Growth in debt, but barely at all in New Zealand

Michael Reddell Financial stabilty, Housing

I’m a bit tied up for the next couple of days, and so posting might be light and insubstantial  My share in the stewardship of a financial entity that has now operated for decades without appropriate authorisations and approvals is somewhat time-consuming (thank goodness we have a Reserve Bank to deal with cases where major commercial banks don’t follow the rules).

But for today, I’m just going to leave you with a simple chart. presumably constructed by Moody’s from BIS data, that I found in a newsletter last night.  It shows the change in the ratio of business and household debt to GDP between 2007 (just prior to the recession and financial crisis) and 2017 for 41 advanced and emerging countries.

household and corporate debt

In some quarters you hear a lot about high and rising debt in New Zealand.  I’ve pointed out previously that the “rising” bit is mostly wrong –  and that levels comparison across countries are difficult to do meaningfully, because of issues such as the tax treatment of debt.  Despite the surge in house prices in the last few years, household debt as a share of GDP isn’t much higher now than it was in 2007.

What this chart highlights is that New Zealand is towards the end of the spectrum with the least increases in private debt as a share of GDP.   Of these 41 countries, only five advanced economies and two emerging ones had less of an increase (more of a fall) than New Zealand.

And here is a slightly more detailed chart on the specific New Zealand data, showing credit for each of the three sectors the Reserve Bank reports, as a share of GDP.

credit

In the years leading up to 2007 we did, indeed, see a big increase in private sector indebtedness (as a share of GDP), across households, farms, and non-farm business.  In the crisis-prediction literature it was a classic warning sign –  taking on lots of new loans very quickly is often associated with a serious deterioration in credit standards.    But it didn’t come to anything much, at least outside the (small) finance company sector.

Sure, we had a serious recession in 2008/09 –  as most other countries did (it was largely a global phenomenon, with roots in the US in particular) –  but our core financial sector came through the recession unscathed.  Banks weren’t perfect by any means (they are run by humans in a world of imperfect information so that is hardly surprising) and of course there was some increase in loan losses and provisions.  But nothing to threaten the soundness of any major institution or the system as a whole.

There probably are some serious questions to ask about what has gone on, and what might yet happen, in some of the countries in the chart that have had big recent increases in debt to GDP ratios –   China most notably –  but as was the case pre-2007, a big increase in debt is unlikely to be any sort of safe predictor of future financial sector problems.

And whatever the situation abroad, New Zealand at present doesn’t look like one of those places where anyone should be concerned about financial system risks.  Yes, our house prices are cruelly high, but the structural policy failings that took them there don’t show any sign of being sustainably fixed.  And there just hasn’t been much new debt taken out for other purposes.

All this is, of course, backed up by successive waves of stress tests undertaken by the Reserve Bank.   Which does leave you wondering why we now have such a regulatorily-distorted and suppressed market in housing credit.

 

Towards a more open central bank

Michael Reddell Reserve Bank Act reforms, Transparency

Earlier in the week I wrote a post making the case for reform of the Reserve Bank to be done in such in a way that encourages a much more open central bank, at least in its monetary policy dimensions (there are similar, but different, issues around the other areas of the Bank’s responsibilities).     That post was prompted by the public efforts of the “acting Governor” and his deputy (and acknowledged candidate to be the new Governor) to push back against (a) external members on a new statutory Monetary Policy Committee, and particularly (b) to resist any suggestion of any greater transparency around monetary policy.   As I illustrated in that post, what these officials dislike are systems that work well, and have become established, in places as diverse as the United Kingdom, Sweden, and the United States.  There is no obvious reason why such an approach could not work well in New Zealand.  And it is not as if the Reserve Bank’s reputation now stands so high that no sane person can envisage any possible room for improvement.

I gather that Spencer and Bascand have since given other interviews restating again their opposition to reforms along these lines.  Whatever their views, it is astonishing that they are carrying on this campaign in public –  even as Bascand has been privately making his case to be the next Governor.  They are bureaucrats, who are paid to operate under the laws, and governance arrangements, that Parliament – acting on behalf of the people –  establishes.  Good statutory provisions governing powerful public agencies involve striking a balance between, on the one hand, drawing on technical expertise, and on the other hand, protecting the interests of citizens against over-mighty bureaucrats advancing their personal interests and/or the interests of their bureau.    Openness and transparency are among those protections.  It is perhaps telling that Bank officials are keen on openness when it allows them to advance their views on this issue –  to protect their patch –  but not when it might prove awkward for them.   Graeme Wheeler was much the same  –  last year willing to go public to tell us that for one controversial OCR decision every single one of his advisers had supported him, but then willing to fight all the way to the Ombudsman to prevent citizens seeing comparable numbers for other decisions (even ones well in the past).  The only principle that seems to guide them on such matters is patch protection and self-interest, precisely the things we need protection against (and the sorts of things that motivated the Official Information Act 35 years ago).

In the purpose provisions of the Official Information Act, the very first item is this

to increase progressively the availability of official information to the people of New Zealand in order—

  • to enable their more effective participation in the making and administration of laws and policies; and
  • to promote the accountability of Ministers of the Crown and officials,—

and thereby to enhance respect for the law and to promote the good government of New Zealand

It is a mindset that has never taken hold at the Reserve Bank.    And thus it was encouraging that in the Speech from the Throne the other day there was an explicit commitment to “improving transparency” around monetary policy.

But after my post the other day, someone got in touch to point out that I’d left out one argument for a more open (monetary policy) central bank.  This correspondent noted that they would have

….added another argument for the value of individual responsibility of committee members: Central banks should stop pretending that the future is knowable, and the economy well understood. Monolithic representation of THE Bank view perpetuates that dangerous myth.

I agree entirely.  To have left it out the other day was an oversight, but it was also something implicit in many of the other arguments and international experiences.

Getting monetary policy roughly right –  the best than anyone can hope for –  is a process of discovery, iteration, revision and so on.  It isn’t a case of one wise person, or even a handful of wise bureaucrats, consulting the secret oracle, and revealing truth to the peasants.   Members of a monetary policy committee –  or the Governor under current NZ law –  get to make the final decision on the OCR, but they know no more about how the economy works, or what might happen next, than any number of other observers.  Indeed, of the four members of Wheeler’s advisory Governing Committe, only one could be considered pretty much fulltime focused on monetary policy (the chief economist).  Of course, they have more analytical resources at their command –  but, in fact, those are our resources, paid for by taxpayers.

When it suits them, the Bank will –  correctly –  emphasise just how much uncertainty there is about the appropriate monetary policy, and how the economy and inflation might unfold in future.  But, if so, what do they have to be afraid of from a much greater degree of openness?

I went back and listened again to the relevant bits of Thursday’s press conference.  Governor-aspirant Geoff Bascand was quite explicit that he thought people needed to focus on the issues that “the Bank” had set out in its Monetary Policy Statement, on “the risks ‘the Bank’ was considering”, on “the substance”.  Bascand didn’t want people focusing on the other issues, or divergences of views, and so on.

It is the same old mindset: we know “the truth”, we know which issues are important and which aren’t, we know how best to balance risks, and so on. And “we” can’t possibly risk letting people know that there might, at times, be genuine differences of view among able people at the Reserve Bank.   But what evidence do they have for such claims?  Either of the degree of knowledge they (implicitly) claim for themselves. or for the level of risk they claim explicitly to worry about.    Instead, life is just easier for bureaucrats if we maintain the secrecy, and continue to channel a monolithic view –  monolithic this time, monolithic next time, monolithic the time after, even though each of those monolithic views may be quite different from each other.

It would bore readers to run through the evidence for how often the Governor’s monolithic view has been wrong (or central banks in other countries have been wrong).  Sometimes one could count him culpable. At other times, things just turned different than most people –  inside or outside the Bank –  reasonably thought likely.  That is the nature of the beast: things are highly uncertain and nothing is gained, no one’s interests (probably not even those of really capable bureaucrats) are advanced by keeping on pretending otherwise.  The evidence to the contrary is there almost every time any central bank sits down and deliberates on monetary policy.  Mostly, it seems as of Spencer, Bascand, and McDermott have settled in a comfortable rut.  It may suit them, but that isn’t a good argument in institutional design.

I noted the other day the Supreme Court offers a good counter-example.   Final appellate decisions are, in some ways, quite like OCR decisions.  They aren’t necessarily “the truth”, but they are final.   Smart lawyers make sophisticated arguments on either side of any particular case.  Smart judges often enough disagree among themselves.  Some decisions end up being made by a 5:0 vote, but many are 3:2 decisions, and the Chief Justice can easily be in a minority.    Court hearings are, typically, open, and decisions – in the affirmative, and dissenting –  are typically published.    Only an idealist would pretend that the decision is “truth” –  the only possible, or sensible, way of reading the facts and relevant statutes.  But that particular panel of judges –  chosen for their character and expertise –  gets to make the final decision.

It isn’t clear why monetary policy should be so different.  It is even more provisional since, although each OCR decision is final, the panel is back every couple of months looking at an only slightly different set of facts, but sometimes reading them in quite different ways.  I’m not suggesting –  at the ludicrous extreme –  broadcasting meetings of a Monetary Policy Committee, but I can see no possible harm – to the public, or to a well-managed Reserve Bank – from shifting to a culture of much more radical openness, suited to the specifics of monetary policy.   Why shouldn’t the relevant background papers be published, even with a bit of a lag?  Doing so would not only gives stakeholders more a sense of the quality of the staff analysis, it would allow outsiders to point to things staff might (being human) have missed.    Why shouldn’t dissenting opinions, carefully crafted, be included in the minutes (much as the appellate judges do)?  And why shouldn’t members of the MPC –  each independent statutory appointees, and accountable as such –  be giving thoughtful speeches, or interviews, outlining how they see the issues around monetary policy, in ways that invite input from outsiders.  Capable people –  the only sort who should hold these roles –  need have nothing to fear from the contest of ideas.  From such exchanges, from such scrutiny, usually better decisions –  still imperfect –  will emerge.  And the public will have a better sense of the limits of what they can expect from any agency in an area so (inevitably) riddled with uncertainty.

Openness can be messy.  There will be mis-steps at times.  But that is nature of a free and open society.    Choreographed uniformity of view should be left to Xi Jinping.  I noticed a day or so ago that Robert Kaplan, head of Dallas Fed, was on the wires observing

“History has shown that normally when we have a substantial overshoot the Fed ultimately needs to take actions to play catch-up,” Kaplan said in an interview with the Financial Times.

Kaplan said he was actively considering “appropriate next steps” when asked if he was willing to consider a rate rise at the upcoming Fed meeting, FT reported.

I’m sure there are plenty of people around the Fed who will disagree with Kaplan’s particular perspective.  But the question for old-school bureaucrats like Spencer and Bascand is what possible harm, to the conduct of monetary policy or the interests of the American people, is done by such openness?  I can’t see any.  I hope the Minister of Finance –  helped by the forthcoming Independent Expert Advisory Panel –  will draw the same sort of conclusion, and ensure that the new legislation is crafted, and key appointments are made, accordingly.

The costs of Brexit

Michael Reddell Trade, UK

That was the theme of a presentation in Wellington on Monday, organised by the research institute Motu, by visiting British economist Richard Harris.  Harris is a professor of economics at the Durham University business school, but had apparently spent some time at Waikato early in his career.

The presentation was promoted as an update on the Brexit negotiations, seven months into the two year Article 50 notice period.  Of course, it takes not much more than a cursory glance at your British media outlet of choice to know that things are not going that well, not helped by the tenuous hold on office the current government has.   Competing agendas all round don’t help either.  Plenty of people in the British government –  and the Opposition –  didn’t want to leave.  For them, minimal change from the status quo would be the best outcome. But for those who actually favoured Brexit that solution would, understandably be anathema –  the goal for many of them was to restore the UK’s freedom of action to that of a typical sovereign state.    And on the other side, some countries face pretty bad outcomes if there is a hard British exit.  For others it isn’t much of an issue. For some it might even be an opportunity, to attract multinationals –  including in the financial sector – that have operations currently based in Britain.    And although everyone knows that rising trade barriers comes at a (likely) cost to all countries, the EU doesn’t want any other countries –  or regions –  getting the idea that leaving the EU was a serious option.

Harris’s presentation helped me see more clearly where the EU “divorce bill” demands are coming from, and put the numbers in some sort of context.  At present the UK pays a net 14.6 billion pounds a year into the EU, and the sort of numbers observers like the FT think the EU might accept are only the equivalent of two or three years’ “membership fee”, in a club that apparently operates five year budgets.  At present though, as the FT observes, a number acceptable to Brussels would be “deadly” in Westminster.

It was also interesting to see some numbers on how restrictions on trade between the UK and the rest of the EU would rise if there is no trade deal and the two sides fall back to trading on WTO terms.   On goods, tariffs would rise from zero at present to around 4.4 per cent on average.   On services, where barriers are mostly non-tariff, the restrictions would rise from a tariff-equivalent of around 2 per cent to something nearer 8 per cent.   In principle, the UK could offset this to some extent by securing early trade agreements with other countries –  including countries that the EU does not have deals with –  but good deals, with significant countries, aren’t likely to be secured easily or quickly.  As various commentators have noted, the EU-Canada trade agreement took eight years. New Zealand is already among several countries objecting to early EU/UK proposals to divvy up agricultural import quotas.

Even though there is a lot of talk about smoothing the customs barriers between the UK and rest of the EU –  including on the Ireland/Northern Ireland border –  to faciliate, for example, the value-chains in manufacturing that rely on the seamless movement of goods, there doesn’t seem to be any great optimism as to whether any of these schemes can be made to work well.   That matters, even more than to the UK, for Ireland in particular, which has a very large share of its trade with the UK (and not just with Northern Ireland).  The Irish have been making opportunistic bids to try to semi-detach Northern Ireland from the rest of the UK.

It was pretty clear that Harris hadn’t voted for Brexit, and didn’t support it now.  But he had a pretty hard-headed assessment: the decision had been made and there was no imaginable way it was going to be reversed.   He couldn’t see how effective deals could be in place in March 2019, and even talk of transitional periods beyond that had all sorts of (technical and political) problems.  He envisages a pretty “hard Brexit”, and is very gloomy as to how the UK will cope.

In fact, that was one of the odder aspects of his talk.  He presented a (familiar) chart showing that in the 20 years to 2007. British productivity growth had been faster than that in most other major advanced economies.  But since 2007 there has been no productivity growth at all in the UK.  No one quite knows why, or even how much of what we see might be measurement and how much genuine.  Performance has been poor recently, but that has nothing apparent to do with Brexit.

And yet Harris used this record to claim that if Britain was to take advantage of Brexit, it needed to have a high productivity economy to benefit from comparative advantage.  He said it twice, so it presumably was an intentional statement.  But Stage 1 economics students learn that everyone has a comparative advantage: economy B might be better at producing all sorts of different goods that economy A (that’s absolute advantage), but comparative advantage just tells you that economy A will nonetheless be occupied producing the things it is relatively less bad at producing.     Misunderstanding that point didn’t fill me with confidence in the rest of the presentation, although I’m guessing he just meant that one might be more optimistic about British economic outcomes –  in or out of the EU –  if it was managing decent productivity growth now.

Harris did present the results of a couple of modelling exercises that have been done on how large the real economic costs of Brexit might be.  They usefully highlight that the costs won’t just fall on the United Kingdom –  indeed, one of them envisages job losses (transitional presumably) twice as large for the rest of the EU as for the UK (the EU is of course much larger).    There are losses in this scenario because, even with full free trade with the rest of the world (which won’t happen any time soon), there are typically fewer profitable trade opportunities with places further away than with places close to home (one of NZ’s problems).

In one paper (by Vandenbussche et al), it is estimated that the level of British GDP will fall by 4.5 per cent in a “hard Brexit”.   What I hadn’t realised –  or thought about before –  is that Britain might not be the biggest loser.  In this particular model, Irish GDP would fall by almost 6 per cent, and that of Malta –  with close historic ties to the UK –  would also fall by 5 per cent.    If a 5 per cent loss of GDP seems large, no one really knows the likely absolute magnitudes. Harris quoted estimates from another study by Dhingra et al: they in turn had bad and less-bad scenarios, but the central estimate of lost GDP for the UK was around 2 per cent.

There is a pretty widespread view among economists that these costs, whatever the precise number, are both large and avoidable.  Of course, they might be avoidable, if Brexit was to free up Britain to adopt far-reaching microeconomic reform and liberalisation.  Sadly, that doesn’t seem remotely likely at present –  and of course, many of the costly restrictions the UK imposes now (eg land use restrictions) are entirely home-grown.

Instead, economic elites lament the choice to exit the EU and wish, longingly, that it could be reversed.  That sentiment is perhaps particularly evident in places like the IMF and the OECD –  and Harris cited quite a bit of material from the latter organisation, which has an institutional bias away from the national in favour of the multinational.

I suspect, by the tone of the questions, and the sympathetic murmurs when Harris made particular points, that there weren’t many people in Monday’s seminar who were sympathetic to Brexit.  I am.  Were I a Brit, I’m pretty sure I’d have voted for it –  although, in truth, I’m not sure I’ve ever voted in New Zealand for a programme that might reduce GDP per capita by 4 per cent.  But Brexit has just never seemed primarily like an economic issue, and that seems to be the difference between the public –  polls suggest they are still pretty evenly divided as they were last June –  and most economists.

And so I stuck up my hand and suggested that if we’d been doing this sort of modelling 60 years ago, as territories pondered the possibility of independence from Britain, the results would surely have shown that, for almost all of them, they would be worse off economically than if they’d stayed with Britain.  (And that modelling would never have allowed for the gross mismanagement that followed in many of the newly independent African countries in particular).  And yet if they had been presented with estimates of a 5 per cent loss of GDP, how many would have turned down the chance to be independent – to be free?  Even now, decades on, few probably regret the independence choice –  Somalis might be an exception.   The essence of my point of course was along the lines of why shouldn’t Britons today make a similar choice about the EU.  (And, of course, a 4 per cent loss of productivity sounds big, but it is the loss of 2 or 3 years productivity growth in normal times, invisible over a 50 year horizon.  Adding another week’s annual leave probably reduces GDP per capita by a couple of per cent.)

I’ve made this point here previously, but I was interested in how Harris was going to respond to it.  His response was to acknowledge that many Scots had certainly favoured independence, even at an economic cost – although of course they, like the Quebecois in the 1990s – decided to stay part of the larger country.  But then he fell back on avoidance, arguing that the issues were different for India or Zambia, as their cultures had been squelched by the British etc, and no one could suggest that anything of the sort could be said of Britain and the EU.  Had I had the chance of a rejoinder, I’d have noted that my points would have applied to the choices New Zealand, Australia, and Canada (and Ireland –  although the cultural issues were a bit different) had made to progress towards full economic and political independence.  It may well have come at a cost, but few then –  and fewer now –  will have regretted the choice.  And in all three countries the predominant population was English.  Probably few Slovaks regret their divorce from the Czechs.

Harris’s fallback was that “the EU was always only an economic club, and it remains an economic club”.      That was the conceit of many in Britain.  It was never the vision of the founders of the EU, or of those driving it today.  The very treaties envisage an ‘ever-closer union”, and even today newspapers such as the FT are full of talk of plans for closer banking or fiscal unions, even talk of an EU finance minister.   New entrants to the EU – although not Britain, Sweden and Denmark –  are obliged to commit to enter the euro.  And –  as a matter of conscious and deliberate choice –  being part of the EU means individual nations surrender the right to legislate for themselves in many areas.  That is a (lost, or foregone) freedom that many Britons seemed (and seem) willing to pay some price to reclaim.  If you don’t value the nation state –  or you aspire to some mega European state –  you’ll think that choice irrational.  But most people do seem to value the nation state –  and not just in the UK.    And the British exit polls last year suggested that it was just those sorts of “chart one’s own destiny” considerations that counted with those voting to leave.

Nearly half (49%) of leave voters said the biggest single reason for wanting to leave the EU was “the principle that decisions about the UK should be taken in the UK”. One third (33%) said the main reason was that leaving “offered the best chance for the UK to regain control over immigration and its own borders.” Just over one in eight (13%) said remaining would mean having no choice “about how the EU expanded its membership or its powers in the years ahead.” Only just over one in twenty (6%) said their main reason was that “when it comes to trade and the economy, the UK would benefit more from being outside the EU than from being part of it.”

In the end, who knows whether it will matter much.  All the modelling assumes that the EU itself carries on much as it is.  A pessimist – perhaps an optimist –  might wonder whether the EU itself will last in its current form for much longer.  Public opinion in other EU countries seems to ebb and flow.   The next recession –  whenever it is –  is just going to accentuate the tensions already apparent in many countries, given that few EU countries have any material “fiscal space” and the ECB is likely to go into the recession with interest rates already at or below zero.  Perhaps in the end Britain will prove to be a pathbreaker –  something the eurocrats and EU-oriented elites must fear very deeply.

Harris concluded with a couple of slides making the point as to how little trade New Zealand firms/individuals and those in the UK now do.   He was inclined to the view that, therefore, what happens around Brexit doesn’t really matter to us.   I’m not sure he is right there –  even setting aside wishful thinking about full free trade between us, including in agriculture.    Even in the transition, a disruptive hard Brexit is the sort of event that could –  in the wrong circumstances –  matter for the world economy in 2019.  And for a small country, looking to materially increase its export orientation, we should certainly be hoping that a country of the size and sophistication of the UK can make it –  and prosper –  alone.  If they can’t, it wouldn’t bode well for us.

An open central bank is the way to go

Michael Reddell Reserve Bank Act reforms

The new government is setting up a process to review the Reserve Bank Act, including –  but not limited to –  giving effect to Labour’s campaign promises to introduce some sort of employment objective to the Reserve Bank Act and to create a statutory committtee, including external appointees, to take OCR decisions.

It is a once-in-a-generation opportunity to reshape the central bank, a key policymaking (and implementing) institution in our economy and financial system.   As the Minister has pointed out, the current Act was written almost 30 years ago.  Lots of things about monetary policy, and the wider role of the Bank, turned out differently that was expected, or perhaps hoped for, thirty years ago.   Little about the New Zealand system has been followed by other countries who’ve reformed their central banks in the years since.

Of course, the bureaucrats at the Reserve Bank (“the old guard” as Bernard Hickey described them last week) aren’t keen on change at all.  Bureaucrats rarely are.  For years they have been successful in keeping secret their preferences –  Graeme Wheeler refused to release any of the work they’d done on reform issues and options a few years ago –  but last week they went public.    Unlawfully appointed “acting Governor” Grant Spencer, and his deputy –  and declared candidate to be the next Governor –  Geoff Bascand, used the platform of the Monetary Policy Statement press conference to outline their opposition to change –  or at least to any change that might diminish the power of Reserve Bank management (ie them, or people like them).

Spencer loftily declared that, of course, they weren’t opposed to a committee.  In fact, they supported one. But, in his words, they already had a committee, they thought it worked well (perhaps unsurprisingly since they are members of that  – purely advisory –  committee), and would be happy to see it established in law.   But, asked about outsiders on the committee –  something the government had promised, both in the Labour Party campaign, and in the Speech from the Throne the previous day-  Spencer was very wary.  How, he wondered, could we sure of finding enough suitable people without insuperable conflicts of interest? (How, I wonder, do we manage with almost every other agency of the state?)  Worse still was the idea that the members of any new Monetary Policy Committee might individually be held to account, and their views on the OCR be known to the public.   Why, Spencer declared, it could turn into a “circus”, with much too much focus on monetary policy –  as, he asserted, it had in some other countries.  Bascand worried that people might focus on the views of members of the committee, not on the issues “the Bank” wanted to focus on.

It was like some sort of blast from the past. Many bureaucrats, for example, hated the idea of the Official Information Act too.  Open government is an anathema to most.  But of considerable benefit to citizens.    Not one of the three “old guard” sitting at the top table at that Reserve Bank press conference has ever shown any serious or sustained interest in open government, especially as it applies to the Reserve Bank.  They are, in practice, devotees, to the “cult of the expert”, in which the public is told only what the “wise experts” determine they should know.   Thus, our Reserve Bank will happily tell you what they think the OCR will be in 2020 –  by when the decisionmaker will have changed, and the PTA and Act too –  but they fight tooth and nail, too often with the support of the Ombudsman, to keep secret their current deliberations, current analysis, or the advice the “acting Governor” receives on current monetary policy.   It is tidy, to be sure.  Open government isn’t –  in fact, it is often a bit messy.  But it benefits citizens, and over time actually makes for better government institutions and policies as well.

As I noted the other day, despite claims that an open central bank could turn into a “circus”, neither Spencer nor Bascand has offered any evidence in support of their claim.  There are aspects of how central banks work in other countries that, at times, career central bankers don’t like. But the interests of career central bankers and bureaucrats and those of the public don’t necessarily overlap much, if at all.

Each country has its own system, with its own idiosyncracies.  Many of those provisions aren’t –  and probably shouldn’t be – written into law.  Institutional cultures need to evolve.

But in Canada, they manage to run an open programme of research and dialogue as part of each five-yearly review of the inflation target.  In Sweden, members of the monetary policy decisionmaking board can, and do, articulate their views, not just in speeches around the decisions, but in substantive records in the minutes.  At the Bank of England, the Governor has been willing to be out-voted (and for that to be in the published minutes), even to vote differently than his own senior executives (some of whom are members of the Monetary Policy Committee).  The Bank of England runs a staff blog that, at least at its foundation, was sold as an opportunity for staff to challenge established orthodoxies (it is a good blog, although it never quite delivered on that –  unrealistic promise).  In the United States, senior researchers have been free to publish papers and books that disagree quite strongly with the way the Fed has run monetary policy.   The Atlanta and New York Feds have competing, and published, nowcasting models of current GDP growth.  John Williams –  head of the San Francisco Fed –  was not long ago out in public suggesting that the Fed shift away from inflation targeting, towards something more levels-focused.  As I noted then

I’m not persuaded by Williams’ case, but what struck me is how open the system is when such a senior figure can openly make such a case.  The markets didn’t melt down. The political system didn’t grind to a halt.  Rather an able senior official made his case, and people individually assessed the argument on its merits.

The FOMC doesn’t publish minutes as detailed as those of the Riksbank, but voting members can record their dissent from a majority decision, and they (and other regional Fed heads) can and do use speeches to articulate their own thinking about the economy and monetary policy. It is rarely, if ever, as explicit as “I’ll be voting for a 25 point increase at the next meeting”,  but outlining how that particular person thinks about the economy, the risks, and perhaps the challenges/opportunities the Fed faces.

My impression –  and I’ve kept an eye on these things for a long time –  is that the Swedish, British and US system all work well.    I’ve heard current and former Governors of some of these places moan about the systems, and individuals –  Stefan Ingves of the Riksbank, who was famously wrong in his disagreement with Lars Svensson, was here only about three years ago.   But since the whole point of dispersed, and open systems, is to limit the power of a single Governor, that unease should more likely be seen as a feature than as a bug.  Same goes for the claims of Spencer and Bascand here.

There have been concerns –  again from internal career people –  that externals on Monetary Policy Committees may use the visibility of a public platform to pursue their next career opportunity.    This was strongly asserted of one particular member of the Bank of England MPC in its early days –  a member who made life difficult for the Bank of England management.

It is, probably, a bit of an issue.  But it is no less so for management people.  I”m old-fashioned enough to think that Governors of the Reserve Bank (like Prime Ministers)should retire, and settle for gardening, charity work or whatever.  But it isn’t the way public life now runs.  Don Brash was on the board of our largest bank just a few years after ceasing being Governor, Ben Bernanke makes large amounts of money from his new roles in the financial sector,  Glenn Stevens has just signed-up as adviser to a macro hedge fund, and if I recall rightly when Graeme Wheeler announced he wasn’t seeking a second term as Governor he indicated that he had always planned to do only five years and then to step back into Board roles.    There is empirical evidence that the prospect of the “next job” has, at the margin, influenced monetary policy decisions that central bankers have made, and real concern that it can affect regulatory policy decisions.     These aren’t just issues for central banks –  and they certainly aren’t just issues for part-time external members of policy boards.

And the other issue that often gets raised is the potential for “confusion” or heightened market volatility.    The public, and markets, just won’t (it is suggested) be able to cope with differences of view in plain sight.  Strangely enough, they seem to in other countries.  There is no evidence I’m aware of suggesting that market conditions are less volatile here because we have a secretive monolithic central bank, but if such evidence exists perhaps the Bank could publish it, or point us to it.  If anything, there is a possible counter-argument (which I wouldn’t want to make much of) that if it is known that a variety of voters on a monetary policy committee have different views, and different (explicit or implicit) models, and if those views are being updated in public periodicially, market adjustment might be easier and less disupted than being restricted to a six-weekly decree from the mountain-top.  As I say, I wouldn’t want to make much of that argument –  open government is good in its own right, and seems to work (in central banks) in various other democratic countries –  but it is just to note that the argument doesn’t run all one way, even on this narrow point.

The “acting Governor” attempted to back his opposition to any sort of open acknowledgement of differences of view –  on a subject where, the Bank rightly and regularly reminds us, there is huge uncertainty –  by comparison with the Cabinet.

Cabinet collective responsibility has, historically, been an important part of our system of government.  In ye olden days – ie before MMP –  all our government ministers were, without exception, from a single political party.  They were elected on a common platform and, even if there were intense rivalries among them, they expected to seek re-election on a common platform.  These days, of course, we have often have ministers outside Cabinet who are representing parties not considered part of the government, and those ministers –  not having a common programme –  are not bound by the conventions (which is all they are) of Cabinet collective responsibility.

But even if Cabinet collective responsibility is one legitimate model, it is hardly the only one.  In Parliament, for example, laws are debated and passed, and who voted for the law and who voted against it is no secret.  MPs lobby, and are lobbied, give speeches, go on disagreeing after the final vote, but the law is the law.  The authority and robustness of the law is not diminished by robust open debate.  If anything, it is the alternative that would worry us –  the Chinese People’s Congress anyone?  Our local authorities mostly debate things openly –  majorities win, minorities lose, and life goes on.   And talking of the law, no one seems to think it a problem, that a bench of judges on the Supreme Court will often divide 3:2, and the Chief Justice might well be on the losing side.  Dissenting views can be, and typically are, properly documented and made available.

And it is worth reminding ourselves the nature of the OCR decisions. They aren’t once-for-all decisions, but ones that are revisted every couple of months, precisely because new data come available, and what to make of that data remains very uncertain.   There are, often enough, no self-evidently “correct” answers.   It is the sort of climate in which good decisionmaking is likely to be advanced by as open an approach as possible, and public confidence in the quality of the decisionmaking is likely to be advanced by the ability of citizens to assess the arguments (and the quality of the argumentation) of those given statutory power to make these decisions.  Truth doesn’t simply flow from the Reserve Bank to the public.

And the open approach seems to work in a variety of other countries.  It isn’t the only approach that can work.  But it does work, without obvious problems, in Sweden, in the UK, in the United States, three otherwise quite different countries.  There is no reason why it shouldn’t work here.

How might a reformed Reserve Bank work in respect of monetary policy?

  • The (monetary) policy targets should be set by the Minister of Finance in each year’s Budget (essentially the UK system),
  • all members of the statutory Monetary Policy Committee should be appointed directly by the Minister of Finance (the Australian system),
  • all members should be subject to confirmation hearings at Parliament’s Finance and Expenditure Committee.   Members would not be subject to parliamentary ratification, but the committee could publish any serious concerns it hard (essentially the UK system),
  • probably a five member committee (Governor, a Deputy Governor, and three non-executive members), with all members having overlapping five year terms (the Swedish system has a majority of external members),
  • a statutory requirement to publish the minutes of MPC meetings, including the numerical vote on any OCR decision, within two weeks of the meeting date (publication of minutes, on a timely basis, is now pretty standard),
  • publication of all the background documents for each monetary policy decision within two months of the relevant policy annoucement,
  • no statutory prohibitions on the ability of individual members to make speeches or give interviews on monetary policy matters (pretty standard these days).

On that final bullet point, I don’t think this is a matter for statute, and it is something the new Monetary Policy Committee should work out for themselves over time.  Institutional cultures need to be able to be able to evolve.  Having said that, I would strongly favour a more open approach –  of the sort that works well in several countries abroad – and would encourage the government to appoint people (as Governor and as committee members) who are committed to building an open institution, and yet who can engage effectively, and with mutual respect, with each other.

I’d also establish a statutory provision allowing the Minister of Finance to appoint an external reviewer perhaps every five years, to encourage periodic  independent external review of how the system is working, and of how the Bank has been conducting monetary policy.

Many of the issues are about culture rather than statute, but I would hope that the new Governor will look carefully at encouraging staff to engage more openly on policy and analytical issues.   Blogs have been adopted by several overseas central banks, but the precise vehicle is less the issue than the cultural change that should be encouraged.

None of this sketch outline should be considered as the details of what I might recommend to the government’s review when it gets underway.  There are lots of fine-grained details to consider in reshaping the statutory provisions around monetary policy, and quite a few interdependencies among them (let alone interdependencies with other functions, and issues around what –  precisely –  an MPC would and wouldn’t be responsible for).  If they invite proper submissions, I will make one –  and publish it –  but my point today has really just been twofold:

  • open systems work well in various other countries –  including countries with central banks that are at least as well-regarded (generally better in my view) than our Reserve Bank, and
  • to sketch out a set of arrangements that look as though they could be workable for New Zealand and which could, with goodwill and the right people appointed, deliver us a more open, more effective, and better-regarded central bank for New Zealand.

And to suggest that, no matter how genuinely Spencer and Bascand might believe their points in opposition to serious reform, the views of the Reserve Bank “old guard” are best seen as (predictably) serving the interests of Bank management, rather than those of the public, and shouldn’t be taken very seriously unless they can advance much more evidence (than the zero so far) of the sort of potential problems the sorts of open systems that work well in other countries might credibly pose.

It isn’t clear how committed the government is to serious reform. But they have an open opportunity to put in place something much better and different, more suited for this generation.  Doing so will require good laws and good people.  I hope they don’t let the opportunities –  on either front –  slip by.

 

Competitiveness indicators well out of line

Michael Reddell Exchange rate, New Zealand economic performance, Productivity

In my post yesterday, buried well down amid long and fairly geeky material, I showed this chart.

wages and nomina GDP phw an unadj.png

Using official SNZ data, it suggests that over the last 15 years or so nominal wage rates in New Zealand have risen materially faster than the income-generating capacity of the New Zealand economy (nominal GDP per hour worked –  a measure that takes account of the terms of trade).   Since a big part of what New Zealand firms are selling when they try to compete internationally is (the fruits of) New Zealand labour, it probably shouldn’t be too surprising that our tradables sector producers have been struggling. As a reminder, we’ve had no growth in (a proxy measures of) real tradables sector GDP since around 2000 –  two whole governments ago.

The OECD publishes a real exchange series, all the way back to 1970, using real unit labour cost data.  Unit labour costs are, in effect, wages adjusted for productivity growth.  The real exchange rate measures compares how our economy has done on this competitiveness measure.

OECD real ULC

(There are other real exchange rate measures in which the fine details are less stark, but the picture is very similar.)

Broadly speaking, our real exchange rate was trending gradually downwards for the first 30 years of the series.  And each trough was a bit lower than the one before it.  That was, more or less, what one might have expected.  New Zealand’s productivity performance had been lousy relative to those of other OECD countries, and countries with weak relative productivity performance should expect to experience a depreciating real exchange rate.   On one telling, the weaker exchange rate helps offset the disadvantage of the lagging productivity.  On another, given that tradables prices are set internationally, a country with a weak productivity growth performance will tend to have weaker (than other countries) non-tradables inflation.    Another way of expressing the real exchange rate is the price of non-tradables relative to the (internationally set) price of tradables.

But over the last 15 years or so, we’ve seen something quite different.  The real exchange rate isn’t trending downwards any longer.   In fact, there has been a really sharp increase.   Competitiveness, on this measure, has been severely impaired.

It is not as if, after all, productivity growth has suddenly accelerated in New Zealand relative to other advanced countries.  We’ve done no better than hold our own against the median of the older advanced economies, and we’ve been achieving much less productivity growth than, say, the former communist eastern and central European OECD countries.     But on this measure, the real exchange rate recently has been 40 per cent above the average level in the 1990s, and even higher than it was in the early 1970s.

But aren’t the terms of trade extraordinarily high too?  Well, in fact, no.     They’ve increased quite a lot in the last 15 years or so, but here is a chart showing the terms of trade back to 1914 (using the long-term historical research series on the SNZ website and, since 1987, official SNZ data).

TOT back to 1914

Current levels aren’t much different from the average level for the quarter-century after World War Two.

On this OECD measure, the real exchange rate is higher than it was in the early 1970s (the previous peak in the terms of trade).  But since then, productivity growth (real GDP per hour worked) is estimated to have been far less than the median advanced economy experienced over that period.  In other words, the median OECD country (those 22 for which the OECD has data for the whole period) managed productivity growth  of around 150 per cent over 1970 to 2015 (the most recent year for which there is data for all countries) and New Zealand managed productivity growth of only 75 per cent.  It would take almost a 50 per cent increase in New Zealand’s productivity –  all other countries showing no growth –  to recover the relative position we had in 1970.

Competitiveness is a really major issue for the New Zealand economy.  It isn’t so much of an issue for the firms that operate here now –  they’ve survived and adapted.  It is more about the firms that never started-up, or which started up and couldn’t make it, or which started, flourished and found that they could prosper rather better abroad.   As trade shares (of GDP) shrink, in many respects this is a de-globalising economy.

Which made it rather odd to hear the (economist purporting to be the) “acting Governor” of the Reserve Bank declare that he, and the Bank, were comfortable with the level of the real exchange rate after the recent 5 per cent fall.  He declared that the exchange rate was now close to “sustainable, fair value”.    Taking a real economic perspective, it is anything but.

Such imbalances don’t have anything much to do with monetary policy, but they are symptoms of policy failures that need addressing urgently if we are to finally begin to turn around many decades –  stretching back even 20 years before 1970 –  of sustained economic underperformance.

 

Some labour market statistics that really should be looked into

Michael Reddell labour market, New Zealand economic performance, wages

There was a curious line in the Labour-New Zealand First agreement, under “Economy”.

Review the official measures for unemployment to ensure they accurately reflect the workforce of the 21st century.

I wasn’t (and still am not) clear what the two parties had in mind.  It got some people rather hot and bothered, with suggestions of political interference to get numbers that happened to suit the government of the day.  That interpretation seemed pretty far-fetched.  Plenty of people –  politicians included –  have views on what Statistics New Zealand should collect and report data on.  And governments have to decide what to fund Statistics New Zealand for –  regional nominal GDP data got added to the mix a while ago, there are now weird (and intrusive) things like the General Social Survey, and on the other hand we still don’t have monthly CPI data, monthly industrial production data (in both cases, unlike almost every other advanced country) or quarterly income-based measures of GDP.   Rather rashly, governments and SNZ appear on course to degrade our travel and immigration data.

So I don’t have a problem if parties to a government want to have a look again at some or other area of our official statistics, and perhaps even get Treasury and MBIE to commission some expert or other to have a fresh look at indicators of unemployment etc.  I’d be even more pleased if such a review led to the allocation of a bit more money to Statistics New Zealand.  But I’m not sure there is much of a problem with the HLFS as it is, even if my confidence in the data have taken a bit of a dip since my household has been in the survey (over the last few quarters).   Oh, and when they made changes to the HLFS last year, and made no attempt to backdate the new employment and hours series, simply leaving a level shift in the official series that was a bit trying too (one always has to remember to make a rough and ready adjustment for the break – I almost forgot to in the charts below).

Is it a bit odd and arbitrary that the headline measure of unemployment doesn’t count you as unemployed if you managed one hour’s paid work in the survey week, even if that was the only hour you managed to get all quarter and you’d really like a 40 hour a week job?    Absolutely it is.    But so long as the headline unemployment measures are used either for cross-country comparisons, or for comparisons within New Zealand over time, precisely where one draws that (inevitably) arbitrary line won’t matter very much.  Other countries also calculate headline unemployment rates that way, and we’ve been using the HLFS since 1986.

It is more of a problem when complacent commentators misuse the measure to go on about how “unemployment” is “only” 4.6 per cent, as if all is rosy.   Of course, even a 5 per cent “true” unemployment rate would mean that over a 40 year working life, the typical person would be unemployed –  on the quite narrow definition –  for two years.  That is a large chunk of time, and (like me) probably few of those commentators ever spent any time unemployed on this measure.

But SNZ does now do quite a reasonable job of providing a richer array of data that enables users –  and media and other commentators –  to get a fuller picture of overall supply/demand imbalances in the labour market.  We have data on the people in part-time work who would like to work more hours.  And data on people who would like a job but have become discouraged by repeated failure, and have given up searching (to the definitions of the HLFS).  Outside the HLFS we have data on those on welfare benefits.  Now there is even an official underutilisation rate, which can also be compared across time and (with more difficulty) across countries.   At 11.8 per cent that is a pretty high number, and probably one that –  were it more widely known –  would trouble many people (as it does me).   These numbers tend not to matter much to macroeconomic commentators, focused mostly on cyclical fluctuations, since the various different series tend to move together and a demand for long-term time series drives people quickly back to the headline measure.  But it doesn’t make the other measures less valuable or important for other purposes.

It is meaningless to say that “the” unemployment rate is 4.6 per cent, but that would have been as true in 1997 as it is 2017.  Then again, it probably isn’t meaningless to say that all the measures of excess labor supply are higher than they were 10 years ago, a period over which demographic trends have probably been working to lower the long-run sustainable rate of unemployment (on whichever measure you choose).

Statistics New Zealand don’t seem any better informed about the review

[Labour market manager] Ramsay said Statistics NZ had no more information about the review apart from what was in the coalition agreement.

“Nothing at this point. No content at all.”

But if there are resources to spend on reviewing and improving labour market statistics, I’d be making a bid for something around wages data.

A repeated theme from the Labour Party during the election campaign was that wage growth has been slow, and that this needed to change.  When the Labour Party leader was, at times, challenged about this claim, her response was that people didn’t “feel” better off.    Now, I’m sure perceptions matter a lot in politics, but ideally perceptions –  and the policies of governments – will be informed and shaped by the data, rather than the other way round.

In a post a few months ago I illustrated, using national accounts data, that the labour share of income has been trending up in New Zealand over the last 15 years or so.  COE

Over that period, on official data, New Zealand’s experience has been quite different from that of the other Anglo countries (and much of the commentary we read is British or American).  Across the OECD as a whole, the labour share in the median country hasn’t changed in the last 15 years, and New Zealand has had one of the larger increases. [UPDATE: An interesting illustration of how different the Australian experience has been.]

One of the problems in making sense of what is going on is that (a) we don’t have a quarterly income-based measure of GDP, so we fall back on the published wages data, and (b) the published wages data are all over the place.

Still most widely quoted is the very-volatile Quarterly Employment Survey measure of average hourly wage rates, a measure that (by construction) is subject to compositional changes  (if, this quarter, lots more low-skilled get jobs, even at good wage rates for those jobs, average hourly wage rates will fall even though no one is earning less per hour than they were).

Then there is the Labour Cost Index (LCI) which doesn’t purport to be a series of wage rates, but rather a proxy for unit labour costs. In other words, it is an attempt to measure wages adjusted for changes in productivity etc.  It is a smooth series, and is given prominence by SNZ, but it tells us nothing at all about the growth in the hourly earnings of the people who are in employment (adjusted for changes in composition).

And then there is the Analytical Unadjusted Index.  Even the name would deter most casual users.  It is found buried among the Labour Cost Index series, and  –  at least on paper –  looks like the best series we have.  It is constructed from the raw wages data SNZ collects to generate the headline LCI series, and is constructed in a stratifed way, to eliminate (or minimise) distortions arising from compositional changes.

This is what inflation in the Analytical Unadjusted series looks like

analytical unadj nov 17

It is relatively smooth –  conforming to economists’ priors about how labour markets work –  and, of course, (nominal) wage inflation is much lower it was a decade ago.  (Remember that the tick up in the most recent quarter is the impact of the pay-equity settlement.)    Of course, CPI inflation is also a lot lower than it was then.

A couple of months ago, I did a post using the Analytical Unadjusted data, deflating it by core inflation and comparing it with growth in real GDP per hour worked.  Real wage inflation appeared to have been running well ahead of productivity growth (the latter, non-existent, in aggregate, for the last five years).

But in that chart, I didn’t take account of the terms of trade.  A higher terms of trade – and New Zealand’s have done quite well in the last 15 years or so –  lifts the incomes the economy can afford to pay.  A better way to look at things might be to compare nominal wage growth with growth in nominal GDP per hour worked.  There is a lot of short-term variability in nominal GDP growth –  as dairy and oil prices ebb and flow  – but if we look at cumulative growth over fairly long periods we might hope to find something interesting.  Over very long periods of time we might expect hourly wage rates to increase at around the rate of growth in nominal GDP per hour worked.

The Analytical Unadjusted data go back to mid 1990s for the whole economy, and to the late 1990s for the private sector.   Here is what the resulting chart looks like.  Both series –  wage rates and nominal GDP per hour worked – are indexed to 100 when the Analytical Unadjusted data start.  (Recall that we still only have q2 GDP data).   I’m showing the ratio of the two series: when the line is rising, wage rates are rising faster than nominal GDP per hour worked.

wages and nomina GDP phw an unadj.png

For the first seven or eight years, the chart looks much as you’d expect.    There is quarter to quarter volatility in GDP, which is reflected in the ratio, but broadly wages were rising at around the rate of growth of  nominal GDP per hour worked.  Wages outstripped nominal GDP growth in the late boom years –  even as the terms of trade were rising –  and have done so again, in the last five years.   Over the last 15 years, private sector wage rates –  on this measure –  have risen perhaps 12 per cent faster than growth in the value of nominal GDP per hour worked.  (And the tax switch in 2010 will have boosted nominal GDP, without any reason to expect it would change pre-tax wage rates. so the “true” increases in wages relative to underlying GDP is even larger than the chart suggests).

I find this picture plausible, and I think I can tell a sensible story about what might have been going on.  But before I tell that story, here’s an alternative chart.    The QES wages data go back further, to 1989.  And here is what the chart of QES ordinary time wages rates looks like relative to growth in nominal GDP per hour worked back to 1989.

wages and nom GDP QES

It is on exactly the same scale as the previous chart.  But on this measure, private sector wages have barely kept pace with nominal GDP per hour worked growth over almost 30 years now (and have been losing ground since end of the 1990s), while public sector wage rates have outperformed (but almost all the out-performance was in the 1990s, under those spendthrifts, Ruth Richardson and Jenny Shipley.

I just don’t believe that the QES picture is portraying an accurate picture of what has been going on in the labour market.  For a start, it is inconsistent with the national accounts (the labour income share chart, which suggests that something turned in labour’s favour 15 years or so ago).  And the labour income share chart looks more consistent with the stratifed Analytical Unadjusted based measure.

To be clear, I’m not suggesting that labour has done particularly well.  The productivity performance of the New Zealand economy has been pretty lousy –  especially in the last five years –  and the unexpected (and outside our control) improvement in the terms of trade only offsets a bit of that gap.   Absolute levels of nominal GDP per hour worked in New Zealand remain very low by advanced country standards and, thus, so do wage rates.   But given the relatively poor performance of the economy as a whole, labour hasn’t done badly at all.  If people have feelings about these things it doesn’t look as though they should be about evil capitalists (or evil governments) rapaciously transferring money to themselves or their rich mates.  Simply that poorly performing economies –  with little or no productivity growth –  shouldn’t expect much wage inflation.  If there is rage, it should be about successive governments of both parties that have done nothing to redress that failure.

There might still be some serious problems with the statistics.  But if the Analytical Unadjusted series is roughly right (even if not many commentators cite it), how might one explain what it shows?  My explanation is pretty simple: the (real) exchange rate, which stepped up sharply about 15 years ago and has never sustainably come down since.    When the exchange rate is high, firms in the tradables sectors make less money than they otherwise would have done.   The usual counter to that is that the terms of trade have risen.  But the increase in the real exchange rate has been considerably more than the higher terms of trade would warrant, and in any case much of the gains in the terms of trade have come in the form of lower real import prices, rather than higher real export prices.

And why has the exchange rate been so high?  Because the economy has been strongly skewed towards the non-tradables sector which –  by definition –  does not face the test of international competition.  Demand for labour in that sector has been strong, on average, over the last 15 years, and it is the non-tradables sector that has, in effect, set the marginal price for labour.  For those firms, in aggregate, the lack of productivity growth doesn’t matter much –  they pass costs on to customers.  But it matters a lot for tradables sector producers, who have to pay the market price for labour, with no ability to pass those costs on (while the exchange rate puts downward pressure on their overall returns).  Another definition of the real exchange rate is the price of non-tradables relative to those of tradables. Consistent with this sort of story, in per capita terms real tradables sector GDP peaked back in 2004 (levels that is, not growth rates).

Perhaps it isn’t the correct story. Perhaps there is some serious problem with the data.  But if the government is serious about the words in the Speech from the Throne

A shift is required to create a more productive economy

one (small) step towards getting there might be set out to resolve the puzzles, and apparent inconsistencies, in our labour market (wages) data.  At present though, the best-constructed series suggests a badly-unbalanced economy.  Workers haven’t done badly given the poor performance of the overall economy, but the foundations haven’t been laid for durable real income growth –  if anything, they’ve been progressively whittled away as the foreign trade share of the economy has eroded.

 

 

 

 

The Reserve Bank second XI takes the field

Michael Reddell Monetary policy, Reserve Bank, Reserve Bank Act reforms

The second XI at the Reserve Bank fronted up to present today’s Monetary Policy Statement.    There was the unlawfully appointed “acting Governor” Grant Spencer –  who is now signing himself as “Governor”, not even as acting Governor –  the chief economist, John McDermott, and the new head of financial stability (and openly acknowledged applicant for Governor) Geoff Bascand.    At best, they are holding the fort until the new Governor is appointed, and a new Policy Targets Agreement put in place, but despite that Spencer still felt confident enough to assert that “monetary policy will remain accommodative for a considerable period”.     How would he know?  He won’t be there.

One could feel a little sorry for the Bank.  After all, not only is the second XI holding the fort, but a new government took office only a week or so ago.    Between Labour’s manifesto commitments and the agreements with New Zealand First and the Greens, there are a lot of new policy measures coming.  But there is not a lot of detail on most of them.    The Bank’s typical approach in the past has been not to incorporate things into the economic projections until they become law (at, in the case of fiscal policy, in a Budget).   They’ve departed from that approach on this occasion, and have incorporated estimates of the macro effects of four new policies:

  • fiscal policy,
  • minimum wage policy,
  • Kiwibuild, and
  • changes to visa requirements affecting students and work visas.

I suspect they’d have been better to have waited.  On fiscal policy, for example, there are no publically available numbers yet –  just last week the Prime Minister told us to wait for the HYEFU.    On immigration, there has been nothing from the new government on the timing of any changes.  And on Kiwibuild, there is no sign of any analysis behind the assumption the Bank has made that around half of Kiwibuild activity will displace private sector building that would otherwise have taken place.  And so on.

And then there are the numerous other policy promises the Bank hasn’t accounted for.  In the Speech from the Throne yesterday there was a clear commitment to “remove the Auckland urban growth boundary and free up density controls” in this term of government.  If so, surely that would be expected to affect house prices and perhaps building activity?   Binding carbon budgets are also likely to have macro effects.

I’m not suggesting the Bank can produce good estimates for any of these effects.  Rather, they’d have been better to have stayed on the sidelines for a bit longer, since they were under no pressure at all to change the OCR today, rather than incorporate rough and ready estimates of a handful of forthcoming changes, with little sign that they have really stood back and thought about how the economy is unfolding.

And the conclusions they’ve come to do seem rather questionable.  The “acting Governor” kicked off his press conference talking of the “very positive” economic outlook.  I’m not sure how many other people will agree with him. As the Bank themselves note, they’ve been surprised on the downside by recent GDP outcomes, and housing market activity has been fading.  Even dairy prices have been edging back down, and oil prices have been rising.  (And, of course, there has been no productivity growth for years.)

The Bank forecasts an acceleration of economic growth –  even as population growth slows –  on the back of additional fiscal stimulus and additional building activity under the Kiwibuild programme.    Like other commentators, I’m rather sceptical that we will see anything quite that strong.  But even on their own numbers, productivity growth over the next few years is now projected to be weaker than the Bank was projecting in August.       And if Kiwibuild really is going to add so much to housing supply, in conjunction with slower population growth than the Bank was expecting, how plausible is it real house prices will simply be flat as far the eye can see (or the forecasts go)?  Not very, I’d have thought.

In the end, the numbers don’t matter very much.  Spencer will be gone at the end of March, and we’ll have a new Governor and a new PTA.  A new Governor will make his or her own assessment, and own OCR decisions.  But part of what that person will need to do is take a look at lifting the quality of the Bank’s economic analysis.

For all the talk of initiatives promised by the new government, the Monetary Policy Statement itself was striking for containing not a word –  not one –  mentioning that the monetary policy regime itself is under review.  Of course the “acting Governor” can’t pre-empt changes the detail of which aren’t known, but the Act does require the Bank to discuss in MPSs how monetary policy might be conducted over the following five years: a horizon over which we’ll have a different PTA, a different Governor, an amended statutory mandate, and a statutory committee to make decisions.

My main interest was in the contents of the press conference, where journalists raised both the issue of the proposed new mandate and the proposed changes to the statutory decisionmaking model.    In both cases, I suspect the second XI said too much.

Asked about the proposed mandate changes, Spencer began noting that he couldn’t say too much as the review was just getting started.  He then went on to assert that “moving to a dual mandate was unlikely to have a major impact on how policy is run”, explaining that in many ways flexible inflation targeting is akin to a “dual mandate” (something that, in principle, I agree with).     But then, somewhat surprisingly, he claimed that the proposed change could lead the Bank to become more flexible, potentially allowing greater volatility in inflation to promote greater stability in employment.  I guess it depends on the details of the changes, which none of us yet knows, but it was the first I’d heard of anyone calling for more volatility in inflation.  Over the last decade, those who think the Bank hasn’t put sufficient weight on the labour market indicators (like me) would have been quite happy to have seen core inflation at the target midpoint on average.  The previous Governor committed to that, but didn’t deliver.

On which note, it was a little surprising to hear the Chief Economist talk about how the Bank had improved its forecasts, and got its inflation forecasts right over the last couple of years.  That would then explain why core inflation has remained persistently below the target midpoint???  And has not got even a jot closer in the last couple of years?

Spencer noted that at present the Bank regarded the labour market as ‘pretty balanced’, such that a dual mandate wouldn’t make much difference right now.   But it turns out that they really don’t know.

They were asked a question about the government’s goal of getting the unemployment rate below 4 per cent, and –  fairly enough –  drew a distinction between structural policies that might lower the NAIRU and anything monetary policy could do.  When pushed, they argued that on current structural policies, an unemployment rate lower than 4 per cent would be inflationary, and suggested that estimates of the NAIRU range from 4 to 5 per cent at present.

But then all three of the second XI went on.  Spencer noted that the estimates are ‘very uncertain” and that in anticipation of a “dual mandate” the Bank was now doing some work to come up with some estimates of the NAIRU, suggesting that they haven’t had a precise estimate until now [although there were always assumptions embedded in the model].    Then the chief economist –  who at almost every press conference tries to discourage the use  of a NAIRU concept –  chipped in claiming that any NAIRU was “very very variable” and “changes all the time”, without offering a shred of evidence for that proposition.

And then the head of financial stability chipped in, opining that estimates of NAIRUs around the world have been declining (not apparently seeing any connection between this thought and (a) the NZ experience, and (b) his colleague’s observation a few moments earlier that the numbers were pretty meaningless anyway.

Out of curiousity I had a look at the OECD’s published NAIRU estimates.  This is the NAIRU for the median OECD monetary areas (ie countries with their own monetary policy plus the euro-area as a whole).

nairu oecd

The estimate for 2017 is 5.3 per cent.  That for 2007 was 5.5 per cent.     There just isn’t much short-run variability in the structural estimates of the long-run sustainable unemployment rate. That is true for other advanced countries.  It is almost certainly true for New Zealand.    It reflects poorly on the Reserve Bank how little they’ve done in this area, and it one reason why a change in the wording of the statutory mandate is appropriate.  The unemployment rate is a major measure of excess capacity, pretty closely studied by most central banks but not, until now it appears, by our own.

(Of course, had they wanted to be a little controversial, they could have noted that proposed structural policy changes –  notably the increased minimum wages they explicitly allowed for –  will tend to raise (not lower) the NAIRU to some extent.)

If they were at sea on the unemployment rate issue, what really staggered me was the way Spencer (and Bascand) used the press conference to campaign for minimal changes to the statutory governance and decisionmaking model for monetary policy.      They didn’t need to say more than “decisionmaking structures are ultimately a matter for Parliament, and we will be providing some technical input and advice to the Treasury-led process the Minister of FInance announced earlier in the week”.

But instead, they took the opportunity to campaign for as little change as possible.  Spencer noted that they agreed the Act should be changed to provide for a committee, but noted that they already had a committee, they thought it worked well, and they would like to reflect that in the Act.   Others might challenge whether the advisory committee, or the Governor, has done such a good job in the last five years (or today) but set that to one side for the moment.

They loftily conceded that there were possible advantages to having externals on a committee –  the potential for greater diversity of view. But they were concerned that in a small country it could be very difficult to find outsiders with unconflicted expertise to make the system work.  There was nothing to back this –  no explanation, for example, as to how places like Norway and Sweden manage, or how we manage to fill the numerous other government boards in New Zealand.

But what they really hate –  and I knew this, but was still surprised to hear them proclaim it so openly, just as a proper review is getting underway –  is the idea that any differences of view might be known to the public.   They could, we were told, tolerate a system of ‘collective responsibility’ –  in which all debates are in-house and then everyone presents a monolithic front externally –  but were strongly opposed to any sort “individualistic committee” in which individual views might become known.    These systems –  of the sort prevailing in the UK, the United States, Sweden, and the euro-area –  have, they claimed, the potential to become a “circus” with too much media focus on monetary policy, and a concern about “heightened volaility” in financial markets.   Spencer went so far as to suggest that an individualistic approach could undermine the reputation and credibility of the institution.

A slightly flippant observer might suggest that the second XI and their former boss have done that all by themselves –  between the actual conduct of policy, and attempts (in which they all participated) to silence one of their chief critics.  A more serious observer might ask for some evidence from the international experience, to suggest that the more individualistic approach has damaged the standing of the Fed, the BOE, or the Riksbank.  Are these less well-regarded organisations than the Reserve Bank of New Zealand?    I’d have thought it would be hard to find such evidence.

Bascand –  one of the declared candidates for Governor –  then chipped in to note that what management was concerned about was to ensure that the focus of discussion was on the issues “the Bank” had identified, not on individuals or their particular views. Loftily –  earnestly no doubt – he declared that they wanted the focus to be on substance.  No doubt, as defined by management.   It reinforces the point I’ve made often that Bascand is the candidate for the status quo.  Bureaucrats setting out to protect their bureau.  Predictable behaviour – even if usually more subtle than this –  and what the public need protecting from.

There are successful central banks that adopt the collegial approach –  the RBA is one, albeit one with a rather old-fashioned committee decisionmaking model –  but there is nothing to suggest, in the international experience, that that model produces better outcomes, or a more credible central bank, than the individualistic approach.  Indeed, many observers would regard Lars Svensson’s open disagreement with his colleagues on the Riksbank decisionmaking committee as a useful part of the process that finally led the rest of the committee, including the Governor, to abandon their previous excessively hawkish approach a few years ago.

The second XI’s approach is that of “the priesthood of the temple” –  we will tell you, the great unwashed, only what it suits us to tell you, in the form we want to present it.  It is simply out of step with notions of open government, or with a serious recognition that monetary policy is an area of great uncertainty and understanding is most likely to be advanced by the open challenge and contest of ideas.

Fortunately, the new government shows signs of seeing things differently.   There is a minister for open government (admittedly, lowly ranked), a commitment to improving transparency under the Official Information Act.  And in the Speech from the Throne yesterday there was an explicit commitment –  not referenced by the Second XI, still trying to relitigate – that

“The Bank’s decision-making processes will be changed so that a committee, including external appointees, will be responsible for setting the Official Cash Rate, improving transparency.”

Note the use of “will”.   The Bank management’s preference for a “collective model” would do nothing at all to improve transparency.

It is all a reminder of how uncertain things still are, and how important the membership of the Independent Expert Advisory Panel the Minister of Finance has pledged to appoint as part of review of the Act might be (including whether the panel is really “expert” or –  as rumour suggests – a politician might chair it).   And also how important it is that Bank management do not have a leading say in the advice that goes to the Minister.  Management is paid to implement Parliament’s choices, not to devise models that cement in the dominance (and secrecy) of management.

It is also a reminder of just how important the appointment of the new Governor is, and why it remains hard to be confident about just how committed the government is to serious change when they’ve left that appointment in the hands of the Reserve Bank Board –  all appointed by the previous government, all on record endorsing the way things have gone for the last five years, and with a strong track record of serving the interests of management rather than those of (a) the public and (b) good public policy.

700 years of real interest rates

Michael Reddell Economic history, Interest rates

When I mentioned to my wife this morning that I’d been reading a fascinating post about 700 years of real interest rate data her response was that that was the single most nerdy thing I’d said in the 20 years we’ve known each other (and that there had been quite a lot of competition).   Personally, I probably give higher “nerd” marks to the day she actually asked for an explanation of how interest rate swaps worked.

The post in question was on the Bank of England’s staff blog Bank Underground, written by a visiting Harvard historian, and drawing on a staff working paper the same author has written on  bond bull markets and subsequent reversals.    It looks interesting, although I haven’t yet read it.

Here is the nominal bond rate series Schmelzing constructed back to 1311.

very long term nom int rates

And with a bit more effort, and no doubt some heroic assumptions at times, it leads to this real rate series.

very long-term real rates.png

Loosely speaking, on this measure, the trend decline has been underway for 450 years or so.   It rather puts the 1980s (high real global rates) in some sort of context.

In the blog post the series is described this way

We trace the use of the dominant risk-free [emphasis added] asset over time, starting with sovereign rates in the Italian city states in the 14th and 15th centuries, later switching to long-term rates in Spain, followed by the Province of Holland, since 1703 the UK, subsequently Germany, and finally the US.

In the working paper itself, “risk-free” (rather more correctly) appears in quote marks.  In fact, what he has done is construct a series of government bonds rates from the markets that were the leading financial centres of their days.     That might be a sensible base to work from in comparing returns on different assets –  perhaps constructing historical CAPM estimates –  but if US and West German government debt has been largely considered free of default risk in the last few decades, that certainly wasn’t true of many of the issuers in earlier centuries.  Spain accounts for a fair chunk of the series –  most of the 16th century  – but a recent academic book (very readable) bears the title Lending to the borrower from hell: Debt, taxes, and default in the age of Philip II.  Philip defaulted four times ‘yet he never lost access to capital markets and could borrow again within a year or two of each default’.  Risk was, and presumably is, priced.  Philip was hardly the only sovereign borrower to default.  Or –  which should matter more to the pricing of risk –  to pose a risk of default.

In just the last 100 years, Germany (by hyperinflation), the United Kingdom (on its war loans) and the United States (abrograting the gold convertibility clauses in bonds) have all in effect defaulted – the three most recent countries in the chart.  Perhaps one thing that is different about the last 30 or 40 years is the default has become beyond the conception of lenders.  Perhaps prolonged periods of peace –  or minor conflicts – help produce that sort of confidence, well-founded or not.

I’m not suggesting that real interest rates haven’t fallen.  They clearly have. But very very long-term levels comparisons of the sort in the charts above might well be concealing as much as they are revealing.    They certainly don’t capture –  say –  a centuries-long decline in productivity growth (productivity growth really only picked up from the 19th century) or changing demographics (again, rapid population growth was mostly a 19th and 20th century thing).  And interest rates meant something quite different in an economy where (for example) house mortgages weren’t pervasive –  or even enforceable – than they do today.

As for New Zealand, at the turn of the 20th century our government long-term bonds (30 years) were yielding about 3.5 per cent, in an era when there was no expected inflation.  Yesterday, according to the Reserve Bank, the longest maturity government bond (an inflation-indexed one) was yielding a real return of 2.13 per cent per annum.    Real governments yields have certainly fallen over that 100+ year period, but at the turn of the 20th century New Zealand was one of the most indebted countries on the planet  whereas these days we bask in the warm glow of some of the stronger government accounts anywhere.  Adjusted for changes in credit risk it is a bit surprising how small the compression in real New Zealand yields has been.

The Robertson reviews of the RB Act

Michael Reddell Rennie review, Reserve Bank, Reserve Bank Act reforms

When you’ve favoured a reform for the best part of 20 years, and made the case for it –  inside the bureaucracy and out –  for several years, then, even though it was a reform whose time was coming eventually, there is something deeply satisfying about hearing the Minister of Finance confirm that legislative change will happen.    That was my situation yesterday when Grant Robertson released the terms of reference for the review of the Reserve Bank Act, including specific steps that will before long end the single decisionmaker approach to managing monetary policy.   Various Opposition parties had called for change (the Greens for the longest), market economists had favoured change,  The Treasury had tried to interest the previous government in change five or six years ago, before Graeme Wheeler was appointed.  But now the Minister of Finance has confirmed the government’s intention to introduce legislation next year.   The amended legislation won’t be in place before the new Governor takes office, but presumably the policy will be clear enough by then that the new Governor will know what to expect, and what is expected of him or her.  Reform was overdue, but at least it now looks as though it will happen.

There were several aspects to yesterday’s announcement from the Minister of Finance:

  • the new “Policy Targets Agreement”,
  • the two stage process for an overhaul of the Reserve Bank Act, and
  • inaction on the appointment of the new Governor.

In what looks like not much more than a photo opportunity, Grant Robertson got Grant Spencer, current “acting Governor” of the Reserve Bank over to his office and together they signed a “Policy Targets Agreement” that was, in substance, identical to the one Steven Joyce and Grant Spencer had signed in June.

There was no legal need for a new Policy Targets Agreement (even if either of these two documents had legal force, which they don’t), and no incoming Minister of Finance has ever before requested a new PTA (the Minister has to ask, and can’t insist) that is exactly the same as the unexpired one that was already in place.   When National came to power in 2008, they did ask for a new PTA.   The core of the document –  the obligations on the Governor –  weren’t altered, but they did replace clause 1(b), which describes the government’s economic policy and how the pursuit of price stability fits in.  Under Labour that had read

The objective of the Government’s economic policy is to promote sustainable and balanced economic development in order to create full employment, higher real incomes and a more equitable distribution of incomes. Price stability plays an important part in supporting the achievement of wider economic and social objectives.

National replaced that with

The Government’s economic objective is to promote a growing, open and competitive economy as the best means of delivering permanently higher incomes and living standards for New Zealanders. Price stability plays an important part in supporting this objective.

If the new Minister of Finance really thought a new PTA was required to mark his accession to office, surely he could have at least replaced the National government’s policy description with one of his own –  even simply going back to Michael Cullen’s formulation, which actually mentioned full employment.

Apart from the photo op, I’m not sure what yesterday’s re-signing was supposed to achieve.  The Minister presented it as providing certainty to markets, but it does nothing of the sort: we are in the same position now we were a couple of days ago, Robertson had already told us he wouldn’t make substantive changes until the new Governor was appointed and we still have no idea who that person will be, or what the precise mandate for monetary policy only a few months hence will look like.  Nor, presumably, does the Reserve Bank.

And by signing the document, Robertson seems to have bought into Steven Joyce’s “pretty legal” (but almost certainly nothing of the sort) approach to the appointment of an “acting Governor”.    As I’ve noted previously, the Reserve Bank Act does not provide for an acting Governor except when a Governor’s term is unexpectedly interrupted (death, dismissal, resignation or whatever), and –  consistent with this –  there is no provision in the Act for a new Policy Targets Agreement with an acting Governor (since a lawful acting Governor will only be holding the fort during the uncompleted term of a permanent Governor who would already have had a proper and binding PTA in place).    Spencer’s appointment appears to have been unlawful, and Robertson has now made himself complicit in this fast and loose approach to the law.   Consistent with the fast and loose approach, he allowed Spencer to sign yesterday’s Policy Targets Agreement as “Governor”, not as “acting Governor”.  He cannot be Governor, since under the Act any Governor has –  for good reasons around operational independence – to have been appointed for an initial term of five years.  And he isn’t acting Governor, since there is no lawful provision for him to be so in these circumstances.  At best, he is “acting Governor” –  someone purporting to hold that title.

The heart of yesterday’s announcement, however, was the two stage process for reviewing and amending the Reserve Bank Act.

Phase 1:

The review will:
• recommend changes to the Act to provide for requiring monetary policy decision-makers to give due consideration to maximising employment alongside the price stability framework; and

• recommend changes to the Act to provide for a decision-making model for monetary policy decisions, in particular the introduction of a committee approach, including the participation of external experts.

• consider whether changes are required to the role of the Reserve Bank Board as a consequence of the changes to the decision making model.

A Bill to progress the policy elements of the review, including on the details necessary to introduce a potential committee for monetary policy decisions, will be introduced as soon as possible in 2018. This will give greater certainty on the direction of reform in advance of the appointment of the next Reserve Bank Governor, currently scheduled in March 2018.

Phase 1 of the review will be led by the Treasury, on behalf of the Minister of Finance. The Treasury will work closely with the Reserve Bank who will provide expert and technical advice. An Independent Expert Advisory Panel will be appointed by the Minister of Finance to provide input and support to both phases of the Review.

Phase 2:
In line with the Government’s coalition agreement to review and reform the Reserve Bank Act, the Reserve Bank and the Treasury will jointly produce a list of areas where further investigations of the Reserve Bank’s activities are desirable. This list will be produced in consultation with the Independent Expert Advisory Panel.

This list, and the next steps for the review, will be communicated early in 2018. This phase of the review will incorporate the review of the macro-prudential framework that was already scheduled for 2018.

It is clearly intended as a pragmatic approach.  With a new Governor to take office in March, they want to get on with the specific changes Labour campaigned on  so that they come into effect as soon as possible after the new Governor is in office (realistically, it is still hard to envisage the new Monetary Policy Commitee making OCR decisions and publishing Monetary Policy Statements until very late next year –  perhaps the November 2018 MPS – at the earliest.)  It also appears to aim to separate the things on which the government mostly just wants advice on how best to implement changes they’ve promised, from other issues that may need looking at but where the parties in government have not taken a strong position.

But it still leaves me a little uneasy, on a couple of counts.

First, while it would be easy enough, after due consideration, to make limited changes to the Act to give effect to the desire to make explicit a focus on employment/low unemployment without many spillovers into the rest of the Act (I listed here a handful of clauses I think they could amend to do that),  I’m less sure that is true of the monetary policy decisionmaking provisions.    As the terms of reference note, if monetary policy decisions are, in future, to be made by a statutory committee, it raises questions about the role of the Bank’s Board –  whose whole role at present is built around the single decisionmaker (the Governor has personal responsibility for all Bank decisions not just monetary policy ones).

But how can you sensibly make decisions about the future role of the Board without knowing what changes (if any) you might want to make to the Bank’s other functions?  If, in the end, you leave all the other powers in the hands of the Governor personally, something like the current Board structure might still make sense, with some minor changes as regard monetary policy decisions.  But if you concluded that a statutory committee was also appropriate for financial stability issues, and that even the corporate functions should be governed in more conventional ways (Board decides, chief executive implements), there might be no place at all for a Board of the sort (ex post monitoring and review agency) we have now.    Decisions about the governance of an institution need to start by taking account of all the responsibilities of the institution, not just one prominent set of powers.

Second, it may be difficult to maintain momentum for more comprehensive reform once the government’s own immediate priorities have been dealt with.    On paper, it doesn’t look like a problem, but resources are scarce, legislating takes time and energy, implementing new arrangements for monetary policy takes time and energy, and it would be easy for momentum on the second stage to lapse (whether at the bureaucratic level, or getting space on the government’s legislative agenda).    That risk is compounded by an important distinction between phases one and two.    In phase one, the Treasury is clearly taking the lead, on behalf the Minister.  In phase two, we are told, “the Reserve Bank and the Treasury”  (the order is theirs) will “jointly” produce a “list of areas where further investigations of the Reserve Bank’s activities are desirable”.    A joint list raises the possibility of the Bank holding a blocking veto –  not formally, but in practice –  and where the Bank is more interested in (a) blocking other far-reaching changes that might constrain management’s freedoms, and (b) advancing whatever list of minor reforms it might have in mind itself.

Perhaps in the end much will depend on the Minister himself, and on the Independent Expert Advisory Panel he plans to appoint.  But the Minister of Finance will be a very busy man, and up to now he has shown little interest in reforms of the Reserve Bank legislation beyond the first stage ones.

What of the panel?  We’ll know more when we see what sort of people are appointed to it, and how much time they are being asked to give to the issue.

In a set of Q&As released with yesterday’s announcement the Minister indicated of the panel that “they will be individuals with independence and stature in the field of monetary policy, including governance roles”.   That is probably fine for phase one (which is monetary policy focused), but the bulk of the Bank’s legislation, and much of its responsibility, has nothing to do with monetary policy at all.  So if the panel is going to play a substantive role in the planned phase 2, I’d urge the Minister to consider casting his net a bit wider.

As to who might serve on it, there aren’t that many with what look like the right mix of skill, experience, and independence.  It is sobering to reflect that when the (still secret) Rennie review on related issues was done earlier in the year, not a single domestic expert was consulted.  I imagine they will want to draw mainly on people who actually live here.  But if possible, I would urge Treasury and the Minister to consider inviting Lars Svensson to be part of the panel –  as someone who has undertaken a previous review for an earlier Labour government, someone who supports an explicit employment focus, and someone with practical experience as a monetary policy decisionmaker.    David Archer – a New Zealander (and former RB senior manager) who now heads the BIS central banking studies department – might also be worth drawing on.

The third dimension of yesterday’s announcement was the Minister of Finance’s comments about the process for appointing a new Governor.    There I think he is making a mistake.

In his Q&As, the Minister noted that “the process for appointing a new Governor is in the hands of the Board”.

Newsroom reports that, when asked, Robertson noted that

“I’ve met with the chair of the board and he has assured me that process is underway and well under way and going well. I sought an assurance from him that any candidates he was interviewing would be ones who would be able to implement a change to policy along the lines we’re going, he expressed his confidence about that but in the end the process itself lies in his hands.”

Appointing a new Governor of the Reserve Bank is –  or should be –  the most consequential appointment Robertson will make in the next three years.  For a time that person will, single-handedly, wield short-term macro-stabilisation policy (which is what monetary policy is) and –  perhaps indefinitely –  will wield all the regulatory powers of the Bank.  Even if committees end up being established for both main functions, the Governor will have –  and probably should have –  a big influence on how, and how well, macro and financial regulatory policy is conducted over the next five years.

There has been a pretty widespread sense that the Reserve Bank in recent years has not been operating at the sort of level of performance –  on various dimensions –  citizens and other stakeholders should expect.  That isn’t just about substantive decisions, but about supporting analysis, communications, operating style etc.  And yet the Reserve Bank Board –  and chairman Quigley –  have backed the past Governor all the way (whether on minor but egregious issues like the attempts to silence Stephen Toplis, or on the conduct of monetary and regulatory policy).   But the new government claims to want something different.   The issue isn’t whether a potential candidate can, as a technical matter, manage the sort of phase 1 changes the Minister plans.  I’m sure any competent manager could.  The more important issues are around alignment and vision.  Is the Minister content to leave the process to the Board –  all appointed by the previous government – and take a chance on them coming up with someone who represents more than just the status quo?   At this point, it appears so.  Apparently, the selection process will not be reopened, even though the advertising closed months ago and the role of the Bank (and Governor) is to be changed.

It is quite an (ongoing) abdication by the new Minister. In (almost all) other countries, the Governor of the Reserve Bank is appointed directly by political leaders (Minister of Finance, head of government or whoever).   Those leaders no doubt take soundings in various quarters, but the power –  and the responsibility –  rests with the politician.   Here, Grant Robertson just rolls the dice –  relying on a bunch of private sector directors appointed by his predecessors –  without (it seems, from the tone of his comment above) a high degree of confidence in the outcome.  Perhaps he’ll like who the Board comes up with. But if he doesn’t, so much time will have passed that he’ll be stuck. He can reject a Board nomination, but they’ll just come back with the next person on their own list, evaluated according to their own sense of priorities etc.  It isn’t the way appointments to very powerful positions –  the most powerful unelected person in the country for the time being –  should be done.

And two, very brief, final points:

  • now that the government has changed, and the Minister who asked for the Rennie review of Reserve Bank governance issues has gone, surely there can be no good grounds for continuing to withhold Rennie’s report and associated papers?  It is not as if it is playing any role in the current Minister’s thinking.

    Newsroom also asked Robertson if he had seen a review of the bank undertaken by former State Services Commissioner Iain Rennie that was requested by former Finance Minister Steven Joyce.   He said he was yet to see it, but had asked Treasury about it.

  • we are told to expect a new Policy Targets Agreement when the new Governor is appointed.   Presumably, true to past practice, the first the public will know about it is when the document –  guide to macro-management for the next five years –  is released.    It would good if the Minister of Finance would commit now to proper transparency, including pro-active release (once the document is signed) of  relevant documents.  It would be better still if he would think about adopting the considerably more open, and rigorous, Canadian model.

    Less than a year since completing the last review of its inflation-targeting mandate, the Bank of Canada is starting to prepare for the next one in 2021.

    Consultations kick off in Ottawa on Sept. 14 with an invitation-only workshop of economists that will be webcast on the central bank’s website. It’s an early public start to the process, and comes amid a growing sense that a deeper look at the inflation target is needed after almost a decade of poor economic performance.

A more open approach to these issues – as practised in Canada for years – has much to commend it (even if I didn’t always think so when I was a bureaucrat.)

Why are NZ interest rates so persistently high (Part 1)?

Michael Reddell Interest rates, New Zealand economic performance

On Friday, I illustrated (again) just how large and persistent the gap between New Zealand’s long-term interest rates and those in other advanced countries has been.   If anything, that gap has been larger in recent years (say, since 2009/10) than it was in the previous decade, but there has certainly been no sign of the gap shrinking.    It is at least as large now as it was 20 years ago.

Previous posts have illustrated that the gap is large and persistent however one cuts the data.  It exists whether one looks just at the big advanced economies (my charts on Friday focused on G7 countries) or just at the small ones (places like Norway, Sweden, Switzerland, and Israel).  Short-term interest rates are more variable than long-term ones, but on average the gap exists in short rates as well as long rates.  (If you aren’t convinced of the relationship between short and long rates, here are the average short and long-term interest rates for the last decade for each of the 18 OECD monetary areas –  ie countries with their own monetary policies, plus the euro-area as a bloc).

short and long term rates OECD

(The country on the far right of the chart is Iceland.)

Today’s post and tomorrow’s are about why those large and persistent gaps exist.  They will repeat material I’ve covered in earlier posts over the years, but readers come and go, old posts can be hard to find, and the issue hasn’t shown any signs of going away.   Much of today’s post is about a process of elimination: clearing away various possible explanations that, on my reading of the evidence, don’t take us very far.

10 years ago, the Reserve Bank wrote a short paper on exactly this issue.  It was part of our submission to the inquiry being undertaken into monetary policy by Parliament’s Finance and Expenditure Committee.   I wrote the paper, but it was of course signed out by the powers that be, including the then Governor Alan Bollard and his deputy Grant Spencer.  Rereading it this morning, I don’t now agree with every word of that earlier document –  partly because my own thinking has gone beyond where we had got to then – but it still does a good job of laying the foundations.  I’d be surprised if today’s Reserve Bank sees any reason to disavow that 2007 interpretation.

In writing the earlier paper, one of our main concerns was to distinguish between things the Reserve Bank could sensibly be held responsible for and things that really had little or nothing to do with us.   In particular, so we argued, the Reserve Bank sets the OCR, and expectations about the future OCR affect longer-term interest rates, but that does not mean that over prolonged periods of time the Reserve Bank gets to decide the average level of real interest rates in New Zealand.

In a mechanical sense, then, if short-term interest rates are persistently higher than those in other countries it is because the Bank put them there. However, the OCR is not set arbitrarily. Rather, the Bank looks at actual inflation outcomes, and at all the data on the outlook for inflation, before setting the OCR with the aim of keeping inflation comfortably inside the target range over the medium-term. If the Reserve Bank was consistently setting the OCR too high, we would expect over time to see inflation averaging towards the bottom end, or perhaps below the bottom, of the target range. In fact, inflation has consistently averaged in the upper half of successive target ranges – this decade, for example, inflation has averaged 2.6 percent. If monetary policy had been set consistently too tight, the solution would be easy. But there is no sign of that.

It has, at times, been argued that New Zealand’s inflation target was too ambitious and that this might explain why New Zealand’s interest rates have been persistently higher than those in other countries. In the early years of inflation targeting, our inflation target was lower than those in other countries, but …… our target (midpoint at 2 percent) has been firmly in the international mainstream. The most common developed country inflation target (actual or implicit) is around 2 percent. ……there is no convincing reason why achieving an inflation target of around 2 percent should, over time, be any more demanding in New Zealand than it is in other developed countries.

One thing has changed since then.  (Core) inflation has been averaging a bit below the target midpoint, but even so the average inflation rate here over the last five or ten years has been very similar to that in the typical (median) advanced economy.    Monetary policy settings that have been a bit tighter than necessary can, at most, explain only a small part of the average gap between New Zealand and international interest rates (nominal and real).

As we pointed out 10 years ago, credit risk wasn’t a compelling explanation either.    That story feels even more robust today than it did then.    Our government finances aren’t the very strongest in the entire OECD, but they are among the best.   And the negative net NIIP position (the net indebtedness of all New Zealand entities to the rest of the world) is smaller, as a share of GDP, than it was 10 years ago.  Plenty of observers worry about high levels of private sector credit but (a) as a share of GDP it isn’t much different now than it was 10 years ago, and (b) the crisis literature tends to worry more about quick increases in debt ratios at least as much as high levels.

(Small) size isn’t really much of an explanation either.   There are a couple of possible strands to a story about size.  The first would be something about secondary market liquidity.  The New Zealand government bond market is tiny in comparison to those of, say, the United States, Japan, France, Italy, or even Germany.   That makes it difficult, or expensive, to offload a very large position, and might (in principle) given rise to an additional “illiquidity premium” in our long-term interest rates.

In practice, it doesn’t seem likely to be a material part of the explanation.  Over the last decade, for example, our real interest rates have been about as much above those of the small well-managed OECD countries as they have been above those of the G7 countries.   And the “illiquidity premium” is a story that should apply to bond rates more than to overnight rates and yet over the last few decades our short-term rates have been higher relative to our long-term rates than has been the experience of most other advanced countries.  Over the last decade, interpreting that relationship has been made more difficult as many other countries had short-term rates near-zero and felt unable to take them any lower even if they’d wanted to.    But even over the last decade, there has been no sign that New Zealand’s long-term interest rates have been surprisingly high, given where short-term rates were.

I covered off another possible small country story in a post last November

There is another possible story which hasn’t really entered the mainstream of the New Zealand debate, but should be covered off for completeness.  It notes that New Zealand is a small country, with quite a volatile terms of trade, and that the currencies of such countries offer less-good diversification opportunities, suggesting that anyone investing here would require a higher return than elsewhere.  It sounds initially plausible, but it has a number of problems.  The first is that our interest rates have been persistently higher than those in other not-large countries with their own currencies ……  And the second is that if this were an important channel, it would suggest that small countries face a higher cost of capital than large ones, which would limit the growth prospects of small countries.  But (badly as New Zealand specifically has done) there is no real sign that small countries typically grow (per capita, or per hour worked) more slowly than large ones.  At present, I don’t think it is a particularly strong candidate to explain New Zealand’s persistently high interest rates.  Apart from anything else, if this were the story, why would New Zealand have accumulated –  and maintained – such a large negative net international investment position (NIIP) (still among the largest of the OECD countries)?

Monetary policy doesn’t explain the gaps, and neither do size or credit risks considerations.  Here was the Reserve Bank summary a decade ago

Standing back, it seems unlikely that factors such as credit risk, size and market liquidity help very much at all in explaining the persistent gap between our real interest rates and those in other developed countries. Apart from anything else, if these factors were (collectively) an important influence, we would expect to see New Zealand firms and household taking on less debt than those in other countries. In fact, of course, one of the well-recognised facts about New Zealand is that our households are highly indebted by international standards, and that the nation as a whole has been unusually willing to borrow, and raise equity capital, from abroad.

Productivity growth doesn’t help as an explanation either.

If a country had very strong persistent productivity growth it would, all else equal, tend to have higher interest rates than would be seen in other countries.  There would be lots of profitable investment opportunities in that high productivity growth country, lots of (expected) income growth that people might be consuming in anticipation of, and so on.  And over time, that high-productivity growth country could expect to see its real exchange rate rise.  Unfortunately, high productivity growth isn’t the story of New Zealand in the last few decades.  Indeed, more often rather the reverse.  Over the last five years, we’ve recorded no labour productivity growth at all.  Over the last 10 years, at best we’ve only been around a middling OECD country for productivity growth, and over longer-terms still we’ve had one of the worst records anywhere.      I illustrated a few months ago, the depressing comparisons of productivity growth between New Zealand and the emerging economies of central and eastern Europe.

A more prominent explanation for New Zealand’s persistently high interest rates points to the large negative NIIP position and asserts that the explanation for high interest rates is pretty straightforward: lots of debt means lots of risk, and hence the need for a substantial risk premium on New Zealand interest rates.  Taken in isolation –  if someone told you only that a country had a large negative NIIP position this year –  it might sound plausible.  Once you think a bit more richly about the New Zealand experience it no longer works as a story.

Here was the Reserve Bank commentary on this possible story a decade ago.

But the fact that this correlation exists between net international positions and local interest rates does not explain very much at all. In particular, it does nothing to explain what leads countries such as New Zealand to take on such large amounts of foreign capital in the first place. More specifically (and given that the Crown now has no net debt), what motivates New Zealand firms and households to take the actions that lead to this accumulation of foreign capital? And having accumulated the foreign liabilities (and New Zealand’s, as a share of GDP, have not changed much in a decade), what makes higher interest rates sustainable here for prolonged periods?

First, our NIIP has been large (and negative) for a very long time now –  for at least the last 25 years, and over that time there has been no persistent tendency for the NIIP position to get better or worse for long.  By contrast, 20 years earlier than that New Zealand had almost no net foreign debt.  The heavy government borrowing undertaken in the 70s and 80s had markedly worsened the position.  It is quite plausible that foreign lenders might then have got very nervous and wanted a premium ex ante return to cover the risk. In fact, we know some (agents of) foreign investors got very nervous –  there was the threat of a double credit rating downgrade in early 1991.  But when lenders get very nervous, borrowers tend to change their behavior, voluntarily or otherwise, working off the debt and restoring their creditworthiness.   And in New Zealand, the government did exactly that –  running more than a decade of surpluses and restoring a pretty respectable government balance sheet.  But the large interest rate differential has persisted –  in a way that it did in no other advanced country (including those that went through much worse crises and threats or crises than anything New Zealand has seen in the last 25 years).

As I’ve already touched on, short-term interest rates are set by the Reserve Bank, in response to domestic inflation pressures. But long-term interest rates are set in the markets.  If investors had really been persistently uneasy about New Zealand’s NIIP position, we might not have seen it much in short-term interest rates, but should certainly have expected to see it in the longer-term interest rates. (That, after all, is what we see in various euro countries that have lapsed in and out of near-crisis conditions).   But in one obvious place one might look for direct evidence of such a risk premium, it just isn’t there.

And remember that when risk concerns about a country/currency rise, one of the first things one typically sees –  at least in a floating exchange rate country –  is a fall in the exchange rate.  It is a bit like how things work in equity markets.  When investors get uneasy about a company, or indeed a whole market, they only rarely succeed in getting higher dividends out of the company(ies) concerned.  If the companies were sufficiently profitable to support higher dividends the concerns probably wouldn’t have arisen in the first place.  Instead, what tends to happen is that share prices fall –  and they fall to the point where expected dividends, and the expected future price appreciations of the share(s) concerned, in combination leave investors happy to hold those shares. In that process, an increased equity risk premium is built into the pricing.

At an economywide level,  if investors had had such concerns about the New Zealand economy and the accumulated net debt position, the most natural places to have seen it would have been in (a) higher long-term bond yields, and (b) a fall in the exchange rate (and perhaps a persistence of a surprisingly weak exchange rate). But we’ve seen neither in New Zealand.  Had we done so, presumably domestic demand would have weakened, and net exports would have increased.  The combined effects of those two shifts would have been to have reduced the negative NIIP position, and reduced whatever basis there had been for investors’ concerns.  Nothing in the New Zealand experience over the last 20 years or more squares with that sort of story.

And that is the really the problem with the most common stories used to explain New Zealand’s persistently high interest rates. They simply cannot explain the co-existence of high interest rates and a high exchange rate over long periods.

My story attempts to.  More on that tomorrow.