Robertson on productivity: not much basis for confidence

I’m not going to write much about the Productivity Hub (Productivity Commission, MBIE, Treasury, and Statistics New Zealand) conference yesterday on “Technological Change and Productivity”.   Not all of it was even about productivity, not all of it was even relevant to New Zealand (there was a genuinely fascinating presentation from a US academic on the economics of wind and solar power, which must matter a lot if half your power is generated from fossil fuels, but rather less so in a country where 90 per cent of power is hydro-generated).   And there was lots of focus on micro data on firm (or agency) level productivity, even though no work in that area has yet been shown to shed much light on the large gap between economywide average productivity in New Zealand and that in most other advanced OECD countries.   But the “Reddell hypothesis” did get a (positive) mention from the platform, when the Productivity Commission’s Director of Economics and Research, Paul Conway, reprised some of the thoughts from his 2016 “narrative”, highlighting the likely importance of the macroeconomic symptoms: persistently high real interest rates (relative to other countries) and a high real exchange rate.   Conway suggested that we should focus much more on bringing in highly-skilled migrants, and that if that led to a reduction in total numbers that might well be a good thing.     With 47 MBIE people among the 200 or so (mostly public service) registrations, I don’t suppose that proposition commanded universal assent, but there wasn’t any further open discussion.

I couldn’t stay for the final session, but fortunately that speech has been made widely available.  The Minister of Finance gave an address on “The Future of Work: Adaptability, Resilience, and Inclusion”.   At one level, I was pleasantly surprised: there was more about the productivity challenges New Zealand faces (our overall underperformance) than I’d expected.  And if I’m sceptical about the Treasury Living Standards Framework, and attempts to build policy around “well-being”, I couldn’t really disagree with the thrust of this line from early in the speech

Improving productivity is key to improving wellbeing. By producing more from every hour worked, businesses become more profitable, incomes rise, and workers’ wellbeing rises as time is freed up and purchasing power rises.

And it was good to have the new Minister of Finance remind us that productivity growth (lack of it) has been a longstanding problem in New Zealand.  Although even then he seemed inclined to underplay the problem: for example, basically no productivity growth at all for the last five years.   And he noted that GDP per hour worked is now around “20 per cent below the OECD average”.   But since the average includes places like Turkey and Mexico, and a group of countries (ex eastern bloc) which weren’t market economies at all 30 years ago, it might be better to highlight the point I made in yesterday’s post:   for New Zealand to catch up with the G7 economies as a whole, we’d require a 50 per cent lift from current levels (assuming those countries had no growth at all), and to match that group of highly productive northern European economies (France, Belgium, Netherlands, Germany, Switzerland and Denmark), we’d need more like a two-thirds increase.   Even to catch Australia –   which lags some way behind the OECD leaders –  would take a 40 per cent increase in economywide productivity.   That lost quarter-century won’t be regained easily.

But it is one thing to recite these numbers (early in one’s term as Minister of Finance).  As even Robertson put it

I am most certainly not the first New Zealand politician to both highlight the challenge of low productivity, nor to say that we will address it.  So the proof will be in what we actually do. 

And what is on that “to do” list?   And that is where it gets a bit disconcerting.

There are a couple of the reviews underway

Our Tax Working Group and the reforms we are making to the Reserve Bank Act are an important part of setting the path to a more productive economy.  That focus on improving productivity is at the heart of the terms of reference for both these reviews.

No serious observer believes that the sorts of changes foreshadowed for the Reserve Bank Act –  desirable as the general thrust might be –  will make any difference whatever to the trend level of productivity in New Zealand.  Monetary policy just isn’t that potent.  As for the Tax Working Group, a (limited) capital gains tax might, or might not, be a good idea but I’d be surprised if anyone believed it would make a very material difference to overall economic performance (and, after all, much of the TWG documentation has a prime focus on fairness).    For all the talk about “too much investment in housing” recall –  as the Minister doesn’t in his speech –  that a key element of government policy is building lots more houses.  Resources used for one thing can’t be used for other things.

What else is the government planning?

The government has committed itself to the goal of a net zero carbon economy by 2050.  This is an essential shift for New Zealand away from an economy that hastens climate change to one that is more sustainable and develops New Zealand’s strategic advantages.

We will need to ensure this is a just transition where affected industries and communities are given the support to find new sustainable growth opportunities.

Again, you might or might not think this is a worthwhile goal, but it isn’t going to lift economywide productivity relative to what would have happened without the net zero goal.   Even the Minister is here focused on smoothing transitions, minimising disruption.

Then there is skills.

The Future of Work was the catalyst for our three years’ free training and education policy. One of this Government’s key policies is to provide one year of free post-secondary education or training, gradually progressing to 3 years by 2025.

So in a country where the OECD data suggest that the skill levels of New Zealand workers are already among the very highest in the OECD, the government is going to spend rather a lot of money (all funded by taxes, with their deadweight costs), in the expectation that a marginal cohort of people who would not otherwise have invested in formal training/education will now do so.  Most of the immediate gains will go to people who would in any case have gone to university (or done other comparable training)  –  I’m expecting my kids to be in that category –  and most of the people who take up formal training who otherwise would not have done so, are likely to well below the leading edge in terms of productivity potential.    If there are gains at all economywide –  which seems unlikely, but I’m open to persausion –  they will almost certainly be pretty small.  It is mostly a middle class welfare policy, not a productivity policy.

Then there is regional development policy

A major example of this is the Provincial Growth Fund developed as part of our coalition agreement with New Zealand First.  This will see significant investments in the regions of New Zealand to grow sustainable and productive job opportunities.

The details of the Fund are to be released shortly and will provide some of the most significant development of our regions in decades.  These will be driven from the ground up, with the Government as an active partner.

If it ends up less bad than a boondoggle we should probably be grateful.  It isn’t the sort of policy that has a great track record, and it is hard to be optimistic that one new minister –  with a vote base to maintain –  is going to transform the sort of flabby thinking around regional development presented at Treasury late last year.   At very very best, it is all rather small beer.  Recall that we need a two-thirds lift in economywide average productivity to catch those northern Europeans.

It goes on

It is my strong belief that the most critical element to New Zealand succeeding in the Future of Work is a renewed social partnership between businesses, workers and the government. 

If we look at Germany as an example, union members often sit on company boards as part of the decision-making process, ensuring that employee wellbeing is considered alongside high-level corporate profit and financial targets.

One of my goals as Minister of Finance is to develop this new partnership at a system-wide level to promote a combined work stream on how we can apply these lessons to other industries and sectors. 

Maybe the Minister doesn’t see this sort of stuff mostly affecting productivity performance.  But if not, what will?

Perhaps R&D.

In the Coalition Agreement with New Zealand First we have set a target of hitting an R&D spend of 2% of GDP in ten years. That’s more than a 50% increase in R&D investment relative to GDP over that time and will make a significant contribution to improving our productivity.

Officials say that this is an ambitious goal. We believe this can be done, with the Government incentivising such vital work by the private sector.

Minister for Research, Science and Innovation, Megan Woods, has already begun work on overhauling New Zealand’s R&D regime, with Ministers set to discuss officials’ initial findings later this month. We are committed in the first instance to restoring R&D tax credits to give firms some certainty about their investments.

But, as with earlier comments the Minister made in his speech about relatively low rates of business investment, there is no suggestion that the government has thought about what it is in the economic environment that leaves private businesses –  pursuing profit opportunities where they find them –  unwilling to spend more, whether on R&D or investment.

It was interesting that the Minister of Finance chose to highlight comparisons with Germany in his speech.  As I’ve pointed out in an earlier post,  Germany doesn’t have an R&D tax credit (actually of those successful northern European countries I highlighted earlier, neither does Switzerland) –  although the senior OECD official whose seminar I attended the other day, who didn’t seem wildly enthused about the merits of such tax credits, did note that the German government is under business pressure to introduce such a scheme because, eg, France and the Netherlands have them.

There are stories galore about what gets claimed for under R&D tax credits, and one person at the seminar the other day indicated that the Australian government is currently looking to wind back its R&D tax credit, having realised that a significant amount of money is being rorted.  If free tertiary education is (largely) welfare for middle class parents and their children, R&D tax credits look like welfare for the owners (often foreign) of businesses.    The R&D spending already happening would, presumably, have taken place anyway, so if there is to be a tax credit in respect of that spending it is pure gift (on top of the advantage of being able to immediately expense anyway).   There will be significant incentives to reclassify some activities as R&D that weren’t previously (because there was no advantage to doing so).  Some of that will bring to light genuine R&D spending that wasn’t previously visible – slightly tongue in cheek, the OECD official noted this was one advantage of R&D credits.   Other spending won’t really be R&D at all, and IRD will be engaged in a constant battle to hold the line.  And perhaps there will be some additional R&D work undertaken that wouldn’t otherwise have occurred.  But surely –  a bit like the increased teritary participation that will flow from fee-free study –  most of that will be, almost by definition, the least valuable, most marginal, activities; the stuff not worth doing without a subsidy?

It is, frankly, a bit hard to believe that even the best R&D tax credit –  and I gather MBIE officials are working hard to limit any abuses and wasteful transfers in the forthcoming tax credit –  will be a transformative part of the story.

Let’s go back to those northern European countries, with a slide from the OECD official’s presentation:


France –  third bar from the left –  has some of most generous government support for business R&D of any country in the OECD database, including a generous tax credit.   That support has materially increased in the last decade, but it was still fourth highest in 2006 (the white diamond).   Germany (DEU) has low overall government support, and no R&D tax credit at all.     These are both advanced industrial economies, situated right next to each other, with lots of trade between them.   And here is OECD data on the respective levels of real GDP per hour worked.

fr and ger

Identical at the start, identical at the end, and never –  through the whole period (Mitterrand, absorbing East Germany or whatever) – any very material deviation between the two lines.  It is the sort of relationship –  univariate and all –  that makes it more than a little hard to take seriously suggestions that introducing an R&D tax credit here will make any material difference to our relative productivity performance.

And here is the OECD data (for 2015) on R&D spending in each of those six highly productive northern European countries, and New Zealand.  “BERD” is business expenditure on research and development.

R&D spend n europe.png

Remember that Germany and Switzerland are the two of the northern European group that don’t have R&D tax credits, and provide little direct government support to business R&D.   I’m not suggesting any sort of perverse relationship  –  a lot probably depends on the specific sectors businesses in particular countries concentrate on – but it should at least be a little sobering to reflect that the two countries in that grouping with no R&D tax credits have higher rates of business spending on R&D than any of the other countries in the group (even with all the incentives that such credits create to classify spending as “R&D”).  One might wonder if the big French incentives –  increased in the last decade –  might not have been sold on the basis on “we are lagging behind Germany in R&D spend” and need to “do something” to catch up.

Mostly, a reasonable hypothesis still looks to be that firms will invest (including spending on R&D) when it appears to be profitable for them to do so.  If so, it might be better to spend some more time understanding what holds firms back –  addressing issues at source if possible –  rather than just throwing more government money at a symptom.  There isn’t much sign the government has done anything more than highlight a few trendy symptoms, rather than really engaging in an integrated narrative of New Zealand’s economic performance.  The Minister of Finance concluded his speech yesterday

I want us to re-write our productivity story, so that New Zealand becomes a leading example of a sustainable and productive economy in which everyone gets a share of economic success.

It is a worthy aspiration –  shared, no doubt, by a long line of predecessors stretching back decades –  but there is little sign of the sort of serious thinking –  or even engagement with the full range of symptoms (eg weak export share, high real interest rates, high real exchange rate, physical remoteness and yet rapid population growth) – that would provide much reason for confidence that they might yet devise an effective strategy to respond to the specifics of New Zealand’s situation.

And since a common response whenever I write along these lines is “but what would you do differently?” here are links to a version of my story given to a business audience , a version given to the Fabian Society, a more recent version to a general audience.   In the margins of the conference yesterday, one person commented that he thought one problem was that few officials had read my original paper, prepared a few years ago for a Reserve Bank/Treasury-hosted conference, which puts the basics of the argument in a standard two-sector (tradables and non-tradables) analytical framework, here is the link to that paper too.





More than a quarter of a century behind the advanced world

I’m spending today in a conference organised by the Productivity Commission and various government departments on technological change and productivity.  Yesterday afternoon I went to a seminar at the Productivity Commission at which one of the conference speakers, a senior OECD official, was speaking on technology, “innovation policy” etc.  It had been billed as something that would address the huge gap between New Zealand average productivity levels and those in much of the rest of the OECD.  In fact, it hardly touched on that issue at all, and much of the discussion had the feel of analysis and advice for the OECD grouping as a whole, and particularly its more advanced members (the speaker himself was Dutch), rather than for a laggard country.

For New Zealand the biggest challenge, by far, is –  as it has been now for some decades –  catching-up again.  Decades ago we were at or near the frontier –  economic frontier that is, rather than physical remoteness –  with per capita incomes in the top 2 or 3 in the world.  These days, probably a few New Zealand firms are at or near the frontier, but the overall New Zealand economy lags quite badly behind.

My favourite base for comparison is real GDP per hour worked.  Levels comparisons are really only approximate, but using OECD data –  based on the 2010 purchasing power parity (PPP) exchange rates –  here is how New Zealand’s real GDP per hour worked compared to the OECD countries that have higher average productivity than we do.   You could discount Ireland to some extent –  there are some measurement/classification issues around their tax system, and in truth productivity in Ireland might be nearer German or Dutch levels. On the other hand, I don’t show Slovakia which, on this particular metric, went past us a couple of years ago.

GDP phw Feb 18

As it happens, of the 23 bars shown, the G7 countries’ total is the median observation.  Our real GDP per hour worked in 2016 was only 67.6 per cent of that for the G7 group of countries as a whole.  In other words, it would take a 50 per cent increase from here –  with no change in those countries – for us to catch up again.   If we take the subset of countries from Belgium to Germany, it would take about a two-thirds increase in our average productivity to catch up again.  When the OECD data series starts –  1970 –  average productivity here was about equal to that of the G7 countries as a whole.

Another way of looking at these same data is to look at when other countries reached the level of productivity New Zealand had in 2016 (37.5 USD per hour, expressed in real 2010 terms, converted at PPP exchange rates).

Some of the other OECD countries first get to that level in the early-mid 70s (Luxembourg, Switzerland, Netherlands, Norway).  Two only got to our current level in the mid 2000s (Iceland and Japan), but of course even that leaves us at least a decade behind.    The G7 countries as a group got to our current level of real GDP per hour worked in 1990, and the median country (as per the chart above) got to our current level of real GDP per hour worked in 1989 –   27 years, or just over a quarter of a century, ahead of us.  Jacinda Ardern would have been in primary school then.

One can’t too much weight on the precise numbers/data –  different conversion rates will produce somewhat different gaps –  but the gaps are huge, and we –  in aggregate – are a long way behind.  I’m hoping –  but am not optimistic –  that today’s conference might help shed some further light on the matter.  I’d settle for some hardheaded realism about how far behind we now are –  lagging the core of the advanced world (the countries we usually liked to compare ourselves too) by a quarter of a century now.

And, of course, the idle hope is that some political leaders might (a) care and (b) set about doing something about closing the gap.  Productivity is the foundation for prosperity, and many desirable social goals.  It isn’t everything of course –  even if, in economic terms, it is almost everything in the long run.   But in all the hoopla about the first 100 days of the government, or even its challenges for the next thousand, there wasn’t any sign of a determination to reverse these decades of underperformance.  Sadly, although there were a few references to the productivity failure during the campaign, the new government seems to have lost interest even faster than their predecessors did.

Reserve Bank attempts to play distraction

A slightly strange story –  but one that rings very true – leads the business section of this morning’s Dominion-Post.  In the story, Hamish Rutherford reports on an interview with the Reserve Bank’s long-serving chief economist John McDermott.   If the interview is at all accurately reported, McDermott appears to have got himself into one of his periodic grumps with the private market economists.

I worked closely with McDermott for six years –  he was my boss, and we sat directly opposite each other.  He is mostly a pretty amiable guy, and in an earlier phase of his career had published a lot of research (a few years ago he was still, apparently, one of the New Zealand economists most cited in formal economics literature).   But he doesn’t react that well to people disagreeing with him, especially openly (some of my other concerns were outlined in this earlier post on one of his 2017 speeches).   There is often a testiness about his reactions –  combined with a condescending tone of a “you just don’t understand” type.

And yet, of course, together with his colleagues he has been consistently wrong about the inflation outlook (and, thus, monetary policy) for at least the last five years.   (In fairness, of course, except during the Bank’s very grudging series of OCR cuts in 2015/16, the median market economist has generally been even more wrong.)

But what of the latest interview?

A top Reserve Bank official has dismissed criticism from bank economists about his forecasts as “nonsense” saying the bank is ready to cut interest rates if growth lags.

On Thursday both Westpac and ASB accused the Reserve Bank of being too optimistic in its forecasts for economic growth.

But Dr John McDermott, the Reserve Bank’s chief economist for the past decade said the bank economists appeared to misunderstand the process creating Reserve Bank’s forecasts.

“Nonsense” is strong language.   And both the Westpac and ASB chief economists previously worked in the forecasting part of the Reserve Bank, albeit a few years ago now.

Here is Westpac

However, we still think the RBNZ is expecting too much of the New Zealand economy. In our view, the recent plunge in business confidence portends a slowdown in business investment that the RBNZ has not allowed for. Furthermore, we expect the Government’s upcoming changes to the tax treatment of investment housing, the foreign buyer ban, gradually rising fixed mortgage rates and lower net migration will slow the housing market later this year. A slow housing market would, in turn, lead to slower consumer spending than the RBNZ anticipates. Finally, we doubt that construction activity will accelerate in 2019 to the extent that the RBNZ expects, even with the KiwiBuild scheme in operation. Capacity constraints in the construction industry are just too binding.

Agree or not, they sound like plausible points on which reasonable economists might disagree, without resorting to name-calling.

But –  as he has often done in the past when his forecasts have been called into question – McDermott falls back on a claim of being misunderstood.

Rather than predicting what the economy will do, the bank worked out what kind of growth was needed to generate sufficient inflation. The variable in the equation is interest rates, which the bank can change.

In an interview in the Reserve Bank’s headquarters in Wellington, McDermott, repeatedly said if the economy was not growing fast enough to generate inflation, the bank will cut the official cash rate.

“It’s not about being optimistic or hopeful, it’s actually, if we don’t get that growth rate, we are going to lower interest rates because otherwise we won’t get the inflation rate.”

McDermott just shouldn’t be allowed to get away with this sort of special pleading  (even setting aside the fact that he and his bosses have actually delivered core inflation well below the target midpoint for years now).   He makes a partially fair point that one can’t just look at the Bank’s GDP forecasts in isolation.   But that is true of anyone’s forecasts.  While it is inflation targeting, the Reserve Bank will always show inflation coming back –  more or less slowly – towards the target midpoint.      And so, at very least, one has to read the interest rate and GDP forecasts together.

But in Westpac’s case they think GDP growth will be lower than the Bank is projecting, and that interest rates will be a (very) little lower than the Bank is projecting.  Against that backdrop it seems quite reasonable for them to say that the Bank is being too optimistic about how much GDP growth is likely over the next couple of years with interest rates around where they are now, or even a bit lower.

McDermott goes on

“Our inflation forecasts are always 2 per cent, it’s always 2 per cent.  [eventually]

“It is because we plan to succeed, and then you go, ‘well, how do you do this’. And so, the monetary policy statement’s objective isn’t an unadulterated forecast about what we think will happen, it’s what do we need the plan to look like to make it happen.”


The problem with McDermott’s story is that his forecasts today influence policy today.  Thus it is fine to talk  –  as McDermott often does –  about revising forecasts in light of developments.  But better still, how about getting them (more) right first time round?    The Bank believes that it will, with current interest rates, generate more demand and economic activity –  and thus more inflation –  than some of the private economists (eg Westpac and ASB) think likely.     The Bank is in that sense more “optimistic” than these private economists.  If the Bank is wrong, we will eventually find out, and (slowly, grudgingly) policy will be adjusted, but in the meantime we’ll have missed out on some growth (they expected) and inflation will have fallen short of the target (again).  If they are indeed too “optimistic” now, it matters.

McDermott goes on

McDermott said many bank economists did not appear to understand the process.

“They sit outside, they don’t get to influence policy. We get to move [interest rates]. Inflation has to be 2 per cent, and engineer backwards, what do you need growth to be, to engineer 2 per cent [inflation].”

So if growth starts lagging, you’re going to cut the OCR?

“Yes. That’s the game,” McDermott said. “So the fact that they think we’re being optimistic is a nonsense, because if it doesn’t eventuate, we get to alter interest rates.”

It is exceedingly unlikely that bank economists did not “understand the process”.  The process has been operating in basically the same way for more than 20 years now, it is extensively documented by the Bank in published material, and three of four main banks now have chief economists who started their careers in the Reserve Bank Economics Department.  What is going on here is that the Reserve Bank chief economist is on the defensive, and rather than defend the substance of his forecasts he attempts to muddy the waters with suggestions that the private economists just don’t understand.

Thus, we are told, McDermott

 would “remind” several chief economists of the process used

Which won’t change the fact that there is a difference of forecasts –  of views.

In a way, he even concedes the point.   The final sentence of the hard copy version of the article isn’t in quotation marks but here is what McDermott is reported as saying

McDermott said it would be a different situation if the banks were saying that the forecasts were too optimistic based on the OCR remaining at the current level.

So what was all the name-calling about?   As McDermott knows, neither Westpac nor ASB is forecasting an OCR cut, and the Reserve Bank isn’t forecasting an interest rate increase for some time.  The private economists and the Reserve Bank all have the OCR at 1.75 per cent throughout this year and well into next year, and thus their GDP forecasts for the next year or two are apples-for-apples comparisons.   It is quite reasonable to say that Westpac and ASB think that Reserve Bank is too “optimistic” (and they don’t need to state all their ancillary –  but rather obvious –  assumptions every time they make the point).

The article also contains this observation and comment

While economists have slowly come around to the Reserve Bank’s view that the OCR will stay at its current low for at least a year, none give a significant chance that the Reserve Bank will cut.

McDermott suggested they were wrong to do so.

“The market thinks ‘you guys are never gonna [cut]. They’ve been through almost a whole year of ‘there’ll be no chance you guys are going to cut interest rates’. Well, that’s not true.”

But again, this looks like a deliberate attempt to skew interpretations.   The Bank – rightly in my view –  has talked of the possibility of cutting the OCR, but in all its comments last week –  including from the “acting Governor” –  it came across as very reluctant.  And its published OCR forecasts don’t have a flat track as far as eye can see –  in fact the track starts edging upwards from the middle of next year.  And what of the market economists?   A couple of the more prominent ones are included in the NZIER Shadow Board exercise.  Here were their latest probability distributions for where they think the OCR should be.

shadow board feb 18

The chief economist of Westpac a few days ago thought there was 25 per cent chance that the OCR should have been lowered.   Indeed, in their post OCR commentary, Westpac explicitly said

If anything, we would put the odds of an OCR reduction this year as slightly higher than the odds of a hike

(Perhaps if the Reserve Bank really wants people to stop focusing on possible OCR increases they should, at last, drop the endless rhetoric about a “normalisation” of interest rates?)

I’m also a bit sceptical of the Reserve Bank’s growth projections.  As I’ve been pointing out for some time, in each set of quarterly forecasts they project a return to productivity growth.  In the latest numbers, after four years of basically zero growth in their “trend labour productivity” measure, they forecast a steady pick-up in productivity growth such that by 2020/21 they expect 1.2 per cent annual productivity growth.  In a single year, they expect as much productivity growth as the total productivity growth they show for the six years to March 2019.   Without any material productivity-enhancing micro reforms, and without any substantial reduction in the exchange rate, if that isn’t “optimistic” I’m not sure what is.   I really hope they are right, but it looks too optimistic at present.

No doubt the private bank economists will just grumble quietly, and their view of McDermott will be adjusted another notch downwards.    After all, they’ve seen what happens to those of their number who too openly criticise the Reserve Bank –  recall that McDermott was one of those deployed by Graeme Wheeler last year in his heavyhanded attempts to silence BNZ chief economist Stephen Toplis.

But we –  the New Zealand public – deserve better.    We need a reformed Reserve Bank, a properly independent statutory monetary policy committee, not simply staffed with bureaucrats, and we need quality senior staff of the Reserve Bank who are capable of engaging openly, and authoritatively, on the sort of issues and uncertainties we face in making sense of the economy, without resort to name-calling or rather desperate attempts to suggest that people who disagree with the Bank just don’t understand, and that they need to be called in and “reminded” of the process.




Parliament should fund the Reserve Bank annually

Readers may well be getting a little tired of the run of posts this year on issues relating to the review of the Reserve Bank Act.  In truth, so am I.    However, The Treasury is inviting comments, with a deadline of later this month.

There are two stages to the review.  The first, led by Treasury, is around implementing reforms Labour campaigned on (a statutory monetary policy committee, and adding some sort of employment goal).  The second –  as yet ill-defined – is to be led jointly by the Reserve Bank and Treasury and is to look at any other issues that the Minister agrees warrant review.  For now, The Treasury is inviting views on what issues should be looked at in Stage 2.

My broad response to them on that question has been “anything and everything”.  The Reserve Bank Act –  and the other Acts the Bank operates under –  has grown like topsy over 30 years.  Roles and functions have changed.  Expectations around transparency have changed. And models that might have seemed sensible in 1989 – eg the role of the Board –  no longer do so today.   Probably the Act should be rewritten from scratch, but even if that doesn’t happen, no part of the current Act should be outside the scope of the review.   My post the other day proposed structural separation –  spinning out of the Bank a new Prudential Regulatory Agency.

Today I want to focus on funding the Reserve Bank’s operations, an aspect of the Act that could be easily overlooked as part of the review, but where current legislation falls far short of best practice.

Historically, there were typically no checks on the spending of a central bank.  Central banks “printed money” –  physically or electronically – and didn’t need to rely on tax revenue appropriated by Parliament.   They typically earned a lot of income by issuing (zero interest) bank notes, and investing the proceeds (often in government bonds).  I regaled my kids recently with the tale of the night –  the RBNZ 50th anniversary –  when the Bank took over the Michael Fowler Centre and hosted a banquet and dance (free) for staff and spouses, includng a McPhail and Gadsby floor show.  The kids asked who paid for it, and struggled to get their minds around the notion that “we just printed the money”, but that was the way things were.  These days –  rightly –  the Taxpayers’ Union would be all over such extravagance –  or the chauffeur for the Governor (and, if I recall rightly, even the Deputy Governor).  There was an Annual Report, of course, but little detail and no effective spending control or accountability.  It wasn’t that the Bank was always extravagant –  it wasn’t – but there were few or no external constraints.

The reformers of the late 1980s recognised the need for things to change.   But expenditure control took a distinctly secondary place to promoting and preserving the operational independence of the Bank in the conduct of monetary policy (recall that at the time the Bank was conceived of largely as a monetary policy agency).    There was much less concern about controlling spending than about closing off backdoor ways for a Minister of Finance to exert pressure on the Bank’s monetary policy.  The ability to threaten an annual parliamentary appropriation –  “go easy on monetary policy or I’ll cut your funding”  –  was seen as an important risk

And thus we ended up with the Funding Agreement model.  Under this model, the Governor and the Minister of Finance may reach a five-yearly agreement, which has to be ratified by Parliament,  on how much of the Bank’s income can be used for operating expenses in each of the subsequent five years.   I wrote about the model when the current funding agreement was ratified in 2015.

There had even been talk –  probably not welcomed at The Treasury –  of using the Permanent Legislative Authority route (a model used for judges’ salaries and Crown debt servicing), a model under which no parliamentary authority would ever have been required for the Bank’s spending.  Even at the time, that seemed a little self-important.

The Funding Agreement model certainly means that for most of any five year period, the Reserve Bank does not need to worry about ministerial pressure exerted via its budget.  And, as it happens, there has always been a Funding Agreement in place, and those funding agreements did help to lower substantially the level of spending at the Bank.  In that sense, they were a step forward relative to what had gone before.   But they are very far from best practice.

Treasury has a nice document on its website outlining the principle and process of parliamentary authorisation of public spending.  It begins this way

A long-standing principle under the Westminster style of government is that no expenditure of public money can take place without the prior approval of Parliament. In New Zealand, both the Constitution Act 1986 and the Public Finance Act 1989 continue this historical requirement.

Appropriation ensures that Parliament, on behalf of the taxpayer, has adequate scrutiny of how public resources are to be used and that the Government is held accountable for how it has used the public resources entrusted. The Estimates specify for each appropriation:
• a maximum amount of resources that can be consumed
• the purpose for which the appropriation can be used.

As they go on to note, most appropriations are for only a year at a time.

The Reserve Bank model falls short in a whole variety of ways:

  • there is no legislative requirement for there to be a funding agreement at all, and no (formal) consequences if the Governor and Minister do not (or cannot) agree on one,
  • there is no breakdown of the agreed level of spending between the Bank’s (quite different) stautory functions, and thus no restriction on the ability of the Bank to spend the money  in one area rather than another as it chooses,
  • there are no penalties or formal adverse consequences if the Bank spends beyond the limits set out in the funding agreement,
  • while the Minister and the Governor can agree to a variation in the level of the funding agreement during its term there is no ability for the Minister (say, a new government) to override the agreement, even temporarily (as, say, there is in respect of monetary policy itself),
  • in (almost?) all areas of public spending, the Minister asks Parliament for approval, and Parliament approves (or rejects) the proposed level of spending.  Officials make bids and try to persuade ministers of a need for more money for their department or agency, but they have no ability to block or formally constrain choices of the Minister and Parliament.  But the Reserve Bank Governor –  himself, in effect, appointed by unelected people (the Board) –  has that degree of control (no agreement needed, any agreement needs the Governor’s assent, and no consequences from failure to agree).

And it isn’t even that workable a model.  No corporate sets operating expenditure budgets five years in advance –  circumstances change, the price level changes, and so on.

And this is not some trivial government entity doing some unimportant function.  It isn’t primarily a trading entity spending money to make money.  The Reserve Bank is the key entity responsible for short to medium-term macroeconomic management, and has a huge range of discretionary power in areas of financial sector regulation.   And it has several billion dollars of Crown capital. The financial expenditure provisions are a glaring anomaly, out of step with one of the fundamental principle of our system of government.

The system hasn’t been grossly abused: mostly the Reserve Bank seems to spend fairly responsibly, and the Minister is advised by Treasury at the point of renegotiation.   But, equally, it is not as if the Minister and the Bank have gone above and beyond the formal statutory provisions: they could, for example, lay out detailed annual estimates, by functions, at the time the Funding Agreement was released, and report actuals against those estimates over the following five years.  But they don’t even do that: it is the sort of lack of transparency that led me to suggest earlier that there is no more transparency around the Bank’s spending plans –  one line item per year –  than there is around that of, say, the SIS.  And unlike the Bank, the SIS needs an annual parliamentary appropriation or it can’t spend anything at all.

A common argument –  at least among central bankers –  is that somehow central banks are different.  There is only one important respect in which they are: they earn far more than they spend.  But even that isn’t very important here.  Central banks make money largely through the statutory monopoly on currency issue, which is just (in effect) another form of taxation.  And spending and revenue are two quite different bits of government finance: IRD might collect lots of money, but it can only spend what Parliament appropriates.

And what of those arguments about avoiding back-door pressure?  Even they don’t mark out central banks.  After all, we don’t want ministers interfering in Police decisions either (a rather more important issue than a central bank), but Police are funded by parliamentary appropriation.  So is the Independent Police Complaints Authority.   There are plenty of regulatory agencies where policy might be set by politicians, but the implementation of that policy is set by an independent Board, and where backdoor pressure could –  in principle be applied.  Other bodies publish awkward reports that make life difficult for politicians.  But those bodies too are typically funded each year by parliamentary appropriation.  It is just how our system of government works.

When I wrote about this issue in 2015 (having only recently emerged from the Bank), I was hesitant about calling for radical change.   The funding agreement system itself could be tightened up in various ways, which might represent an improvement on what we have now.   But there isn’t any very obvious reason not to start with a clean sheet of paper, and build a new system –  aligned with how we manage public spending in the rest of government –  starting from the principle of annual appropriations, with a clear delineation by functions (monetary policy, financial system regulation, physical currency etc), and standard restrictions on the ability of ministers to reallocate funds across votes).

I’m not aware of any country that funds it central bank by annual appropriation.  But historically, central bank spending all round the world was subject to weak parliamentary control.  This is one of those areas where the international models aren’t attractive, and the standard should instead be the way in which we authorise spending across the rest of government.   This is a policy and regulatory agency –  not, say, primarily a trading entity (like, eg, the New Zealand Superannuation Fund) –  and should be funded, and held to account, accordingly.

Inflation is – still – expected to rise

Inflation is expected to rise gradually towards the two percent midpoint of the target range.

That was what the then Reserve Bank Governor said in the press release for the March quarter Monetary Policy Statement five years ago.

And today Grant Spencer (the unlawful “acting Governor”) said

Overall, CPI inflation is forecast to trend upwards towards the midpoint of the target range

So much time has passed, and so little has changed.  I could probably compile a complete set of those sorts of quotes, drawing from every OCR review for at least the last five years.

And this is how the Reserve Bank’s preferred core inflation measure has actually been performing.

core inflation feb 17

December 2009 was the last time core inflation was at 2 per cent.  And there is little or no sign that –  despite all the Reserve Bank forecasts –  that the gap has been closing.

The Reserve Bank doesn’t publish core inflation forecasts, but since they also don’t typically forecast price shocks (the sorts of one-offs that get sifted out in the core measures), their actual medium-term inflation forecasts are a reasonable proxy.   On the numbers published this morning, it will be September 2020 before we could expect to see core inflation back to 2 per cent –   if so, core inflation would have been below the (explicitly highlighted) target midpoint for more than a decade.  Even though over that whole period our Reserve Bank has not once come close to exhausting the limits of conventional monetary policy.

And the worst of it is that neither in the published statement this morning, nor in the press conference could the Bank’s second XI (holding the fort until the new Governor takes office next month) offer any explanation for why they are more likely to be right this time than in those previous five years of statements affirming that inflation was heading back to the target midpoint.   In fact, there was no sign of them even attempting such an explanation.

Over the years core inflation has been below target we’ve had the big boost to demand from the Christchurch repair process, a material further step up in the terms of trade (albeit with a fair amount of volaility), a significant reduction in unemployment, and the demand effects of an unexpectedly strong and persistent rate of population growth.  We’ve seen the end of the fiscal consolidation phase too.  And there has been no sign of core inflation picking up much, if at all.    What, we should expect to be told, is likely to make things different over the next few years?   And why have they got things wrong – again – over the last couple of years?

The Bank claims the output gap is now near-zero, but on their own (inevitably imprecise) estimates those resource pressures are a bit less than they were, and haven’t changed much for several years now.

In the press conference, there were several questions about the case for an OCR cut, which the Bank sought to bat away (not remotely convincingly in my view).  The “acting Governor” acknowledged that there is a risk that the next OCR adjustment could be a cut –  if the downside inflation surprises continue –  but repeatedly sought to play down the significance of the 2 per cent target midpoint, which –  as a focal point – was explicitly added to the Policy Targets Agreeement in 2012.  Asked –  channelling lines run in this blog –  whether it might not be time to take some risks, after eight years of (core) inflation below target, Spencer could only fall back on observing that inflation had been inside the range, and that what mattered was to be patient and confident that inflation would be back to the target midpoint before long.  In other words, trust us, even though that trust has been misplaced for years now.

Asked then whether there was not also a case for acting now to push up inflation to create more policy leeway (in nominal interest rates) when the next recession comes, Spencer could offer nothing more than the limp observation that “we have to have a good reason to change policy”, and that they wouldn’t want to change rates until they could be confident the policy could be sustained (even though the whole point of this particular proposal is to use lower policy rates in the short-term to generate higher policy rates in the medium-term).

I suspect that much of what is going on is the same old line was used to hear repeatedly from Graeme Wheeler – the “normalisation” of interest rates which are currently –  in the Deputy Governor’s words –  “very stimulatory”.   A common way of judging whether policy is “very stimulatory” or not might be to look at inflation developments, which suggest –  for now at least –  that the neutral interest rate has fallen.   The siren call of “policy normalisation” has tantalised central banks for much of the last decade –  none more so than the Reserve Bank of New Zealand, with two unwarranted and reversed sets of OCR increases –  and isn’t helping the cause of good policy.  Perhaps –  perhaps even probably –  at some point interest rates will move up quite a lot and stay higher, but that hasn’t a helpful guide to practical policy at any time in the last decade.   Actual (core) inflation, by contrast, has been.   The Reserve Bank now seems tantalised by the official rate increases in the US and Canada, but there is little sign of that becoming a generalised pattern across advanced country central banks –  partly because there is little sign of generalised increases in core inflation.

There was one new interesting development in the Monetary Policy Statement.  Buried in a footnote was the report of a new point estimate for the NAIRU of 4.7 per cent (in the press conference, they added a range of 4.0 to 5.5 per cent), based on some as yet unpublished research work.  I welcome the publication of the estimate –  a step forward –  but I’m a bit sceptical about their number (which is actually higher than the NAIRU estimate the Bank had in its models a decade ago, and there are good reasons to think NAIRUs –  here and abroad –  have been falling over time).  But if they really believe the story that the output gap is zero and the unemployment gap is zero, and their own data show (see chart here) that there is nothing unusual about the current relationship between core tradables and core non-tradables inflation, then it raises some questions they don’t seem to have attempted to answer.  Given that actual core inflation has been persistently low, it would suggest that inflation expectations are also well below the target midpoint.  As I’ve illustrated again recently, that is certainly the case in bond market indicators (unlike say the case in the US), but the Bank continues to assert that there is no issue and that inflation expectations are securely anchored at 2 per cent.  Something in their story doesn’t seem to add up.

In a way, today’s Monetary Policy Statement doesn’t matter much:

  • Spencer himself retires in six weeks or so, just after the next OCR review,
  • a new single-decisionmaker Governor will take office, and we have heard as yet nothing from him about his approach to the role,
  • there will be a new PTA, which the government has not yet given us any details (although there have been some suggestions that the 2 per cent midpoint reference might be removed),
  • the statutory goal of monetary policy is to be amended later this year (presumably also requiring a new PTA), but with no details yet, and
  • a statutory Monetary Policy Committee is to be put in place shortly, including with outside members.

In other words, what Grant Spencer thinks today about future policy isn’t that important and obviously isn’t binding.  But there is no reason why the analytical part of the document could not have been a lot more persuasive –  if in fact the existing senior management team has a compelling story to tell.  As it is, they don’t seem to.

At the end of the press conference, Bernard Hickey invited Grant Spencer to reflect on his involvement with many Monetary Policy Statements over the years (going back to the very first one in April 1990 –  which I drafted most of, and Grant was my boss).    He offered only two brief thoughts: flexible inflation targeting had proved to be a good framework, and the (slightly cryptic) patience is a virtue.   I wasn’t sure if that latter observation was as close as we were going to get –  from a thoroughly decent senior public servant –  to an acknowledgement that the 2014 tightening cycle, driven by a combination of conviction that inflation was about to take off (above 2 per cent) and repeated talk of “policy normalisation”  –  had been a mistake.

If so, we should be grateful, but it is still important that the Bank shouldn’t be so paralysed by its previous mistake –  an inevitable human tendency –  that it fails to do its job.  It is increasingly difficult to see why we should confidently expect core inflation to get back to 2 per cent on current policy, or what harm might be done from signalling more strongly the possibility of a lower OCR.  After all, as both the “acting Governor” and the chief economist said, the aim isn’t to be exactly at 2 per cent each and every quarter, and if anything a period of inflation a bit above 2 per cent –  not sought, but if it happened –  might actually help to rebuild confidence that the target really was centred on 2 per cent, not operating as a ceiling of 2 per cent.

Should the Reserve Bank be broken in two?

I’ve come to think so.

The Reserve Bank has two main functions:

  • conduct of monetary policy (and supporting activities –  currency issues, foreign reserves management, interbank settlement accounts), and
  • prudential regulation of banks, non-bank deposit-takers, insurance companies (and roles around payments system and AML thrown in for good measure.

These quite different functions are conducted in one institution, but they needn’t be.  In fact, in most advanced countries they aren’t.

Historically, there wasn’t much prudential regulation in New Zealand at all.  There was lots of direct regulation of various types of financial intermediaries (banks, building societies, savings banks and so on) but most of the regulation (reserve ratios, interest rate controls etc) was macro policy focused, not about financial system stability or depositor protection per se.   That regulation –  often administered by the Reserve Bank, but individually approved by the Minister of Finance –  was a substitute for the sort of market-based monetary policy all advanced countries now rely on.   As interest and exchange rates were freed up, the panoply of direct controls was stripped away.   Our great bonfire of such controls took place in 1984 and 85.

By the time what became the Reserve Bank of New Zealand Act 1989 was going through Parliament, the primary conception of the Reserve Bank was as a monetary policy agency.   Sure, there were some regulatory provisions –  and in particular provisions around the handling of bank failures –  but it was seen as pretty peripheral activity.  If anything, it became more peripheral as the 1990s unfolded: the framework covered only banks (increasingly a foreign-owned group), there was a shift to a largely disclosure-based regime, and the function took very few staff  (from memory, only around 10 or 12 staff).  For practical purposes it probably wasn’t too much of an issue that the two functions were in one institution.

But as the 21st century unfolded so too did a dramatic change in the supervisory and regulatory activities the Reserve Bank was involved in.    There were new classes of entities to regulate or supervise, new functions (payments system and AML) to regulate or supervise, new statutory reporting obligations, a reduced reliance on disclosure (even for banks), and new powers and new appetite for more direct and discretionary regulatory interventions (culminating, for example, in the numerous iterations of LVR controls in recent years).  The Reserve Bank now is at least as much of a financial regulatory and supervisory agency as it is a monetary policy one.  A large share of the staff, a large share of the budget, and a large share of the Govenor’s time is now devoted to these functions.

I’m not here offering a view on the merits, or otherwise, of these new activities.  The point is simply that Parliament has either specifically mandated the Bank to do these new things, or written legislation that has allowed the Bank to do them.    And those functions don’t look like going away any time soon.  After all, if many details are a bit different from models used in other countries, the broad direction –  more comprehensive, more intensive, controls –  isn’t exactly some idiosyncratic New Zealand thing.  It is the way of the world, for good or ill.

At times, the Reserve Bank has tried to make a virtue of this “all in one” model.  In the wake of the 2008/09 recession, the former Governor Alan Bollard made much of the idea of a “full-service central bank”, very well-positioned to carry out the variety of different functions because they were all located in a single institution.    More often, the Bank has pointed out that there is a range of ways of organising these activities, suggesting that no one model is clearly superior.

There is certainly a range of models used in other countries, but once one looks a bit more closely there are also some pretty clear patterns which emerge.  Specifically, New Zealand’s current model is out of step with the main stream of advanced countries.

People here often, and naturally, look to Australia.  Once upon a time their Reserve Bank and ours had a lot in common in what the institutions were responsible for, and both had evolved through a phase where direct controls had been mostly about monetary policy.  But about 20 years ago, the emerging regulatory functions were spun out of the Reserve Bank and a separate Australian Prudential Regulatory Authority (APRA) was established.     There has been no sign that the Australian authorities are unhappy with that model, which seems to work well, allowing both the RBA and APRA to concentrate on their own primary areas of responsibility.

There are plenty of advanced country central banks which are responsible for bank supervision.  But in most cases now those national central banks are part of the euro-area: they don’t themselves set monetary policy (although each Governor has a vote at the ECB), and would struggle to justify existing as independent entities were it not for the supervisory roles.

But if we look at advanced countries that do have their own monetary policies, I could find only three others –  Czech Republic, Israel, and the United Kingdom –  in which the same agency is responsible for monetary policy as for prudential supervision.   The US is –  in this area as so many –  a curious hybrid system, in which the Federal Reserve has some –  but not remotely all – responsibility for prudential supervision.  But as far as I could tell, the following OECD countries have monetary policy and prudential supervision conducted by separate agencies:

Canada, Australia, Norway, Sweden, Korea, Japan, Poland, Chile, Turkey, Mexico, Switzerland, and Iceland

I’m not sure that Turkey or Mexico offer models of governance for New Zealand, but the presence on that list of small well-governed countries like Norway, Sweden and Switzerland –  as well as tiny Iceland –   gave me pause for thought.

And the more I reflected on the issue, the harder it was to identify good reasons why New Zealand should now stay with the all-in-one model:

  • probably the most common argument made is about the possible “synergies” between financial regulatory and monetary policy functions.  But there are snyergies, connections, and potentially valuable information overlaps all over the place.  Between fiscal and monetary policy for example, and yet we –  and every other advanced country –  keeps fiscal policy advice and governance quite separate from monetary policy.   And I could mount arguments of possible synergies between the Reserve Bank’s financial market activities and the role of the Financial Markets Authority, and yet no one seriously argues for putting the FMA into a mega Reserve Bank.     Specialisation, and specialist agencies, has tended to be the way in which advanced country governments have organised themselves (often backed by information-sharing protocols, and effective working relationships across agencies –  eg a typical Cabinet paper will reflect perspectives or comments from a range of agencies with relevant perspectives on the topic),
  • as it is, the synergies between the monetary policy related functions and the prudential regulatory ones are generally pretty slight –  almost vanishingly so in normal times (and there are some conflicts).   The timeframes are different, the instruments are different (indirect influence vs direct controls), the required mindsets are different, the Bank’s own financial market operations are typically quite mundane, and its research capability (developed mostly for monetary policy purposes) has rarely been used to produce research around the regulatory or supervisory functions.     One of my former colleagues likes to argue that one should conceptualise the Bank’s regulatory role as akin to that of a banker knowing his or her customers, and (eg) maintaining covenants on the credit facilities of those customers.  But mostly monetary policy isn’t about lending to banks –  and certainly not to insurers or credit unions –  and when there is lending involved in monetary policy, the Bank typically seeks to expose itself to minimum credit risk.   Crises can be, and are, different –  lender of last resort, and provision of emergency liquidity is a core part of a central bank role –  but it doesn’t seem to have been an obstacle to other small well-governed countries separating out the monetary policy and regulatory functions into different institutions.
  • organisational cohesion and culture are likely to be better-fostered in institutions that have a single main purpose,
  • the same goes for the senior leadership of the organisation.  20 years ago it would have been inconceivable that the Governor would be focused primarily on anything other than monetary policy –  that was overwhelmingly the Bank’s role –  but now it is not so at all, and yet the sort of skills, expertise, and even relationships that might be needed to be responsible for monetary policy –  with considerable macroeconomic discretion, and associated accountability, may be quite different from what best suits a regulatory agency.   We might well benefit from having both a highly capable macro and markets focused Governor of the (monetary policy) central bank, and the head of a specialised financial regulatory agency.
  • governance structures and accountability models would be likely to develop more naturally if the two main functions were structurally separated into different institutions.   (And it is more difficult than it should be to hold the Governor effectively to account when he is responsible for two, quite different. big areas of policy).
  • Specifically, the Bank’s regulatory activities would quite naturally fit with something much closer to a standard Crown entity sort of model (as with the FMA) –  in which key big picture policy matters were decided by the Minister of Finance (with advice from Treasury and the agency), while the Board of the agency was responsible (with operational autonomy) for the implementation of the framework.  The monetary policy (and related) functions don’t fit that sort of model, partly because of the inevitable quite substantial degree of policy discretion –  and hence need for ongoing transparency and accountability –  that are (largely rightly) seen to need to go with monetary policy.

I’ve argued previously that it seems mistake to push ahead with the proposed Stage 1 reforms flowing from the review of the Reserve Bank Act, without first completing an overall review of how the functions the Bank currently undertakes should best be organised, governed and held to account.

And so here is my model:

  • the Reserve Bank becomes responsible for the conduct of monetary policy (and directly associated functions –  interbank settlement, notes and coins, foreign reserves management.   In my post on Monday I outlined how I would establish a statutory Monetary Policy Committee.   The same people, appointed the same way, would comprise the Board of the Reserve Bank, and would be responsible for all the functions of the Reserve Bank.  Specific statutory provisions –  of the sort outlined in Monday’s post –  would cover them when meeting as the Monetary Policy Committee.  Note that this model would also increase the chances that the executive members of the Monetary Policy Committee would be genuine experts in the area, devoting of their time and energy to monetary policy,
  • a New Zealand Prudential Regulatory Agency –  parallel to APRA –  would be established to take responsibility for the regulatory and supervisory functions the Bank currently has  (but with a revision and streamlining of powers, so that  major policy framework decisions are once again matters for the Minister of Finance).    There is a variety of possible structures.  A typical Crown entity would have a non-executive Board responsbile for the institution, employing a chief executive to run the day to say organisation, generate advice, and implement the policies of the Board.   But a small executive Board (akin to APRA) is an alternative approach.
  • perhaps the (formal) establishment of a Financial System Council, with representation from the Reserve Bank, the NZPRA, and the FMA, to offer advice –   perhaps especially systemic advice –  to relevant ministers.

There is no role in this model for anything like the current Reserve Bank Board.    That Board is almost totally useless, and I’m not aware of anyone who thinks it adds value.  In many ways that isn’t surprising.   The Board was designed as agent for the Minister and the public holding the Governor to account, in particular for his conduct of monetary policy (but also for his more general stewardship).   It isn’t a model found anywhere else in the New Zealand public sector, and for good reason.  The Reserve Bank Board has no independent resources, it meets at the Reserve Bank, its Secretary is a senior Reserve Bank manager, and the Governor himself sits on a Board whose prime purpose is to hold the Governor to account.   It is a highly successful recipe for “duchessing”:  the Board comes to see itself more as part of the Reserve Bank, acting to defend the Bank and the Governor, lulled by all the smart people who present to it (and with few/no formal powers), rather than as some sort of independent source of scrutiny or critical analysis.

Part of the failure is structural –  the system was set up in a way that meant it would almost inevitably fail (at least once monetary policy was conceived of as anything other than mechanical, and once the functions broadened out) –  but that doesn’t remove responsibility from the people (often otherwise quite able) who have served on the Board over the years.   In the 15 years the Board has been required to publish Annual Reports –  which, bad sign, they choose to publish buried in the midst of the Governor’s Annual Report –  they have never once made even a slightly critical or sceptical comment about the performance of the Governor or Bank, on policy or other areas of performance.  Disgracefully, they stood by silently while Graeme Wheeler and his senior management tried to silence Stephen Toplis’s criticism –  and, of course, they cheered on Wheeler’s public attack on me when I drew the Bank’s attention to an apparent leak of an OCR decision.    They serve no useful function, and should be disbanded as part of the current review, and amended legislation.

Of course, that doesn’t mean there is a reduced need for scrutiny and accountability.  My point about the Board is that, in effect, over almost 30 years they simply haven’t served that role –  they just function as a department of the Bank, protectors of the insiders.  Effective accountability doesn’t really involve the power to fire –  or to recommend dismissal –  the main formal accountability power the Board has: no Governor (or MPC member) will ever be fired for policy-incompetence related cause during their term (and nor should they be), and the same goes (and should) for independent financial regulators.  But reappointment is another matter altogether.  And much about accountability is the quality of the questions, the bringing to bear of alternative perspectives etc.    The new government has proposed –  in fact promised before the election, although nothing has been heard of it since –  to establish a Fiscal Council, to help provide genuinely independent scrutiny of fiscal policy and associated analysis.  I’ve argued previously –  and repeat the call today –  that this new entity should actually be set up as a Macroeconomic Review Council, responsible for independent scrutiny (published reports etc) on fiscal policy, monetary policy, and systemic financial regulatory policy.  Operating at arms-length from all the agencies –  Treasury, Reserve Bank, NZPRA, and FMA –  and not resourced by them, it would have a better chance of making a material contribution than the Reserve Bank Board has done, and could help promote scrutiny and associated debate.

A little anecdote of how the Reserve Bank’s Board seems to allow itself to be subsumed into the Bank

A month or so ago I lodged an Official Information Act request with the Reserve Bank’s Board –  explicitly asking for it to be delivered to the Board chair – asking them

  • how many OIA requests the Board had received in 2016 and 2017, and
  • for copies of the Board’s policies and procedures for handling OIA requests.

It seemed to be a pretty straightforward request.   The Board is, after all, statutorily distinct from the Bank, is required to publish its own Annual Report, and (in my experience) had good, well-filed, sets of Board papers.   With a new emphasis from SSC on agencies reporting on performance with OIA requests, I felt sure it would be an easy request to answer.  At most, surely, counting the number of OIA requests might require a quick flick through, say, 10 sets of minutes for each year.  I guess I also –  naively –  assumed that, with the current review underway, the Board would be keen to demonstrate the independent way in which it operated.

More fool me.

A couple of weeks ago, I had a response from one Roger Marwick in the Reserve Bank’s Communications Department telling me that under the Reserve Bank’s charging policy –  note nothing about the Board –  they would want to charge for this information, but noting that I might be able to reduce the charges by narrowing the scope of my request.

So I asked them what the cost would be if I simply restricted the request to the number of OIA requests.     And Mr Marwick responded that it would make no difference because all the costs were associated with that limb of the request.

So I then went back to him –  this was 12 days ago now –  suggesting that if that was the case, I presumed he could now provide me with the Board’s policies and procedures (since he’d just told me that all the costs were associated with the other limb of the original request.

I’ve heard nothing more since.  Last Friday, I went back to Mr Marwick and specifically asked for clarification as to whether the Board was refusing to release the policies and procedures, or were still considering the matter (as fast as reasonably practicable –  the statutory standard).  And again, I’ve heard nothing more.  My suspicion is that there are no Board policies and procedures for handling OIA requests, and that even though the Board’s whole role is to operate at arms-length from the Bank, holding it to account, they’ve just made themselves part of the institution, and left the same management they are paid to hold to account to handle such things.  And, clearly, have no interest themselves in the number or nature of requests being made of them.

In short, they are useless and ineffectual, at least for anything other than giving cover to the Governor.   But perhaps it shouldn’t really be surprising: this was the same Board that, on the basis of their own disclosed papers, doesn’t even comply with such basic requirements of good public sector governance as the Public Records Act.

UPDATE: A day after posting this, I had an email from the Reserve Bank backing down.  I have now been provided with the number of OIA requests made to the Board, and a copy of the Bank’s policies for handling OIA requests, with this observation

requests addressed to the Board are processed in the same way as those addressed to any other part of the Bank. The policy for handling OIA requests addressed to the Board is the same as the Reserve Bank’s policy. In the case of OIA requests made of the Board, the Bank informs and consults the Chair on the requests, and the Chair informs the Bank of the preferred response.

But since the decision to waive charges –  and thus avoid an appeal to the Ombudsman –  is described as having been made by the Bank, not the Board, I think it largely serves to illustrate my point, that the Board works hand in glove with management rather than serving as an sort of independent check on them.



Towards a statutory monetary policy committee

As part of the review of (parts of) the Reserve Bank Act, The Treasury is inviting comments and suggestions, on how the changes in stage 1 of the review (statutory goal of monetary policy, establishment of a statutory monetary policy committee) should be implemented, and on what else should be reviewed in the forthcoming stage 2 of the review.

Last Thursday I went along to a Stakeholder Engagement Roundtable, in which Treasury had invited various private economists in to offer our perspectives on those issues.  My post on Thursday –  on the statutory goal of monetary policy –  was, in effect, part of my notes in preparation for that meeting.   In the discussion, opinion was fairly mixed on the merits of making a change, but it was generally recognised that the government had committed to change and so the main issue was how best to give it legislative form.

The second chunk of the discussion was about the establishment of a statutory monetary policy committee.  Here there seemed to be greater unanimity that reform was desirable, and that part of any reform should be a greater emphasis on transparency, including individual accountability.

I’ve covered my own views on various of these points in earlier posts, but for ease of future reference, I thought I’d bring them together in a single post.  My model would not replicate that in any single other country, but is probably closest to the monetary policy committees in the United Kingdom and Sweden.

Who should appoint the members of the committee?

All of the members should be appointed by the Minister of Finance.   People who exercise significant statutory power –  and the conduct of monetary policy is certainly that –  sholu.d either be elected themselves or appointed by those who are themselves elected.  That is the general approach we take to governing New Zealand:  whether it is Cabinet, the courts, the boards of Crown entities, the Commissioner of Police, or the Auditor-General.  There is no particularly good reason why members of a Monetary Policy Committee should be different.    There are probably unique aspects to all governance appointments, but nothing around monetary policy marks it out as warranting putting another layer between the elected and the decisionmakers.

This is, of course, in contrast both to the current model (single decisionmaker –  the Governor –  in effect appointed by the Bank’s Board), and to the model Labour campaigned on (where external members would be appointed by the Governor –  putting them at a further removes from someone who has to actually face the voters).  Allowing the Governor to appoint the external members would risk substantially undermining the reasons for the reforms.

In the United States nominees for the Federal Reserve Board of Governors are required to win Senate confirmation.  That isn’t our constitutional model.  In the United Kingdom, appointees are required to face a parliamentary select committee hearing before taking up the role.  The committee can’t block the appointment, but can report on the suitability of otherwise of the nominee.   This might be a useful feature to add here.  It isn’t an approach we take generally, but monetary policy makers exercise wide powers of discretion (much more, say, than a typical Crown entity Board member) and, with ex post accountability difficult to maintain, it seems reasonable that those taking up such roles should face some open scrutiny at the start.

There is a counter-argument that the Governor should be free to appoint his or her own Deputy (as might be normal in a commercial context).  To which my response would be that if the deputy was not serving on a statutory committee, exercising statutory powers, that model would be fine.  But if the Deputy Governor is to exercise statutory powers, they should be appointed by someone who was elected, and who is accountable to voters: as far as I can tell, that is the typical model (including, for example, in Australia and the United Kingdom).

How many members should there be?

I’d favour either five or seven.  Any larger number would make it unduly difficult to fill the roles with good people consistently through time.

Either way, I’d favour having two internals (executives) – the Governor and a Deputy Governor –  with the remaining members being part-time non-executives.  It is highly desirable to have a majority of members who are outside the managerial hierarchy of the Bank.  Put the structure the other way round and there is a high risk that, over time, the non-executive members will be neutered (with management coming to block vote), and that  then good people will be unwilling to put themselves forward to serve on the committee.  Non-executives will always be at some disadvantage –  re access to analysis, and ability to influence the research agenda etc – and only be holding the majority of votes on the committee will they be able, if they choose, to consistently push back against that pressure.

The counter-argument often made is often about technical expertise: the choice between internals and externals is often presented as a choice between experts and non-experts.  To which there are several responses to be made.  First, as the Reserve Bank is currently structured, the internals will often not be “experts” on monetary policy at all –  none of the Governors since 1989 could really be classed as “experts” on monetary policy, although of course over time they acquired considerable experience, and even among Deputy Governors there have been considerable differences of expertise and background.  And the skills of being a good chief executive –  running the organisation, generating the analysis, managing the operations –  also aren’t necessarily those of a leading monetary policy expert.

But perhaps as importantly, while I think it is vital to have expert advice and analysis, as inputs to decisionmaking, it isn’t clear that we want technical experts making policy decisions, and exercising the (inevitable) degree of discretion that monetary policy makers do.  Some people with technical expertise may be able to serve effectively as decisionmakers (and communicators) but the skills aren’t the same at all.  And if the internal members of a Monetary Policy Committee, with all the technical resources of the Bank staff at their command, cannot convince one or two non-executive members of the merits of their case, it seems unlikely that they will be able to convince the wider public.

What sort of non-executive members should be appointed?

I’m wary of making much of an internal vs external distinction, and instead focus on that between executives and non-executives.  After all, there has been no internal candidate appointed as Governor since 1982.

But in considering non-executive appointments (three or five in my model) there are a few relevant considerations:

  • no one should be appointed to represent a particular interest group.  Of course, everyone has a background, but once one takes up a position on an MPC your commitment has to be to implementing the Act and serving the interests of the country as a whole,
  • there should be no prohibition on non-resident or non-citizen members (although I would favour no more than one at a time).   We are a small country, and there can at times be valuable perspectives that people employed abroad can offer (and it is a model the UK has used), as one vote among five or seven,
  • it would be desirable to have one member with some reasonable academic exposure to monetary policy, but undesirable to think of a Monetary Policy Committee as, say, a research conference or an academic seminar,
  • people with sound general Board-level skills can make a valuable contribution to an MPC, regardless of their formal academic background.  One doesn’t typical won’t an telecoms company Board stuffed full of tech people, and there isn’t any obvious reason why a Reserve Bank MPC should be different.  The ability, and willingness, to ask hard questions, and even just to say “tell me that again, in ways I can understand” is a valuable part of the mix.

How long should MPC members’ terms be?

I would favour five year terms, perhaps with a limit of one reappointment each.  With five or seven members, one appointment would come up every year or so, enabling a government is the course of a three year term to replace gradually around half the members of the committee, but not to launch a purge on newly taking office.   Terms of this length seem reasonably conventional (and are the same as those of the Governor, and Board members, at present).

Individualistic or collegial?

I’ve outlined here previously why I strongly favour the sort of individualistic model adopted in the UK, the USA and in Sweden, in which individual members of the MPC are individually accountable for their votes.  The current management of the Reserve Bank really dislikes the model, but they have never been willing, or able, to articulate –  from the experience of other countries –  what the nature of their concerns is, and how they balance any such concerns against the interests of democratic accountability, in a model in which decisionmakers exercise considerable discretion.

As I’ve documented here over the years, formal effective accountability for monetary policy decisions is hard –  much harder than those who devised the current law thought at the time it was drafted.  In practice, accountability can be exercised only through public scrutiny and challenge, and at the point where a member of the MPC is up for reappointment.  Against that backdrop –  and in a game where there is so much uncertainty – it is highly desirable that individual MPC members’ votes should be recorded and published, and that members should have the opportunity to have their views recorded in minutes that are published in a fairly timely fashion.  The Reserve Bank’s management has at times expressed concerns about this approach –  used elsewhere –  “muddying the message”, but in fact there is so much uncertainty about the way ahead (what is going on with the economy and inflation) that over time it will usually be preferable to have in public the sorts of issues and concerns that were bothering decisionmakers, rather than just some sort of somewhat-artificial consensus about an immediate OCR decision.

In a similar vein, MPC members should all be free to make speeches, give interviews etc articulating their own views on the issues the MPC is facing.  I’m not suggesting some sort of chaotic free for all: it would no doubt be desirable for members to develop protocols in which members ensured that other members were aware of forthcoming speeches and interviews, agreed to circulate draft texts to each other in advance, and perhaps agreed to avoid comment altogether in the week or so (say) prior to an OCR announcement.  Commonsense and common courtesy can resolve many potential issues.

Who should chair the MPC?

The Governor.  I hadn’t particularly thought of this issue, but it came up at the Treasury meeting the other day. There is an argument for a non-executive chair –  the approach in most Crown entities – but provided there is a majority of non-executive members I’m not sure I see the case for departing from the universal international practice, in which the Governor chairs the MPC.    (It is also perhaps worth noting here that in other countries –  including the UK – it has not been a problem if the Governor has at times voted with the minority.  Smart people will often view the same data quite differently.)


The amended Act should require the publication of minutes, and the record of individual votes, within a reasonable time –  perhaps to be determined by the Minister –  of the particular OCR decision.  As I’ve noted previously, I do not favour either keeping, or eventually publishing (even with very long lags), transcripts of MPC meetings.

I would also favour moving to a system where the background papers for MPC meetings are routinely and pro-actively published (perhaps six weeks after the OCR decisions to which they relate).  Ideally, I would not consider this something that should be legislated, but given the obstructiveness of the Bank, and the willingness of successive Ombudsmen to aid and abet the Bank in keeping such papers secret even well after the relevant decision, the legislative option may need to be considered.

As I’ve noted repeatedly before, the Reserve Bank is quite transparent about stuff it knows little abour –  eg where the OCR might be a couple of years hence –  but isn’t very transparent at all about what it does know about.  Transparency is valuable in itself –  an essential part of democracy –  but in a small country with limited pools of expertise, the ability of greater transparency to facilitate more informed and debate and scrutiny of the issues is almost instrumentally useful.

Should there be a Treasury representative on the MPC (in a non-voting capacity)?

I don’t have a strong view on this issue, but it is a model that is used in a number of countries, and could help to formalise a recognition of the relationship between various bits of economic policy.    The model appears to have worked, without undue problems, in the UK.     But if it is to be done, it needs to be recognised that it would involvement a non-trivial time commitment by someone reasonably senior in Treasury –  and time/resources are scarce.

The Policy Targets Agreement

At present, Policy Targets Agreements are (a) signed with the Governor personally, consistent with the single decisionmaker model, and (b) have to be agreed with an incoming Governor before that person is formally appointed or takes office.  It is a poor model, and not one that is much imitated abroad.

Under my reform model, the MPC as a whole would be responsible for monetary policy and the onus of a PTA should also rest on them.  To do that probably requires rethinking the PTA model, and might suggest moving to the system adopted in some countries –  eg the UK –  where the goal (PTA) is specified by the Minister of Finance, and the MPC is simply responsible for conducting policy consistent with that goal.  The UK model isn’t ideal – the target can be changed at the Chancellor’s whim in the annual Budget –  but a system in which the target is specified every few years, after  advance consultation with the MPC of the day (and ideally with the wider public, and with FEC), would seem to have some attractions.  To get the right balance between responsibility for setting overall goals –  resting with the elected government –  and a degree of stability, perhaps the appropriate review period might be six months after a change of government (with provisions for other changes to the PTA only in exceptional circumstances –  say with the agreement of the majority of the MPC.)

The final issue Treasury asked us about under this heading was about the role of the Bank’s Board.  There seemed to be pretty universal agreement among attendeees that the Board adds little or no value.  But, as I’ve noted here previously, you can’t really answer the question about the appropriate role of the Board without thinking harder about the overall organisation of the institution (rather than simply one function –  monetary policy).  I’ll come back to that on Wednesday.

And on a completely different topic

Regular readers will know that I live in Island Bay.  Some will have seen the story in yesterday’s Sunday Star-Times suggesting that our local primary school was “New Zealand’s richest primary school”, based on reported donations in 2016 of $490000.    This qualifies as pretty poor journalism.  Island Bay School is a decile 10 school (although I suspect in the poorest 10 per cent of the top 10 per cent of neighbourhoods).  It was reported that

“Island Bay school’s 460 students contributed $490000 donations in 2016 –  an average of $1065.46 per student for the year’s schooling”

In fact, those parents who paid the scheduled annual donation paid around $250 per child, in other words only around a quarter of the total.   But one, very wealthy, old boy made one very generous donation.  Here is the Principal’s newsletter from 10 March 2016

I awoke to the best news ever this morning: Sir Ron Brierley, an old boy of the school, has generously agreed to donate a sizeable sum to the Rimu Block modernisation project. This gift, combined with Ministry of Education funding, gives us sufficient funding to realise our full vision for the modernisation of Rimu. This would not have been achieved without the generosity of Sir Ron, who has been a wonderful friend and supporter of Island Bay School over the years. In 2011 he kindly contributed towards the Learning Hub and now he has made this contribution towards Rimu Block.

As a parent, it always amused me that such a left-leaning school (and successive Principals) were taking such large amounts of money from a generous capitalist.  It is a real gain to the school, but it is almost totally irrelevant to the debate around the “donations” that parents are asked for each year.