but perhaps there will be more in the forthcoming “consultation” document?

Controls are begetting controls, but controls also beget disintermediation.  One of the arguments in 2013 for the “speed limit” approach to LVR restrictions (as opposed to a blanket ban) was that it would limit the extent of disintermediation (mortgage lending business moving from banks to other lenders).  But now the Governor himself is resorting to a blanket ban, in respect of people running small businesses, who typically have a greater degree of financial sophistication (including regular dealings with advisers such as lawyers and accountants) than most first home buyers.  Another reason why the Bank wasn’t too fearful of disintermediation was the belief – which I think was real at the time, but in fact was just another misplaced hunch – that the controls would be short-lived.  That has also gone out the window now, with controls layered on controls (lending restrictions on banks still exist in the rest of the country, where house prices rose 2 per cent in the last year).

Non-bank lenders (especially non deposit-takers, over whom the Reserve Bank has no regulatory control) will probably be busy this morning planning how to gear up their businesses.  I wonder what assurance can the Reserve Bank offer that if fringe lenders gear up to provide loans to investment property purchasers (and have portfolios much less diversified than a typical bank’s) that both the efficiency and the soundness of the financial system as a whole will not end up impaired?  Perhaps again the answer will be in the “consultation” document?

For decades, bank supervision – dedicated to promoting the soundness and efficiency of the financial system, as Parliament required – went on behind the scenes.  Ordinary borrowers didn’t need to pay any attention to what the regulator was up to, and nor should they have to.   The Reserve Bank focused on ensuring that adequate buffers were in place in case something very nasty happened.  And they did that without directly impinging on any individual borrowers’ plans.   Risks to banks arise from whole portfolios of loans, not from individual loans to SMEs (which is what investment property purchasers, or refinancers, are).  The Reserve Bank set the minimum capital requirements based on whole portfolios of loans, and recognising systemic risks, and then private borrowers and lenders – surely better equipped for the job than any official – decided whether or not a particular loan made sense.     In the last couple of years there has been a sea change, and not for the better.

High Auckland house and land prices are almost entirely a reflection of poor quality policy: unnecessary central and local government rules that impede the ability of supply to respond adequately in the face of policy-fuelled rapid population growth[1].  It has almost nothing to do with credit policies of banks.  In again interfering with the credit policies of those private businesses, the Reserve Bank will be rather arbitrarily redistributing some gains and losses, while imposing some deadweight costs on the whole economy as the efficiency of the financial system is eroded (and probably that of the housing and holiday home markets as well).  The Bank’s actions will probably dampen Auckland prices a little, for a short time.  Some people will buy a little more cheaply than they might otherwise have expected, and others will miss out.   But where is “dampening house prices” as an objective in the Reserve Bank Act?

And all the while there is still no evidence of a systemic threat to the New Zealand financial system.    Yes, house prices might fall substantially at some point, but the Governor has no better insight than anyone else on when, if ever, the balance of regulatory land use restrictions and policy-fuelled population growth will change.  More importantly, his existing capital requirements have been shown, by the stress tests, to be able to cope if house prices do fall sharply.  Administering prudential policy to promote the soundness of the financial system is his job –  and he looks to have done it – not trying to protect some house buyers over others, or fussing over whether people might eventually lose money on a purchase, all with no better information about the risks than anyone else has.

In this morning’s Dominion-Post the Governor is again reported as invoking the spectre of the US post 2006 “bust”.  But if that really is the parallel he is worried about, he has shown no evidence, and produced no sustained narrative, to illustrate why he believes that is a serious threat here.   Is there, for example, any evidence of a sustained deterioration in lending standards here – as there was, induced by policymakers, in the US?   It is a little hard to believe when credit growth is so modest, and the evidence of his own stress tests argues against it.   But if he has a case, let’s hear it.  I upset the Governor deeply a couple of years ago when I suggested that New Zealand deserved better than one of the rushed documents being prepared in advance of the first LVR restrictions.  I’d repeat the suggestion now, but I’d reframe it:  the law requires him to do better.  Yesterday’s document just did not provide the material to allow us to assess the Governor’s policies, proposed, present, and past.  That reads like a breach of the law.  It might be something for the Bank’s Board to ponder when they discuss this FSR at their next meeting.

Actions like those of the Reserve Bank, going well beyond their statutory mandate, are threatening and damaging in more ways than one.  At a micro level, it disrupts the business and life plans of many people, adding to costs, and unnecessarily and arbitrarily skewing the playing field in favour of some classes of participants over others.  But it goes deeper.  Next month we mark the 800^th anniversary of Magna Carta, which recognises that the government and its agents are often a threat to our liberties and need restraining.   The ability of private firms and individuals to go about their business should be restricted only when there is clear evidence of harm.  And when government does intervene, citizens are required to obey the law, not just the wishes of bureaucrats, having to cow before ominous threats that they are “expected to observe the spirit of the restrictions” not yet in place (which seems to be drifting rather too close to something like the Fitzgerald v Muldoon case).  Perhaps some good might eventually come from the latest episode if it finally prompts some interest (beyond the Green Party and The Treasury) in reopening important questions about the governance of the Reserve Bank –  just how much power, and how many functions, we should vest in a single unelected official.

[1] Low interest rates probably play a part.   Equilibrium land prices are typically higher when real interest rates are low, but without supply and land use regulatory restrictions the pure land component of a typical suburban house + land package would be pretty small.    Unimproved rural land (the factor in genuinely fixed supply) trades at less than $50000 per hectare.

While I was typing the previous post, where I mentioned this OIA request, the email below turned up.  Given that the Bank has found precisely one email, and released it with no deletions, it is (a) difficult to understand why Grant Spencer went public supporting a capital gains tax, when the Bank has previously been sceptical of any benefits from such a tax, and (b) difficult to see how the Bank has complied with the law in taking so long to respond.  Surely the timing of the press conference and of the Governor’s FEC appearance would not have had anything to do with how expeditiously they handled several simple OIA requests?

Michael Reddell

Via email: mhreddell  at gmail.com

Dear Mr Reddell

On 16 April 2015, you made a request under the provisions of Section 12 of the Official Information Act (the Act), seeking:

Any material prepared, or distributed, in the Reserve Bank over the last 12 months on capital gains taxes, whether on houses or on other assets.  Without otherwise limiting the scope of the previous sentence, this request should encompass any analysis of capital gains taxes undertaken by Bank staff or consultants to the Bank, any academic articles distributed widely among analytical or policy staff, minutes of any policy committee meetings in which capital gains taxes were discussed.  It should also include any advice on capital gains taxes provided to the Minister of Finance, the Minister of Housing, Treasury, Inland Revenue, and/or the Bank’s own Board.

The Reserve Bank is providing to you an email message to Deputy Governor Grant Spencer that he received while drafting the speech titled Action needed to reduce housing imbalances.

Email to Grant Spencer 24 Mar 2015.pdf

Academic articles that may have been distributed widely among analytical or policy staff are either publicly available documents or available upon request from the institutions that published them. Accordingly, the Bank is refusing this part of your request under section 18(d) of the Act – the information requested is publicly available.

Minutes of policy committee meetings do not include capital gains taxes and the Bank has not provided advice on capital gains taxes to the Minister of Finance, the Minister of Housing, Inland Revenue, or the Bank’s own Board. Accordingly, this part of your request is refused under section 18(e) of the Act – because the information does not exist.

The Reserve Bank intends to publish this response to you on its website. http://www.rbnz.govt.nz/research_and_publications/official_information/

Under the provisions of section 28 of the Act, you have the right to complain to the Ombudsman of the Reserve Bank’s decisions about your information request.

Yours sincerely

Angus Barclay

External Communications Advisor | Reserve Bank of New Zealand

2 The Terrace, Wellington 6011 | P O Box 2498, Wellington 6140

1. +64 4 471 3698 | M. +64 27 337 1102

www.rbnz.govt.nz

The Reserve Bank’s Financial Stability Report is due out later this morning.  As I have a few other things to do, and I want to read the whole thing (well, I might make an exception for the payments system discussion) I don’t expect to comment on it today.

Instead, I wanted to prompt some thought about how in New Zealand we ensure that there is adequate scrutiny and contest of ideas around powerful government agencies operating in the economic and financial area.

Late last year, Ross Levine, a professor at Berkeley, visited Victoria University and the Reserve Bank.  It was a very stimulating visit. One of Levine’s books, written with a couple of co-authors, is Guardians of Finance, in which he argues that US financial regulators are too close to those they are regulating, and that something needs to be done to counterbalance that bias.  To be clear, Levine is not alleging any personal financial corruption on the part of anyone involved, but rather highlighting the role played by the large financial resources of the sector, the complexity of the issues, and the revolving door which sees people moving between regulatory and regulated institutions.  The authors also highlight what they call “home-field advantage”  –  drawing from evidence from sports, they suggest that regulators will naturally become attuned to, responsive to, and share to some extent the perspectives of those whom they regulate (moving within a common professional, and sometimes personal, milieu).

Levine argues that these weaknesses were a significant part in explaining the 2008/09 crises, and that institutional change is needed as some form of counterbalance.  I found the connection to the crisis unconvincing for a variety of reasons, including but not limited to the fact that senior regulators who had tried to stand up against the risks building up in the system would almost certainly not have been reappointed.  But I was most interested in his proposal for a new US agency –  the Sentinel.

The one power this small institution would have would be the right to obtain any information it wanted/needed from financial regulatory agencies.  It would be insulated from short-term political pressure to some extent, by being funded by a prior claim on seignorage.  It would be shielded from too much financial sector or financial regulator influence by restrictions on the ability of staff to move from the Sentinel into financial sector or financial regulatory positions.  Any useful impact it had would come from the quality of its research and analytical material.   It is proposed that the agency would pay well, and offer a prestigious and influential opportunity for top-notch people from across a range of disciplines.

In reading Levine et al’s book, and in discussion with Levine during his visit, I had been thinking about the relevance of his insights to New Zealand.    The result was this discussion note

discussion note thoughts prompted by Levine et al’s Guardians of Finance

which I jotted down on the Saturday before Christmas, when my wife and kids had already left town.  (At the time, it was mainly for my then colleagues at the Reserve Bank, but since I expected to be leaving the Reserve Bank shortly I deliberately wrote it out of Bank time and off Bank premises.)

In it, I explore the idea of introducing greater challenge and contest in respect of a range of economic policy and advice functions in New Zealand  (not just, and not even primarily, financial regulatory ones).  The issues are different in New Zealand to those in the US in a wide variety of ways, but the lack of scrutiny and challenge is a much more serious problem here than there –  not through ill-will or malevolence on anyone’s part, but mostly because of being a small country.

I highlight the way that review agencies have been set up in many areas of New Zealand government in the last 30-40 years, and suggest that the scrutiny and review of the economic policy and advice functions now lag behind.  My concrete proposal was the establishment of a small Macroeconomic Council, to independently scrutinise and challenge thinking and policy (advice) emerging from agencies such as the Treasury, the Reserve Bank, the FMA, and MBIE.  Such an agency would deliberately operate outside government –  a contrast, say, with the Productivity Commission (which has done some very good work, but operates –  by statute –  inside government, largely on topics assigned by ministers).

There are weaknesses with the proposal, and if I were writing the note today I would make some of the case differently.  But I think there is a real weakness in our system, and the confidence that the public can have in the quality of regulatory and advisory processes suffers because too few resources are devoted to scrutiny and challenge.  In some ways, I’m uncomfortable suggesting spending more public resources, but as even the 2025 Taskforce pointed out, the things that governments really needs to do need to be done excellently.

In the meantime, I hope that the Financial Stability Report has complied with Parliament’s requirements and will

contain the information necessary to allow an assessment to be made of the activities undertaken by the Bank to achieve its statutory prudential purposes under this Act and any other enactment.

Remember, it is for us –  citizens, Parliament –  to make our own assessment.  The Bank’s own assessment is likely to be interesting, but we need the information and perspectives to evaluate their case, and their activities, to ensure (in the words of Levine’s sub-title) that regulators really are working for us.