Coronavirus economics and policy: 25 March

Typing the date I notice that in the Christian calendar today is the Feast of the Annunciation –  the announcement of a coming Saviour and Redeemer – and that today it is nine months until Christmas.  One can only wonder how things will be, here and abroad, on Christmas Day 2020.

But what about current policy and related issues?  First, to get out of the way a couple of important, but less central or immediate issues.

The first is around accountability.  Personally, I’m uneasy that Parliament is simply closing down for the time being, in the middle of one of the most severe crises in our history, with an unprecedented usurpation of power by the executive.  But whatever the shorter-term questions, challenges etc (that the planned Select Committee is unlikely to do much about) there will be a need for a serious reckoning with how the authorities, political and official, handle all stages of this pandemic –  those past and those, perhaps over many many months –  still to come.  After the 1918 pandemic, the New Zealand government set up a Royal Commission, which reported back within about six months.  The report is here.   It seems like a good model for a variety of purposes: accountability, documenting issues and experiences, and learning from what worked well (and what do not) for future pandemics.     It would be a welcome commitment to openness and accountability if the Prime Minister would now commit that once the pandemic is passed such an independent and powerful Royal Commission will be established (in case there is a change of government before then, ideally that would be endorsed –  or done jointly with – the Leader of the Opposition.

In the meantime, a serious commitment to accountability and openness –  around contentious and highly uncertain re effect policies (and even choices not to act) –  would be enhanced if the current government would commit to the pro-active release of all Covid-related papers going to Cabinet, to Ministers, and to government agencies and officials who have either independent policymaking power or delegated authority to set operational policy on these matters,  (There might perhaps be a few  – very few exceptions – around national security, but openness builds trust –  or exposes weaknesses, which in turn is a basis for correcting and improving things.)

The second is around economic data.  New Zealand’s official data are pretty mediocre at the best of times –  one of only two OECD countries with only a quarterly CPI, badly lagging GDP numbers, no monthly read on the unemployment rate, and so on.   It is hard not to imagine that the official data will only get much worse this year, with long delays even if adequate numbers are finally able to be patched together.  It would be helpful for analysts if Statistics were to give an early outline of their plans and contingency plans.

But in the meantime, it would also be highly desirable if the authorities (whether SNZ or economic agencies like MBIE, the Reserve Bank or the Treasury) and getting together a timely public dashboard of high-frequency administrative data.  Things it might cover could include, for example:

  • daily or weekly new welfare benefit applications,
  • weekly bank credit data
  •  weekly data on electronic payments
  • daily or weekly arrivals data

These –  and no doubt others –  would be valuable not just now as we tumble into the abyss, but through all the inevitable ups and downs –  perhaps quite volatile ones –  in the coming months.   If/when we eventually get official data it will be good for the economic historians (and the Royal Commission) but for now we need a range of timely high frequency data (no doubt all stuff that could be compiled by people working from home).

What I really wanted to focus on today is the announcement by the government and the banks (and the Reserve Bank) yesterday afternoon.   There were very few details in the announcement, but what we know is this:

The package will include a six month principal and interest payment holiday for mortgage holders and SME customers whose incomes have been affected by the economic disruption from COVID-19.

The Government and the banks will implement a $6.25 billion Business Finance Guarantee Scheme for small and medium-sized businesses

The scheme will include a limit of $500,000 per loan and will apply to firms with a turnover of between $250,000 and $80 million per annum. The loans will be for a maximum of three years and expected to be provided by the banks at competitive, transparent rates. The Government will carry 80% of the credit risk, with the other 20% to be carried by the banks.

The Reserve Bank has agreed to help banks put this in place with appropriate capital rules. In addition, it has decided to reduce banks ‘core funding ratios’ from 75 percent to 50 percent, further helping banks to make credit available.

Take the “payment holiday” first.  I guess it was always likely for customers that were only fairly modestly indebted and had a fair amount of collateral to offer –  indeed, in those circumstances the willingness to offer such an extension is obviously sensible and mutually beneficial.

But do note that this offer by the banks  –  how much was it a genuine offer, and how much were they coerced into it –  includes (or seems to) all existing residential mortgage and SME borrowers.  Just on the mortgage side, that includes those who will have taken on loans in the last year or two with LVRs well in excess of 80 per cent.  It seems highly likely that market-clearing house prices will be falling at present, perhaps really rather a lot, even if the market is highly illiquid and there won’t be any open homes for the time being.   And although people don’t have to stump up with the cash for the next few months, interest is still accruing.  Floating first mortgage rates are still around 4.5 per cent, and on a $500000 mortgage a household will  run up perhaps another $12000 of debt in the coming six months.    An 80 per cent LVR last month could easily be a 100 per cent LVR next month, and worse than that if the security had to be realised in the near future.   Typical business lending interest rates are higher than those for residential mortgages.

I am not, of course, suggesting that banks should waive the interest.  But these continued high interest rates just reinforce the absurdity of the Reserve Bank Monetary Policy Committee simply refusing to cut the OCR any further, having cut it by only 75 basis points in the biggest economic slump of our lifetimes.  Setting monetary policy in a way that delivered, say, zero per cent low-risk retail lending rates would deliver real sustained relief to borrowers, and treat depositors as is appropriate at present (time having no value, or even negative value).

And what of the business loan guarantee scheme?  It looks relatively attractive to the banks, especially as (at present) there is no sign of any guarantee fee, however modest, and will enhance/underpin to some extent and for some classes of customers their willingness to lend a bit more.  Since banks know their own customers they still need to make decisions about which firms are likely to survive, with enough prospect or security that the bank is likely to get its money back.

But I doubt it will be that attractive to many businesses at all, and they may be something of an adverse selection problem in those who actually seek to use it.    And those interest rates –  the official statement says “competitive transparent rates”, while RNZ this morning referred to them as “normal commercial rates”.  Time has little or no economic value at present, at least across the economy as a whole.  Risk-free rates should be negative in a deflationary slump like this, and normal commercial rates –  which always carry a risk margin – probably should be pretty much zero.  That is hundreds of basis points less than firms are, and will, actually pay.  Fixing that would provide real relief, and perhaps a bit more willingness to take on a bit more debt, but the Minister and the Governor simply refuse to do anything about it.

But if debt service relief –  real relief, not just delays –  would be of considerable help, the real issue remains the dramatic slump in revenue many firms have already seen and that many more are just now beginning to experience.   And there is extreme uncertainty about (a) how much worse things might get (bounded at zero revenue I guess, but often with fixed outgoings), and (b) when, and how strongly even then, things might improve.  No one knows, and certainly your typical owner of a modest-sized business doesn’t.  Many of them won’t have much collateral, and they will have low profit margins at the best of times (Martien Lubberink at Victoria yesterday highlighted that The Warehouse group seems to fit that bill), and for many it won’t be obvoius why it is worthwhile to borrow, rather than to simply close down now and perhaps get lucky enough to be among the earlier people to realise any remaining assets.  Even if there is a robust business there five years hence, it won’t be so for the current owners if they take on lots of new debt in the interim.

It may get a bit tiresome to keep reading it, but the government’s approach still does not seem to recognise –  or if it recognises the point, be willing to do anything serious about it –  that the biggest issues around the survival of firms is dramatic income loss and extreme income certainty.  While they avoid confronting that more and more businesses will close by the day.

Which, of course, brings me back to my income guarantee proposal, guaranteeing households and firms (to the extent they maintain paid employees) 80 per cent of last year’s net income for the coming year.    It is the sort of national economic pandemic insurance policy we might well have signed up to if we’d thought seriously enough about the issue 20 years ago (experts have always advised that a really severe pandemic would be along one day).   We can’t –  or shouldn’t –  go offering that level of comfort indefinitely, but given the position successive governments have kept net public debt to (zero per cent on the best OECD measure), we can –  and should –  certainly do it for a year.  It buys both firms and households (borrowers) and banks a reasonable amount of time.  If, perchance, economic life looks like returning to normal in six to nine months, it would have served its purpose, and avoiding many liquidations and insolvencies.  If there is still huge uncertainty, or worse, by then, everyone can start adjusting further.  It isn’t a policy that will or should save every firm, or perhaps even every household, but it would offer a valuable affordable buffer –  one that we’ve either paid the premium for in the last 25 years (getting/keeping that low debt) or could do so over the 25 years after the crisis in over.

And we should back it up with a 20 per cent (legislated) temporary cut in wages (and probably rents).  There are plenty of households that are going to do just fine economically this year, even as the economy’s capacity to generate returns has slumped dramatically.  It is about fairness, shared sacrifice, (and perceptions thereof) and about actually easing the burden on some of those firms (whose “profits” are now deeply negative) everyone wants to hold together if we can.  Complement it with a windfall profits tax if you like for the few firms that might do exceptionally well through all this.

I really hope it doesn’t take much longer before the government is finally willing to confront that “income loss and extreme uncertainty” nexus, and be prepared to take steps that meaningfully address it, in ways that help stabilise for now (and to the extent possible) firms, households, and (thus) underpinning the ability of banks to lend.

Oh, and what stops them just getting on and doing the little it would take to dramatically cut interest rates?

Coronavirus policy and economics: 24 March

And so the die is cast and the motley crew (of, I’m sure, well-intentioned people) that make up our government have decided on a lockdown  Liberties are shredded, but I guess people will still be free to shop at The Warehouse.  It seems a curious business.

We must hope the strategy “works”, but the problem seems to be that (a) it isn’t clear there is a strategy (just another tactical choice), and (b) it isn’t really clear what “works” means here.    The Prime Minister yesterday referred to those standard worst-case types of death numbers, that have been around pandemic planning for years.     And she talked in terms of how the lockdown should probably dampen the local outbreak.  But there was no sense of how we get from a four-week lockdown to the end, when the virus is no longer a threat (whether the hope of a vaccine is realised, or because a less-lethal version just becomes part of the normal mild perils of winter).  In particular, there is no sense of how many lives any particular set of policy responses are credibly likely to save, in a world population with no underlying immunity.   I guess the only honest answer is that no one knows, but it would be good to have sense from the government of the central estimates they are working with, and the confidence bands around those estimates.  Without anything like that it is all but impossible for citizens to reach a view on the merits of any planned set of interventions, or a strategy.

There are various efforts around to attempt at least sketch outlines of a cost-benefit analysis (though typically of “policy intervention” defined very generally).  Some people simply object to such exercises as somehow immoral in the face of the threat.  I disagree.  I think they can help frame some of the discussions society has to be having.  Even if, say, you or I might give everything (if necessary our very lives) to save our children, that simply isn’t the way public health policy (or any other area of public policy for that matter) actually works.   We make choices about costs and tradeoffs, whether it is about speed limits, food safety or (closer to this blog) bank capital.

A few weeks ago, I tried to tease out, in a back of the envelope sense, some of how one might like to think about the issues (towards the end ofthis post).   A couple of extracts

According to the Treasury’s CBAx spreadsheet, the value of a statistical life (price community would pay to avoid premature death) this year is just on $5m.   25000 people at $5m each is $125 billion.  However, the evidence so far – including the Chinese data –  is that the deaths are very concentrated among older people.   On the Chinese data –  which may have its weaknesses –  the median age of those dying looks to have been as high as the late 70s, whereas the median age for all New Zealanders last year was 37.3. Remaining life expectancy at 80 seems to be about a quarter of that at 37, so we can chop down that maximum possible saving (from avoiding premature deaths) to no more than, say, $31 billion.

But, of course, even that is too high, since the implicit assumption is that all those lives could be saved with appropriate policy responses.  And from everything I read that seems incredibly unlikely.  Often people seem to talk about using policy measures and costly private actions (distancing etc) to spread out peaks and reduce the intense, perhaps overwhelming, peak pressures on the health system, and thereby (a) reduce the number of deaths and (b) make the whole experience less intolerable for those who would die anyway and those who, while sick, live.   Obviously I have no idea how many lives might be saved in total, but no one seems to seriously suppose it is anything like all of them.  If it was half, it would –  all else equal – be worth spending $15 billion or so to avoid those premature deaths.

Of course, there are other potential benefits to be added, including any sustained impairment of health (eg lung functioning) for some of those who recover.

Probably three weeks ago $15 billion seemed a really big number.  Sadly, now it is chicken-feed relative to the output losses New Zealand will suffer this year.  The loss in the June quarter alone could end up getting on for doubling that, if the lockdown gets extended much.

But in any such discussions, it is also worth bearing in mind that we need to think about marginal effects on both sides of the “equation”.   How many lives will be saved over the next couple of years by the planned set of interventions vs the additional economic cost from the New Zealand’s government’s interventions.  Both what the rest of the world’s governments do, and what the wider public (here and abroad) do anyway isn’t, in principle, relevant to the calculation.    And a great deal of the economic losses we are now facing, and about to undergo, are already baked-in.   There would be no tourists anyway, as just one example.  There would be massive investment uncertainty.  There would be increased physical distancing and postponement of events, and so on.

It is hard to put numbers on any of these items, but the discipline of writing the assumptions down, expressing realistic confidence intervals, articulating the basis for your judgements on each line item, and then disclosing that material to the public should be a part of what is going on now  It is also at least partly about accountability, for some staggeringly big choices governments are making now, and look set to continue to make in some form or another for some time to come.    I don’t have a strong view myself –  interesting question to ask is whether, if there was a referendum today you would support the lockdown – but confidence in judgements being made is only likely to be enhanced if there is good, robust analysis underpinning those judgements.

(And here we should make only little allowance for the mad rush; they’ve had two months to learn from Wuhan and prepare and yet in all too many fields of government it is increasingly clear how little that time was used for serious bad-case planning and preparation.  That seems particularly evident –  perhaps just because it is my focus – in the economic policy area.)

Of course, the more immediate issues now are around economic policy.   The interviews on the morning shows this morning suggest an announcement from the Minister of Finance later today around credit.   Unfortunately, there is still no hint in any comments from the Governor or the Prime Minister that they are yet willing to do what is really needed.   Simply being willing to extend credit to firms might be helpful, but it isn’t really the issue, because for many firms it simply won’t be worthwhile to borrow, taking on more debt against the totally unknown horizon at which something like normality might resume (hint, it isn’t after four weeks).     We need a comprehensive system of income guarantees (80 per cent of last year’s net) for individuals and for firms that stay fully staffed and capable, for the year ahead.   Just possibly, the guarantees would not prove to be needed for that long, but that is really beside the point now: what matters now is uncertainty and expectations, and not just for the next few weeks (still what the wage subsidy is doing).  (My macro-stabilisation package here.)

This sort of guarantee is the sort of policy (“ACC for the whole economy” as someone put it to me) that will help buy a reasonable amount of time, and give firms some confidence in a willingness to take on debt (while still leaving each firms’ owners to make their decision about likely future viability).  Is such a scheme likely to be expensive?  Sure, but in a sense we paid the premium already, in that low public debt over the last few decades.  We should expect the (unwritten, implicit) policy to be honoured, not obviously as some matter of law, but of charity and good economic sense.

The other thing where there is no progress evident at all is on securing a substantial easing in monetary conditions, and substantial relief of servicing costs (not so much the cash outlay as the legal liability) of borrowers.  On RNZ this morning the Governor was talking up all his tools, but it all really amounts to almost nothing.  He can do large scale asset swaps, and in doing so ease some pressures in specific markets.  But monetary conditions are tightening and they need to be loosening a lot.  He talks of the further tools he has at his disposal, but apart from easing specific stresses, they simply don’t amount to much, nothing like the scale of the need (and one of his own MPC, his chief economist) told us that just before the crisis really intensified).

Interest rates need to come a lot further down.  Business and household borrowing costs at present probably should be no higher than zero.   Even getting towards that would require the OCR to be set significantly negative.  That can quite readily be implemented.  It really needs to be done, and the indifference – and bluster, bordering on outright misrepresentations –  from central bankers, including our own, on the failure to adjust interest rates is frankly quite incredible, ie almost literally unbelievable.  OCRs don’t stop being effective at zero, it is just that too many central bankers stopping trying (while doing lots of handwaving).

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

geof m

I’m sure (well, know) he isn’t the only sceptic, here and abroad, but that isn’t going to stop me championing an idea whose time is long overdue (after all, the near-zero bound only exists because of government regulatory restrictions and monopolies –  it isn’t a given of nature).

What to make of Geof’s specific arguments?

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

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

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

There is always resistance to paradigm shifts, and too many central bankers and the like are operating within a paradigm that simply isn’t open to negative interest rates –  even though in New Zealand we went for years with substantially negative real rates a few decades ago.  That really now needs to change, and fast.  Our Reserve Bank could show the way.  Our economic policy position, our stabilisation options, would be improved if they did.

UPDATE: I remembered that I meant to mention an idea a reader passed on this morning.  Since many many businesses will fail anyway, and in many cases that may involve personal bankruptcies, in respect of personal guarantees of business borrowings, in this exceptional climate is there a case for considering cutting in half the period in which someone who goes bankrupt is unable to be involved in running a business.  Like everything in this crisis, there are risks, but it might be an option worth some officials thinking about.

Self-imposed constraints (the latest from the RB)

The Governor of the Reserve Bank had an op-ed in the Sunday Star Times yesterday, and I’d intended to use it as the basis for post today.   The column is quite as complacent, relative to the fast-unfolding reality, as anything we’ve had from Orr since first we heard from him on the coronavirus topic at the mid-February Monetary Policy Statement.  Even last week he was telling Mike Hosking that his level of concern wasn’t really that high (“six out of ten” was his line, and none of it sounded like simply an attempt not to spark a panic, and he told RNZ’s Kathryn Ryan that it was ridiculous to compare what was unfolding with the Great Depression (of course the specific causes are differerent, but when people make those comparisons they are typically highlighting the scale and severity of the drop in output and/or the  –  largely self-imposed –  limitations of monetary policy).  Everything Orr has said on the subject has sounded as if it might have been reasonable 10 days earlier, but not when he actually said or wrote things.   Complacency has been the best description, in a climate in which it is the last thing we can afford from our powerful, but barely accountable, head central banker.

But I’m not going to waste time unpicking the latest column, which it isn’t even clear why he wrote.

Before moving on, this is the standard real GDP estimates for New Zealand for the Great Depression (there are no official numbers that far back, although there were a lot of partial indicators).

nz depression

Real GDP in New Zealand is estimated to have fallen by about 15 per cent, peak to trough, over three years ( as a reminder it had fully regained those losses, though not got back to the previous trend, before Labour’s icon Michael Savage took office in December 1935).

Any bets on how deep the fall will be in New Zealand’s GDP over even just the first half of this year?   It depends a bit on how intense any lockdown is, but if someone forced me to put a number on the likely fall (June quarter GDP relative to last December quarter’s) it would probably be 25-30 per cent (similarly numbers are bruited about by serious people in the US, with the risks skewed to something worse.

And, reverting to the Great Depression, what got things going again then?  Well, the UK –  our major market, and less hard-hit than many countries – went off the Gold Standard in September 1931 allowing a substantial easing in monetary conditions.  And we, without yet having a proper currency of our own, further devalued against sterling in January 1933  (the US threw in some monetary policy easing later in 1933 as well).  In other words, letting off the previous self-imposed shackles of monetary policy made a great deal of difference for the better.

This is a quite different, but for now much more severe, sort of shock.    It seems unlikely that we can envisage even beginning much of any economic recovery until the virus situation is more or less sustainably under control, not just here and abroad.  Neither monetary nor fiscal policy will stop the deep drop in GDP going on right now, and probably shouldn’t even think to try right now (we are deliberately closing things down as part of fighting the virus).

But that doesn’t mean significant monetary policy easing would not still be helpful.  There are those worrying falls in inflation expectations, and more immediately there are the still-high servicing costs of a rising stock of private debt.  Public and private debt overhangs were a big issues, including in New Zealand, in the Great Depression, exacerbated then by the sharp fall in the price level.    It is pretty unconscionable that in this climate, where time has no value, floating rate business borrrowers are still paying 5 , 6 or more per cent interest rates.  That is almost solely because the Governor and the Bank refuse to do anything about significant negative interest rates possible –  it is this generation’s Gold Standard (there was a real aversion to moving away from it, and yet doing so finally made a huge difference for the better).

The Governor likes to claim that the Bank still has lots of monetary policy leeway within his own refusal to take the OCR negative (even though his chief economist told the public two weeks ago that it really wasn’t so)

yuong ha

Really just “a little”.

And I think it is safe to say that we have had fairly confirmation of Ha’s (generally not very controversial point) this morning.  The Bank and MPC issued a statement in which they committed to buying $30 billion of government bonds over the coming year.

It was a pretty feeble programme, even if the headline number was big.  A year is a very long time at present.  And whereas the RBA the other day announced an asset purchase programme centred around targeting government bond yields of three years to maturity at 0.25 per cent, it isn’t really clear what the goal of our MPC actually.  Settlement cash balances –  which is what banks get when market participants sell bonds to the Reserve Bank –  aren’t the binding constraint on anything.

And what did this large asset purchase programme announcement do?   The yield on a 10 year government bond fell by 50 basis points.  That is a big move for a single day, but……that still leaves the 10 year bond rate materially above the lows reached after the MPC’s cut in the OCR last Monday.  Quite possibly, without this action bond yields and corporate credit spreads would have spiked still higher.  So I’m not opposed to the action, but all it has done is to stop monetary and financial conditions tightening further, when what the circumstances demand is a really substantial easing of monetary conditions.    It isn’t as if there was a great deal (much at all, it seems) of an easing in the exchange rate either.   And this was the MPC’s preferred unconventional tool……as I said last week, if they are going to refuse to go negative it really is game over for monetary policy, at just the time when adjustment is most needed.  Recall the 400+ basis point cuts in retail rates we typically see in a New Zealand downturn, all of which will have been less dramatic than what we are now experiencing.  Central banks huff and puff and wave their hands to suggest lots of action, and they have done useful stuff on liquidity (again to stop conditions tightening) but the Reserve Bank of New Zealand is not alone it seems in playing distraction, to divert attention from what little monetary policy is doing given the self-imposed (wholly self-imposed) constraints.

(All of which said, even relative to the RBA, our MPC is not doing as much as they could.  As noted above, they could explicitly target and securely anchor government bond yields.  They could also still cut the OCR, even without going negative: the headline rates in both countries are 0.25 per cent, but in New Zealand that is the rate we pay banks on deposits at the Reserve Bank, while in Australia the deposit rate is lower again.   These are small differences, of course, but there is no sound analytical or systems reasons for not using all the leeway even their self-imposed constraints allow them.

Of course, the much more immediate huge issue is what the government is going to do to underpin the credit system and support a willingness of banks to lend and firms to borrow.  The only secure foundation for that remains some mix of grants and income guarantees (which will become grants).  I can only repeat that the most useful way of thinking about these thing is as the national pandemic economic policy we would have adopted twenty years ago if we’d thought hard enough, been serious enough, about what could happen: undertake to underpin all net incomes at 80 per cent of last year’s for the first year (reducing after that if the issue is still with us).    The fiscal costs are easily manageable for New Zealand: if guaranteeing 80 per cent of incomes than even if full year GDP fell 40 per cent, it would still only be a fiscal commitment of 20 per cent of GDP, and we are starting with net government debt (properly defined) of zero per cent.   It isn’t the exact dollars that really matter at this point, let alone trying to distinguish good and bad firms, but the certainty such a guarantee –  ex post insurance policy –  would provide in capping the extreme downside risks, individually and collectively for the first year.  It wouldn’t stop all exits –  some have already happened, some firms are likely to think it not viable to come back even with a grant/guarantee –  but it is the best option to help stabilise the economic damage, and to ensure that banks are able and willing to play a strongly facilitative part.

On Q&A yesterday the Minister of Finance suggested more announcements very shortly. I hope so but what worries is that once again whatever they do will be inadequate and not really get ahead of the issue. There is an opportunity now, but time is running down fast.

Another sobering chart

On Saturday I showed the then-current version of this chart.

aus 22 march

As I noted on Saturday morning

It is much the same locally-exponential pattern we’ve seen in so many other countries.  If current rates of increase continue then by the end of tomorrow Australia will have per capita numbers akin to those in the US or UK yesterday.  That is the sort of impact exponential growth has.

Australia now has as many, slightly more, cases per capita than the US and UK had on Friday.

What about New Zealand?  In this chart I’ve shown the Australian numbers divided by five (to put them on the same per capita basis as New Zealand).

nz and Aus

Perhaps at a very first glance, New Zealand doesn’t look too bad.  But look across the chart not up and down.  Our latest observations are where Australia (in equivalent population terms) was just a week ago. There is no evident or obvious reason to expect that in a week’s time we wouldn’t be something like where they are now  (or if there is such a reason no political ‘leader’ has been willing to try to articulate one).

And yet our government continues to pretend to believe there is no community transmission, confirmed or not.  It is simply extraordinary.  Reversing the presumption now – in light of what has happened in ever other similar country, but most notably in Australia with whom until almost now we’ve had a Common (travel) Virus Area –  seems much the safer option.

Sadly, it seems on a par with how the government and the Ministry of Health have treated the threat from the start.  It was, after all, only about three weeks ago that the Ministry was tweeting, on its official account, that there was more to fear from rumours, stigma etc than from the virus itself.  Nine days ago, on their website they asserted that the risk of outbreak was low.  And presumably acted/advised accordingly?

And then there is the elected government and the Prime Minister in particular (the Minister of Health has been largely invisible and apparently irrelevant).   Because it is so easy to lose track of what was said even a few days ago I went back and read the transcripts of her post-Cabinet press conferences since the start of the you (28 January was the first).  Admittedly the questioning was often equally lethargic, but it was truly startling just how complacent the Prime Minister had consistently been.  There was no apparent sense of urgency, no apparent recognition that significant spread globally was –  if not a certainty – a very high probability against which the whole of government and the private sector should be preparing, and no attempt to get out in front and alert the public to the serious threat that was looming.

Now, you might argue that our Prime Minister wasn’t much different to those abroad, and from what one sees that might be a fair comment.    But it isn’t exactly an excuse for any of them is it, with the full horror of Wuhan already in view by the end of January.   You might also argue that few/commentators were sufficiently alarmed either, which is probably also fair.   But the government is the government –  hugely well-resourced by any other standards, and fully linked in to the intelligence and threat assessments of other countries.  On the economic side, it is not much more than two weeks ago that the Prime Minister was playing down the risk of recession – laughable, if not so serious, even then –  when now we are heading into the deepest (and they are all temporary) and most sudden deep slump in New Zealand history.

When they have finally taken actions, they’ve usually been like knee-jerk reactions (often a mere day or so after denying any intention of anything of the sort, going all the way back to the first China travel ban, which they were bounced into by Australia a day after telling the Chinese foreign minister they’d do no such thing).   And, most concerningly to me, there is simply no evidence of a strategy, and no willingness to engage the public on the options, choices and risks around threats and policies that have huge huge economic, social, and civil liberties implications for us all –  not for days, but potentially for months or a year or more.  It is simply inexcusable, and almost beyond belief (even as we have to watch it day by day).    The four-stage scheme they rolled out on Saturday is certainly no strategy, and although it might have been a welcome start six weeks ago, coming out with no substance in a much-vaunted Prime Ministerial address on Saturday, it had all the feel of having been dreamed up on the back of an envelope on Friday afternoon.  There is no evident strategy.  There is no evident exit strategy for anything done so far, or anything they have in mind.   Some of the specifics even look untenable, notably the detail of their schools policies.

In fact, the more I’ve reflected on the issue over the weekend, the more I wonder how much relevant planning has been done at all.    I was recalling the huge effort that went into pandemic planning in the public sector in abour 2005/06, which I had quite a lot to do with (the economic dimensions of).   The problem with that work, as I reflect back now, is that it was mostly based on something like a re-run of 1918, where a huge proportion of the population was off work sick, or caring for the sick, but that the country was never “locked down”, and it envisaged the pandemic passing through perhaps in waves, but pretty concentrated ones, as in 1918/19.  I don’t recall anyone giving any serious thought to the idea of closing the border indefinitely (short closures sure), to locking down the economy and social interactions for many months at a time.  Perhaps in the subsequent decade, official agencies revised their planning – I hope so, but I was in public sector economic agencies until 2015, and never heard a hint of that.     And given how lethargic the whole of government was in January and February you have to worry that officials, in our greatly diminished public service are just now making it all up as they go along.

One specific dimension that got my goat was the PM lecturing (and that was her tone, repeatedly) the country about stocking up in supermarkets.   She assures that everything not only is  fine now, but always will be, no matter what stage of the crisis we get too.

First, looking backwards, one of the supermarket chain heads at the weekend said buying last week was just ahead of that in the run-up to Christmas, “but for Christmas we have a long time to prepare”.  That seemed like a fair point for him to make, but why had the Prime Minister and the government not been working with supermarkets weeks and weeks ago to emphasis the fast-building threat and urging them to increase production to cope with possible surges in demand.  Such demand was entirely foreseeable, conditioned on a recognition of the risk.  The public shouldn’t be hectored by the PM for what is her failure and that of her government.

But the bigger issue is forward- looking where she has been grossly over-promising.  It might be reasonable to suggest people slow down for a few days and let the supermarkets restock (having herself been neglectful from the start), because it probably is reasonable to assume that supermarkets will remain stocked in the early days of any lockdown.

But the Prime Minister seems not to recognise at all that in such a climate many people will prefer to avoid supermarkets if at all possible, and to have inventory in the home rather than in a public place.  That will be especially so if and when the health system becomes overloaded –  as people warn it may within a month or so –  and people reasonably fear that if they and their families get sick they may not be able to get decent treatment.

And I trust the government to keep supermarkets open in some form or another throughout, and am moderately confident the basics will be kept available –  perhaps intermittently at times, and for some goods.  New Zealanders should not starve (Irish peasants used to have adequately nutritious diets of milk, potatoes and oats).  But, frankly, most people want more than milk, potatoes and oats.  And none of us knows (a) what production the government will deem essential, (b) what factories will still be adequately staffed (and distribution channels have to hold up), and (c) what other countries will deem essential. Because, you see, although the PM talks blithely of international trade in goods continuing, that only means much if international production of things New Zealand imports continues.  As just one example, I just had a look at the back of the dishwasher powder container, and was surprised to learn it comes from……..Poland.  Hard to imagine production of dishwasher powder would be an essential in Poland if/when they are in lockdown.  It is quite plausible that lots of non-basic non-perishable goods could rapidly become quite hard to get.  Buying extra now is utterly and totally rational, whatever the Prime Minister says.  To not do so would mean putting a great deal of faith not just in the good intentions and words of the government, but in some tail-event optimistic scenario about how everything will work in a period –  that as even the Minister of Finance put it –  could last for months.

Personally, I simply have no confidence in anything they say or do anymore.

(And, please note, nothing in this is advocating any particular set of anti-virus policies now.  There are genuinely hard choices.  My kids are still at school this morning (we had the conversation yesterday).  But there is no evidence of strategy, there is no evidence of engagement with the public re what the future holds, there is no evidence they’ve thought through the limits of the state (as Matthew Hooton put it on Twitter the other day, there are some things more important than public health, but what does the PM think those are?) and so on.   It is a pretty egregiously bad performance so far, all compounded –  this is an economics blog –  by the manifest inadequacies of the economic policy response to date from government and the Reserve Bank –  and yes, I have just seen the latest RB release.)

 

 

 

A sobering chart

It astounds me that I have not seen this chart once in the New Zealand media (or from any of our political and bureuacratic officeholders –  I hesitate to call them “leaders”).

aus cases 2

Australia confirmed their first “community outbreak” case on 3 March, when there were 33 cases in total (just fewer than we had yesterday).

It is much the same locally-exponential pattern we’ve seen in so many other countries.  If current rates of increase continue then by the end of tomorrow Australia will have per capita numbers akin to those in the US or UK yesterday.  That is the sort of impact exponential growth has.

There was routinely a lot of trans-Tasman travel.  There is, apparently, still a lot of travel this way as people try to get home.  And while in the last few days self-isolation was supposed to be practiced, there are numerous stories of it simply not being following consistently.  My worst one was a story someone told me the other day: they’d gone to the hairdresser, who was young and pregnant. The hairdresser passed on the story of a customer who’d come in the previous day and commented that while she was in self-isolation she really needed to get her hair done.  The hairdresser, perhaps unsurprisingly burst into tears.

All this means that one can think of New Zealand and Australia as having been essentially a Common Virus Area –  what is mine is yours, and what is yours is mine.  Since we haven’t been doing the sort of aggressive mass testing that some have called for –  although the pace has stepped up in the last few days –  it seems simply irresponsible for the government to be running policy on the presumption that we do not have community out break here.  No one can be certain, but the question has to be what is the safer assumption to make decisions on right now.  Given the rest of the world, given Australia, given the lags (when you confirm community outbreak you should wish you’d acted a couple of weeks earlier), the only sensible approach now is to assume presence, and act accordingly.  But apparently in an interview on Newshub this morning, the government’s chief official on health matters said they were still assuming the opposite, staking a great deal on their view being right.

I see the Prime Minister is to speak at midday.  We’ll see what she says.

For me, I’m less interested in specific announcements or new rules, but on whether there is evidence that (a) they are going to break with the past and actually take the public into their confidence and engage on the issues, options, costs and risks, (b) whether they finally are willing to front with the public on the severity of what is to come, health or economics, (c) whether there is any sign of a developed stable framework for thinking about policy responses through time (d) whether they any sense of an exit strategy for whatever approaches they adopt, (e) whether there is any sign they have identified what things they belief to be more important than public health in this specific situation, and (f) whether they have thought through seriously how sustainable, economically or socially, whatever strategy they adopt is, or whether they are still just attempting to buy “a bit more time” and risking lurching again before long.

These are difficult issues, and few leaders here or abroad seem to be handling them at all well, but no one made any of them take office.

I had been planning to write a post today prompted by the economic and other policy choices and trade-offs implied by the very useful Imperial College paper published earlier in the week, but I might now come back to that –  and particularly questions about whether suppression strategies are worth the costs to the economy and society and its freedoms and values, if anything like what the Imperial College authors suggest it implies were to be an accurate representation of the issue.

UPDATE: Unfortunately, the PM’s statement did not seriously or adequately address any of the sorts of issues raised in the paragraph a couple above.

Reserve Bank still behind the game

There was a new announcement from the Reserve Bank this morning.  The two key elements, as summarised by Westpac are

       A Term Auction Facility. The RBNZ will lend to banks for up to 12 months, taking Government bonds, residential mortgage-backed securities, and other bonds as collateral. This basically ensures banks will be well-funded for the foreseeable future. This will prevent an increase in the cost of bank funding, which in turn will help ensure that short-term interest rates for businesses and households remain low.

–       FX swap market funding. Banks sometimes borrow money from offshore and swap the debt back to New Zealand dollars. In recent days the cost of performing this swap has exploded. Left unchecked, this could have caused an increase in the cost of funding New Zealand banks, which in turn could have led to higher interest rates in New Zealand. The RBNZ has essentially offered to facilitate some of those swap arrangements, which will keep the cost of overseas funding contained.

Both initiatives seem sensible, as (for that matter) does the rest of the statement (although the new Fed USD swap line is surely of symbolic significance only, recognition that we are a real advanced economy, since New Zealand banks tend not to have an underlying need for USD.

I’m guess the fx swap market activity will make a useful difference. But I wonder how much difference the Term Auction Facility will make though.  I recall conversation with bankers at the height of the 2008/09 crisis who observed that their boards simply would not look at Reserve Bank funding –  however reasonable the term –  as a particular secure foundation on which to maintain, let alone expand (as it hoped for this time), their credit.  Time will tell, but the Reserve Bank of Australia announced a much more aggressive package yesterday afternoon, including provisions explicitly allowing banks to borrow more –  at very low fixed rates –  to the extent they increase business credit this year.

There were also indications in the statement that the Bank has been dabbling in the government bond market

Supporting liquidity in the New Zealand government bond market

The Reserve Bank has been providing liquidity to the New Zealand government bond market to support market functioning.

But, as Westpac notes,

However, the amount of liquidity provided seems tiny so far, and has had little effect on longer-term Government bond rates.

Funding rates through the fx swaps market aren’t transparent to you and me.  But bank bill yields are readily observable.  As I noted in yesterday’s post they had moved much further above the OCR than one we normally expect (especially when the Bank has committed not to change the OCR itself).    On this morning’s data, that gap is still 42 basis points (a more normal level might be around 20 basis points.   When the goal is supposed to be abundant liquidity and interest rates as low as possible (consistent with MPC’s self-imposed floor on the OCR), there is simply no need or excuse for these pressures.  Surely they aren’t worried about some spontaneous outbreak of inflation?

Similarly, here is the chart for the 10 year bond

il

In other words, barely below the levels at the start of the year, before any of us had heard of the novel coronavirus, let alone had our economies shredded by it.   The 10 year rate appears to have dropped a little further this afternoon, but it is still well above where it probably should be.

The Reserve Bank of Australia yesterday announced a significant bond purchase programme designed to cap three year government bond yields at 25 basis points (with flow through effects on the rest of the curve.  Our Reserve Bank has still done nothing of substance on that front –  and our shorter-term government bonds yields are well above 25 basis points.  Why not?  Well, there is no obvious reason for the lethargy –  inflation isn’t about to be a problem –  other perhaps than that Orr and Hawkesby went so strongly out on a limb with their complacency about the situation, as recently as last week and this, and Orr has never been one to be willing to concede he might have got things wrong (despite being in a game where such errors are, from time to time, inevitable).

Ah, but perhaps inflation and inflation expectations are just where we want them.  But no.  These are the New Zealand inflation breakevens (difference between nominal and indexed 10 year government bonds.

breakevens mar 20

Recall that the target is 2 per cent, and these are 10 year average implied expectations.  Things were not that great anyway –  not averaging much above 1 per cent in the last couple of years –  but now we are down to 0.65 per cent.  (It isn’t quite as precipitate as the fall seen in the US, but hardly comforting even if the data are harder to interpret than usual.)   This risk –  inflation expectations falling away, raising real interest rates all else equal –  used to worry the Governor.  Nothing has been heard of the line from him or his offsiders since it became a real and immediate threat.

There isn’t really much excuse for the MPC’s sluggishness and inaction.    After all, they talked about bond purchases being next cab off the rank, and then markets went haywire, their peers in Australia acted, and they did nothing.  Of course, it doesn’t help that it seems the Reserve Bank was seriously unprepared.  You’ll recall that as recently as Tuesday last week, we had 19 pages of high level stuff on alternative instruments from the Governor, with the clear message he thought we were well away from needing them.  We were promised a series of technical working papers “in the next few weeks” but despite the crisis breaking upon them almost two weeks later we’ve seen nothing.  All those years they had to prepare, and it seems all too little serious preparation was actually done (as we now know –  because they told us so –  despite all the talk of negative interest rates as an option, it now turns out they’d taken now steps to ensure banks’ system could cope).

But none of that need stop the Reserve Bank launching a large scale bond purchase offer (or auction programme).  It isn’t operationally complex.  The Bank transacts these securities in the normal course of its business, and each year buys back bonds approaching maturity.    There won’t be any systems implications.

I wonder if one other reason they are reluctant to act is a sense that then people would see how little the alternative instruments they favour actually offer.  While they don’t act, there is a pretence that there is a big bazooka.   But only while they don’t act.

As I’ve noted previously, I think there is fair consensus on the last decade’s unconventional policies in other countries: at times there were some real and significant benefits in case of specific market dysfunctions, but beyond that the beneficial effects were relatively limited.  Asset purchases, with a policy-set OCR floor, have no mechanisms that would lower interest rates to bank customers.  They’ll cap government bond rates, probably with some benefit to interest rate swaps rate, but the biggest effect will simply be to flood bank settlement accounts with a lot more settlement cash.  And since that is a rock-solid asset (now) fully remunerated at the OCR itself, it won’t prompt material behavioural changes.

You needn’t just take my word for it.  Last Friday in the Herald  the Bank’s chief economist (and MPC member) Yuong Ha (who had spent some years monitoring financial markets in his previous role), was talking about alternative instruments (bond purchases, intervention in the interest rate swaps market and so on).   He was quoted this way

yuong ha

These tools “give you a little more headroom, a little more time and space”.  In some circumstances “a little” might be all the situation demands.  In these circumstances it is grossly inadequate and simply no substitute for failing to act on interest rates.

That is part of why I think they should get on now and do the large scale bond buying, or even buying foreign exchange assets.  With an interest rate (OCR) floor in place it just won’t make much macro difference, the emperor’s new clothes will be exposed for what they are(n’t), and perhaps we might finally get some focus on the crying need to get retail interest rates lower.

Recall the Bank’s claim that bank systems aren’t ready.  For a start, this should be challenged, and some naming and shaming should go on.  Apparently some banks aren’t ready, but others are.  Name them.  Second, at least for wholesale products all the big banks must be finel –  lots of financial products abroad have had negative interest rates for several years, and our own inflation-indexed bonds were trading at negative yields at times in recent months.   Perhaps as importantly, actual retail rates –  and it is probably the retail components of some banks’ system that are the issue –  are still well above zero, both term deposit rates and retail lending rates.  If the OCR –  a wholesale rate – could be set to, say, -2.0 per cent (without triggering conversions to physical cash on a large scale), term deposits might still be only around zero, and retail lending rates higher again.  There is a lot of space the Bank could use to drive retail rates down without even having to envisage negative rates for the main retail products.  In times like the present every little helps. (As an example of the issue, the Australian banks today announced a scheme to freeze debt repayments for SME borrowers for six months, which is fine, but those borrowers are still paying an interest rate of perhaps 6 per cent, in a climate where time –  which is what an interest rate is mostly compensating for –  currently has no, or perhaps negative, value.)

Perhaps the Bank, The Treasury and the Minister of Finance are now cooking up some decisive intervention to support the credit system as a whole  rather than just extending government loans to the iconic and politically connected Air New Zealand.  Such an intervention is sorely needed, and once again the government is behind the game.  The credit system is probably the most pressing point right now, but it is no excuse for the MPC, an independent operator, to be not doing its  job.  The times demand a large easing in monetary conditions, including in real interest rates.  The Bank is delivering almost nothing, all while playing smoke and mirrors with the suggestion that its next instrument offers much more potential than is really there.

Once more our key decisionmakers fall short.

There would be nothing to lose now by bold and decisive action.  Nothing.

Retail interest rates fall substantially in recessions…

I’m out of town today, so just something short.

I’ve noted in various posts recently that in past recessions in New Zealand since we liberalised in the 1980s the OCR (or prior to 1999, the 90-day bank bill rate) had fallen by around 500 basis points in a typical (median) recession.   Small sample and all that, but it was a reasonable stylised fact (and happened to around the same size adjustment as you see in the longer run of US data).

But, of course, the OCR isn’t a rate paid by anyone –  technically in fact it is the rate the Reserve Bank pays banks on their settlement account balances.   In thinking about the experience of firms and households one has to look at retail interest rate and how they changed.  In the 2008/09 recession, for example, there was quite a widening in the margin between the OCR and retail deposit and loan rates.

One can identify five reasonably material downturns in the interest rate data on the Reserve Bank’s website.  Here are the changes in floating first mortgage interest rates in each of them.

Floating first mortgage new customer housing rate Six-month term deposit rate
percentage point chg in downturn
post 87 crash -4.3 -4.3
1991 -6.2 -4.9
1998 -3.1 -3
2001 -1.8 -1.9
2008/09 -4.6 -4.6
Median -4.3 -4.3
Now -0.8 -0.1

Not all of those events were particularly significant for the New Zealand economy, and the 2001 interest rate falls combined the effects of the northern hemisphere economic slowdown that year and the precautionary cuts the Reserve Bank implemented after 9/11.

But across this sample, the median reduction in both deposit and residential mortgage rates was 4.3 percentage points.  For the two deeper recessions, 1991 and 2008/09 the changes were larger still.

I’ve also shown the adjustments we’ve seen this year to date.   The main banks all lowered their floating mortgage rates on Tuesday by the full 75 basis points of the Reserve Bank’s OCR adjustment.  But retail deposit rates have only just begun to fall.

And in even The Treasury’s view, this recession “could” be bigger than the 2008/09 one (more realistic would be to view 2008/09 as tiddler by comparison, even if one allowed for nothing more than the elimination of our international tourism industry).

And then there are two problems to ponder:

  • first, the MPC has pledged not to change –  raise or lower –  the OCR for at least a year.  So if one believes they will keep their word, what you see now is all you get.  Retail lending rates aren’t going any lower, and retail deposit rates will take a while to catch up but probably won’t fall more than 75 points either.  75 basis points is a great deal less than 430 points, and
  • second, while it was probably good PR for the banks to cut point for point on Tuesday, actually it looks as though they’ve ended up with squeezed margins.  Here is a chart showing the 90 day bank bill rate less than floating first mortgage rate, up to yesterday

bill rate

The 90 day bank bill rate is usually a bit above the OCR, and fluctuates mainly with shifts in sentiment re future OCR adjustments.  When the OCR is expected to be cut imminently the 90 day rate drops below the OCR.  That had happened recently. But note what happened after Tuesday’s cut: the margin between the bill rate and the OCR is now higher than at any time in the last two years.  That would usually only occur if the OCR was expected to be raised, but that clearly isn’t the story as the MPC just pledged not to change the OCR for at least a year.  In fact, it points to liquidity pressures in the local market (details not known to me).    The Reserve Bank’s liquidity operations would usually be able to ease such pressures, and it is a bit surprising they haven’t already done so.

But the key point remains: there is no prospect of further retail interest rate reductions in the middle of the most severe adverse shock of our lifetimes.  75 points is it.     It is a ridiculously small adjustment.  But that is what you get when (a) the Reserve Bank fails to do anything about removing/easing the effective lower bound, (b) fails to ensure banks’ systems were ready for negative interest rates, and (c) pledges not to cut the OCR any further anyway. It really is Alice-in-Wonderland stuff.

Even in circumstances like the present where we aren’t –  or shouldn’t be for now – trying to stimulate aggregate demand, low interest rates play an important role in managing economic downturns.  First, they help lower debt service costs, including for existing flexible rate borrowers (and most New Zealand debt reprices fairly frequently), and do so by transferring some prospective income from depositors to borrowers, consistent with the idea that time is temporarily less valuable.  Second, at a wholesale level they help to weaken the exchange rate, which also typically plays a significant part in buffering adverse shocks.  And third, the flexibility to adjust rate, actually exercised, helps to support and stabilise medium-term inflation expectations.

Did I mention the exchange rate?  In the 1991 recession, the TWI fell by about 10 per cent. In the 1998 recession, the TWI fell by 17 per cent, and in the 2008/09 episode the fall was in excess of 20 per cent.

And this time?  Well, the TWI yesterday morning was only 5 per cent lower than it had been at the end of December, despite the adverse shock being much greater than in any of those earlier events.    This week, we have had the extraordinary sight of the New Zealand dollar approaching parity with the Australian dollar.  I’m sure a variety of factors help explain that, but an unexpected commitment from the MPC not to lower the OCR further can’t have helped.  The TWI appears to have fallen overnight and perhaps before long panic and flights to cash/flights to home will mean the TWI will fall a long way, but monetary policy so far has been an obstacle in the road.

The economy is already in deep strife, and the problems are going to get a lot worse.  We shouldn’t settle for the complacency of central bankers talking up their adjustments, their alternative instruments etc, and all the while retail rates have barely moved, relative to the scale of change seen in most past (smaller) downturns.

The Minister of Finance should simply insist that the Bank sort it out, including getting bank systems fixed post-haste.  There is no conceivable way in which on OCR with a positive sign in front of it makes any sense in today’s New Zealand economy.  Retail deposit rates really should be negative, and retail lending rates probably should be too.