On the trail of negative interest rates

I’m still less than entirely well, so posts here will stay less frequent and less regular than usual for a while yet.   That means things like last week’s OCR decision pass by with little comment (my only one will be, in what conceivable world five years ago would a severe global recession, the drying up of a major local export industry, falling inflation and inflation expectations here and abroad, and recognised downside risks be met with precisely no monetary policy action?).

But I see that the Governor has been out giving interviews –  the ones I noticed were with Stuff and the Herald – and some of his comments conveniently tie in with what I was wanting to write about the results of an OIA request to the Bank that belatedly turned up in my inbox on Monday, on the elusive question of what the Bank is (and isn’t) doing about negative interest rates.

You’ll recall that in the second half of last year the Governor was dead-keen on the option of negative interest rates.  It wasn’t just a passing comment, but a very substantial interview.   Who knows, perhaps the rest of the MPC didn’t agree with him, but he was supposed to be the spokesman for the Committee as a whole.  We don’t know what the other MPC members –  the ones who don’t, at least on paper, work for Orr –  think, and they seem to exist in a state of purdah, refusing ever to make speeches or give interviews.

As recently as the Governor’s speech on 10 March this year –  when he and his colleagues were still attempting to play down the economic challenges of Covid – the Governor outlined his preferred tools.  He promised then that

We will provide our full analysis of each of these tools against the principles we hold in coming weeks – so that people can fully understand our thinking and, of course, provide input.

None of that analysis has ever been published.  The list of tools was clearly organised in order of the Governor’s then preference: forward guidance (just a variant on what they always do) was first, and then

Negative OCR

Reduction of the OCR to the effective lower bound (the point at which further OCR cuts become ineffective), which may be below zero. The Reserve Bank could consider changes to the cash system to mitigate cash hoarding if lower deposit rates led to significant hoarding.

Not only did a negative OCR appear to be in play, but that really encouraging second sentence suggested they might actually have considered doing something –  they are technically easy things to do – to allow the OCR to have been cut even further below the negative levels which at present could lead to large-scale shifts into physical cash.

That was then.  A few days later the MPC decreed that in fact that OCR would not be changed, up or down, from 0.25 per cent for a year, claiming the matter was really ou of their hands as “banks weren’t ready”.

It was, and remains, a very strange argument given that:

  • several other advanced countries had had negative official rates for some years,
  • a large share of global government bonds had been trading with negative yields for some years,
  • in New Zealand the first negative yields (on indexed government bonds) were recorded last year, at about the time of that interview the Governor gave,
  • the Reserve Bank had shown revived interest in these issues for a couple of years, and
  • that eight years previously an internal working group (set up by the then Governor, chaired by me) recommended that relevant departments should ensure that (a) the Bank’s own operating systems, and (b) commercial banks’ systems could cope with negative interest rates.  Those recommendations were accepted at the time.

In other words, if the Bank’s claims now are really true, commercial banks seem to have been astonishingly (or conveniently, since banks hate negative interest rates) remiss and (more importantly, since it is a powerful public agency) the Reserve Bank ((Governor, Deputy Governor, MPC –  and the Board paid to hold them to account) had to have been asleep at the wheel.  Given a decade’s advance notice of the risk that market-clearing interest rates would go negative here too, they would appear to have done nothing.  That would be egregious neglect –  for which people at the bottom, the involuntarily unemployed, would pay the price.

The Bank, of course, likes to claim that it is highly transparent –  they have been at it again this week – even as they remain as obstructive as possible on anything they don’t want to be transparent about.    The negative interest rates situation has been one of those topics.  For example, they’ve staunchly refused to release any of the background or advisory papers the MPC received running up to 16 March, on this or any aspect of monetary policy (as a reminder, the government itself has been pro-actively open, even with papers that may embarrass some or other bits of government).

I had one go with an Official Information Act request that got nowhere.  But it is a bit harder to stonewall Parliament, and thanks to the efforts of the National Party members of the Epidemic Response Committee we got some useful material out of the Bank.    The Bank didn’t want to draw any attention to this material, but it was there on Parliament’s website, and I wrote about it here.

The Bank told MPs that they’d started to take things seriously at the end of last year

More broadly, bank supervisors raised the issue of preparedness for negative interest rates at banking sector workshops in December 2019.

In late January 2020, the Reserve Bank’s Head of Supervision sent a letter to banks’ chief executives formally requesting they report on the status of their systems and capability.

By late January, of course, Wuhan was already locked-down.

The Bank told the MPs that there had been a range of issues identified, and while they hoped banks were doing something about them, it didn’t want to put any pressure on banks because they were busy people, and had other priorities (which, even if so, would not have been the case had the Bank done its job several years earlier).

None of this was very satisfactory.  They never explained –  or were pressured to –  their own past failures, nor why these alleged readiness issues had not been obstacles in other advanced countries (the euro-area, Sweden, Switzerland, Denmark, Japan), the prevalence of negative wholesale rates abroad.

A few weeks later again, the Governor told the Finance and Expenditure Committee (hearing on the May MPS) that a letter had gone out to banks just the previous week apparently urging or requiring them to have systems ready by the end of the year.   I then lodged a further OIA request

OIA 16 may

Section 105 is the dreadful provision in the Reserve Bank Act which allows the Bank to avoid any scrutiny of its bank regulatory activities under the OIA.  When the response to this OIA arrived this week, they had invoked it to allow themselves (so they claimed) to refuse to release anything in response to item (a) in my request.    This is a provision that, to the extent it had any merit, is designed to protect highly sensitive individual institution material in the middle of a banking crisis (in fact, of course, anything commercially confidential is already protected, and reasonably so, under the OIA).  The readiness of banks’ systems and document for negative interest rates is clearly not primarily –  barely at all – a prudential issue, but primarily a monetary policy one.  But that doesn’t stop the Bank –  the ones that always claim to be so transparent.

However, the Bank did belatedly release what I was after under the second and third strands of my request.  The full response is here.

The 29 January letter is on page 4 of the response.  It is a catch-all letter from the head of bank supervision drawing attention to various issues large and small that the Bank wanted to deal with this year (among the latter, the Bank’s Maori strategy).  Here is the relevant text on negative interest rates

wood negative

Okay I guess, but with little or no sense of urgency.

There is a three page table summarising the responses from each individual bank (although remarkably one banks appears to have never even responded), complete with this interesting  somewhat defensive observation from the Reserve Bank which I had not initially noticed.

“We acknowledge the banks’ responses to our letter of 29 January were a preliminary assessment of their readiness to implement negative interest rates.”

The table is interesting.  Of the 19 banks, a fair number are described as ready, but it is fair to note that a number of issues are also highlighted, in some cases in enough detail to be genuinely somewhat enlightening.    This is all, however, material that could have been pro-actively published in March, and which the Governor –  and those commenting on his draft speech –  must have been aware of on 10 March.

Perhaps it is also worth noting that these are individual bank responses, without the benefit of any RB pushing and prodding to better understand how binding perceived constraints might be, what workarounds might be possible, let alone with any sign of the Bank itself having learned from the experience of their counterparts in countries that had operated with negative interest rates for years.

Anyway, all this was then somewhat overtaken by the new letter, dated 7 May.  It is from the Deputy Governor, Geoff Bascand to the chief executives of banks.    This must have represented the Bank’s (or MPC’s) thinking at the time of the May MPS, although there is no hint –  of course –  of it in the minutes of the MPC meeting.   The letter set out a deadline of 1 December 2020 for banks to ensure that they were capable (with status reports due yesterday).  That wasn’t news, but what was was how limited the Bank’s requirement’s (and ambitions) now are, in the middle of the deepest economic slump in a long time.

Bascand letter

In other words, they’ve just given up on negative retail interest rates.    It isn’t true that in other countries there have been no negative retail interest rates, even with policy rates slightly negative (here is story from just last year of negative retail mortgage rates in Denmark, and recall that lending rates are usually higher than funding rates).  And, of course, look back up to the quote from the Governor’s March speech –  as recently as then they were open to the possibility of taking the steps that might allow the OCR usefully to be cut more deeply than other countries have done.

Coming back to today, what also interested me was that the Governor continues to muddy the waters on this.  In his interview with Stuff there are quite a few comments about negative interest rates.

The Reserve Bank is still warning retail banks to get ready for a negative official cash rate. Rolling this out has been said to be difficult because banks systems weren’t ready and some contracts with depositors didn’t envisage a negative interest rate – effectively a charge on depositors.

Orr said most banks were in a good position to deal with negative rates.

“Some large multinational banks have been dealing with negative interest rates for a long time and some of the smaller banks, which have much simpler systems, are good to go,” Orr said.

“Only a handful of banks” were having difficulty with negative rates.

Orr appeared to downplay the extent to which a negative rate would impact all areas of a bank.

“What we’re doing at the moment is double checking with all of the banks, so they’re not trying to get absolutely everything capable of a negative [rate] because we don’t need absolutely everything.

“We’re saying it’s a small proportion; it’s the wholesale side of the business,” Orr said.

Ordinary depositors likely wouldn’t notice a difference because rates would still be positive for depositors.

“Internationally the experience has been that banks have been highly reluctant to go below zero for a deposit.

“In fact, retail banks’ reluctance to pass on negative rates to consumers are likely to act as a brake on the Reserve Bank’s appetite to push rates lower.

“There is a limit to how far negative wholesale rates can go in large part because the retail rates end up holding up,” he said.

Read that and you wouldn’t know that the Reserve Bank had told banks they didn’t need to bother about negative retail rates –  in fact, you’d get the impression it was banks that could never envisage offering such products, even though they are on offer in other countries.

But you’d also get the impression that the Governor was more concerned for banks than for the New Zealand economy and the people who become unemployed because monetary policy isn’t doing its job.  If his Committee had aggressively cut the OCR another 100 basis points, to (say) the -0.75 per cent often envisaged as an effective floor until steps are taken to disincentivise cash hoarding, not only would the banks that had prepared themselves got on with things, and presumably been advantaged, but the others would have snapped to pretty quickly and got workarounds in place.  (That, after all, must have been what happened in other countries, and is more like the way the rest of government operated –  when a wage subsidy was decided on, MSD wasn’t given nine months to do systems testing etc; when a small business loan scheme was decided on IRD didn’t months to prepare).

And there is no sign at all of the Reserve Bank taking seriously steps to remove the obstacles to a more deeply negative OCR, even though those obstacles are all of the public sector’s making.

Perhaps none of this would matter very much if you believed the spin about what good monetary policy was doing overall, including through the LSAP programme.    But it is just spin.   Benchmark term deposit rates have been falling a bit more recently, but that means they are now 85-90 basis points lower than they were at the start of the year.  But, of course, expectations of future inflation have also fallen quite a lot.  There is a range of possible measures, but a reasonable pick might be a fall of about 60 basis points.  In other words, real retail deposit rates are down perhaps 30 basis points in the midst of a savage slump for which there is no obvious end.   The exchange rate is usually a key buffer for New Zealand, a significant part of how the monetary transmission mechanism works.  It bounces around a bit, but at present the TWI is sitting almost bang-on the average level for the second half of last year.  For all the handwaving and big numbers (around the LSAP) monetary policy just isn’t doing its job, and the Bank seems to have little interest in it doing so.

On Monday I went to hear a speech the Governor gave.  In the course of that address he seemed to defend monetary policy doing not much on the grounds that “the expenditure had to be immediate”.  And at one level, for the March/June quarters no one is really going to dispute that –  monetary policy doesn’t work that fast, and there was a need (or a good case) for lots of immediate income support, especially for people rendered unable to work by government fiat.  But that was then.    Wage subsidies have replaced lost income (a large chunk of it) for a few months –  at the expense of an increased involuntary burden on taxpayers to come – but meanwhile we are still in a deep recession, still have our borders largely closed, and the state of the world economy appears to be worsening.  Monetary policy should have been positioned –  and should now be positioned, it isn’t too late –  to support domestic demand and activity through the (probably protracted) recovery phase –  much lower interest rates, and a much lower exchange rate.  As it is, monetary policy –  designed as the primary countercylical tool – has done almost nothing and the Bank seems quite unbothered about that.

It isn’t good enough.  We need better from the Governor and his Committee (including, for example, to actually hear the excuses of the rest of the Committee members), and we need the Bank’s Board –  hopeless cause I guess –  to be doing its job holding the Committee to account.  But, of course, the person who could make this all happen is the Minister of Finance, who has long-established directive powers, but seems to prefer to do nothing, content to spend taxpayers’ money while doing nothing to remove the roadblock to getting market price signals better aligned with responding aggressively to our economic plight.  Don’t rock the boat, don’t be bold, don’t worry too much about the actual unemployed seems to be the government’s approach.  Robertson and his boss like to invoke memories of the first Labour government, but it is hard to imagine those big figures in Labour’s history being happy to sit by and see a central bank wave its arms and do nothing to get us quickly back to full employment.






Measuring how much monetary policy has eased

A couple of months ago I wrote a post about the work former Reserve Bank researcher Leo Krippner had been doing – over much of the last decade –  on trying to reduce all the influences on the government bond yield curve to a single number, to represent the effects not just of changes in the OCR (or similar rates in other countries) but also what are loosely called ‘unconventional policies’ undertake in the presence of the (actual or effective) lower bound on the OCR itself, whether central bank jawboning or, for example, asset purchase programmes.

As I noted then

This work wasn’t very relevant to New Zealand itself for a long time (there were internal sceptics as to whether it should even be done)….and yet now it is. (In his speech a couple of weeks ago the Governor even suggested the Bank might publish a semi-official series of such a measure.)   Leo’s work has been recognised in various places abroad –  cited in public by at least one Fed Reserve president, and honoured by the house journal of the central banking community, Central Banking magazine ..,  Leo left the Reserve Bank last year, but is continuing to update his work and earlier this week circulated a note with a Shadow Short Rate series for New Zealand, now that we operate with a formal OCR floor (and ceiling) and in the presence of the MPC’s commitment to buy $30 billion of government bonds over the coming year.

The size of the LSAP programme has been increased substantially since then.

Still more recently, Leo has updated his models for the other advanced economies he looks at, in a way that enables us to look at consistent estimates of the extent of monetary easing across eight advanced economies/areas.

Here is Leo’s estimate of the extent of the overall easing, as reflected in the Shadow Short Rate estimates for each country, since the end of last year (to the end of May).


Perhaps three things stand out from this chart:

  • little or no effective easing in the countries/monetary areas where the official short-term rate was already negative.  Perhaps central bank interventions were relevant in other markets, perhaps for a time they stopped government bond rates rising much, but on this metric, no effective easing relative to the position just a few months back.
  • the largest easing has been in the United States and Canada.  That is no surprise: official short-term rates late last year were quite a bit higher in the US and Canada than anywhere else in this group of advanced economies,
  • Leo’s estimate of the New Zealand SSR suggests an easing equivalent to 117 basis points.    Recall that the OCR itself was cut by 75 basis points and so, if one accepts this as a good estimate for how much some mix of the LSAP programme and forward guidance is doing, all the rest is not thought to be worth more than about 40 basis points.    Not exactly consistent with the tone of the continued rhetoric from the Governor, who repeatedly insists –  he was at again on CNN yesterday (whoever runs their Twitter account seemed breathlessly excited that the Governor was on CNN) –  how much difference his MPC’s LSAP programme is making.

Leo has taken his estimates of the SSRs all the way back to the 1990s (the more yield curve information the better for trying to distill what is normal and what is not).  So out of interest I had a look at what happened in the previous severe recession.

When the recession of 2008/09 started all these countries except Japan had official policy rates clearly above zero.  In those circumstances, the SSR is much the same as the official rate.

In this chart, I’ve shown the median SSRs for (a) the big 4 central banks in the sample (US, euro-area, UK, Japan) and (b)  all eight central banks from mid-2007 to the end of 2014.


On these measures, monetary policy kept easing (on the whole) until well into 2013 –  in some cases by official rate cuts, in some by QE measures, in some cases by forward guidance (or perhaps just growing doubts in markets about when official rates might ever need to rise).

In this chart, I’ve shown the fall in the estimated SSRs for each country from mid-2007 (about the peak in rates, including in New Zealand) to (a) mid-2009, and (b) to the lowest point in the period in the chart.


One almost needs a different scale to compare these estimates with those for the  –  more savage –  economic downturn we are now in the midst of (see first chart).

And bear in the mind that in both episodes inflation expectations have fallen quite a lot in many most of these countries.  Adjust for that and the differences in the falls in the real (inflation-adjusted) SSRs would be even more stark.

Now it is certainly true that back in 2013 (say) longer-term government bond yields were still quite a bit higher than they are now (in the US, for example, 10 year rates in mid 2013 were about 2 per cent).  But then estimates of neutral rates have also fallen over that period.

I’m not entirely convinced by the SSR approach.  I set out some of the reasons in my earlier post, and in exchanging notes with Leo I don’t think he would disagree with any of those individual points.   Perhaps the simplest to explain point is one Leo himself included in his paper releasing the New Zealand results: the SSR is not a rate that can be transacted (unlike an OCR), and in New Zealand longer-term interest rates don’t tend to directly affect many borrowers other than the government itself (and monetary policy isn’t supposed to be about shaping the government’s behaviour –  it is a market mechanism, designed to change relative prices facing private sector firms and households).    I’m also a little uneasy about the fact that the Reserve Bank’s LSAP is explicitly targeting mainly long-term interest rates –  which, among other things, is impairing what information might be in those rates, which relate to periods well beyond the current crisis –  while, say, the Australian and US asset purchase programmes are (sensibly) targeted at the shorter end of the bond yield curve (horizons relevant to this recession, and in a sense trying to mimic what a lower policy rate itself will tend to bring about directly if those central banks were willing to cut their policy rates further).

There is also the point I noted in my earlier post that for New Zealand Leo treats the effective floor on the OCR as being 0.25 per cent.  But since that last post, the Governor has explicitly reiterated that it is a temporary floor only –  now only 9 months until the commitment expires –  as he did again yesterday in his CNN interview.  Leo advises that if the effective floor were set a bit lower, the SSR estimate itself would be closer to the OCR.  In other words, the extent of the fall in the New Zealand SSR may actually be skewed higher than is really warranted.

If I have my doubts about the indicator, it is still of some value in providing summary estimates across both time and country, it is the sort of methodology the Bank has in the past expressed enthusiasm for (without tying itself to specific numbers), his approach has received approbation from his peers in yield curve modelling etc, and Leo’s estimates are made available, including on his website.   And they leave us with the twin points that:

  • the extent of monetary policy easing in New Zealand this time is little more than that of the cut in the OCR itself,
  • the extent of the falls in the SSRs in all countries (even Japan) is much less than we saw in the period of the last serious recession.

It is fine for central bankers to talk –  as the Governor does –  of fiscal policy carrying the main load at present but

a)  there was significant fiscal support provided in all these economies (including New Zealand)  in the last episode as well,

b) fiscal policy operates coercively (relying wholly on the sovereign power to tax) and for many purposes –  other, say, than basic income support –  is inferior to monetary policy for stabilisation and recovery purposes,

c) in most if not all these countries recovery after 2008/09  –  best proxied probably by a return to normal of unemployment rates –  took (a) far longer than was expected then, and (b) far longer than most are still envisaging for a recovery now from this more severe downturn, and

d) fiscal policy has its limits (quite probably close to being reached, and more “political” than technical), in a way that monetary policy properly run –  ie not imposing an artificial floor on policy rates –  does not.  It is all the odder that central banks like ours (with the acquiescence of excessively conservative politicians) are acting so starkly to hold up interest rates at time when very  weak investment demand and a high precautionary savings demand would almost certainly deliver short-term market-clearing interest rates that are deeply negative (and while “market-clearing” might seem bloodless to you, what it means in practice is clearing the labour market and supporting a prompt return to full employment).





Negative interest rates

How long have I been banging on about the potential limitations of monetary policy in the next recession and issues around negative interest rates?  The first such post I could find on the blog was almost five years ago to the day, and as I’ve noted previously it had been a concern for some time before, going back to 2010 in the wake of the last serious recession and then the internal working group I chaired at the Bank when Alan Bollard rightly was concerned about downside risks at the height of the euro crisis.  (That was the report, adopted by senior management, which recommended that steps be taken to ensure that banks could operate effectively with negative interest rates.)

Ken Rogoff has been writing about such issues, and publishing in various prestigious fora, for at least as long.   And Rogoff is a Professor of Economics at Harvard and also served as Chief Economist at the IMF for a couple of years.    He and Carmen Reinhart wrote the book This Time is Different: Eight Centuries of Financial Folly  that attracted so much attention in the wake of the 2008/09 crisis.   As I noted in a post a couple of years ago he and another former IMF chief economist Olivier Blanchard proposed dealing with the lower bound issues by raising inflation targets (the suggestion at the time was to something like 4 per cent), which would –  if successful –  raise neutral nominal interest rates and provide more policy leeway in the next recession.

In the last few years his focus has shifted to addressing the lower-bound issues at source.  There was his 2016 book The Curse of Cash which I wrote about here in which –  among other issues physical cash raises –  he addressed the lower bound issues and proposed to address them in part by progressively removing higher denomination banknotes, leaving in time nothing higher than a $20 note.  More recently still there have been various papers, including last year’s paper (with a PhD student co-author) “The Case for Implementing Effective Negative Interest Rate Policy”.   And there have been a couple of short papers in recent weeks.    There was a piece on Voxeu by Rogoff and LIlley about three weeks ago.  This was the abstract

In the aftermath of the Global Crisis, conventional monetary policy has been constrained by low interest rates in many major economies. This has spurred debates on the possibility of introducing negative interest rates in the monetary policy toolkit. This column uses evidence from the US to show that not only do the markets expect the low interest rates to persist into the future, but they also expect the use of negative interest rates down the line.  Moreover, markets no longer believe that even quantitative easing can bring inflation to target, which leaves very few alternatives for monetary policy apart from negative interest rates.

As here, breakeven measures of implied inflation expectations in the US are now well below target.  There is a nice chart for the US suggesting that (at least then) markets there had already moved to put a non-trivial probability on materially negative short-term interest rates in the next couple of years.


Focusing on the medium-term implied inflation expectations they note that this

…suggests that the market’s change in beliefs has moved beyond the present crisis, and it now has re-evaluated the extent to which it expects the Fed to be constrained more generally. One problem with such a scenario is that it poses a perverse feedback loop. As the Fed becomes more constrained by the zero lower bound, the expected inflation rate falls, lowering the neutral nominal interest rate, which in turn makes the zero lower bound more binding.

Very much the same point I’ve been making here.

This week Rogoff has a very accessible piece on Project Syndicate (thanks to a reader for drawing it to my attention) under the simple and stark heading “The Case for Deeply Negative Interest Rates”.  His summary

Only monetary policy addresses credit throughout the economy. Until inflation and real interest rates rise from the grave, only a policy of effective deep negative interest rates, backed up by measures to prevent cash hoarding by financial firms, can do the job.

Some of the emphases are a bit different in a US context  (where much of government at all tiers is highly indebted)

For starters, just like cuts in the good old days of positive interest rates, negative rates would lift many firms, states, and cities from default. If done correctly – and recent empirical evidence increasingly supports this – negative rates would operate similarly to normal monetary policy, boosting aggregate demand and raising employment. So, before carrying out debt-restructuring surgery on everything, wouldn’t it better to try a dose of normal monetary stimulus?

More generally

It is not rocket science (or should I say virology?). With large-scale cash hoarding taken off the table, the issue of pass-through of negative rates to bank depositors – the most sensible concern – would be eliminated. Even without preventing wholesale hoarding (which is risky and expensive), European banks have increasingly been able to pass on negative rates to large depositors.

Some issues are relevant to the US and the euro-area but not in same form to us

A policy of deeply negative rates in the advanced economies would also be a huge boon to emerging and developing economies, which are being slammed by falling commodity prices, fleeing capital, high debt, and weak exchange rates, not to mention the early stages of the pandemic. Even with negative rates, many countries would still need a . But a weaker dollar, stronger global growth, and a reduction in capital flight would help, especially when it comes to the larger emerging markets.

In our case, a much lower exchange rate would make a material difference to the fortunes and prospects of the tradables sector.

Rogoff ends

Emergency implementation of deeply negative interest rates would not solve all of today’s problems. But adopting such a policy would be a start. If, as seems increasingly likely, equilibrium real interest rates are set to be lower than ever over the next few years, it is time for central banks and governments to give the idea a long, hard, and urgent look.

From which I’d depart only in replacing that “long” in the final line with a “short and intense” –  this isn’t the time for year-long reviews, but for early and decisive action (as has been managed on so many other fronts in recent months).

There has been a view in some quarters over the last few years that negative interest rates don’t work (in the sense of boosting demand, credit, inflation or whatever) and could actually be contractionary in their effect.  I’ve been sceptical of that, but also inclined to wonder whether results for slightly negative interest rates  –  where there might be threshold effects –  would generalise to deeply negative wholesale and policy rates.   Rogoff links to a recent paper, newly updated last month, by several researchers mostly at the ECB which uses very disaggregated data to suggest that actually negative interest rates in Europe have worked.   Their abstract is as follows

Exploiting confidential data from the euro area, we show that sound banks pass on negative rates to their corporate depositors without experiencing a contraction in funding and that the degree of pass-through becomes stronger as policy rates move deeper into negative territory. The negative interest rate policy provides stimulus to the economy through firms’ asset rebalancing. Firms with high cash-holdings linked to banks charging negative rates increase their investment and decrease their cash-holdings to avoid the costs associated with negative rates. Overall, our results challenge the common view that conventional monetary policy becomes ineffective at the zero lower bound.

The channels they examine look to work a little differently with negative than with positive rates, but not less effectively.

Another central bank with significant experience with mildly negative rates in Sweden’s Riksbank.  A year or so ago, a couple of Riksbank researchers published an accessible treatment of the Swedish experience, from a top-down perspective.    They summarise their results (with all sorts of caveats in the body of the paper) this way

It has been suggested that the response of bank lending rates to interest rate cuts may become weaker when the policy rate passes below a certain level. This column argues that in the case of Sweden, the pass-through of policy rate cuts below zero to the economy has been reasonably good and monetary policy has been effective even at negative policy rate levels.

As all researchers in this area recognise, a big problem is that limited data.  Only a few central banks have had negative policy rates, almost entirely in a single economic cycle, and none of them have taken the policy rate very deeply negative and dealt directly to the ability for big players to convert into physical cash.  So we cannot say with certainty what would happen if we took the – fairly straightforward –  steps that would enable the OCR to be cut to -3 or -5 per cent.  But the signs look fairly promising, whether on the limited experience we have, or  pretty basic economic theory (all else equal, holding New Zealand dollars will typically be much less attractive if NZD assets are earning a lot less than those in other countries).  And the idea of simply letting the Reserve Bank sit on its hands and do almost nothing that matters macroeconomically (hand-waving around big bond purchase programmes is mostly a distraction in macroeconomic terms, whatever value it might initially have added to market functioning).

You’ll recall that Westpac’s economists last week came out picking that the MPC will abandon its firm pledge not to cut the OCR further and go modestly negative later this year.  That would be welcome –  better than the status quo –  but inadequate, and not commensurate with the scale of the adverse economic shock.  In my post the other day I argued that in next week’s Monetary Policy Statement

The MPC on 13 May should:

  • abandon the “no change for a year pledge”,
  • cut the OCR to zero,
  • announce that the OCR will most likely be cut further in June (which would get many of the benefits immediately, but give a little time if there are some real system issues re a negative OCR), and
  • commit to have in place by June robust mechanisms that for the time being removed, or greatly eased, the current effective lower bound on short-term wholesale interest rates.

As it happens there have been a few other contributions on monetary policy locally this week.

Yesterday morning I heard the local chief executive of Westpac on RNZ talking about all the system and documentation changes that would be needed –  one has to assume he was talking about his bank, as he was quite specific in some cases –  to cope with negative (retail?) rates.  Unfortunately, the interviewer simply took Mr McLean at his word, and didn’t either challenge him on just how vital these things were or why – with 10 years global notice – a big bank like his appeared to have done nothing before now. (My initial reaction was a bit like that to the Governor –  if Mr McLean had spent less time championing all the right-on causes he and the Governor are so fond of –  especially climate change –  and actually managed his bank, his borrowers might be rather positioned now.)  Of course, from a public policy perspective, the bigger question is about years of failure from the Reserve Bank –  under Wheeler, his “acting” replacement, and more recently under Orr –  to ensure that the banking system could readily cope with the sort of cuts to the OCR that it was easily foreseeable some shock soon might make necessary.  In Orr’s case, it is particularly inexcusable given that big interview he gave eight months ago articulating why he favoured negative interest rates as a policy option.  “Saving the world” might seem more glamorous, but stabilising the local economy and keeping inflation target was actually his job.

Then there was a strange comment reported from the Leader of the Opposition.

Bridges said fiscal policy, rather than monetary interventions from the Reserve Bank, would need to do the heavy lifting in the Covid-19 response.

That clearly isn’t true –  it is simply a choice by the MPC to do nothing, and by the government which does not use clear legal statutory powers to compel them to act differently.  Sadly, it is still too much of the conventional wisdom.   I’d probably have forgotten about except that this morning Bridges is reported as worrying about risks of too much public debt being taken on.  Macro policy squares that circle –  delivers accelerated recovery without lots more debt –  by using monetary policy: yes, deeply negative rates in this context, to provide the support and stabilisation into the recovery towards full employment.  Such, it seems, is the power of conventional wisdom and the fear of successive Oppositions –  Robertson in Opposition was quite as bad, in less important circumstances –  to challenge anything that the (on their record) not-overly-capable RB/MPC does.

And finally, another reader this morning sent me this clip from a recent BNZ research report, previewing next week’s MPS.

We would strongly argue that lowering the cash rate further would provide almost no assistance to the economy. The cost of debt is the last thing on anyone’s mind now. The lack of availability of debt might be a concern and, for many, the lack of income to repay debt will be a pressing problem. Pushing interest rates sub-zero will do nothing to ameliorate those issues. Moreover, even if the cash rate was to go negative, it would not be fully passed on to borrowers as the banks will still be funding themselves with positive interest rates. Term deposit rates are excruciatingly low for many as it is. The last thing the household sector would want is zero rates across the board. And even at zero, it would mean bank funding costs well above the cash rate.

The research report is headed “RBNZ Can’t Save the World”, to which one can only agree.  What it can do –  what it is charged with doing –  is keep inflation and inflation expectations at around 2 per cent, and support as rapid as possible a return to full employment.  At present, those two goals are tightly aligned, given how high unemployment is forecast to be, and how far medium-term inflation expectations have fallen.

Perhaps it as well to remember here that the BNZ has been the most consistently “hawkish” –  pro tightenings, often uneasy about easings –  of any of the local banks for many years.  That has made them more wrong than most.

But that specific extract above simply makes little sense.  Sure, most businesses would probably prefer a quick and full rebound in demand/activity over a fall in their debt interest rate, but it isn’t as if the two concerns are in conflict –  in fact, lower interest rates and lower exchange rate will, in time, do their bit to support a stronger recovery.  And despite the bank economist’s claim that no one much cares about interest rates, the evidence is pretty clearly against that in the very low interest rates being offered on the government’s scheme (and the Opposition’s proposal yesterday).  In fact, the worst credits in the country –  those who can’t raise funds elsewhere –  get the cheapest rates, while deposit rates –  in the middle of a savage slump – remain positive in real terms, barely down this year, sending all the wrong signals.  And then there is the distraction: as BNZ knows only too well, if the OCR were taken to -0.5 per cent –  as Westpac suggests will happen and should happen –  retail rates, deposits and lending rates, would be still positive.  For now, negative retail rates are some way away.

And if, perchance, depositors were reacting negatively to, say, 1 per cent term deposit rates, what are they going to do instead?  Spend the money?  Well, that’s good – that is monetary policy working.  Shift it to another currency? Well, that’s good –  a lower exchange rate would be monetary policy working.  Seek to buy another asset?  Well, that’s pretty good too –  increasing both wealth effects and Tobin’s Q effects encouraging new investment, so that’s monetary policy working.  And, of course, in aggregate it is not as if deposits are going anywhere –  it is a closed system, with a floating exchange rate.  Your purchase is my sale etc etc.   Oh, if it makes people worry a bit about future inflation, that’s good too –  that’s monetary policy working to hold up, or lift, inflation expectations to something like target.

Like Ken Rogoff, I think the case for deeply negative interest rates now is pretty overwhelming.  It would ease the pressure on fiscal policy, it would support the tradables sector (on which our future prosperity rests), it would ease servicing costs on existing borrowers (and bring market rates closer to rates the government itself is happy to lend at).  There is nothing particularly odd about negative rates, at a time when savings preferences are high and investment intentions are very weak –  the interest rate simply serves to reconcile the two, while getting the economy towards full employment –  and in the particular circumstances of New Zealand, a materially negative OCR would be needed to even get retail interest rates close to zero.  As it is, recall that New Zealand now has materially higher retail rates than Australia, despite the deeper economic slump. That is a choice –  an anti-stabilisation choice –  made by the MPC, blessed by the Minister of Finance.



Golden fetters and paper chains

In various posts over the years I’ve mentioned how countries finally got out of the Great Depression.  Generally that involved breaking the link between their respective currencies and gold and then being able to adopt more-expansionary macroeconomic policies.  That was relatively easy to do as a purely technical matter, but it took a long time for countries to get there (a handful of significant countries not until 1936).  I’ve worried aloud that given how low the starting point for nominal interest rates was going to be that in the next serious downturn the refusal of central banks –  and it is simply a refusal –  to take policy rates deeply negative would end up as much the same sort of fetter as gold once was.

The definitive book-length treatment of this angle on the Great Depression is Berkeley professor Barry Eichengreen’s  Golden Fetters.  It was published in 1992 – decades ago now – and going by the marks in the margin of my copy I seem to have read it once a crisis since then.  It is one of those books that repays rereading, partly because the contemporary context against which one reads it is different each time.  I read it again last week.

What follows is informed by Eichengreen, although refracted through my lenses.  There are places where Eichengreen’s argument isn’t fully persuasive (and he has one or two facts wrong about New Zealand).

Much of the book is scene-setting for the experience of the Great Depression.  That includes a perspective on the pre-War Gold Standard, which tied together most of the major (and many of the minor) economies of the time, with a leadership role played in particular by the Bank of England.    In many of the core countries –  UK, France, Germany notably –  central banks played an important role, but in other countries operating on a gold standard there was no central bank at all (most importantly, the United States, but also countries like New Zealand and Canada-  all three of whom were net capital importers).    Price levels didn’t change much over time (the British price level was about the same in 1914 as it had been in 1834), capital flowed freely, trade (and migration) was extensive, and if there were periodic crises or threats to the system, central banks worked together to maintain stability.

World War One greatly disrupted the picture.  Some countries formally went off gold, others didn’t formally but there were enough interventions that the pre-war parities didn’t act as any sort of constraint on price levels.  Huge debts –  internal and external – were run-up in the process, and the US moved from being a net borrower to being a net lender to the rest of the world.  And in the aftermath of the war there were reparations obligations established, huge distributional fights (inside countries) as to who should cover what portion of the accumulated costs, and some countries collapsed into hyperinflation sooner (Austria) or later (Germany).   All manner of other countries had much higher price levels than pre-war, and in some –  notably France –  high inflation remained an issue well into the mid-1920s.

Against that backdrop, in many quarters a return to a money convertible to gold was seen as partly as a key confidence-building commitment, and partly as a return to something like normality.  It took a long time –  in one case, Japan, it din’t actually happen until early 1930 – and for good reason.  There were debates about which rate to restore parity at –  the UK eventually, perhaps unnecessarily, chose to re-peg at the pre-war parity, which implied several more years of moderate deflation.  For France, having had so much inflation, the pre-war peg quickly became unrealistic and they stabilised at a considerably devalued exchange rate to gold.  For Germany, of course, hyperinflation made a nonsense of the pre-war parity.

There hadn’t much gold mined in the previous few years, and yet global price levels were much higher than they had been.  That in itself posed some challenges.  But international cooperation and trust wasn’t what it had been pre-war either.  And particular policy choices made by the US and France meant that those two countries’ central banks accumulated an increasing share of the world’s gold are were unwilling and/or unable to let those inflows flow into much looser domestic monetary conditions (France, for example, having just stabilised was understandably averse to a fresh wave of inflation).  The UK –  still operating as a major global financial centre, significant source of long-term foreign lending –  operated with low gold reserves.  Germany, with a populace only too conscious of hyper-inflation just a few years previously, had high minimum gold cover requirements, but those buffers couldn’t be cut into.  Higher interest rates in the US – as in 1928/29 – forced both the UK and Germany to adopt tighter domestic monetary policy.   And so on.

The Depression itself got underway in a variety of countries influenced by various factors, domestic and international.    The 1929 sharemarket “crash” wasn’t particularly important, except perhaps in shaping the mindset of various US policymakers (including at the Fed) who were uneasy about much looser monetary policy because they reckoned the excesses of speculation needed to be purged.    Some countries were affected worse than others early on –  Australia for example on the worse side, and France on the more positive side.

Generally, however, monetary conditions did ease as the respective economic conditions deteriorated.  But the fixed exchange rate system, underpinned by convertibility to gold, severely limited what could be done with either fiscal or monetary policy –  and that was true even in the countries with large gold holdings, the US and France.

The financial crisis aspects really intensified in mid-1931, in Austria and Germany (where there were significant domestic banking system issues) initially, and then spilling over to the UK, where the economic slump itself had been relatively mild –  relative being the word –  but the pressure eventually told on gold parity.   The re-formed National government –  still led by former Labour Prime Minister Ramsay McDonald –  decided not to impose further pain on the domestic economy (which might have been insufficient anyway) and went off gold.    The break in the parity was initially envisaged as temporary, and it was some months before domestic policy itself became much more expansionary.  But the consequence of the lower exchange rate –  although many smaller countries moved to peg to sterling, giving rise to the “sterling area” which persisteed for several decades) and easier domestic monetary conditions meant that the UK was the first significant economy to recover from the Depression.

The US held on to the old gold parity until April 1933, and while that old parity held it acted as a real and binding constraint on the ability of domestic authorities –  including the Fed – to run much easier policy.   Fear of devaluation sparked capital (and gold) outflows.   But as Eichengreen records, many of the senior Fed officials were not that keen on much easier policy anyway, and some saw the roots of the Depression primarily in past speculative excesses.  Even in the US, concern about possible inflation risks – in the depths of a deflation –  were heard, and were evidently sincere.  The US later returned to a gold parity (while prohibiting for decades citizens from holding gold) but at a much-devalued exchange rate.

Those inflation concerns were all the greater on the Continent.  Germany never abandoned the old gold parity, but just rendered it non-binding with an increasing complex of exchange controls and other payments restrictions.   But for the remaining gold countries –  most notably France, Belgium, Netherlands and Switzerland –  the tensions grew between the desire to maintain the parity –  whether as symbol of normality or (more strongly in the French cases) ran increasingly up against the losses of competitiveness producers in those countries faced as other countries devalued, and the market recogmition of those pressures (thus capital flight).  It wasn’t until 1936 that those parities were finally abandoned.

As Eichengreen notes, at the end of it all, by the late 1930s, real exchange rates among the major economies had not changed that much at all.  Some countries had got the initial advantage of moving earlier (the UK notably) but in the longer-term the beneficial effect was not breaking the gold parity and getting a lower exchange rate, but breaking the constraints (domestic and international) on domestic macro policy (fiscal and monetary).  As he also notes, it wasn’t enough just to break from gold, since countries also had to be willing to break with the Gold Standard ethos, and allow/adopt looser macro policies.  One obstacle to that had been the fear of inflation.  That fear might look unreasonable –  whether from this standpoint, or contemplating a country with a deep deflation in the early 1930s –  but the hyperinflationary and high inflation experiences really weren’t that far in the past, and had been utterly destructive for many.

Eichengreen has a nice table late in the book illustrating how industrial production –  the main macro variable at the time, before quarterly national accounts were a thing –  responded in different groups of countries.

eichengreenLook at the last two columns and you can readily see the difference of experience in the countries that went off gold/devalued (sterling area and the “other depreciated currencies” lines) with the experience in the gold bloc countries, where even by 1935 industrial production was still 20 per cent lower than in 1939.

It need not have been.  It wasn’t as if the 1920s and 1930s were a period of underlying economic stagnation.  The US –  by then the world’s leading edge economy – experienced really strong total factor productivity growth in both the 1920s and the 1930s.  I’m sure some economic ups and downs were inevitable, but nothing on the scale and duration of what actually happened in the 1930s was in any way inevitable –  it was largely the consequence of a succession of choices, of almost entirely well-intentioned people, working against the backdrop of presuppositions, presumptions about normality, and the backdrop of some deeply unsettling experiences, that led to those savage and prolonged losses.   When countries broke the golden fetters –  and for many it was regretted initially or felt to be hugely risky – economies started to recover, and the gains in an increasing number supporetd a sustained global recovery in demand.

(You might be wondering where New Zealand fits in all this.  That is mostly another post.  We had no central bank.  We went off gold in 1914.  That left our banks issuing their own currency, in practice loosely pegged to sterling (but not legally so), with banks managing domestic credit based on their holdings of London funds.  Our exchange rate – managed by the banks – was allowed to depreciate a bit, but the big movements were in September 1931 when the UK went off gold and their exchange rate depreciated against the rest of the world and so, thus, did ours, and –  more importantly –  then in January 1933 when the government initiated a formal devaluation against sterling (still not having a central bank) over the objections – and resignation –  of the Minister of Finance (and with not a little domestic unease and debate).  In 1931 and 1932 even after the UK went off gold our economic policy options were very very few, and our devaluation was much more of a turning point (probably helping that it was followed a couple of months later by the beginnings of the US reflation).  I have an old post on New Zealand and the Great Depression.)

Of course, the point of the post is to draw some loose comparisons between the golden fetters of the early 1930s, which proved so costly in the specific circumstances of the time, and what I’ve taken to calling the paper chains, the refusal of the world’s central banks now to do anything about taking official interest rates deeply negative, even though standard macroeconomic prescriptions –  such as the Taylor rule –  suggest that is exactly what should be done.

I’m not suggesting it is some sort of allegory for our age, in which every detail of the 1930s can be mapped to something now.  It can’t.  It is really just about a single point: that self-imposed constraints, which can seem very very important to preserve at the time, can actually in some circumstances prove incredibly costly, and in those circumstances the sooner they are jettisoned the better.

One area in which the parallels certainly aren’t exact is around fiscal policy.  Most countries in the 1930s had very little freedom of fiscal action initally, precisely because of the monetary/gold parity constraints  –  increase your fiscal deficit and the resulting increase in demand will also result in increased current account outflows (of gold).    In some cases – New Zealand –  there was just no effective borrowing capacity at all –  thus, Keynes’s advice to Downie Stewart that I’ve quoted here previously (“if I were you I’d try to borrow; if I were your bankers I would not lend to you).  We have nothing like those sorts of technical constraints.  But that doesn’t mean there are no limits in practice –  as we saw after 2008/09, public tolerance of continued very large ongoing fiscal stimulus, even in badly affected countries, was really quite limited.  In the real world, fiscal policy isn’t any sort of fully adequate substitute for monetary policymakers choosing to sit on the sidelines –  dealing, perhaps, with market liquidity issues, but not doing much about the overall stance of monetary policy, even as deflationary risks mount (thus, real retail interest rates have not fallen at all in New Zealand and Australia this year, despite the huge economic slump).

There is a, perhaps understandable, sense in some quarters that there wasn’t too much wrong with economies last December.  Perhaps, but things have now changed, and if one strand of macro policy – typically the most important for cyclical purposes, and easiest to adjust –  is allowed to sit on the sidelines doing nothing –  and elected ministers have the power to change thatg –  there is risks that this economic downturn ends up much more severe and protracted than it needs to be.  All because central bankers won’t break free of their paper chains and their old mindsets (aggravated in New Zealand’s case by the stunning negligence of a Reserve Bank that talked modestly negative interest rates for some time but did nothing at all to ensure there were no technical/systems obstacles): we pay the price for both lack of preparation and the reluctance/refusal to break the paper chains and put in place quickly the sorts of rules and practices that could allow official rates to be taken deeply negative for a time, in turn supporting demand (directly and via the exchange rate) and supporting medium-term expectations about the economy and inflation.




Measure what is measurable, and make measurable what is not so

Late last year a (long ago) former Reserve Bank economist closed down his blog just like that. I didn’t have anything quite so dramatic in mind.  But after my elderly mother died last August, I got to thinking about the next stage in my life and how I could best use what skills and talents I have.  And before Christmas I’d decided that today would be my last day of high-frequency blogging.  Why today?  Well, for all practical purposes it is the fifth anniversary of the blog; five years today since I left the Reserve Bank.  It wasn’t that I’d run out of ideas or energy, but there is always the opportunity cost to consider, and I’d begun to map out a series of archival-research-based projects (mostly in New Zealand economic history) I wanted to pursue, as well as making more space for some other interests and priorities.   I’d planned to keep writing here perhaps once a week or so.

That is still what I want to move towards at some stage.  But in the middle of the most dramatic economic developments, and wrenching dislocations of economic policy, of our lifetimes it doesn’t quite seem the time to change course just yet.  We’ll see how things go, but for now, quite probably for at least the rest of this year, normal service continues (and in the meantime thanks to all of you who’ve become readers –  numbers that, for a fairly geeky New Zealand focused blog, I never imagined – and to (almost) all who’ve commented, either on the blog itself or directly to me).

And today I’m indulging the inner geek.

One of the most frustrating (to me) aspects of the response to the massive economic dislocation by the government and the Reserve Bank is their utter complacency, bounded by some deep-seated conventional wisdom, that interest rates can’t, shouldn’t, and won’t move down from here –  the OCR having been cut, in the biggest slump in modern history, by a mere 75 basis points.    The Minister of Finance was at it again in his testimony to the epidemic select committee yesterday highlighting the “certainty provided” by the MPC’s commitment not to change the OCR for some considerable time.  I presume he had in mind the idea that the MPC wouldn’t raise the OCR – as if anyone has supposed such increases were at all likely in the foreseeable future –  but he seems totally uninterested in the idea that considerable relief could be provided, and desirable income rebalancings achieved, with much lower interest rates.

Sadly most of our media also seems more interested in channelling conventional wisdoms rather than challenging them.  So I’ve heard MPs and journalists ask the Minister of Finance about commercial rents, but never once about interest rates, even though commercial rents are based on private contracts, whereas the OCR –  which influences a wide range of variable private interest rates – is directly under official control.   If the Reserve Bank refuses to act –  as it appears they do –  the Minister has existing statutory powers to simply override them.  They aren’t powers that should be used lightly, but they were put in the Act for a purpose, and these are pretty extreme times.  If the Minister refuses to use his powers, he makes himself directly party to the choice to hold New Zealand retail interest rates well above where they should be at present.   All while facilitating/encouraging firms and households to take on more debt at these interest rates.

Still, for the time being at least, the MPC’s floor is the floor, and markets have to take that into account in pricing other securities.  This has been an issue in a variety of other markets for some considerable time, particularly since the last recession when various central banks got a point where they were simply not willing to cut further, no matter the economic conditions, or to make the changes (around physical currency) that would have made further deep cuts –  of the sort Taylor rule estimates in the US, for example, suggested economic conditions warranted –  effective.   Central banks fell back on trying to do what they could –  often not much –  with other “unconventional” instruments.

And years ago, a Reserve Bank of New Zealand researcher Leo Krippner, got interested in the question of how one might represent the effectiveness of such policies in a single number.  Whereas in normal times, the OCR itself readily expresses the stance of policy, if there is a self-imposed floor on the OCR but other things are being tried, how best to express the overall stance of policy.

Leo is an expert in yield curve modelling, and got to try to estimate how different the interest rate yield curve was –  especially in the US –  in the presence of the floor on the Fed funds rate, as a result of unconventional policies (“QE”, loosely).     He has published various technical papers in journals, but I think his first paper in the area was published in 2012 in the Reserve Bank’s Analytical Notes series.  I was the editor of that series, and one of my priorities was to ensure that as much as possible was accessible to intelligent lay readers, and my impression is it still remains a good introduction to the work Leo is continuing to do and to update.

One can think of a yield curve of government bond interest rates (from overnight out to, say thirty years) as, broadly speaking,  a series of market implied expectations about the future setting of the official overnight interest rate (the OCR in New Zealand).  All else equal, if the central bank sets a floor on the OCR –  which is regarded as binding and credible – markets pricing say a 10 year bond will rule out any chance of an OCR below that floor, and the 10 year bond rate will be higher (all else equal) than it would be in the absence of such a floor.  On the other hand, if large scale bond purchases by the central bank –  even actively targeting a bond rate (as Japan and now Australia are doing) –  may succeed in lowering to some extent where the bond yields settle, relative to the floor-constrained normal market price.    Leo’s work, calculating what he calls a Shadow Short Rate, attempts to combine the OCR and this effect into a single number.

This work wasn’t very relevant to New Zealand itself for a long time (there were internal sceptics as to whether it should even be done)….and yet now it is. (In his speech a couple of weeks ago the Governor even suggested the Bank might publish a semi-official series of such a measure.)   Leo’s work has been recognised in various places abroad –  cited in public by at least one Fed Reserve president, and honoured by the house journal of the central banking community, Central Banking magazine (for whom I do some reviewing: my light lockdown reading is here).  Leo left the Reserve Bank last year, but is continuing to update his work and earlier this week circulated a note with a Shadow Short Rate series for New Zealand, now that we operate with a formal OCR floor and in the presence of the MPC’s commitment to buy $30 billion of government bonds over the coming year. (The quote that heads this post, from Galileo, appears upfront in Leo’s note.)

Leo’s modelling estimates that the overall stance of monetary policy is “approximately equal to an OCR of -0.48 per cent”, compared to an OCR itself of 0.25 per cent.    If so, that suggests a small but somewhat useful contribution from the “unconventional monetary policy” or UMP.  Small because even a total of 150 basis points of effective easing is tiny by comparison to the scale of the economic shock.

There are a number of caveats to this modelling.  Leo articulates some of them himself

  1. The SSR is an estimated value rather than a setting like the OCR or an observed market short rate. Hence, any SSR series will (unavoidably) vary with the model specication and data used for its estimation. The choices I have made for the SSR series in this note have produced more favorable properties than alternatives for the United States,4 but the magnitudes of negative SSR estimations can easily vary by fractions of a percentage point on re-estimations, and sometimes more for UMP periods if the lower-bound setting in the model needs revisiting in light of central bank communications and/or actions. My model for New Zealand currently uses a lower-bound setting of 0.25%, consistent with the RBNZs 16 March 2020 forward guidance.
  2. Related to estimation, in the present global UMP environment compared to previous years (e.g. for the United States easing/tightening cycle) yield curves may no longer capture sufficient information to quantify the stance of monetary policy. The reason is that yield curves in New Zealand and around the world are now very at(i.e. longermaturity rates are close to shorter-maturity rates). Only time (and updated analysis) will tell on this aspect, and model refinements may be needed.
  3. The SSR is not a market rate at which borrowers and lenders can transact, particularly in UMP times when the OCR and short rates will remain close to zero while the SSR may become increasingly negative. Hence, SSR declines in UMP times will not result in the same cash flow effects from interest payments and receipts as OCR cuts in CMP times, so the SSR transmission to the economy may differ from at least that perspective.

I went back to Leo and asked about how safe it was to use a floor of 0.25 per cent for New Zealand (after all, we’ve seen more than a few policy lurches from the Reserve Bank over the last year, in fact over the last few weeks, and some other central banks have – eventually –  shown a willingness to take their policy rates lower, in the Swiss National Bank’s case as low as -0.75 per cent.  Leo noted that if one were to assume the New Zealand floor was anything like that low, the SSR for New Zealand would still be much the same as the OCR itself.

He went to say (with his permission to quote)

The longer answer is: should one use an assumption of the effective  lower bound in the model (perhaps something like your -0.7, but also  see further below), or should one use a value that central banks have  indicated they would go to? Across the different economies I’ve  modeled, I’ve noticed that the different yield curves seem to use the latter. For example, the US yield curve data has pretty much respected  the lower point of the 0-25 bp range, and the euro area data (OIS  rates) has pretty much respected the incremental settings of the ECB  policy rate. In particular, neither have had longer-maturity yields  rush to, say, the -75 bps of Switzerland.

So, based on what I’ve seen with the data, I set the lower-bound for  each economy according to the central bank’s indications. And then I  lower that if/when the policy rate gets set lower (which, again, seems  to be how the yield curves behave – perhaps not rational though, I agree).

To which my response in turn was to note that in at least some of those overseas central banks –  the Fed in particular –  the stated floor has been consistently applied for a decade, while the Reserve Bank of New Zealand has no track record in this area at all –  indeed in that same speech a few weeks ago the Governor was openly talking of negative rates as a possibility.  A rational investor in the current climate, with a Governor prone to lurches (and, actually, in the presence of override powers), might not price in a 100 per cent chance of the MPC sticking to its word.  Time will tell.

My bigger unease about this work, stretching all the way back to that 2012 paper (where I recognise a couple of sentences I insisted on being added) is the third in Leo’s own list of caveats above: the SSR is not a rate that can be transacted, and if much of borrowing and lending in an economy is either at (or swapped back to) or very close to a floating rate, the actual OCR (self-imposed constraint and all) will be a lot more important than the SSR estimate might suggest.  In the US, for example, a lot of mortgage lending takes places at very long-term fixed rates (and so what happens to very long-term bond and swap rates has a direct transmission mechanism).  That is much less so in New Zealand (or Australia or the UK).  That is consistent with some of the doubts I’ve expressed in earlier posts around quite what difference the Bank’s large scale asset purchase programme really makes where it matters (thus, on my telling, the main advantange of that programme is that it should reveal quite quickly how severe those limitations are and turn the focus back on the OCR and that self-imposed floor).

This stuff won’t be everyone’s cup of tea, but I’m really glad to see that Leo is continuing with this work –  he says he will provide updated estimates on his website http://www.ljkmfa.com each month for the time being –  and will be interested to see whether the Reserve Bank follows through on the suggestion of a quasi-official series (for what its worth, I would suggest they not do so, and use work such as Leo’s as a reference point for commentary/research when it is relevant).

The government should insist the OCR be deeply negative for now

It really is quite remarkable that the government is willing to shred our civil liberties, abandon Parliament, ban funerals –  to my mind, the most egregiously inhumane, almost evil, specific of the entire Ardern partial lockdown –  and accentuate, for now, the temporary implosion of the economy, and yet the same government is unwilling to act to bring about lower interest rates.

They have a recalcitrant public agency that simply refuses to (has formally promised not to) act, in face of a huge slump in activity and employment, a period when time has no economic value.  And yet they just sit politely by, as if this was some minor difference of emphasis over 25 basis points or so.  They have all the powers they need to act, but simply refuse to do so.  Having chosen not to act, interest rates are current levels are now the direct responsibility of the Prime Minister, the Minister of Finance, and the rest of the Cabinet collectively.

Consider a thought experiment.  Suppose that for the last 18 years instead of an inflation target of 1-3 per cent, centred on 2 per cent, we’d actually had a target of 9-11 per cent, centred on 10 per cent. (Note, I do not think this would have been an appropriate or necessary policy, but just humour me for a moment).  And pretty much everything else –  good and bad – about the economy to the end of 2019 unfolded as it did.  Assume that coming out of the Great Recession a decade ago, central banks would still have struggled to (or been as reluctant to) do what it takes to keep inflation at target, but they had more or less got there by 2019.  Perhaps core inflation was about 9.7 per cent, perhaps inflation expectations (a mix of survey and market measures) were somewhere between 9 and 10 per cent.    And, consistent with that, assume the OCR had been 9 per cent at the end of last year (a full percentage point below the target midpoint just as it was in real life.)

(And, yes, I know all about the interaction between the tax system and inflation which mean these things aren’t exact by any means, but for now this is just a very simple story.)

And then the coronavirus hits, and all that followed around fighting the virus  – policy measures here and abroad, personal choices to distance etc here and abroad – happened just as in real life.

Oh, and the economy?  Well, serious people would still be talking about the unemployment rate going to perhaps 25 per cent, a really major export industry had simply closed down, investment demand (national accounts sense) was heading for zero, and so on.

Does anyone imagine, for the slightest moment, that in such an alternative world –  but a path we and other countries’ could have chosen –  that the OCR would have been cut by only 75 basis points?

Of course not.    Not only do typical New Zealand (or US) recession see around 500 basis points of cuts, but even in crisis-type events in the past (precautionary responses to 9/11 and the 2011 earthquake) the Reserve Bank has cut by a bit more than that  –  and the Christchurch earthquakes, after the very brief initial hiatus, represented one of the largest positive, unforecast, demand shocks to the New Zealand economy ever experienced.

Who knows how low the OCR would have been cut in that alternative world where the OCR had started at 9 per cent.  But we know that in the 2009/09 recession – when GDP fell by about 3 per cent –  the Bank cut by 575 basis points. In the US, where the Fed cut by about 500 points in 2008/09, versions of the Taylor rule later suggested that the Fed funds rate could more appropriately have been cut by another 500 basis points on top of that.

So why (didn’t and) don’t adjustment of this magnitude happen?    Because central bankers abroad –  but specifically here, where the MPC has set an explicit floor at 0.25 per cent –  have becom almost terrified of the possibility of seriously negative nominal interest rates, and have spent a decade doing nothing much about making such outcomes work effectively.  Far too much of the focus of central bankers this last decade was on looking to the next tightening, and the idea of “normalisation”, not preparing for the next serious downturn –  now upon us in unusual and particularly savage form.

But they would have had few qualms in lowering a nominal OCR of 9 per cent –  in the presence of a 10 per cent inflation target –  to, say, 1 per cent.    It makes no sense.  It is bad money illusion in reverse, without any good justification.

Now, of course, everyone knows and accepts that monetary policy isn’t going to stop GDP collapsing over the next month (at least) –  perhaps on a scale just without precedent ever (if we ever had the data).  But it wasn’t really that much different in the fourth quarter of 2008.  Really substantial cuts in official interest rates happened, and rightly so, but in a climate an extreme loss of confidence, fear etc, that wasn’t going to stop GDP falling right then.  At the best of times, the lags are longer than that.

But markedly lower interest rates, when massive excess capacity is opening up and the neutral interest rate is falling, still do a number of useful things:

  •  they signal to markets (and the wider public) that the central bank is thoroughly serious about doing its job, and keeping inflation expectations up very close to target  (the risks around this not happening are much greater in our real world than in the alternative, higher inflation target, world I mentioned above),
  • they get relative prices positioned as soon as possible in way that puts the economy in as less-bad position as possible for the eventual recovery (not just the bounce back to a, say, 15 per cent loss of GDP if the lockdown itself is eased/lifted),
  • and the greatly ease debt servicing burdens, reallocating income from (close to) variable rate depositors to (close to) variable rate borrowers, consistent with the new stylised facts in which time for now has no economic value.   As it is, short-term term depositors are still being taken at positive real interest rates – even as the economy is shutdown –  while variable rate borrowers, even with rock-solid collateral, are still paying substantially positive real interest rates.  All this at a time when the government appears keen to encourage firms to borrow more….

Given the significant margins between the OCR and retail interest rates (lending and borrowing) we really need, and should have, a substantially negative OCR –  deeply negative in real terms, and not that inflation expectations have been falling.

You might be wondering if (materially) negative official interest rates is just some hobbyhorse of mine.  Even if that we the case, it is still the arguments that should be examined, not the advocates.  But it isn’t the case.  Over the last decade or more, people like former Bank of England Monetary Policy Committee member Willem Buiter, or US academic Miles Kimball (who was the guest of the RB or Treasury just a few years ago) have been among those pushing the case for ensuring that official interest rates could be taken a lot lower in the next crisis.

As a refresher, the twin obstacles are that (a) central banks now have a monopoly on the issuance of physical currency, and (b) as monopolies do, did not innovate over time so still operate with much the same rules and technology as 100 years ago.  If the OCR were to be taken deeply negative, on those rules, it would at some point become attractive for wholesale investors, in particular, to switch from holding securities and bank deposits, to holding physical cash.   If so, you can cut the OCR all you like and it won’t make much useful difference to anything, except stocks of zero-interest cash.  It doesn’t happen easily: storage and insurance costs are real, AML restrictions are annoying, and it isn’t worth doing if you think the OCR will only be very low for a month or two  We don’t know quite where the limits are, but the current consensus has been that no one is really willing to try  –  on current rules – below about -0.7 per cent.

But those rules and practices can be changed.  Ideally, doing so would have been properly consulted on and socialised over a long period by governments and central banks. But in a crisis –  perhaps especially a crisis where surfaces, including bank notes, can carry the virus –  things can be done very quickly.  They should be in this case.    Suspend the issuance of net new bills in excess of $50, cap the total currency issuance (for now) at, say, 20 per cent above the current level, and if revealed demand for currency is higher than that, ration by price (run a weekly auction at which banks offer a premium over face value to buy physical currency, which they can pass through to all customers or just those taking a large amount of cash, at their discretion).

Of course, having led to believe for the last couple of years that a modestly negative OCR was an option they were open too, the Governor now tells us that the Reserve Bank simply never got round to ensuring that all banks’ systems would be able to cope with negative interest rates.  That’s a pretty stunning indictment, that he/they should be held to account for one day (perhaps the Simon Bridges-chaired select committee could summon him?)

As I’ve noted before, mostly even if what the Governor says is true, it is more likely an excuse for inaction (action they don’t want to take) rather than a real and valid justification.  As I’ve noted previously, many wholesale interest rates abroad have been modestly negative for years now.  An bank operating internationally has to have been able to cope (even in New Zealand some of our inflation indexed bond yields had gone negative).   And even setting all that aside, if the OCR were set to say -2 per cent, that would still only be consistent with term deposit rates near zero and lending rates still positive (business one quite a lot positive).    There is material relief that can be given, that really should be given urgently, without the main retail rates even getting to the point of going negative.   And, frankly, it is surely time for some naming and shaming.  If better banks have systems that can operate negative rates, it will provide a competitive advantage and put pressure on those who just didn’t get ready to fix things quickly (even if initially in an improvised way).  In the current climate, an OCR of -5 per cent might be something good to aim for.

A couple of my old colleagues have offered brief dissenting views in comments on earlier posts. I appreciate them taking the time to do so.    I dealt with the first comments, from Geof Mortlock, in a post late last week

A former colleague, from mostly a banking supervision background, left a comment yesterday disagreeing with my call for negative rates.



What to make of Geof’s specific arguments?

First, I don’t accept that it would be destabilising to the financial system at all –  if anything, at the margin it would assist financial stability by shifting the burden from borowers (increasingly indebted in most cases) to depositors (time is offering no real return right now).

I also don’t belief that there would be anything like the sort of flight to Australia Geof suggests.  After all, exchange rates –  even NZD/AUD are volatile enough and transactions costs high enough – to swamp any possible small interest gains.   Perhaps more to the point, in a floating exchange rate system, unless there is a run to physical cash – and recall that under my model cash would be more expensive to purchase/withdraw –  the total deposits in the banking system do not shrink because someone seeks to withdraw money.    For every seller of NZD there has to be a buyer.  And, frankly, the more people wanted to sell NZD at present, the better –  a materially lower exchange rate is one more helpful part of the stabilisation package.

Finally, Geof also notes that lower interest rates won’t do much to boost spending right now.  That is, of course, true and a point I’ve been making throughout.   The point of policy right now is not to boost spending (the time for “stimulus” will be later) but, in this case, to ease servicing burdens materially, and to help stabilise and reverse the falls in medium-term inflation expectations that risk materially complicating the recovery phase, by starting us off with higher real interest rates than those we went into the crisis with.

Ian Harrison, now of Tailrisk Economics, also weighed in

I think the negative interest rate is a diversion, with several problems and does nothing that can not be done more effectively in most cases by direct interventions in our wartime economy.

Thinking about the flow through to interest rates people are paying – banks have reduced the floating rate to 4.5 percent – a huge margin still. It appears that the fixed rates where the business gets done haven’t moved much at all.

My off the top of the head suggestion is to pretend that time doesn’t exist for one two or three months. Time bound contractual -rents interest wouldnt exist for that period. lots of fishhooks and inequities of course. and it would put the banks under pressure. If that got too much then the OBR could be activated for the entire banking system and owners’ interest effectively confiscated.

But I think this is itself something of a distraction, and (after all) my scheme actually involves some quite direct interventions.  I quite like, at a conceptual level,  the idea of pretending that time doesn’t exist for contractural purposes in the midst of the crisis, but no one believes that problems are going away in two or three months.  When, for example, do we suppose the tourism sector might be back to “normal”.  Not next year would be my guess: we need relative prices to signal resource-switching and draw forward demand as recovery begins to beome possible.

As for OBR, it is of course a bank failure/resolution tool, but for now at least the presenting problem is not potential bank failure  (that could become a risk in time, as the toxic brew of falling asset prices and collapsing incomes lasts long enough) but the sustainability of borrowers themselves.  And using OBR in a bank failure –  unlikely to ever happen –  does nothing to relieve borrowers or support existing companies holding together.

Ian followed up on Friday with another comment

The problem with relying on a reduction in the OCR is that the transmission to borrowers who actually need the relief is highly uncertain. Some thing as direct as a maximum interest on bank lending would have some of the desired effect. – say 6percent, accompanied by no reduction in lending limits.

To which my response is that yes the transmission is a bit uncertain in the abstract.   In concrete terms though, what Ian suggests could be achieved by making it a condition of participation in the governments’s business loan guarantee scheme that any OCR cuts are fully, or almost fully passed through.  If necessary –  it is an emergency – legislation could be used directly.   And we don’t need 6 per cent interest rates for reasonable credit business borrowers at present, but something more like zero or negative (still a significant risk margin over, say, an OCR of – 5 per cent),

And finally, Geof put in another comment

Your continued advocacy for zero or negative interest rates ignores the commercial reality that, in periods of stress, such as this, the risk premium in interest rates will rise. This as true (maybe even more so) in a period of prospective deflation. Lenders will price in the risk of lending such that, even in periods where the zero default rate might be zero or negative, bank lending rates will be positive. Equally, bank funding rates are unlikely to go to zero or negative given that depositors, especially at the wholesale level, are factoring in the increased (but still low) risk of bank default. As credit markets globally tighten further, that risk premium is likely to rise. I therefore view your stance on negative interest rates as commercially unrealistic and inconsistent with how a well functioning market could be expected to operate.

As for Ian’s suggestion of regulatory caps on interest rates, I think that would be daft. Such regulatory responses rarely produce desired outcomes. They distort risk pricing in both funding and lending rates and impede efficient credit allocation.

The smartest way to address borrower stress is to provide targeted income support for a defined period, together with debt servicing holidays. If the lockdown is effective in markedly lowering infection rates to a low level, then we should be able to progressively normalise things after 4 to 8 weeks. Border controls will need to continue for months to come, but if the quick result (15 minute) tests, which are apparently under development, can be deployed as a prerequisite for boarding a plane or ship bound for NZ, or at leadt on arrival here, then maybe the economic damage can be reduced to a significant degree.

What is needed now are the indicators (eg infection rates etc) that will be applied for a progressive easing of restrictions after this 4 week period.

On his first point, as I’ve noted since the OCR in this climate should be deeply negative, retail interest rates that would be zero or slightly negative –  not that 6 per cent advertised rates ordinary SMEs face at present –  leaves plenty of margin for risk premia.

On his second point, if depositors are so confident about alternative investment options –  whether other countries or other assets – as to reluctant to accept negative deposit rates, that is (all else equal) a good thing, monetary policy at work.  Either they are spending (ie demand rising), trying to shift abroad (lowering the exchange rate, welcome), or supporting otherwise cheap asset prices (again one way monetary policy works.

On regulatory caps, of course in general they aren’t a good thing. They might not even be needed with a deeply negative OCR, but even if they are sometimes exceptional times call for exceptional measures.  We’ve seen a few in the last few weeks….

For the rest, I’m not debating what might or might not be possible on testing etc, but no one supposes that even if the current lockdown is lifted in a month or two, that we will quickly snap back to even a recession of the relative shallowness (by these standards) of 2008/09.  We still need, and should want, deeply supportive monetary policy, including because whatever fiscal policy might be able to do as time goes on, it is almost inevitable that there will be pushback before that long about the bills being run up for the future.  Monetary policy is designed to be the principal stabilisation and countercyclical tool.      If it is allowed to work and used decisively again, it can play that role again once the worst of the virus is behind us.

I’m happy to engage with, or respond to, any other sceptics with specific points.  But on the face of it –  and thinking much more deeply and practically – we are overdue some vigorous easing in monetary conditions.  The MPC could and should do it.  But if they refuse, the government should –  in these extreme circumstances –  simply override them and compel them to act.

(In the meantime, of course, the bigger issue is that of extreme uncertainty and downside risk around business and household incomes.  The government has done quite a bit to support households, although quite time limited.  On the business side, there isn’t much other than encouraging firms to take more debt, when for most it simply won’t be worth doing so.  And there are disconcerting hints of the government helping big firms, but not the vast mass of companies that make up most of the economy. My “ACC for the whole economy”,firms and households, remains the best option to provide some insurance, some certainty, to buy time, all without attempting to lock in firms that really may now have no readily conceivable future.)




In those distant days when world sharemarkets were still at or very near record highs –  actually, on Monday –  the Federal Reserve Bank of San Francisco released one of their short accessible Economic Letters summarising some research work done last year on the question “Is the Risk of the Lower Bound Reducing Inflation?“.   The views expressed are those of the authors, not the FRBSF let alone the wider Federal Reserve system, but the authors aren’t just fresh out of college either: one is the executive vice-president and head of research (one of the most senior policy positions) at the FRBSF, and the two authors are senior managers on the research side of the Bank of Canada.

Here is their summary

U.S. inflation has remained below the Fed’s 2% goal for over 10 years, averaging about 1.5%. One contributing factor may be the impact from a higher probability of future monetary policy being constrained by the effective lower bound [ELB] on interest rates. Model simulations suggest that this higher risk of hitting the lower bound may lead to lower expectations for future inflation, which in turn reduces inflation compensation for investors. The higher risk may also change household and business spending and pricing behavior. Taken together, these effects contribute to weaker inflation.

How does this work? Here is their description

If monetary policymakers are constrained by the ELB in the future, recessions could be deeper and last longer because central banks may be unable to provide sufficient stimulus. The greater decline in economic activity in this case would translate into lower inflation during such downturns relative to recessions when the policy rate is not close to the lower bound.

In addition, greater risk of returning to the ELB could also affect inflation during good times, when the economy is performing well and interest rates are above the lower bound. Investors and households often care about the future when making long-term investment decisions that are difficult to reverse, such as setting up a new production plant or buying a house. The possibility that recessions might be more severe in the future because of the ELB can affect their economic decisions today, prompting them to be more cautious to guard against this risk. For instance, households could start saving more in anticipation of possible harder times ahead. Similarly, businesses could engage in precautionary pricing by setting lower prices today if they anticipate a greater likelihood of deeper recessions in the future and do not review their pricing strategy frequently.

As something for the future –  perhaps the very near future –  it all seems a plausible tale, and is consistent with a line I’ve been running here for years, that when the next severe downturn comes markets (and other economic agents) will quickly focus on the limitations of conventional monetary policy and adjust their behaviour (for the worse, in cyclical terms) accordingly, deepening and lengthening the downturn.  But these authors go further and posit that people (real economy and financial markets) have already been factoring the ELB risks into their planning and decisionmaking, in turn directly contributing already to lower inflation and lower inflation expectations (than perhaps the current cyclical state of the economy might otherwise deliver).

I haven’t yet read their full working paper so can’t really evaluate the strength of their evidence on this point.  But if they are capturing something important about actual behaviour in the last decade or so, presumably those effects would be expected to have become larger the closer to the present we come.   Prior to 2007 the Fed (and other central banks other than Japan) had not reached the ELB at all. Immediately after the recession there was a pretty strong expectation that things would return to normal (including normal policy interest rates) before too long –  a view typically shared by markets and by central banks.    Only with the passage of time did those expectations gradually fade –  and perhaps more completely in Europe (where policy rates are still often negative, and pretty consistently lower than those in the US).

For New Zealand, of course, if there is anything to this story, it must be even more recent, having started with higher policy rates, and with markets and the Reserve Bank mostly looking towards higher policy rates until just the last couple of years.   The possibility of reaching the ELB in New Zealand has been a distinctly minority point (yours truly and perhaps a few others) for most of the last decade, in ways that leave me a little sceptical that the story will explain anything much of the inflation experience in New Zealand (or Australia) for the decade as a whole. In both countries, inflation has averaged materially below the respective target midpoints.

Whatever the case for the past, the FRBSF note ends with this point

These findings suggest that the puzzle of how to raise inflation to meet central bank goals may require new ways of addressing the risk of returning to the ELB and new ways of understanding how to set and meet inflation goals.

The problem is that there is a growing risk that it is now too late, and that central banks (and Ministries of Finance) have spent the last ten years not getting to grips with ensuring effective capacity for the next severe downturn, leaving things potentially almost paralysed when that severe downturn breaks upon us.  Which it could be doing right now.

Many advanced country central banks can now barely reduce the policy interest rate much at all –  the biggest problem with former Fed governor Kevin Warsh’s call yesterday for a coordinated international rate cut is that it would immediately highlight the limits, especially in Europe.  Even in a traditionally high interest rate country like New Zealand, there is perhaps 150 basis points of capacity, when the average recession in recent decades has involved 500+ basis points of cuts –  a point our Minister of Finance rather glossed over yesterday in his talk of the advantage of starting with relatively high interest rates.

As the FRBSF authors note

To compensate for this lack of conventional firepower, central banks can rely on unconventional policy tools, such as forward guidance or quantitative easing. While these tools proved effective during and following the crisis, it remains unclear whether they can fully compensate for the diminished conventional policy space and the more frequent encounters with the ELB

That is fairly diplomatic speak, as befits senior officials.  In reality, few really believe that unconventional tools under the control of central banks can adequately compensate for lack of conventional policy space.

In my view, those limits have not really been sufficiently focused on by markets, firms and households, or governments.  There has been quite a lot of wishful thinking around –  hankering for higher neutral rates, inability to spot an near-at-hand risk that might trigger an early severe downturn, or whatever.   But when people look at the looming coronavirus risks –  and markets will no doubt ebb and flow still, just as happened as the financial crisis unfolded a decade ago – and really begin to focus on what can, and will, be done, we are likely to see inflation expectations falling away much faster than in a normal downturn, in turn raising real interest rates and accentuating the problems, at a time when neutral interest rates are likely to be falling further (perhaps temporarily, but real enough for the time being).

To bring that back to the New Zealand situation, after ignoring the issue for a long time the Reserve Bank appears to have begun to take it more seriously in the last 18 months or so. But with little or no transparency and no apparent urgency.  We keep being told they are about to reveal their thinking –  I hope with a view to getting serious feedback etc –  but they’ve already mentioned enough that we can be sure that what they’ve had in mind simply will not make up for the limits of conventional interest rate capacity, even allowing for the likelihood that in such a severe downturn our exchange rate will fall a long way (as it did in most of those previous 500 basis point rate cut episodes).   There is also sadly little sign that the Minister of Finance has shown much leadership or urgency about seriously addressing this problem (again, nothing along those lines in yesterday’s speech –  good enough as far as it went, but it stopped short of the really serious issues/risks).

It would be easy for me to suggest that the Governor has been too much occupied with his tree gods, his climate change interests, his views on infrastructure or the distribution of income, rather than driving action urgently in this area of monetary policy capacity (core day job).  And that is no doubt true, but as a specific criticism it needs to be kept in perspective –  his predecessors had let the issue drift, and his peers at the top of many other central banks have also seemed to prefer to believe things would come right than to seriously prepare for the constrained alternative.  We risk paying the price now –  including with central banks paralysed by their own limitations and reluctant to act early and decisively to lean against (do what they can to buffer) the economic downturn (and downside risks to inflation and inflation expectations).

Quite possibly there is a place for fiscal policy in responding to a serious downturn, even one amid the chaos of a potential pandemic, but there needs to be a lot more realism about the likely constraints on how much, and how longlasting, any discretionary stimulus is likely to last.   There is no real excuse – even in a less fiscally constrained country like New Zealand –  for authorities not to have moved to greatly alleviate or remove the effective lower bound before now, and to have used relatively settled times to have socialised the case for doing so.

And even if the FRBSF authors are wrong about the influence of the ELB on inflation over the last decade, if it very quickly now becomes even more binding – starting from a lower initial level –  it will be front of brain for everyone through the next cycle.    It really needs to be dealt with now.  It isn’t technically hard –  there are various workable options –  but it needs leadership, will, and vision for something to happen, something which has the potential to limit the extremes (depth, duration) of that severe downturn whenever it finally strikes us.


Officials in pursuit of more powers

It is a big few weeks for the Reserve Bank and, in particular, the Governor.   This week the Monetary Policy Committee is gathering for its deliberations leading to next week’s  Monetary Policy Statement.  A couple of weeks later there is the Governor’s six-monthly Financial Stability Report,  and the week after that we are told that the Governor will descend from the mountain-top and reveal his decision on bank capital.   There are at least two press conferences scheduled (MPS and FSR) and given that he has deliberately chosen to release the momentous capital decision only after the FSR press conference one has to hope that he will make himself available to explain and defend his choices (and, although he has staff, all the decisions –  and responsibility for them –  are his alone).

Meanwhile stories rumble around about the possibility that the Bank’s Board has,for once, found its voice and suggested to the Governor that he needed to change his style.  I heard yesterday another version of a story that culminated in the Governor yelling at the chair of the Board after the latter (so it was reported) suggested that aspects of the Governor’s conduct were unacceptable.   I have no way of knowing whether these stories are true, or are just wishful thinking, but given the quiescent and deferential track record of the Board over many years, it would be perhaps a little surprising if there was nothing to the stories now.

One of the other projects the Reserve Bank has underway, which attracts less attention and controversy, is that around the future of cash.  It is both an apt issue to be focusing on and, at the same time, something of an odd one.  And, remarkably, in the discussion document the Bank put out a few months ago there was no mention –  at all, as far as I can see – of the most immediately pressing issue: the limits on the ability to cut the OCR that arise because of the (near) free option people have to shift from bank deposits etc to physical cash.

The future of (physical) cash is somewhat of an odd issue to be focusing on because cash outstanding has been rising relative to GDP.    This chart is from the Bank’s discussion document

cash 1.png

It tends to exaggerate the point, by starting from the trough.  Here is a longer-term chart from a post I wrote on these issues a while ago

notes and coin

All else equal, when interest rates are very low (and inflation is low too) people are more ready than otherwise to hold on to physical cash.  Of course, quite who is actually holding the cash, and for what purpose, is a bit of a mystery, one not really addressed in either the Bank discussion document or in the poll results they published last week, framed in terms of a high preference for using electronic payments media whenever possible.

The Bank included an interesting chart in its document illustrating that although the ratio of cash to GDP is quite low in New Zealand, the rise in that ratio wasn’t out of line with what has been seen in quite a few other advanced countries.  Sweden and Norway –  where the ratios have fallen –  are outliers.

cash 3.png

There is quite a strong suggestion that in the most recent period a big part of what is holding up currency in circulation was the surge in overseas tourism, especially from China.

cash 4

Overseas tourism remains one of the areas where physical cash is much more likely to be used than in normal domestic spending.

Notwithstanding these routine and entirely legitimate uses of physical cash, it is still hard not to conclude that a large chunk of the physical cash on issue –  in excess of $1000 per man, woman, and child –  is held to facilitate illegal transactions, including tax evasion.   That was Rogoff’s view, and as I wrote about here he –  against my priors – converted me to that way of thinking.

So there would seem to be no risk of cash disappearing from the New Zealand scene any time soon.   And yet the monetary policy constraint arguments, that the Bank simply doesn’t address in its discussion document, suggest that if anything the use of Reserve Bank cash (and especially the potential use of cash) should be constrained more tightly than at present.  The Governor may repeatedly assert that unconventional monetary policy options will do just fine, but few other people would look at the international experience of the last decade without thinking that monetary policy ran into limits.  Those limits arise mostly because of the non-interest bearing nature of the cash and the near-free option of converting into physical cash if returns on other short-term securities go, and are expected to stay, materially negative.

This limit need not exist, or at very least could be greatly eased.  Abolish the $100 note, for example, and at very least you double physical storage costs of secure large cash holdings.  Abolish the $50 note and you more than double the costs again (while the ability to give your kids pocket money in cash, or to use cash at the school fair isn’t materially affected).  That was, basically, Ken Rogoff’s argument in the US (restrict central bank notes to no more than $20 bills).  I’ve argued for one of a range of more-wholesale solutions that have been proposed: put a physical limit (perhaps indexed to nominal GDP) on the volume of currency in circulation (perhaps with overrides for bank runs), and auction the right to purchase new issuance (there is no reason why newly-issued cash has to trade at par).  Do that –  perhaps even set the limit fairly generously –  and the effective lower bound, as a convertibility risk issue, is abolished at a stroke.

This is coming close to being a fairly immediate issue.  No one supposes the Reserve Bank could, on current technologies, usefully cut the OCR by 200 basis points or more in a new recession, and yet in typical New Zealand recession something more like 500 basis points has been required.

It is pretty staggering that they haven’t addressed these considerations at all in their document.  Instead, having had submissions (lots of them) on the first consultation document, they issues another consultation document (deadline for submissions tomorrow) bidding for more Reserve Bank powers over the currency system.

The currency system seems to have rubbed along tolerably well for the 85 years since Parliament gave the Reserve Bank a statutory monopoly on the issuance of bank notes  (it seemed to function just fine in the earlier decades as well: whatever the case for setting up a Reserve Bank there was never a robust case for the statutory monopoly on bank notes).

But none of that deters the Reserve Bank.  It is a rare bureaucracy that looks to shrink itself, or is averse to an expansion of its powers, and the modern Reserve Bank seems to be no exception.  This is their bid

cash 5.png

As they note, there is no need for any such powers at present.  Which really should be determinative.  It isn’t like preparing for an extreme national disaster, where it makies sense to have some precautionary powers on the books.  This is about a payments media that is gradually being used less and less (for payments) and where change is exceptionally unlikely to happen overnight.     Were there ever to be severe problems, surely Parliament could address such issues when they arose, rather than inventing new laws now –  and delegating the use to unelected, not very accountable, officials –  just on the off chance?

There should be a strong pushback against this bid for power.  Their (short) document makes no compelling case for legislative action –  and more discretionary regulatory power – now.  Indeed, as they note

There is a host of international examples where cash system participants have found different solutions to fit their unique economies.

It is what the private sector does –  innovate in response to market incentives and opportunities.  They worry –  as busy bureaucrats will –  that “no single organisation has system-wide oversight of the cash system or a formal role to support it”.   There is no such organisation for, say, the corner dairy sector either.  Nor an obvious need for one –  let alone for the government to be taking charge.  They complain that they don’t have information gathering powers over participants who aren’t banks, but offer no analysis or convincing demonstration as to why they should have such powers.

They offer no analysis either as to why the market could adequately manage issues around ATMs or other processing machines, or even for the quality of the notes retained in circulation.    Much of it seems to be made up on the fly –  so it seems, to catch the decisionmaking process around other changes to the RB Act.  Thus they talk of powers to compel banks to distribute cash, but seem to have thought through very of this bid for power for hypothetical circumstances.  This, for example, is the last substantive paragraph of the document.

How accountability would be defined under such regulation, and therefore how sanctions could be applied, warrants further consideration. Banks could be held collectively accountable for the provision of cash services, meaning that banks would share the responsibility for providing access to cash, and all banks within scope would face sanctions for each case of noncompliance. This would be a novel regulatory structure in New Zealand, but might be practically workable and might encourage greater cooperation among banks. Alternatively, each bank could be individually accountable for the provision of certain services in certain areas. However, this presents challenges around how accountability is allocated. Both options present considerable practical challenges, which will need to be investigated in consultation with relevant parties if any policy is developed.

Doesn’t exactly instill much confidence.

Many of the problems the Reserve Bank worries about (perhaps arising one day) would, in any case, largely be a reflection of the statutory monopoly on banknotes. So perhaps a better legislative route would be to look at repealing that restriction –  simple one clause amendment to the Act would do it –  and allow banks to issue their own notes.   Perhaps it is now a little late for that, but we don’t know if we keep on ruling out the opportunity for innovation.  It might be considerably cheaper for banks to issue their own notes (as they issue their own deposits) –  since they wouldn’t have to worry about returning them to a central point for value –  and, conceivably, technological innovation might even allow interest-bearing bank notes  (it is the zero interest nature of  the existing notes that creates the lower bound issue for monetary policy).

Bids for new regulatory powers are often a response to issues, problems (or possible future risks) thrown up by existing regulatory or legislative interventions.  The Bank’s latest bid for more discretionary powers seems exactly in that class of bureaucratic initiatives.   The Minister of Finance should say firmly no to this latest bid, should insist on the Bank openly addressing the effective lower bound issue, and might consider asking the Bank what public policy end –  other than higher taxes –  is served by maintaining the 85 year old monopoly on note issuance.  We got rid of most statutory monopolies a long time ago.


Keep the focus on monetary policy

As we approach the OCR decision this afternoon and as some market economists are now talking about the possibility that the OCR could be below 1 per cent before too long, there has been more and more talk about whether fiscal policy should be brought to bear, to stimulate demand and (in some sense) assist monetary policy in its macroeconomic stabilisation role.  Just this morning there was an editorial in the Herald, a column on Stuff, and a comment from Bernard Hickey at Newsroom.   Some of the discussion is about what should be done now, and the rest is about contingency planning –  what happens when the next serious recession happens if the OCR is still constrained.

Much of the discussion seems to stem from people on the left who aren’t that happy with the government’s fiscal policy.  As someone not on the left, it has always seemed strange to me that Labour and the Greens pledged themselves to keep much the same size of government (and much the same debt) as National –  especially when, at the same time, you were running round the country talking about severe underspending on this, that, and the other thing.   I’m also of the view that structural budget surpluses are a bad thing, in principle, when net government debt is already acceptably low (on the OECD measure of net general government financial liabilities, New Zealand is now about 0 per cent of GDP, which seems like a nice round number – an anchor – to target).  There is an argument there –  whether from left or right – for some fiscal adjustment (taxes or spending), which might have the effect of a bit more of a boost to demand.

But those arguments really have almost nothing to do with the situation facing monetary policy.    They are fiscal and political arguments that should be made, and scrutinised, on their own merits: the arguments would be as good (or not) if the OCR was still 2.5 per cent as they are now, and you can be pretty sure that people on the left would have been making them then anyway?   The Governor of the Reserve Bank, for example, (a pretty staunch representative of the centre left) seemed keen on more infrastructure spending a year ago.  I guess he is a voter to so is entitled to his opinion, but it really doesn’t have much to do with monetary policy.

The general arguments that led countries around the world to adopt monetary policy more exclusively as the primary stabilisation policy tool have not changed.  Monetary policy can be adjusted quickly (to ease or tighten), operates pervasively (gets in all the cracks, without making specific distributional calls), is transparent, and so on.  If we had a fixed exchange rate –  as individual euro area countries largely do –  it would be a bit different (individual countries don’t have the monetary policy option any longer) but we have a floating exchange rate system which, mostly, works well for New Zealand.

To the extent that there is a monetary policy connection to the current calls for fiscal policy to be used (or the ground prepared to use it), it has to do with the looming floor on nominal interest rates.  International experience suggests that, on current laws and technologies, short-term nominal interest rates can’t be reduced below about -0.75 per cent without becoming ineffective (as more and more people shifted from other financial instruments into physical cash).  We don’t know quite where that floor is, as no central banks has been willing to take the risk of going further, but there is a fair degree of consensus (and it has long been my view too).

But that still means that in a New Zealand context there is 200 basis points of OCR cuts that could be used if required.    That isn’t enough for a typical New Zealand recession (rates have often been cut by 500bps), but is still quite a degree of leeway if what we are entering were to turn out to be a fairly mild slowdown in New Zealand.  It could (I’m not hedging here).   That capacity should be used energetically, not timorously.   So the issue –  monetary policy needing “mates” deployed now –  is not immediate.  It is about preparing the ground.

And there, the best macro stabilisation option remains the one the Reserve Bank –  and other central banks –  have done nothing active about, but really should.  Authorities (and it probably needs political support to do so) should be moving to make the effective floor on short-term nominal interest rates much less binding than it is.   It binds because the practice of central banks –  perhaps backed by law – has been to sell banknotes, in unlimited quantities, at par.   That practice can be changed.  It could be as simple as putting an (adjustable) cap on the volume of notes in circulation (quite a bit above the current level, but not at a level that would be transformative) and then, say, auctioning the right to buy additional tranches of bank notes from the Reserve Bank.  In normal times –  with the OCR at, say, current levels – the auction price would be at par.  If the OCR were cut to, say, -3 per cent (and be expected to stay there for some time) the auction price would move well above par, acting as a disincentive on people to attempt to make the switch from deposits to cash.  There is a variety of other ideas in the literature, as well (no doubt) as much less efficient regulatory interventions that could prevent really large-scale conversions happening.

Unusual as such options may sound, this is where the authorities –  here and abroad –  should really be concentrating their energies: giving monetary policy more leeway, in ways that will buttress market confidence that monetary policy will do the job when it is required.  At present, by contrast, when market participants contemplate a severe downturn they look into an abyss wondering what, if anything, will eventually be done, by whom, and for how long.  In a serious downturn that will just worsen the problem, driving down inflation expectations as economies slow (note that in the RB survey out yesterday, medium-term inflation expectations fell away quite noticeably –  and this while we still have conventional monetary policy to use).   And if there are objections that all this is somehow “unnatural”, bear in mind that had the inflation target been set at zero (rather than 2 per cent), as was the normal average inflation rate for centuries, we’d already have run into these practical limits, and been unable to get real interest rates even as low as they are now.

So there is plenty to be done with monetary policy, and the work programme to do it should be something open and active, drawing in the Bank, the Treasury, the Minister, and other interested parties.  The time to do preparation is now, not in the middle of a surprisingly severe downturn.

I have a few other reasons –  than “it shouldn’t be necessary” –  to be wary of calls for large scale fiscal stimulus now.  Just briefly:

  • there would be little agreement on what should be done –  these are inherently intensely political issues.  There is lots of talk of infrastructure gaps etc, but no agreement on what those are, let alone recognition of the twin facts that (a) the best projects, with the highest economic returns, have probably already been done, and (b) New Zealand government project evaluation is not such as to inspire confidence that new projects would add economic value.    And suppose there were attractive roading projects –  perhaps central Wellington and the second Mt Vic tunnel? – we know the attitude of the government’s support partner to new major roads.  Not a thing.  So what should we then spend on?  Uneconomic new railway lines?  Or what?  Perhaps some just favour more consumption or transfers spending – which might be fine if you are a lefty who believes in permanently bigger government, but if you aren’t the issue has to be addressed of how programmes once put in place are unwound later.
  • I don’t rule out the possible case for discretionary fiscal stimulus in the event of a new severe recession (especially if the authorities refuse to address the monetary policy issues above) but my prediction is that (in many ways fortunately) the political appetite for large deficits would not last very long, and that therefore we should preserve the option for when it might really be needed.  It isn’t now.   I take much of the rest of the world after 2008 as illustrations of my point: in late 2008 all the talk was of fiscal stimulus, but within two or three years all the political pressure was to pull deficits back again.  I don’t see why New Zealand would be any different (and that is to our credit, since low and stable debt has become established as a desirable baseline).
  • And thirdly, a point we don’t often hear from champions of more fiscal stimulus, relying more on fiscal policy and less on monetary policy to support economic activity and demand will, all else equal, put more upward pressure on the real exchange rate, further unbalancing an already severely-unbalanced economy (see yesterday’s long-term chart of the real exchange rate).  In a severe recession –  when the NZD tends to plummet –  that isn’t a particular problem, but it should be a worry now (when the TWI is still a bit higher than it was a year ago, let alone thinking about the longer-term imbalances.

Perhaps the Governor and the (experts-excluded) Monetary Policy Committee will proactively address some of these issues this afternoon. I do hope so. If not, I hope some journalists take the opportunity to push the Governor on why he (and the Minister and Treasury) aren’t actively pursuing work to make the lower bound on nominal interest rates much less binding, in turn instilling confidence in the capacity of New Zealand policy to cope conventionally with a severe downturn if/when it happens.

Oh, and I do hope some journalists might also ask the Governor this afternoon about the justification for ruling out from consideration for appointment to the Monetary Policy Committee

“any individuals who are engaged, or who are likely to engage in future, in active research on monetary policy or macroeconomics”

The Governor is, after all, a Board member and was one of the three person interview panel.    What was it that he –  or the Board generally –  were afraid of?    Expertise?  An independent cast of mind?  Of course, it isn’t only active researchers who have such qualities –  indeed, not all of them do either –  but it simply seems weird, and without precedent in serious central banks elsewhere in the advanced world, to simply disqualify from consideration for the (part-time) MPC anyone with the sort of background that many other central banks (Australia, the UK, the euro area, Sweden, the United States, and so on) have found useful, as one part of a diverse committee.

Can anything good come out of the ANZ?

ANZ’s New Zealand operation has had a bad run lately, what with the problems around the version of a model they were using for calculating operational risk capital, and then yesterday’s announcement of the loss of their CEO.    Perhaps it is a failure of imagination on my part, but I can’t claim that either episode greatly bothered me, whether as a customer or more generally.  Yes, both incidents suggest a degree of untidiness that isn’t ideal,  but it is a big organisation and they were pretty small issues.  Perhaps it suggests the local board doesn’t amount to much, but why would that surprise anyone?   Local incorporation is mostly about having (a) some assets that we can be reasonably sure will be available to meet local liabilities in the (very low probability) event of a major bank failure, and (b) having someone to prosecute if governance failures proved to have risen to a prosecutable standard (a reason for the otherwise questionable requirement for some of the directors to be locally resident).   Beyond that, it makes sense for the whole of the ANZ group to be able to be run, as far as possible, as a single entity.

But rather lost amid the headlines yesterday was a very useful new piece from the ANZ’s economics team, “Prospects for unconventional monetary policy in New Zealand”.   It is a very substantial piece of analysis, which gets into quite a lot of detail on how New Zealand might handle a situation in which the conventional limits of monetary policy had been exhausted (ie when the OCR has been cut to some modestly negative level).    I would encourage anyone with even a passing interest in the topic to read it.

Pretty much ever since this blog began in 2015 I have been lamenting the apparent failure of the Reserve Bank to take this issue very seriously.  It never popped up in Statements of Intent or gubernatorial speeches (in the days when we had a Governor who made them), even though many other countries had run into those limits in the last recession, and in most cases the pace of economic recovery had been disconcertingly slow.    Back in 2013 or 2014, perhaps the Bank had some small excuse –  the then management was so convinced the OCR was heading back up (and by a lot) that effective lower bounds just didn’t seem like an issue New Zealand needed to worry about.     But that was five years ago, and the OCR now is 1.5 per cent not the (say) 5 per cent the Bank might have hoped for.

In the last 18 months, there has been some movement by the Bank,  Last year, they published a Bulletin article surveying the experiences of other countries with unconventional monetary policy, and then offering some initial thoughts on options for New Zealand.   I wrote about that article here, welcoming the fact that it had been done, and the survey of other countries’ experiences, but regretting an apparent degree of complacency by the Bank about the New Zealand situation and the likely effectiveness of such policy tools.   That complacent tone characterised various comments the Governor has made at MPS press conferences: lots of handwaving, little hard analysis, and no engagement at all with just how slow the recovery was in most countries that were reduced in unconventional measures.    As I noted, central bank complacency risked coming at a cost –  a cost not to the comfortable central bankers themselves, but to those left unnecessarily unemployed for long periods of time.

The new ANZ piece is valuable for a number of reasons.  First, it will be more widely disseminated than the Reserve Bank article.  Second, it isn’t from the Reserve Bank (we need a wider range of discussion and debate around these isses and risks), and third, it goes into more operational detail (around important features of existing RB liquidity facilities etc) in several places than anything previously in the public domain.

I don’t agree with everything in the ANZ piece, and in particular I was surprised by the number of references to how distortionary or risky unconventional policies have been in other countries.  The rather bigger issue is that they mostly have not achieved much, at least once we got beyond the immediate crisis period (and this is a distinction the ANZ authors make).    As I’ve noted here repeatedly, there is little or no evidence that –  whatever the initial announcement effects –  long-term bond rates have fallen further relative to policy rates in countries that used unconventional policies than in countries that did not.

There was a useful reminder that some official RB interest rates will go negative well before the OCR itself gets to a negative number.    This is from their document


The Bond Lending Facility is a facility whereby market participants can borrow bonds from the Reserve Bank (to support smooth market functioning) and, as the authors note, is little used.

The ANZ authors put more emphasis on the penalty on excess balances in settlement accounts.  I wrote about the Bank’s strange tiering policy in a recent post, but the gist is that the Bank determines for each bank what value of deposits at the Reserve Bank earn the OCR, and anything in excess of that earns 100 points less than the OCR.   Banks manage their settlement cash balances to minimise the extent to which anyone bears that lower return  But if the OCR were at -0.25 per cent, the rate on excess settlement account balances would be -1.25 per cent on current policies.   All else equal, that is a rate low enough that (a) no one else has imposed it, and (b) people might prefer to hold physical cash instead.

I’m a bit sceptical that this is a really important constraint on the ability of the Reserve Bank to use conventional monetary policy down to an OCR of around -0.75 per cent, since there is little reason to suppose the level of settlement cash balances would be rising as the OCR plumbed these new depths (if anything demand might be falling a bit), and banks would –  as the Bank would want –  be aggressively acting to limit the extent anyone bore the additional cost.   But it is an issue that is worth debating further, and which would become salient quite quickly if the Bank went beyond OCR cuts and started using unconcventional measures to boost settlement cash balances materially.  In earlier work, it was recognised that tiering policy would probably need to change if there was aggressive unsterilised asset purchases.

The authors rightly note many of the potential limitations of asset purchase options.  Sure, the Reserve Bank might be able to buy up a substantial portion of the government bonds on issue –  although some holders will be very reluctant sellers, having mandates that specify investment in government bonds –  but even if they could, what would be the channel whereby this would revive demand and economic activity (few borrowers took on long-term fixed rate debt).   And the Bank might be able to intervene heavily in the foreign exchange market –  perhaps on ministerial direction, to ensure the risks fall on the Crown –  but they’d likely be selling the New Zealand dollar when it was already undervalued, and if the OCR can’t go below -0.5 or -0.75 per cent, it isn’t likely that the exchange rate effect would be very large.  Intervening in the interest rate swaps market has been an idea around for a decade, and I’ve never been persuaded it would accomplish much.

But the options and issues really should be more widely debated, and the Reserve Bank and The Treasury should be taking the lead in encouraging open debate and serious scrutiny of the New Zealand specific issues.  As ANZ notes, perhaps interventions can be devised on the fly, but there is no excuse for finding ourselves in that position when we have had 10 years advance notice of the problem.  Adrian Orr’s tree god won’t offer the answers, no matter much Orr invokes Tane Mahuta.

My frustration is that thinking doesn’t seem to have advanced much at all in the ten years. I dug through some old files this morning, and among them I found a paper I’d written at Treasury in 2009 (benefiting from discussion with Reserve Bank staff)  on options if we reached the limits of conventional monetary policy.  I also found a discussion note I’d written in 2011 trying to engender some debate around the legislative provisions that support the near-zero lower bound on nominal interest rates, and was reminded of the report of a Bank working group I lead in 2012 on options if we faced near-zero interest rates (sparked by the intensity of the euro crisis then).  But nothing from either the Reserve Bank or The Treasury that has found its way into the public represents any advance on that thinking and work done up to a decade ago.  It really is pretty inexcusable.  It is almost as if our officials and minister think everything worked just fine in other countries after 2009 –  it clearly didn’t –  or they just don’t care.

Specifically –  and this is a criticism of the ANZ note as well (not even mentioning the issue) – there has been nothing done, no debate held, no analysis published, on dealing with fact that at present people can convert limitless amounts into hard currency, and will do so at some point once interest rates on other instruments (wholesale ones in particular) are substantially negative.   Here was what I wrote on that point in my post last year on the Reserve Bank’s article.

It is striking that the article does not engage at all with either of the two more radical options debated in other places and other countries:

  • reconfiguring the target for monetary policy.   This could take the form of a higher inflation target or, for example, the use of a price level or nominal GDP level target.  Each approach has its weaknesses, but either –  done in advance of the next serious downturn, not in midst when much of the opportunity is lost –  could help raise, and hold up, expectations about the path of the nominal economy, including inflation.
  • taking steps to material reduce the extent of the effective lower bound on nominal interest rates.

The latter remains my preference, for a number of reasons (including that the existing problem arises largely because central banks have  –  by law – monopolised note issue, and then not proved responsive to changing circumstances and technologies. Problems are usually best fixed at source.

If there is still a useful role for physical currency (I discussed some of these issues here), the ability to convert huge amounts of financial assets into physical currency, on demand, without pushing the price against you, is now a material obstacle to monetary policy doing its job in the next recession.    There is a good case for looking seriously at a variety of reform options, such as:

  • phasing out large denomination Reserve Bank notes (while perhaps again allowing private banks to offer them, on their own terms, conditions and technologies),
  • capping the physical Reserve Bank note issue, scaled to growth in, say, nominal GDP (perhaps with provision for overrides in the case of financial crisis runs),
  • putting a spread (between buy and sell prices) on Reserve Bank dealing in bank notes, or
  • auctioning a fixed quota of bank notes, and thus allowing the price to adjust semi-automatically  (when currency demand rises, as when the OCR goes materially negative) the cost of conversion rises.

These sorts of ideas are not new.  They do not get rid of the entire issue –  at an OCR of, say, -10 per cent, even transaction demand for bank deposits might dry up –  but they would go an awfully long way to ensuring that the next recession can be dealt with more effectively than the last.

If, for example, you thought the OCR was going to be set at -3 per cent for two years, then once storage and insurance costs are taken into account (the things that allow the OCR to be cut to around -0.75 per cent now), even a lump sum conversion cost (deposits into physical cash) of 5 per cent would be enough to keep almost everyone in deposits and bonds (even at negative yields) rather than physical cash.  That is a great deal leeway than the Reserve Bank has now.   Having that leeway –  and being willing to use it – helps ensure nominal rates don’t need to stay extremely low for too long.

In principle, many of these sorts of initiatives probably could be done in short order in the midst of the next serious downturn.  But we shouldn’t have to count on unknown crisis responses, the tenor of which have not been consulted on, socialised, and tested in advance.  It may even be that some legislative amendments might be required.

There is no excuse for not having these issue all sorted out well in advance, and having communicated clearly to the public (and ministers and markets) how they will be handled, secure in the knowledge that rigorous planning and risk identification has occurred.

In part, that is because of one other issue that ANZ piece doesn’t touch on (neither did the Reserve Bank article).  Once a new severe recession is upon us, people will fairly quickly begin to appreciate how few effective and credible options central banks and governments have, and react –  eg adjusting inflation expectations –  accordingly.  In 2009, the typical reaction was to expect a quick rebound, partly because that was how economies were perceived to have usually behaved, and partly because so many interventions were being thrown into the mix. Next time, people (markets) will go into a severe downturn with the memory of post-2009, an awareness of the unpropitious starting point, and an awareness of the distinct limitations of unconventional policy. All that is likely to exacerbate the downturn and further complicate effects at countercyclical stabilisation.  People will suffer as a result.

We need some leadership on these issues. If the Reserve Bank won’t or can’t provide it, the Minister of Finance –  who will bear responsibility before the voters –  needs to lead himself, and insist that his agencies do more and better, more openly, than they have done so far.

In the meantime, well done ANZ for a substantial piece of work. Once again, I’d encourage people to read it and think about the issues and constraints it raises.