Funding for lending

I was, conditionally, sympathetic to the Funding for Lending programme the Reserve Bank put in place late last year. At the time they thought (and it seemed plausible they were right) that more monetary stimulus was needed, and – through their own neglect and incompetence over several years – they asserted that a negative OCR could not yet be implemented. The announcement of the scheme clearly narrowed the gap between wholesale and retail interest rates, lowering the latter. This chart from this week’s MPS is one way of illustrating the point.


The effect was achieved by making it known the scheme was coming, and then available. Relatively little was actually borrowed, especially early in the piece.

The scheme works by offering funding to banks (only) at an interest rate equal to the OCR (floating rate, so the rate changes as the OCR does) for terms of three years. The loans are secured, but that isn’t much of a burden to the banks as (eg) they are allowed to simply bundle up their own residential mortgages into bonds the Reserve Bank will take as security (with a significant haircut – ie the value of the bonds has to exceed the value of the FfL loan).

It was a jerry-built scheme, but one could mount a reasonable third-best argument for having announced and deployed it last year. Among the problems with the scheme from the start:

  • it was offered only to registered banks, and not to any other (regulated) deposit-takers  (at odds with any notion of competitive neutrality, a principle that for a long time was important to the Bank),
  • by focusing on driving down retail rates (rather than both retail and wholesale) then it may have meant the exchange rate staying higher than otherwise,
  • lending for a three-year term at a floating OCR rate was, most likely, subsidised funding (it is highly unlikely any bank would have borrowed that cheaply on floating rate terms on market).

But perhaps one could tolerate those problems for a few months, while the negative OCR option was (so they said) not available.  And consistent with that I had not been particularly critical of it (even though by the time the scheme was officially deployed –  as distinct from announced, and announcement effects mattered –  the Bank was also telling us that the negative OCR obstacles had all been sorted out).

All that, of course, was many months ago, back when monetary policy tightenings looked a long way away, and the focus was still more on the risk of unemployment lingering high and core inflation staying very low.   The data moves, but the Bank doesn’t –  or is very slow to.

Where we stand now –  or at least earlier in the week –  was that core inflation was (a bit) above the midpoint of the target range, and the unemployment rate was so low even the Bank suggested (by implication) it was now at or below the NAIRU.   Tightening monetary conditions is clearly called for, and the Bank’s own numbers suggest they envisage quite a lot of tightening over quite an extended period.

So you might suppose that jerry-built interventions cobbled together late in a crisis would be among the very first things withdrawn.  As the Bank’s own document states

The FLP offers secured term central bank funding to registered banks, with the aim of lowering funding costs to stimulate lending growth across the economy and help reduce interest rates for borrowers.

Is the aim of monetary policy any longer to lower funding costs, stimulate lending growth or reduce interest rates? It certainly shouldn’t be, judging by the Bank’s own forecasts and statements.

And yet they insist they are going to keep right on offering the FfL scheme for the next 16 months. It makes no sense.

I was prompted to write this post after reading a Business Desk story this morning by Jenny Ruth. In it we were told that some banks had been borrowing more money this week, including on Wednesday. The amounts involved – $1.5 billion – aren’t huge but (a) the amounts haven’t usually been the issue, and (b) monetary policy works at the margin. But there was also this report of some comments the Governor had apparently made at FEC yesterday in which he ‘described the FLP as “a contract” that the RBNZ won’t break. “We have a clear contract. We thought it was best to honour that. We’re comfortable with honouring that contract,”

This was a new line.  When Jenny Ruth had asked the Governor at the press conference on Wednesday about FfL (and selling back LSAP bonds) we were simply given a line about preferring to use understood and predictable tools.  And so it prompted me to look up the Reserve Bank’s page on the Funding for Lending scheme.

On my way there I had to pass through a “Tools to support the economy” page, which –  still – is full of talk about what the Bank is doing to boost spending, boost jobs, encourage borrowing etc etc.  At very least the page needs updating – things have moved on from last year. 

The Funding for Lending programme page is here, with operational details here.  

And sure enough I found this

Participants may access the funding over a 2-year transaction period. The Bank reserves the right to extend (but not shorten) the transaction period.

Presumably this is what the Governor had in mind when he talked about a “contract”, but it is of course nothing of the sort (unless there are further signed documents the Bank isn’t disclosing, which I doubt).  It is a policy programme, much like the LSAP.  Recall that the LSAP was originally going to be kept going much longer, but circumstances changed and even the MPC concluded it was time to change policy and stop the bond-buying.  It didn’t betray anyone, no one regarded it as a breach of trust or anything of the sort.  If the Governor really regards himself (and his Committee) as somehow bound by that two-year period, it is even sillier than that pledge they made last March –  when they had no idea what was going on – not to change the OCR for a year come what may.

Now, just to be clear.  I am not suggesting that three year loans once made could or should be revoked.  The issue here is access to new loans, from a crisis programme, long after the crisis has past, and in a climate when the Bank itself says it expect to tighten steadily over a couple of years.

Does any of this matter?   I think it does, for a several reasons:

  • the MPC should not be making commitments it regards itself as bound by to periods well ahead where it has no idea what the economic circumstances will be.  Perhaps an initial six-month commitment might have been pardonable at launch, but another 16 months from here is simply indefensible.
  • since the MPC itself expects to raise the OCR steadily over the next couple of years (conditional of course on the economy) short-term market rates will tend to be above the OCR over that period.  Continuing to offer the FfL lending at OCR is not only cheap (subsidised) funding for banks (and recall only banks, not their competitors), but directly tends to undermine the effect of the market-led tightening that is going on.  Overnight rates really should apply to overnight money (or least money that reprices overnight not every 6-8 weeks).
  • and the longer the scheme runs the more it is likely to conflict with the MPC broader policy intentions.  This is so because under the rules from June next year banks can only borrow from the FfL to the extent that they are increasing their lending.  Perhaps there was an (arguable at best) policy goal to have banks increase lending this time last year, but on their own numbers and plans there is no such goal next year when (on their numbers) inflation will be near target and unemployment very low.  If the scheme continues to have any effect at all it will mean the OCR itself having to be pushed a little higher than otherwise.

The macroeconomic implications are probably pretty small, but it is simply bad policy by the Governor and Committee, grossly inadequately explained (if he really thought they were bound by honour or contract he should have developed the case in the MPS). The FfL scheme served a purpose – although given how the economy recovered more in prospect (from when first flagged) than by the time it became operational. But that time has long past now. The window should be closed, retail rates left to find their own level relative to wholesale rate, and the OCR should be deployed only after this abnormal crisis tool has been suspended.

On the MPS

In the end, of course, the bottom line of yesterday’s Reserve Bank announcement was unsurprising and perhaps inevitable – action deferred on account of Covid. It wasn’t as if they were on some statutory schedule, so they could easily have postponed the decision for a couple of weeks, but in the scheme of things the difference between that and waiting for the next scheduled review (6 October) isn’t great. It is clear from the Bank’s forecast numbers they had not been minded to raise the OCR by 50 basis points this time, so if need be they can always catch up by acting a bit more firmly in October.

There was even something to praise. The Bank had revamped the look of the document and – bad-wig new logo aside – it was a definite improvement, even if it is hard to be sure what (if anything) the front cover art might be supposed to represent. And there were, perhaps, a couple of more-interesting graphs than usual. Quite a bit of the media coverage seemed more focused on things the Bank isn’t responsible for – house prices – than on the things it is responsible for.

I guess I had two concerns about the document.

The first was about the analysis. Three months ago the Bank – with more macroeconomic resource than any other agency in the country – thought that well into next year the unemployment rate would be 4.7 per cent and seemed to see core inflation only converging very slowly on the target midpoint (from below). Instead, the unemployment rate is now 4 per cent and core inflation is above the target midpoint, but unless I missed something I saw hardly a mention of this forecasting error and no serious discussion or analysis of it.

Why does it matter? After all, the best of people make mistakes – even in recognising where the economy is at the time you were writing (the May forecasts weren’t finalised until 21 May, and both the CPI and HLFS are centred on the middle of each quarter (in this case 15 May). It isn’t so much the mistake itself I hold against them – although they should have done quite a bit better – but that if there is no analysis of how they made that mistake, and what the fact of the mistake has taught them about how the economy is working at present, how can we have any more confidence in the latest forecasts than in the last (wildly wrong) ones? And the MPS is supposedly an accountable document, not just an opportunity to brush the last set of numbers under the carpet and have another go at the dartboard to generate some new numbers. In particular, why when the momentum of the recovery in demand and activity (and inflation) took the Bank by (considerable) surprise do they think it has suddenly come to an end – implicit, for example, in unemployment rate projections that are 3.9 per cent for next March and 3.9 per cent for the following March (from 4 per cent at present). Or why, with core inflation having picked up quite strongly do they think it will settle as easily and quickly as implied in their numbers (bearing in mind that monetary policy has its greatest effect on inflation with a 12-18 month lag)? It was also a little surprising that there was no serious analysis of the role fiscal policy is, and is expected to, play in supporting (or dampening, as deficits are closed) demand and activity.

I am not running a strong alternative view here. They may prove to be right (and even by more than just chance, so for the right reasons) but there is no supporting analysis – no sign they understand the last 18 months or the last quarter – that should give anyone any more reason for confidence that in an amateur’s shot at a dartboard.

And, of course, if there is nothing in the body of the MPS, there are no speeches, no (searching) interviews, and the so-called minutes are as bland as ever, offering nothing even hinting at hard questioning, challenge, debate, or openness to alternative perspectives. No insight, no understanding, no challenge, no research, no scrutiny, all adds up to no authority. There is no sense that these people are any more than bureaucratic administrators.

The second concern was about policy, although perhaps in practice that boils down to absence of any serious analysis as well. The MPC has chosen to keep going with its jerry-built crisis funding programme, the Funding for Lending programme and to not do anything about reducing the stock of bonds it bought when it was trying to ease monetary conditions (ie until a few weeks ago, although mainly last year), decreeing that the OCR is its “preferred instrument”. Perhaps there is a case for leaving these crisis interventions on the books and jumping straight to the OCR, but if there is a serious case neither the Committee nor the Governor (as, supposedly, their spokesman) made it. Rather belatedly the Committee has now asked staff to prepare a paper on what to do about the LSAP, but why wasn’t that commissioned – and consulted on or published – months ago. When a journalist asked the Governor why MPC wasn’t acting first on the FFL and LSAP schemes, she was fobbed off with a spurious answer about the MPC preferring to operate with tools that were widely understood and which they themselves had a better, more precise, sense of how they would work.

Neither excuse seemed adequate. First, they are already having to factor into their forecasts now their views (implicit or explicit) on what impact the FFL and LSAP are having (and remember that most of the literature says that if there are material effects from schemes like the LSAP they are stock effects not flow effects). Second, the FFL is an explicit crisis intervention, when there is now no crisis, designed for an inability to use negative OCRs which no longer exists. Third, the FFL is explicitly discriminatory (only banks can access it). Fourth, you’ll recall how confident the Governor was last year about the power of the LSAP to influence monetary conditions – rhetoric that now seems to have disappeared completely. And fifth, there was no mention of the large losses (to the taxpayer) that the LSAP scheme has run up, and the substantial market risk the taxpayer is exposed to each day the scheme is left in place (by contrast conventional monetary policy instruments pose little or no financial risk to taxpayers ever).

Perhaps there is a case for their stance (although I doubt it) but it wasn’t made yesterday. The public should expect better from its highly-paid powerful officials.

And finally, two charts. I don’t have any confidence in the Bank’s analysis of house prices, or the new requirement the Minister foisted on them to talk about “sustainable prices”, but amid the breathless talk of the Bank picking a 5 per cent fall in house prices, it is perhaps useful just to focus on this MPS chart.

house prices MPS

Their scenario C is one in which nominal house prices hold steady. Their actual projections (line B) are less hopeful than that. Is it perhaps telling that the MPC shows line A – further strong price growth – out indefinitely – but line D (modest falls) only for a couple of years. Whatever the immediate cyclical situation – and some fall in the next 12-18 momths doesn’t seem that unlikely to be – nothing the government has done even begins to fix the structural failure (which the truncated y-axis in the chart minimises) and all the RB activity in this area is simply papering over cracks and running defence for the government.

The other chart doesn’t show anything new, but it is just nice to see it from a government agency.

MPS productivity

It is a dismal portrayal of the utter failure of successive governments (both National and Labour led). They simply use it as one part of a story as to why New Zealand neutral interest rates might have been falling – inadequate a story as it is, since our long-term real interest rates remain well above those elsewhere, even as productivity growth is worse than in most places. As it is, between things the government has little or no control over (Covid, abroad and here) and those things that are pure policy choice, it is more likely that the next few years will show even worse productivity growth outcomes than the last couple of a decades. The Bank itself – like a true believer – nonetheless projects that trend productivity growth in each of the next three years (ie including the one we are in) will be stronger than in any of the previous six years. That Tui ad springs to mind.

Looking towards the MPS

The Reserve Bank’s Monetary Policy Committee will release its Monetary Policy Statement tomorrow afternoon. We can expect substantial changes from the rather complacent, perhaps even dovish, statement/forecasts they released in May. The hard data have moved quite a lot and the Bank – with phalanxes of macroeconomic analytical resource – was far too slow to recognise what was going on.

Of course, it is anyone’s guess what the MPC will do. Unlike serious countries, or serious central banks, we’ve had no speeches from MPC members, and no position papers outlining how (and why) the MPC was likely to respond if and when the data indicated that tightening in monetary conditions was warranted. Normally, it isn’t much of an issue, since there is usually only a single moving part (the OCR) but we are now still living in the wake of last year’s extraordinary interventions. My focus here isn’t on what the Bank will, or won’t, do, but on what they should do, given the Remit the Minister of Finance has given the MPC.

NZIER run their Shadow Board exercise, in which a mix of (mostly) economists and (a few) people working in business or lobby groups offer their view on what the MPC should do. It is an interesting exercise, if only because respondents are asked to assign probabilities to their view (eg 25% chance the OCR should be 0.25 per cent, 50% it should be 0.5 per cent, and 25% it should be 0.75 per cent – an exercise the Governor used to ask his internal advisers to do, accompanying each of our specific recommendations). They’ve also this time asked not just about tomorrow’s OCR decision but about appropriate policy over the next year. Here are the last assessments.

shadow board aug 21

I’ve always struggled with the idea of 100 per cent certainty about any macro view, especially one about periods a year ahead. If I learned anything in decades of working on monetary policy it was how pervasive uncertainty (and unforecastability) is. If I were answering this particular survey I’d probably run with something like an 80-90 per cent view that the OCR should be higher now, but not much more than a 50 per cent view that it should be higher over 12 months. We just don’t know, and can’t know.

And that would be my first recommendation to the MPC: do not act as if you know more than you possibly can. The Bank insists on publishing economic projections several years ahead, but they rarely contain any useful information about what will happen over the following few years. But the key thing is not to become wedded to your own numbers, or desire to offer more certain than is sensibly possible. The last OCR tightening cycle the Bank undertook in 2014 was a mistake – the case for it was very weak at the time (as I and a couple of others argued internally, a few externally) and even more so with hindsight – but part of what led them astray was that the Governor had become entranced by his own numbers (projections and trend assumptions) and went round openly talking of a programme of OCR increases that would raise rates by a couple of hundred basis points. It creates something of a self-fulfilling momentum, complete with a feeling of needing to follow through.

So whatever the MPC decides on actual policy adjustments tomorrow, the words should emphasise how uncertain and changeable the environment (here and abroad) is, and that the Committee will be guided primarily by hard data (on core inflation and excess labour market capaciity) rather than by castles-in-the-air projections or programmes of tightening. We just do not know what is happening to natural/neutral interest rates – the belief that people did led central bankers, and markets for a time, astray last decade. And when data change there is no harm or shame in changing course; rather than is what central bankers doing their job are supposed to do. The job of the MPC is not to give a clear steer about the future, but (in a stylised way) to adjust short-term interest rates consistent with overall incipient savings/investment imbalances (normally, doing what the market would do if we didn’t have central banks).

The situation at present is complicated because the Bank last year deployed three distinct tools:

  • the OCR,
  • the Large-scale Asset Purchase programme (LSAP), and
  • the funding for lending programme, designed to narrow the wedge between wholesale and retail funding rates.

On the Bank’s own stated logic, I think an OCR adjustment should be the final step chosen if –  as seems to be the case – policy tightening is warranted.

Take the LSAP as an example.  The Bank has repeatedly claimed that the LSAP was highly effective in loosening overall monetary conditions, lowering both wholesale interest rates and the exchange rate.  If so, surely an obvious response now would be to start selling the bonds back to the market, at scale if need be?  After all, every day the Bank holds the bonds the taxpayer is exposed to unnecessary market risk (remember that they have lost us $3 billion or so to date), and there is no obvious good reason for the central bank’s balance sheet to be as bloated as it is for any longer than is strictly necessary. 

Now it is true that other central banks have been reluctant –  after the bond-buying of the last decade – to start actively offloading their bond holdings (although the Fed was doing so), but that was surely was mostly because economies and (in particular) inflation never recovered sufficiently robustly to warrant/require tighter monetary conditions.  By contrast, in New Zealand right now there is a pretty strong case for such a tightening.

Of course, if the Bank really doesn’t believe its own rhetoric (about the efficacy of the LSAP) it would still make sense for them to be getting a sales programme in place, but then they couldn’t claim that bond sales were a substitute for other actions.  As I’ve outlined in previous posts etc, my own view is that the New Zealand LSAP did little or nothing of any macroeconomic significance, but that isn’t what the Governor keeps telling us. 

The next step the Bank should be taking is to end the Funding for Lending programme.  It was a jerry-built crisis intervention that worked –  at a time when the MPC reckoned it could not take the OCR negative –  but we aren’t in a crisis now.     It isn’t a competitively neutral instrument –  only banks have access to it –  and if an efficiency mandate is disappearing out of the Reserve Bank legislation, the concern with economic efficiency and minimising favourable treatment for particular types of counterparties shouldn’t.   It should be discontinued now and the market left to settle the relationship between the OCR and retail and wholesale funding rates. 

What isn’t clear is quite how much impact ending the Funding for Lending programme would have on deposit rates.    The large positive margin between term deposit rates and either the OCR or bank bill rates that has prevailed over the last decade –  often 150 basis points –  is hard to make full sense of (and is larger than the comparable margin in Australia).   But the best guess has to be that removing new Funding for Lending might see that margin widen out from the 50 basis points it got down to back to something at least somewhat wider (perhaps another 50 basis points).

I don’t think I’ve seen mention of selling down the LSAP bonds or ending the Funding for Lending programme in any of the commentaries I’ve seen. I presume that is a sign the Bank has either suggested to banks no change is coming there any time soon or (at least) by silence left that impression.  But these crisis interventions really should be dealt with, and incorporated into the forecasts, before the Committee moves to consider OCR increases.

My read of the economic data is that there is a reasonable case for the MPC to validate quite a significant tightening in monetary conditions (I express it that way because both wholesale and, to some extent, retail rates have begun to move in anticipation).  I don’t think that is even a particularly difficult call.  I don’t base it on forecasts, but on where things stand right now (including, but again not to over-emphasise forecasts, how different things clearly are now from how most thought they would be late last year).     

What are the key variables in that story?  First, of course, is inflation itself –  but core inflation, not the (currently high) headline CPI numbers. On the Bank’s sectoral core factor model – a pretty smooth and persistent series – core inflation is now above the target midpoint for the first time in a decade.    That is a good thing –  (core) inflation should fluctuate around the target midpoint, and not have the midpoint treated as either a ceiling (as it seemed at times in the last decade) or a floor (as it sometimes seemed the previous decade).  But since the general sense was that it would take longer to get inflation back up, and we know policy works with a lag, it is a prima facie case itself for underpinning real interest rates at a higher level. 

And then there is the unemployment rate, at 4 per cent (for the June quarter, centred in May) down to pre-Covid levels.  I’m not going to run a strong independent view on what the NAIRU is for New Zealand but whatever it was a few years ago it is likely to be somewhat higher now, between things like higher benefit levels, higher minimum wages, higher statutory holiday provisions, reduced emphasis on getting people off benefits, and the disruption to labour-market matching from closed borders (both reductions in demand for certain roles and disruption in access to migrant labour).  To be clear, I’m not taking a view here on the wider merits of any of these policies, just noting as a macroeconomist that they are, taken together, likely to raise the unemployment rate consistent with stable inflation.

As it happens, in that same June quarter data we’ve already seen quite an acceleration in private sector wage inflation.  It could, I suppose, be random noise, but it doesn’t seem sensible now to assume so (given that it isn’t out of line with anecdotes, surveys or the unemployment rate itself).LCI private

Even if there is a bit of seasonality in the series, it is the highest quarterly increase since the peak of the labour market boom in the 00s –  when core inflation was definitely accelerating, and when there was still a bit more productivity growth to underpin wage increases than is likely to be evident right now (borders closed and all that).

June quarter data is centred on the month of May (SNZ survey throughout the quarter), but we also have the SNZ new monthly employment indicator that they take from hard (tax) data.  The number of filled jobs is reported to have risen by a further 1.1 per cent in the month of June. and in a series that goes back to 1999 there have been only a handful of months with faster growth in this series.  And over the last 22 years inward migration has mostly been quite strongly, adding to both demand for and supply of labour.  Since Covid, we’ve had consistent modest net outflows of people.    And yet according to SNZ there are now 2.1 per cent more jobs than there were at the end of 2019 (when the unemployment rate was also 4 per cent).  With fewer people here now than then (despite some natural increase), it all points to the unemployment rate heading lower again this quarter. 

Then, of course, there is inflation expectations.  In the Bank’s latest survey of semi-experts (I’m usually included, but somehow the survey email ended up in my Spam folder) , two year ahead expectations rose quite a bit to 2.27 per cent –  the highest the survey has recorded since June 2014.   Since shocks happen, these expectations measures aren’t great forecasts (nothing is) but as a read of how people are feeling and seeing things now they are what we have.

The Bank also does a survey of household expectations, which gets very little coverage. Again, there is no information in the survey on what future inflation will be, but what people think about inflation affects how they think about any specific level of nominal interest rates.  In the latest survey, a larger percentage of respondents expect higher inflation over the next year than at any time in the survey’s history.

household expecs 21

Point estimates –  which are harder for household respondents –  have also moved up quite a bit, for both 12 month and five year horizons.

It is a fairly elementary part of thinking about monetary policy that, all else equal, if inflation expectations move up and you don’t want inflation itself to go much higher, you want interest rates to move up at least as much as the expectations themselves have risen.

If I wanted to mount a counter-argument to my own case, I might cite –  as I often have over the years –  the breakeven inflation rates calculated using nominal and indexed government bond yields.   Very long-term breakevens are still well below 2 per cent (but have moved up) but using the 2025 indexed bond, implied inflation expectations for the next four years are now almost exactly 2 per cent –  not troublesome in a level sense, but far far higher than we were seeing pre-Covid.

The case for not acting now seems, frankly, threadbare.  Will the Australian economy be weaker this quarter and perhaps next?  To be sure, but it isn’t obvious there is a substantial impact on New Zealand (especially as travel flows were already very modest).  Sometimes there is a case for seeing how low the unemployment rate can be driven –  there was a good case for that for much of the pre-Covid –  but not when (core) inflation is already at or a bit above target, and most of the demand indicators suggest that core inflation would –  all else equal – rise further from here.

That doesn’t mean it is time to panic either.  Full employment and inflation near-target are good outcomes in themselves –  especially against the backdrop of the previous decade.  It isn’t time to over-react, or for whippings about how policy settings were too loose for too long, but simply for calmly and deliberately getting on with the job.

For me –  and given the rapid easing last year – that would mean a policy package tomorrow of (a) a programme of bond sales back to the market of $2 billion a month (which over two years would clean out the holdings), (b) a discontinuation now of the Funding for Lending programme, and (c) a 25 basis points OCR increase.

But if they don’t do either (a) or (b)  –  the former more symbolic on my telling than substantive, but wouldn’t be on their own –  the case for a 50 basis point OCR increase tomorrow looks pretty strong.  Not to foreshadow a string of future increases, but simply because we are at full employment, perhaps going beyond, and inflation is at or a bit above target, and perhaps looking to go beyond.  It would simply be a good solid sensible response to some good cyclical economic data (note that the structural fundamentals of the economy are as poor as ever, but that matters to the Reserve Bank only in, eg, interpreting wage inflation data).


Perspectives on New Zealand immigration policy

Several years ago the Law and Economics Association hosted an event in Wellington in which the New Zealand Initiative’s Eric Crampton and I each told our stories about New Zealand immigration policy. My account is here, and a link to the talk I gave is here.

A few months ago a couple of Victoria University of Wellington academics responsible for a Masters class (in a programme I didn’t even know existed (Masters in Philosophy, Politics and Economics)) invited us to do something similar for their class. We did that today.

My text (a bit fuller than what I actually used) is here (if Eric chooses to link to his slides on his blog I will include a link) (UPDATE: link here). My focus was solely on the economic dimensions of immigration policy, and in particular on the implications for economywide productivity (as the best proxy for whether large-scale policy-led non-citizen immigration has been beneficial for New Zealanders). My focus was primarily on the long-term programme, and entirely on the situation in normal times (ie I was not addressing the current Covid mess, which reflects poorly on the government but has no necessary connection to the appropriate medium-term approach).

My approach tends to start from a series of stylised facts about New Zealand’s economics performance in recent decades. This was the list I used this time.

But first, the gist of my story, which starts from a set of stylised facts about our economy.  Most of them are not in contention, even if the meaning and implications are debated:

  • New Zealand’s productivity growth has continued to languish, and even after the reforms of the 80s and early 90s (including a return to large-scale immigration) there has been no narrowing of the gaps. We’ve fallen further behind Australia, and increasingly behind central and eastern European OECD countries.  It would now take a two-thirds lift in the level of productivity to catch the OECD leading bunch,
  • Foreign trade as a share of GDP has stagnated, and this century has gone backwards. This in the new great age of globalisation,
  • New Zealand’s exports have remained overwhelmingly reliant on natural resources (whether agriculture, tourism or whatever).
  • Consistent with this, the rapid growth areas in our economy have been the non-tradable, not internationally competitive, sectors,
  • Also consistent with this, our real exchange rate has remained high, even as productivity has declined relative to other countries over decades,
  • Even as real interest rates have fallen, they have remained persistently higher than those in other advanced economies,
  • Business investment as a share of GDP has been weak (OECD lower quartile),
  • Indications are, globally, that if anything distance has become more important not less, with high value economic activity increasingly clustered in big cities near the major markets of the world,
  • Unlike what we see in the US and Europe, GDP per capita in by far our biggest city isn’t much better than that for the country as whole – if anything the gap has been narrowing.
  • Over the last few decades, no country has aimed to bring more migrants (% of population) than New Zealand did – although Canada and Australia have come close to matching us, and Israel too.   
  • OECD data show the NZ migrants also have the highest average skills levels (but still a bit behind natives) of migrants to any OECD countries.

Not one of the expected economywide benefits of a large-scale immigration promotion policy has shown up. Not one.   And we aren’t five years into this experiment, by 25 to 30.

I stepped through my standard arguments for why large scale immigration here may have been damaging to our medium-term economic performance. I noted that of the handful of OECD countries that have tried anything on the scale of New Zealand’s experiment (Canada and Australia and – in a slightly different context – Israel) none stands out as a productivity leader, and yet very little of the literature on the economics of immigration looks specifically at this group of countries. What isn’t always appreciated is that New Zealand has much more experience of large scale immigration and emigration (the latter, of nationals) than almost any other country – the sustained outflow of natives has been a thing since at least the mid 1970s, while our governments have actively promoted large-scale non-citizen immigration for all but about 15 years since World War Two.

When we’ve considered the economic performance over recent decades of the active immigration-promoting countries, and the countries experiencing outflows of their own people, the ball should really be in the court of the pro-immigration economists to show us, concretely, where and how large-scale immigration is lifting the productivity and incomes of the natives.   That is particularly so in New Zealand, given the disadvantages we can enumerate in advance – distance and continued natural resource reliance – and the signal implicit in the decades-long outflow of natives.

I talked about a number of other problems, and (in particular) gaps, in the existing literature before ending with this conclusion.

There might be all sorts of reasons for favouring high immigration – better ethnic restaurants[1], defence, a liking of big cities, or trains. If your country has prospered greatly, you might be happy to share the gains widely.  But the economic case for large scale immigration, as a way of boosting the productivity outcomes for natives in already advanced economies[2], looks thin at best.  Not many countries have run the experiment in modern times, notwithstanding the models that are claimed to support such an approach.  New Zealand has been at the forefront – actively promoting large scale immigration for all but 15 years since World War Two.  Unfortunately, New Zealand has had the worst relative economic performance of any advanced economy over those decades – we haven’t just come back to the pack, but now languish well down the rankings, have led the GDP per capita tables just 100 years ago (when abundant land, small population, and asymmetrically favourable technology shocks combined in our favour).

As I review the experience of advanced countries, if one wanted to take a punt on policy promoting large scale immigration (and few have) the best places to try look to be countries:

  • Close to the centres of global economic activity (whether Europe, North America, or East Asia),
  • Having experienced an asymmetric productivity shock – whether from the market or other policy reforms – favouring longer-term economic prospects in your country,
  • With economies with substantial reliance primarily on sophisticated manufactured products and high-tech services,
  • With their own people coming back home

And it looks like a highly risky strategy if your country is

  • Very far from anywhere,
  • Heavily dependent on (fixed) natural resources,
  • And has seen little sign of asymmetric favourable productivity shocks for your industries in a quite a long time,
  • Somewhere your own people have been leaving in large numbers

These look to be quite general insights.  And yet few if any of the countries that have three or four of the first characteristics have gone in heavily for policy-led immigration (perhaps Ireland or the UK might have been the closest- but UK immigration per capita was also about a third of New Zealand’s (per capita), and the UK is no productivity star).   Of the countries that went heavily for policy-led immigration, even Canada and Israel each meet only one of the three criteria – and neither can readily show the economic gains from large-scale migration. Australia and New Zealand meet none.

As for New Zealand, we can (sadly) tick all four items in that second class of conditions.  This was – and is – perhaps the least propitious advanced economy on earth to experiment with a large-scale immigration strategy.  And yet we did. If it was perhaps defensible in 1946, and optimistic in 1990, persisting now it just stubbornly wrongheaded, defying experience and evidence.    It isn’t quite as wrongheaded as a strategy to promote mass migration – however able the people – to Kerguelen, the Chathams or the Falklands, but not far short of it.  Australia has coped better with its experiment only because they were able to bring to market lots of natural resources previously lying idle.

It isn’t that people are any different here – locals or migrants.  And water still flows downhill.   But the opportunities just aren’t very good at all.  It is an old line but no less true for that: a definition of insanity is doing the same thing again and again and expecting a different result.  We’ve tried this one far too many times for our own good.

[1] I recall Eric Crampton once suggesting an Ethiopian quota

[2] The contrast, say, to the economic gains New Zealand Maori may have received from 19th C immigration.

Should have done better

A couple of months ago the Institute of Directors approached me about doing a talk to their members in Wellington on monetary policy as it had been conducted by the Reserve Bank over recent times. Somewhat to my surprise, my name had apparently been suggested to them by Alan Bollard.

I gave the talk this morning, and although the date was set ages ago it could hardly have been more timely given the labour market data yesterday, which in a way finally marks the completion of not just the last 18 months’ of monetary policy, but in some ways the last 14 years (for the first time since the 2008/09 recession we have core inflation a little above the Bank’s target midpoint and the unemployment rate back to something that must be close to the NAIRU.

The full text of my remarks, and a few more points I didn’t have time to deliver, are here

Monetary Policy in Covid Times IoD address 5 Aug 2021

What I set out to do was to review how the Bank had done, and what monetary policy had (and hadn’t) contributed over the last 18 months or so.  While I was quite critical in places, and headed the overall talk “Should have done better”, I was also willing to defend them, noting that the surge in house prices had little predictably to do with monetary policy, and was neither sought nor desired.

I’m not going to reproduce the full text in this piece, but here are a couple of sections from towards the end

The unemployment rate is now 4 per cent and the inflation rate – the sectoral core measure the Bank tends (rightly) to focus on – is 2.2 per cent.  Those are really good outcomes – first time in 10 years that core inflation had crept above the target midpoint.  After the last recession it took 10 years to get unemployment back down, not 10 months.

But those outcomes to celebrate aren’t much credit to monetary policy, since when the MPC was setting the policy that was having an effect now they thought their policy was consistent with much worse outcomes. 

But where to from here?  The MPC has belatedly terminated the LSAP.  They really should be ending the Funding for Lending programme, which was explicitly a crisis programme, a stop-gap for when they couldn’t cut the OCR further, and which was not operated on a competitively neutral basis.   But more likely the next step is the OCR.

One possible reason for caution is that coming out of the 2008/09 recession, central banks (and markets) were too keen to start getting interest rates back to what was thought of as “normal”.  The RBNZ made that mistake twice, and quickly had to reverse themselves.  But both times there was no sign of core inflation rising and the unemployment rates were still quite high, so quite different circumstances than we have now. 

[Figures 7 and 8]IOD2


Some will doubt whether 4.0 per cent is the lowest sustainable rate of unemployment but it is getting pretty close to the cyclical lows of the last two cycles (and some measures may have raised the NAIRU a bit).  Wage inflation is rising faster than at any time since 2008, at a time when there is no productivity growth.    But the real guide – especially amid considerable ongoing uncertainty – is core inflation itself.  If it is above 2 per cent, and no one thinks it is about to drop back, then it is time to start tightening – not necessarily aggressively (there is no harm if core inflation goes a bit higher for a while, as it is likely to do), not part of some predetermined programme, but step by step, review by review, keeping a close eye on fresh data.   They need to be tightening at least a bit faster than inflation expectations are rising (on which new data next week).  And since the world economy could be derailed again, and fiscal policy (here and abroad) may start tightening, and very long-term interest rates are still at or near multi-decade lows, be ready to stop or reverse course if the data warrant that.  The great thing about monetary policy is that when the data change, policy can be altered quickly and easily.

The same can’t be said for fiscal policy.  There are plenty of things only government spending can do.  For example, income support to those rendered unable to earn because of pandemic restrictions.  There are plenty of other programmes for which one might make a careful well-analysed and debated medium-term case for spending taxpayers’ money on.  But cyclical stabilisation policy is a quite different matter.    Many fiscal programmes are – rightly or wrongly – hard to get underway, and slow to start (many of those “shovel ready” projects), some are easy to start but hard to stop.  And almost all involve playing favourites, rewarding one group or another – with other people’s money – according to the political preferences of the particular party in power.   Fiscal announceables, once announced, are very hard to take back off the table. 

By contrast, the MPC can and does act overnight, it can reverse itself, and it coerces no one, and picks no winners. Market prices shift and people and firms make their own choices whether or not more or less spending is now prudent for them.  There has rarely been a better illustration of how much more suited monetary policy is to short-term cyclical stabilisation than the surprises of the last year.  

And an overall assessment

How then should we evaluate the MPC’s performance?

It is clear they were poorly prepared.  There is really no excuse for that. It was always only a matter of time until the next severe shock came along.

When they finally began to appreciate the severity of the Covid shock their actions were in the right direction. 

But they can’t be credited with the good outcomes we are now experiencing – inflation and unemployment – because when policy was being set last year they expected their policy to deliver much worse outcomes, and did nothing about it.  We can’t blame them for the economic uncertainty, but they should be accountable for their own official forecasts and what they did with them[1].

The overall contribution of monetary policy to how things have turned out was pretty small.  Mostly what has happened was down to private demand reorganising itself and holding up much more than expected – notably by the Bank – greatly reinforced by the really big swing into structural fiscal deficits. 

As for monetary policy, the OCR cut was modest, and the exchange rate barely moved. The Bank claimed far too much for the LSAP, which was more noise than substance, and in the process they fed a narrative (“money-printing”) that made trouble for them and the government.  If they really believe the LSAP is as potent as they’ve claimed, perhaps they could make a start on tightening by first selling ten billion of bonds back to market.

And if they accomplished little buying lots of long-term bonds at the very peak of the market in the process they have run up big losses.  They dramatically shortened the duration of the overall public sector portfolio and then rates went back up.  These are real losses – at about $3 billion currently, four times the cost of the Auckland cycling bridge, without even the sightseeing bonuses.

We can’t realistically expect policy perfection but we can and should expect authoritative, open, and insightful communications. But MPC’s communications have been poor:

  • They never published the background papers they promised.
  • They never explained their weird ‘no OCR change for a year’ pledge.
  • There has been no pro-active release of relevant papers (unlike the wider central government approach to Covid).
  • They refuse to publish proper minutes – that actually capture the genuine uncertainties and inevitable, appropriate, differences of view, and which would allow individual members to be held to account.
  • Little serious research is published, and insightful analytical perspectives are rare.
  • From not one of them have we had a single serious and thoughtful speech on how the economy and policy are evolving.

In its first major test, the best grade we could give the MPC “could try harder, needs to avoid other shiny distractions, can’t continue to count on good luck”. Oh, and just as well for them that the individuals aren’t on the hook for those huge losses.

As with so many of our public institutions now, we deserve better.

[1] Note that just under three months ago, in the May Monetary Policy Statement, the MPC unanimously concluded that “medium-term inflation and employment would likely remain below its Remit targets in the absence of prolonged monetary stimulus” going on to note that “it will take time before these conditions are met”.

Those huge losses they have incurred for the taxpayer in running the LSAP – which by their own lights would have been unnecessary if the Bank had been better prepared – have not had much attention. They should. Some are inclined to downplay them on grounds of “think of all the macro good that was done”, but as I argue there is little evidence the LSAP made any useful macroeconomic difference to anything. Others downplay them on the feeble grounds that if the bonds are held to maturity the bond portfolio itself will not realise any losses (bonds are paid out at face value). But we can already see the cash cost to the taxpayer beginning to loom rather directly. The LSAP was simply an asset swap – the Bank bought long-term fixed rate bonds, and issued in exchange variable rate settlement cash deposits, on which it pays the OCR. The strong consensus now is that the OCR is about to rise quite a lot. Even if the OCR rises by 1 per cent and settles there indefinitely, the Bank (taxpayers) will be paying out hundreds of millions a year in additional interest. Of course, it could avoid those payments by selling the bonds back to the market – which it should be doing – but that would simply crystallise the losses on the bonds themselves. The taxpayer is materially poorer for the poor policy and operational choices of the Bank – they could have focused on short-term bonds (which are the maturities that matter in New Zealand), they could have had the banking system ready for negative rates, but instead they choice the flamboyant performative signalling routine of buying huge volumes of long-term bonds at what was (reasonably predictably) close to the very peak of the market. All while accomplishing little or nothing macroeconomically.

In a couple of months we’ll see the last Annual Report from the Bank’s old-style board (to be replaced next year). The Board has spent 31 years providing public cover for management. It is hard to envisage them changing approach at this later date. They really should, but the fact that they almost certainly won’t tells you why it was such a poor governance approach (even if the government’s replacement model if something of, at best, a curate’s egg sort of improvement).

(Circumstances, data, and perspectives do change. Some, but not all, of my views have shifted over the 18 months – as I’m sure everyone else’s has. The text of another lecture on monetary policy and Covid, from last December, is here.)

Checking the gap

Back in the very early days of this blog, in a post about the gap between New Zealand interest rates and those in other advanced countries, I ran this chart constructed from OECD data.

int diffs to 2014

There had been no sign of the large gap between our long-term interest rates and those abroad systematically narrowing. These were nominal interest rates, but as another chart in the same post illustrated the gap between our inflation rate and those in other advanced countries had also been quite stable, suggesting that the story held for real interest rates as well. Unless your economy is recording stellar productivity growth year after year, large positive gaps between your real interest rates and those in other countries are usually not thought to be “a good thing”.

In recent months all the focus locally has been on the low absolute level of interest rates. In fact, globally there were stories in just the last few days of some key international real interest rates reaching new long-term lows.

But what has been happening to the gap between our interest rates and those abroad?

The gap between our policy rate (the OCR) and those in other advanced countries has certainly narrowed – New Zealand is just a touch higher than policy rates in the US, UK, and Australia, and even among the countries with negative policy rates the gap to Switzerland (-0.75 per cent) is now only 100 basis points. When I wrote the 2015 post, our OCR was 300+ basis points higher than policy rates in most of these countries.

Of course, if you believe the market economists, those gaps are about to start widening again. New Zealand won’t be the first OECD country to raise policy rates (Iceland and Mexico have already done so this year) but most don’t seem likely to move for some time yet.

But what about longer-term interest rates, which typically embody expectations about future short-term rates?

In this chart, I’ve updated the red line from the previous chart (New Zealand 10 year rates relative to G7 ones) up to June

int rate diffs to 2021

The gap is now a lot smaller than it was for most of this century (albeit quite a bit larger than it was at last year’s lows, when the OCR was expected to stay very low, or be taken lower, for quite a few years to come). At current levels, the gap is a bit higher than it was at the end of 2019 before anyone had heard of Covid.

But what are markets saying about the very long term, beyond Covid and the immediate economic challenges, and focusing on real yields from the inflation-indexed bond markets?

Without a Bloomberg terminal, time-series data aren’t readily available for lots of countries, but here are the yields for New Zealand and the United States (we have two specific bonds, while the US publishes a constant maturity 20 year series). The first chart shows the levels of respective rates, and the second the gap between the yield on the New Zealand 2040 bond and the US 20 year.

real 2021 1

real 2021 2

The absolute levels of all these rates are very low (in the US near record lows), but the gap between New Zealand and US long-term real rates has opened right back up again, and is now around where it was at the start of 2018.

That is just the US of course. But the thing is that, in OECD terms, the US these days is a relatively high interest rate country- highest 10 year bond rates of any of the G7 countries.

Here is a chart of the yields on the German government’s 2046 maturity inflation-indexed bond.

german indexed bond

Even allowing for the fact that the New Zealand government bond matures in 2040 and the German one in 2046, there is gap in yields of something a bit over 200 basis points.

These are really big differences. And they have nothing to do with the policy stances for the time being of respective central banks – which can affect expected real interest rates over the first few years of an indexed bond. but are lost in the wash over 20 years (when people, institutional structures, and central bank mandates change anyway). These differences are about real economy phenomena.

There are, of course, conventional suspects. These are government bonds so what about the respective levels of government debt. But, of course, New Zealand has lower government debt (as a share of GDP) than most OECD countries, including both Germany and the United States. Most probably, we are expected to continue to keep government debt well in hand. If the market were pricing much sovereign credit risk across these economies, the real risk-free gap would be even larger than the numbers I’ve shown here.

Perhaps the real interest rate gaps are now a bit narrower than they were five or six years ago. Even then, however, we should be cautious about welcoming the change without understanding it better. It could, for example, represent (implicitly) a reduction in long-term expectations about relative economic growth and the demand for real resources that business investment gives rise to – and if so we might interpret differently an implicit reduction in expectations about relative productivity growth and an implicit reductions in expectations of relative population growth. As it is, it is simply too early to tell.

Markets tend not to leave free lunches on the table though. And if New Zealand government bonds are offering unusually high local currency yields for a stable low-debt country, the counterpoint is likely to be in the exchange rate. Economists have a model known as Uncovered Interest Parity (UIP) in which the difference in two countries’ risk-free interest rates is equal to the expected change in the exchange rate between those two countries over the period in question. It isn’t a proposition that actual exchange rates (ex post) reflect those initial interest rate differences – all sorts of shocks intervene almost every day – but something like an equilibrium condition ex ante.

If, for example, New Zealand real interest rates for a 20 year maturity are 150 basis points higher than those in other economies, that would be consistent with an implied expectation of a 35 per cent reduction in the real exchange rate over that 20 year period.

Of course, as I’ve shown here, New Zealand interest rates have averaged quite a lot higher than those abroad (even in real terms) for a long time, and although the exchange rate has at times been volatile (less so in the last decade than in the previous couple) we have not seen that sort of sustained fall in the real exchange rate, so there have (ex post) been windfall gains to those who bought and held New Zealand bonds. But that doesn’t change the indications that serious imbalances are still present in our economy (not just this year, not just about Covid, but something deeper and more persistent): persistently higher real interest rates than those abroad, a real exchange rate that has not adjusted structurally lower, weak business investment, low productivity growth, and feeble external trade performance (exports and imports flat or falling as a share of GDP.

(But, to anticipate comments, it has nothing whatever to do with house prices. Repeat after me, over the decades we have built fewer houses – and freed up much less land – than our population growth would have suggested was warranted. It is the commitment of real resources – physical building of houses, subdividisions etc, that (all else equal) puts pressure on real interest rates, not house price developments – lamentable outcomes of other policy choices that they are.)

Thinking about monetary policy

I’m less interested in what the Reserve Bank will be doing at next week’s OCR review, or the one after that (or the one after that) than in what they should be doing. The Bank’s MPC do few/no thoughtful speeches (or really any at all on economic developments and monetary policy), publish little research, and have something of a record at times of lurching unpredictably from one review to the next. Banks employ people who will try to wheedle morsels of information out of Reserve Bank staff and MPC members and read those tea leaves. My interest is mainly in what the Bank should be doing, both absolutely (what is first best policy) and consistent with the mandate they’ve been given by the government of the day. I used to run the line that eventually policymakers will do the right thing (and we will all grope towards knowing what that is, no matter how fervently we champion our individual views), and I guess that is probably still true if avoiding serious outright deflation or runaway inflation is the test. But my confidence has taken a bit of a knock in the last 18 months.

The Reserve Bank went into Covid manifestly ill-prepared. They’d talked up the perfectly normal tool of a negative OCR – used in a variety of advanced countries in the last cycle, regarded as effective by no less than the IMF – only to find just a month or two before the crisis hit that actually banks had technical obstacles (systems issues) that, the Bank concluded, meant they couldn’t use their preferred instrument. It was truly astonishing – not only had they had 10 years’ notice from the rest of the world, and an internal working group that had highlighted to the Governor that specific (work with banks to be ready) issue 7-8 years earlier, but they’d been publishing work and giving interviews on their thinking about the next downturn. And yet they simply hadn’t done the basic operational work to be ready. It was an extraordinary failure, on their own terms – a failure of management (Wheeler, Spencer, Orr, Bascand et al), of the MPC, and of the Board paid to hold the Bank to account on our behalf, as citizens and taxpayers.

Taxpayers? Well, yes, because one of the great things about conventional monetary policy – official short-term interest rate adjustment – is that it costs (and makes) the taxpayer nothing. A key overnight interest rate is adjusted, nothing much about the public sector balance sheet changes, and no material financial risks are assumed on behalf of the taxpayer. The private sector, subject to all the appropriate self and market disciplines, does the substantive adjustments, to spending, investing, saving etc choices. It is one of several reasons to prefer monetary policy as a stabilisation tool – at the other extreme, expansionary fiscal policy just involves writing large cheques with other people’s money.

But unable (so they judged) to take the OCR negative, and unwilling (for reasons they’ve never attempted to explain) to even take the OCR quite to zero, the Bank lurched into the Large Scale Asset Purchase programme (LSAP), in which they have been buying up huge quantities of (mostly) government bonds, heavily concentrated at the highest risk long-end of the bond market where if they affect rates at all they aren’t rates that anyone much in the private sector pays. Short-term rates (out to perhaps a couple of years) are what matter in this market, and the Bank could very easily have managed those rates without (a) many asset purchases at all (market rates respond to expectations of future monetary policy) and (b) without anywhere near as much financial risk (short-term bond prices don’t fluctuate much).

I’ve been running an argument for the last year or more that the LSAP was really little more than performative display (“see we are doing lots, really”), in substance no more than a large-scale asset swap (Bank buys back long-term bonds and issues in exchange short-term liabilities with exactly the same credit risk), in turn exposing the taxpayer to a lot of market/refinancing risk. Of course, the Bank claims otherwise – they claim significant effects on bond rates (but if so, so what) and the exchange rate – but have never provided much supporting analysis. And they have their defenders in the markets – you could read this interesting piece from the ANZ, although you may come away thinking that the ANZ bank thought LSAPs were a good idea as (financial) industry assistance. At best, if there was a case for the LSAP it had long since passed by the end of last year (by when even the Bank recognised that it could have used a negative OCR). And yet they went on – albeit staff (but not the MPC) have been reducing the scale of purchases more recently, partly because there are fewer bonds to buy.

What about that financial risk? The Reserve Bank has about $3 billion of capital, and although capital isn’t a technical constraint on a central bank – it can still run with negative equity – Governors and MPC tend to be reluctant to take on lots of risk for their own institution relative to the amount of capital the institution has. So the Bank persuaded the government to provide an indemnity, covering any losses the Bank ended up making on the LSAP programme. And now there is a line item on the Reserve Bank balance sheet representing those losses, and the claim the Bank now has on the government.


The published data are only to 31 May, and as rates fluctuate (down and up) the market value of the losses changes (as of today probably a bit lower than 31 May), and the Bank also continues to buy bonds. But a $3 billion loss looks like a reasonable point estimate. That is about 0.8 per cent of GDP gone and most probably – since there is no reason to suppose rates are more likely to fall than to rise from here over the years ahead – not coming back. Transferred from you and me, to those lucky enough to offload their bonds to the Crown near the highest prices ever experienced. The pedestrian/cycling bridge in Auckland has been a recent benchmark for reckless public spending, but this has cost four bridges – without even the consolation of somewhere to go sightseeing on a holiday to Auckland.

It is almost certainly the most costly (to the taxpayer) Reserve Bank intervention since the devaluation crisis of 1984 – and at least in that case the Bank’s losses resulted from a refusal of the government to follow Treasury/Reserve Bank advice. It swamps the cost of the 2008 deposit guarantee scheme, which some continue to inveigh against to this day. The public sector as a whole could have locked in the long-term debt funding it needed at last year’s low rates. Instead, the MPC, the Governor and the government acted to prevent it, at great and preventable cost to the taxpayer.

Preventable? Recall, they should have been able to deploy negative rates (their preferred option) which would have cost nothing. They could have focused what purchases they did much more heavily on short-dated bonds (on which losses would have been very limited). And they could have stopped the programme eight or nine months ago, once the negative OCR tool was back on the table. (None of this requires second-guessing purely with the benefit of hindsight the Bank’s macro forecasts – this would have been sound advice on their own contemporary numbers.)

Instead, even as recently as the last Monetary Policy Statement they were on record as suggesting

The Committee agreed that the OCR is the preferred tool to respond to future economic developments in either direction.

In other words, they planned to keep on buying up bonds per the ongoing programme even if economic developments meant overall conditions needed tightening. They’d keep on running up financial risk to the taxpayer and raise the OCR at the same time.

We might hope for a rethink next week, but who knows whether it will happen – there is a often a preference for making significant moves at full MPSs – but what they should be doing is discontinuing the LSAP now (not just letting staff run down new purchases, but winding up the programme completely, and publishing plans to manage – ideally relatively aggressively – the unwinding of their huge bond position). An apology for the losses would be nice too, but instead no doubt we’ll have claims repeated about the great gains the programme has offered with – as is now customary – no attempt to a cost-benefit analysis of this or of alternative approaches.

But, expensive as it has been, no one is probably now arguing that continuing – or discontinuing – the LSAP at current purchase rates is now making any macroeconomically significant difference. So whether or not it is ended isn’t really relevant to the macroeconomic question of what to do about the emerging economic data and the inflation outlook. What should be being done about that?

On balance, I think it is now hard to make a compelling case for the status quo on monetary policy (of things that make a difference, the OCR and the Funding for Lending programme). I’m very conscious of the mistakes the Reserve Bank made in prematurely tightening in the 2010s (on two separate occasions), and the way markets here and abroad often got ahead of themselves in looking to tightenings in that decade. And there is always a risk in using as a reference point rates as they were pre-recession – recall how Graeme Wheeler in particular always used to talk about getting rates “back to normal”.

But there are some important differences this time. Take two (quite important ones): inflation and unemployment.

When Alan Bollard started raising the OCR in 2010 core inflation has been falling sharply , the unemployment rate was about 6 per cent, and the employment rate was well below pre-recession levels.

And when Graeme Wheeler started raising the OCR in 2014, talking confidently on his plans to raise it by 200 basis points, the Bank’s preferred (slow-moving) core inflation measure was around 1.2 per cent, the unemployment rate was about 5.7 per cent, and the employment was still well below (although a bit less below) pre-recession levels. Perhaps the strongest elements in his case for tightening then were the strong terms of trade and the ongoing demand effects of the Christchurch repair and rebuild process.

What about now? Well, core inflation just did not fall during last year’s recession, and the best read now is that it is about 2 per cent (the Bank’s slow-moving preferred measure is up to 1.9 per cent). As for the labour market, the latest official unemployment rate was still a bit above (4.7 per cent) where it was at the start of last year, and the employment rate was a bit below (both gaps being much smaller than in 2010 and 2014). Meanwhile the new monthly jobs indicator tells us that the number of filled jobs is now above levels at the start of last year, even as the number of people in the country has shrunk, suggesting the official unemployment rate now (early Sept quarter) is probably not much different than it had been pre-recession.

Those indicators alone – absent any good reason to think neutral interest rates have fallen a lot since the start of last year – would make a reasonably good, entirely conventional, case for getting some monetary policy tightening underway, all reinforced by stories about the high (possibly record) terms of trade, and the very large government deficit (underpinning demand). And if business confidence surveys don’t often have much pure predictive power there is certainly nothing in them to suggest it would be reckless or irresponsible to see official actions sanctioning the rise already seen in market rates. There is nothing good or bad intrinsically in lower or higher interest rates – they are simply the balancing price, reconciling all the other evident pressures in the economy.

What would be unwise would be for the Reserve Bank – or anyone else – to be uttering views about the economic outlook with any great confidence. There are more than a few big uncertainties out there, and it is always rash – as Wheeler was – for central banks to talk grandly about multi-year interest rate adjustment plans. Events have a way of overwhelming such hubris. The MPC needs to be led by the data, and for now – and given the stance of fiscal policy, which MPC has to take as given – the data probably do sensibly point in the direction of higher interest rates. It might not six months hence, but the MPC simply needs to be led by the data as it emerges.

That shouldn’t mean aggressive moves. Recall that core inflation has been below the target midpoint for a decade or more, and for the entire time (since 2012) when 2 per cent midpoint has been a formal focal point in the target document. Against that backdrop, there is no harm in core inflation going a bit beyond 2 per cent for a while – doing so might help cement in longer-term inflation expectations near 2 per cent (market price indications are still below that, although higher than they were a couple of years back). But a modest tightening now might well see core inflation rise above 2 per cent if the more inflationary/expansionist indicators are for real, while preventing it dropping below 2 per cent if they don’t. “Least regrets” was the mantra the Bank liked to chant.

That also doesn’t mean the OCR should be raised. The first step (other than the performative signalling LSAP) should be to end the Funding for Lending programme. It was an extraordinary intervention that, while second best, worked, lowering retail rates relative to the OCR. But it was a non-neutral operation – only banks had access to it – and runs against the principles of competitively neutral interventions. There isn’t that much FFL lending outstanding – $3 billion or so at the end of May – and of course those who’ve already borrowed get to keep their loans to maturity – but there is no evident need for the facility to still be in place now. For those who worry that early Reserve Bank action might drive the exchange rate higher, using the FFL rather than the OCR is (a) quite a bit less high profile, and (b) retail rather than wholesale focused. Frankly, exchange rate concerns would be better addressed with a tighter fiscal policy.

And, almost finally, if there is a case for higher interest rates now, it is entirely cyclical and says nothing at all about the fundamental strengths (or travails) of the New Zealand economy. Border closures are likely to have reduced potential output a bit, and so have a whole raft of other government interventions (some of which may also have raised the minimum sustainable unemployment rate) . But monetary policy isn’t about potential output; all it can (and should do) is influence things around potential, however good or bad potential may be. As it was in the 1970s – when potential growth slowed but interest rates needed to be raised to deal with inflation – perhaps to some extent it is now.

Should the stances of other central banks be a constraint? I don’t think so. We’ve already seen a couple of OECD central banks move to raise official interest rates this year, and if institutions like the Fed, the ECB, and the Bank of England are more cautious, well the recoveries in each of those places lag a bit behind that here. As for the RBA, they seem an odd mix – their Governor almost seems to be running some sort of 1980s cost-push wage-targeting mental model – but bear in mind that core inflation in Australia was well below their target midpoint going in to Covid, and still is today. Circumstances differ, even if end goals are fairly similar.

School holidays loom and we are heading away so no more posts here for a couple of weeks.

Some economic effects of immigration

Immigration is in the news quite often these days. The government tells us it is planning changes to the rules (in a “having emerged from Covid” world). They’ve asked the Productivity Commission to do a substantial report on New Zealand immigration policy (apparently expected to report after at least some of the government’s policy changes). And, of course, in the short-term while New Zealanders are free to emigrate – to give our government some credit, at least they don’t make departure entirely dependent on the grace and favour of the government as in Australia – it is very difficult for most people who aren’t New Zealanders or New Zealand residents to get into New Zealand at present. There are some compelling human stories (separated nuclear families), but also all sorts of claims about how our individual firms, or perhaps the economy as a whole, might be suffering as a result. Over the last 12 months (to the end of June), there has been a net outflow of 35000 people (New Zealand and foreign) – as a share of the population, the only time there has been a larger net outflow looks to have been in the late 1970s. Quite a contrast to the really big net inflows we’d experienced in the years just prior to Covid.

So it was interesting to see a new research report out from the ANZ economics team looking at “How does immigration affect the New Zealand economy”. As the authors note, it is similar in spirit and technique to a piece the Reserve Bank did back in 2013, which I will come back to later in this post. And has somewhat similar – but probably weaker – results, despite a number of differences, both in data and specification.

It is important to note that (a) these are not highly-detailed structural models of the economy and (b) do not purport to say anything material about the longer-term questions about the economic impact of New Zealand’s immigration policy that are my main focus. The main focus instead is on the impact of some unexpected net immigration over the first two or three years – and the ANZ piece does not even attempt to distinguish between the bits under government control (non-New Zealanders, especially arrivials) and the bits that aren’t (movement of New Zealanders).

Here is how ANZ describes their effort

Net immigration tends to be driven primarily by changes to immigration settings and relative labour market conditions between Australia and New Zealand. At the moment, we can add the pace of border opening. With the
outlook so uncertain, it’s helpful to ask what will happen to the economy if net immigration is stronger or weaker than we expect in coming years. To answer this question we employ a simple model1 that estimates the
relationships between key variables:
 Net immigration
 Growth in residential building consents
 Investment intentions (from the ANZ Business Outlook)
 GDP growth
 House price inflation
 Growth in labour costs
 The change in the 2-year mortgage rate

They use data back to 1998 (not entirely sure why they don’t go further back, but perhaps one of the data series isn’t available further back). Note the problem that bedevils so much of this sort of work. If 20+ years doesn’t sounds too bad (80+ quarters), actually the researchers are trying to distill results from what are really only two events (two complete immigration cycles) and so not too much weight can be put on any particular result.

Note too that the immigration series they are now using (the new 12/16 series mostly) is different in character to the series (the old PLT data) used in earlier work. PLT data used self-reported intentions at the time of arrival/departure, and thus was unaffected by anything that happened after arrival/departure. The 12/16 series – which relies on what people actually did (whether they stayed – here or away – for long) – is importantly different. You might have arrived intending not to stay long, but if conditions while you are here change for the better you may choose to stay. In some respects (but not all) it is (eventually) better data, but the difference is one researchers might want to think about.

I’m also a bit puzzled why – other than advertising their own survey – they used the ANZ Investment Intentions series rather than actual investment data from SNZ.

Anyway, what do the results show? They do a first round suggesting (not very surprisingly) that higher (lower) net immigration is associated with higher (lower) house prices and dwelling consents. Then they attempt to do something a bit more sophisticated and isolate causality. In their words

In this section, we make a few tweaks to the model which allow us to be more definitive about the impact of net-immigration on individual variables like wages.  We can get the answer to the question: ‘what’s the impact of
an X increase in net immigration on house price inflation, holding everything else constant?’
Overall, our findings are consistent with the forecast scenarios – but with the tweaks we’ve made, we can say that our model shows that an increase in net immigration results in higher house price inflation, rather than saying
is associated with higher house prices. That might sound like semantics, but it’s the difference between correlation and causation.

(For those really technically minded there are footnotes on both these model specifications.)

Here are the house prices results


They don’t seem to state the size of the shock, but I guess the point they want to emphasise is that the effect is positive. But actually what surprised me was that, on this model and specification, the effect is only statistically significant for a couple of quarters at most (those dotted lines are 90 per cent confidence bands). Even allowing for the fact that the model is looking at house price inflation not house price levels, that seems a bit surprising.

I’m guessing that the results are stronger for dwelling consents, since they say

The results for residential consents showed a strong positive response to higher net immigration. Together, these findings show that higher net immigration generates sizeable upwards momentum in both prices and activity in the housing market.

But they don’t show the results. If so, it would be a little surprising, since the general story has tended to be that immigration shocks boost house prices first, and only later have a large effect on consents.

What about the other variables in the model? They do find a boost to GDP growth, for the first year or so (not at all surprising, since there are more people, whether as workers, consumers, or people needing a roof).

anz m 2

They report no effect (positive or negative on wages). But what about GDP per capita growth?

anz m 3

They describe this is “it doesn’t look like there’s a strong effect”, but given the confidence intervals it would be fairer to say it is no effect at all. And, frankly, that is a surprise (a point I’ll come back to).

The final observation ANZ make that I wanted to pick up on was their observation that they do not find significant impacts on investment intentions. They don’t make anything of it, but if that result were robust – and I’m sceptical – it should be really rather concerning. There is, on this scenario, an unexpected change in the number of people in New Zealand, and there is no impact on firms’ investment intentions, and yet additional workers need additional physical capital (be it a computer, or tools, or a van, or a desk, or an office or whatever?). I’ve shown cross-country data previously suggesting that in advanced countries business investment (as a share of GDP) has tended to be negatively correlated with population growth, so in a way I’m not overly surprised, but the prevailing official New Zealand story surely requires a belief that more people results in more investment, if simply to maintain pre-existing capita/output ratios. I wouldn’t want to put too much weight on this result – which may depend on the specific variable they chose to use, or whatever – but it should be a slightly disconcerting straw in the wind nonetheless.

So what about that 2013 Reserve Bank paper I mentioned earlier? (Disclosure: I was the editor responsible for the paper, and although I asked for some of the specifications in it, all the results are those of the author – now one of the Bank’s key economics managers.)

That Reserve Bank set out to look specifically at the impact of migration on the housing market, as net migration was just beginning to pick up strongly again. In what is described as a “fairly simple model” this is what the author set out to do.

mcd 1

Using the output gap has some attractions and some disadvantages. From a central bank perspective, one is less interested in whether headline GDP rises and more interested in whether migration shocks add to or ease overall resource pressure. On the other hand, output gap estimates are subject to revision, and are actually revised quite a bit (the 2013 series that McDonald used clearly describes the same economy as the Bank’s latest estimate, but with important differences, including that at the time he wrote the Bank’s official view was that the output gap was already slightly positive, while now they think it was still reasonably negative).

These were McDonald’s summary results (noting that the confidence bands here are 68 per cent confidence bands)

mcd 2

In this model, after five years house prices are still 8.1 per cent higher than otherwise after a 1 per cent of population immigration shock.

I guess the key result I always focused on in this paper was the output gap estimates. Immigration shocks in New Zealand over this specific period tend to have added more to demand (including for labour) in the short-run than they add to the economy’s supply potential (but after 3 years and more – recall these are monthly numbers – that effect fades out, leaving the output gap effect basically zero). That has implications for interest rates (in these models the two year mortgage rate, but there is quite a correlation with the OCR). (It is also consistent with at least some initial boost to per capita GDP – see above – since a given pool of resources in being worked more intensively.)

McDonald also looked at arrivals and departures separately (didn’t seem to make much difference) and at movements of New Zealanders and non New Zealanders separately (where there were some differences – notably the output gap effect is zero for New Zealanders, possibly because the comings and goings of New Zealanders are more purely endogenous). There appeared to be some differences by country of origins (arrivals from Europe/UK boosted house prices a bit less, and more slowly, than arrivals from Asia).

The broad thrust of these results should not really surprise anyone. The notion that immigration has added more to demand than supply in the short term was just a standard feature of New Zealand macroeconomic analysis for many many decades (whether historically or in the forecasts/write-ups of places like the Bank and Treasury more recently). That it is so says nothing – nothing at all – about the pros and cons of large scale policy-led immigration longer-term. The short-term effects are more likely to be that way round in a country that mostly imports “people like us” – often people with a reasonable degree of education and skill, often actually New Zealanders – than, say, in a country where a large chunk of migrants are lowly-skilled illegals (again, whatever the long-term case for either sort of immigration).

And yet, if these results shouldn’t surprise, they clearly do surprise many businesses and business lobbyists, operating entirely with a single firm perspective and either unaware of or deliberately choosing to ignore the macro analysis. Here is eminent economic historian Gary Hawke’s take – from a 1981 chapter in The Oxford History of New Zealand.

“Ironically, the success with which full employment was pursued until the late 1960s led to frequent claims that labour was in short supply so that more immigrants were desirable.  The output of an individual industrialist might indeed have been constrained by the unavailability of labour so that more migrants would have been beneficial to the firm, especially if the costs of migration could be shifted to taxpayers generally through government subsidies. But migrants also demanded goods and services, especially if they arrived in family groups or formed households soon after arrival and so required housing and social services such as schools and health services. The economy as a whole then remained just as “short of labour” after their arrival.

Whatever the possible longer-term microeconomic case for access to a wider pool of skills, a new migrant labourer may ease an individual firm’s constraint or problem – perhaps even a sector’s if they can get a disproportionate share of the arrivals – but large scale migration simply does not ease overall macroeconomic resource pressure.

All that is really a protracted intro to a point I have been toying with. I recall writing a post early last year – probably February – suggesting that the building downside risks to the economy were such that I would be very hesistant to then recommend a significant cut in non-citizen immigration, for fear of exacerbating the near-term economic downturn. For much of last year, my comfort with the pessimistic economic forecasts the Reserve Bank and Treasury were publishing was reinforced by this short-run immigration story: demand effects typically exceed supply effects over the first couple of years so a big net outflow (enforced by Covid border restrictions) seemed likely to exacerbate/extend the economic weakness.

And yet, here we are, borders still closed, still monthly net outflows, significant sectoral dislocations but……the economy at more or less full employment (more jobs filled now than there were early last year, even though fewer people are physically here), and business and consumer sentiment really running rather strongly, investment intentions included.

Where does immigration fit with the story? I’m surprised things are running as strongly as they are but so (presumably, if they have thought about it) must be those constantly rushing to ministers and newspapers to claim that the economic costs of not having access to another migrant labourer are very high (on some rhetoric “threatening our entire recovery”. I’m not trying to suggest that all is rosy about our economy – it clearly is not in any structural sense, but in a short-term cyclical sense (the focus of both the ANZ and RB work) you can’t really complain about things here. The market now thinks official interest rates will/should be on the way back up before the end of the year. Core inflation might even get past 2 per cent for the first time in a decade. Workers often find employers competing for their services.

My honest answer to my own question is that I’m still not clear. I’ve put a lot of weight on the swings in the structural fiscal position – the swing from a near balanced budget 18 months ago to huge cyclically-adjusted deficits now is a really big boost to demand – and official interest rates are lower than they were, all in an economy where the net loss of purchasing power from other factors has been pretty limited (to put it mildly, having in mind the strength of the terms of trade). The short-term macro effects of swings in migration seem pretty clear – need for a roof etc hasn’t changed – so I can only deduce that we’ve had a series of factors at play:

  • fiscal policy (really big boost to demand)
  • monetary policy (modest boost to demand –  through the OCR, little or nothing through LSAP)
  • some slight dampening to demand from restrictions on overseas tourism and export education (most NZ offshore tourist spending seems to have been displaced to additional demand for other things),
  • some boost to net incomes and demand from the rising terms of trade, and
  • a significant dampening to demand from the move from a net migration inflow to an outflow.

It would be consistent with a story in which the overall economy might now be running as strong (cyclically) or even a bit stronger than it was early last year, and one which –  all else equal –  a significant reversal in the net migration flow –  would simply exacerbate (forcing higher interest rates or tighter fiscal policy) rather than relieve.

I’ll have a few thoughts specifically on monetary policy tomorrow.

Long-term spending and revenue

The Public Finance Act requires that every four years The Treasury publishes a “statement on the long-term fiscal position” looking “at least” 40 years ahead. Parliament allowed them to defer the report due last year, but yesterday they published a draft – for consultation – of the report they will formally publish later this year. Quite why they have chosen to go through this additional step, of consulting formally on the draft of a report that is likely to have next to no impact even when finalised, is a little beyond me.

These long-term fiscal reports are fashionable around the world. As I’ve noted previously I was once quite keen on the idea, but have become much more sceptical. They take a lot of work/resource – which should be scarce, and thus comes at a cost of other analysis/advice The Treasury might work on – and really do little more than state the obvious. As I noted when the last long-term fiscal report was published.

I was once a fan, but I’ve become progressively more sceptical about their value.  There is a requirement to focus at least 40 years ahead, which sounds very prudent and responsible.    But, in fact, it doesn’t take much analysis to realise that (a) permanently increasing the share of government expenditure without increasing commensurately government revenue will, over time, run government finances into trouble, and (b) that offering a flat universal pension payment to an ever-increasing share of the population is a good example of a policy that increases the share of government expenditure in GDP.  We all know that.  Even politicians know that.  And although Treasury often produces an interesting range of background analysis, there really isn’t much more to it than that.  Changes in productivity growth rate assumptions don’t matter much (long-term fiscally) and nor do changes in immigration assumptions.  What matters is permanent (well, long-term) spending and revenue choices. 

And I’m old enough to remember people lamenting the potential fiscal implications of an ageing population – at least conditional on government choices – well before long-term fiscal reports were a thing.

What’s more, lots of countries have these sorts of reports, and of them some have very high and rising levels of government debt, and others don’t. It isn’t obvious that access to these sorts of long-term reports really makes any difference at all (see, for example, the US, with a rich array of private and public sector analysis – although do note that the US is well ahead of us in raising the eligibility age for Social Security retirement benefits).

New Zealand, to the credit of politicians in both main parties, has been one of the (not so small) other group of countries where government debt as a share of GDP has been kept fairly low and fairly stable. We’ve had recessions and earthquakes, and governments with big spending ambitions but if you reckon – as I do – that low and fairly stable government debt is generally a “good thing”, New Zealand has been a success story. We even ramped up the NZS eligibility age from 60 to 65 (back to the 1898 eligibility age) in fairly short order. For good or ill – and no doubt there is an argument to be had – government health spending as a share of GDP was not much higher last year than it was 40 years ago (recall, 40 years is the statutory timeframe for long-term fiscal statements).

health 2021

At the start of last year I’d probably have put myself in the camp of those saying “we’ve done okay on fiscal management and there is no obvious reason to suppose we won’t adjust as required in future”. Among other things, there is a certain absurdity in paying out a universal state welfare benefit to everyone at 65 as an ever-increasing share of those 65+ are still in the workforce, so change was likely to happen – it had in other countries, it had here previously and actually Labour in 2014 and National in 2017 and 2020 had campaigned on beginning to raise the age of eligibility (to which you might respond that none of those parties then got elected, but National still won 44.4 per cent of the vote in 2017).

I’m no longer so sure.

One chart that didn’t feature in the draft long-term fiscal report was this one from the Budget.

mcl 2

On their own numbers and estimates, the cyclically-adjusted primary deficit for the current (2021/22) financial year is projected to be really large (in excess of 5 per cent of GDP), at a time when – again on their own numbers – the economy is more or less back to full employment, with an output gap estimate close to zero. Note (again) that this is not a dispute about appropriate policy in the June quarter of last year when most of us were ordered to stay home and many were unable to work. It is about now.

In their text, Treasury is at pains to play down the current fiscal situation. They don’t mention these cyclically-adjusted estimates, but they claim that the situation is temporary, the spending is temporary, and will go away quite quickly. Of course, they have lines on a graph that show such an outcome, but that isn’t the same thing as hard fiscal choices over a succession of years. No doubt there are still some temporary programmes – the subsidies for Air New Zealand and exporters, MIQ costs, and vaccine costs – but a cyclically-adjusted primary deficit in excess of 5 per cent of GDP is getting on for a gap of $20 billion per annum. And every instinct of this government appears to be to spend more.

Here is the chart from the draft report

LTFS 2021

The primary deficit for 2060 on this scenario actually isn’t much larger than the primary deficit The Treasury smiles benignly on this year (assuming it will all go away quite easily). There are long-term issues that need addressing, but perhaps a less complacent approach to the current situation – and the poor quality of a lot of the new spending decisions – might be a better place to start.

Ah, but of course we heard from The Treasury a couple of weeks ago – the Secretary no less – that they are now keener on more government debt and a more active use of fiscal policy. Which probably isn’t the best backdrop against which to make the case for adjustment.

More generally, one of the things that has shifted over the last couple of years – and certainly since the 2016 LTFS – is some sense, especially on the left, that lots more public debt is something to embraced or welcomed, coming at little or no cost (so it is claimed). The focus is always on interest rates (low) and never on opportunity cost (when the coercive power of the state is at work in the spending choices). It makes it a bit harder to mount fiscal arguments about NZS if – as is probably the case – New Zealand could have government debt of 177 per cent of GDP without being cut out of funding markets (although note that, in the nature of such scenarios, the debt ratios mechanically explode beyond that 40 year horizon). And that is another reason why I’m sceptical of the benefits of reports like this: The Treasury really can’t offer any useful insights on the appropriate level of public debt, even if they can offer useful technical advice on the implications of various specific measures that might raise or lower the debt. The real debates to be had are political – both about the debt and the numerous progammes and even (to some extent) around the tax choices.

On NZS here were my thoughts from a post a couple of years ago (emphasis added)

As for NZS itself, personally I’m not overly interested in arguing the case for reform on fiscal grounds but on a rather more moral ground.    Even if we could afford it, even if there were no productive costs from the deadweight costs of the associated taxes, there just seems something wrong to me in providing a universal liveable income to every person aged 65 or over (subject only to undemanding residence requirements).    45 per cent of those 65-69 are now in the labour force –  suggesting they are physically able to work –  which is substantially greater than the 30 per cent of those aged 60-64 who were in the labour force 30 years ago when NZS eligibility was at age 60.

I don’t consider myself a welfare hardliner.  I think society should treat quite generously those genuinely unable to work, especially those who find themselves in that position unforeseeably.  Old age isn’t one of those (unforeseeable) conditions, but personally, I have no particular problem with something like the current flat rate of NZS, or even of indexing it to wage movements (which would be likely to happen over time anytime, whether it was the formal mechanism from year to year), from some age where we can generally agree a large proportion of the population might not be able to hold down much of a job.  I don’t have a problem with not being overly demanding in tests for those finding work increasingly physically difficult beyond, say, 60.   But what is right or fair about a universal flat rate paid – by the rest of the population – to a group where almost half are working anyway?  It is why I would favour raising the NZS age to, say, 68 now (in pretty short order) and then indexing the age in line with further improvements in life expectancy, and I’d favour that approach even if long-term fiscal forecasts showed large surpluses for decades to come.    At the margin, I’d reinforce that policy change with a provision that you have to have lived in New Zealand for 30 years after age 20 to be eligible for full NZS (a pro-rated payment for people with, say, between 10 and 30 years of actual residence).  Why?  Because in general you should only be expected to be supported by the people of New Zealand, unconditionally, in your old age, if most of your adult life was spent as part of this society.

Reasonable people can, of course, debate these suggestions.  But they are where I think the debate should be –  about what sort of society we should be, what sort of mix between self-reliance and public provision there should be, even about what mix of family support and public support there should be, or what (if any) stigma should attach to be funded by the taxpayer in old age –  not, mostly, about long-term fiscal forecasts.

And Treasury can’t help with very much of that. It is what we have politicians, think tanks, and citizens for.

I don’t think enough weight is given to the role that rules of thumb play in disciplining choices. If, in modern floating exchange rate open-capital account economy, many governments can take on almost any amount of debt as they want, and even the interest rate consequences of higher public debt are really quite small, what constrains government choices? No doubt there are a few zealots who think no constraints are necessary, but most people – left, right, or centre – don’t operate that way.

I favour running fiscal policy to two rules of thumb (not legal restrictions, but political covenants/commitments). First, aim to keep the (cyclically-adjusted) operating balance near zero, and second, aim to keep net public debt (all inclusive measures) near zero.

Note that (a) neither rule of thumb would be binding year by year (the state needs to cope with pandemics, earthquakes, or the like), they would be constant aiming points, the standard reference points towards which policy is oriented over several years, and (b) neither rule of thumb says anything about the appropriate size of government (if we conclude we want governments to do more (less) longer-term than adjust tax rates to pay for that. Adjusting tax rates – especially upwards – is a much higher hurdle (and appropriately so) than the Cabinet (commanding a majority in Parliament) simply deciding one morning to substantially alter spending.

There is probably less dispute about the operating balance rule of thumb than about the debt one. Smart people will mount arguments about (a) infrastructure, or (b) the potential capacity of the Crown to capture various high returns. A typical householder or company will, after all, have some debt. But (a) the disciplines on individuals and firms are much stronger, and more internalised, than they are for governments, and (b) much of government activity acts to reduce private savings. I’m not going to pretend there is any great difference between the narrow economics of a 20% debt target vs a -20% one, but zero has a resonance that no other number is ever likely to have. (And if you think this benchmark is demanding, on my preferred analytical measure – the OECD series on net general government financial liabilities – New Zealand has been between 10 per cent and -5 per cent of GDP continuously since about 2004.)

If you want the state to do more, make the case, have the debate for higher taxes – which takes the resources from specific identifiable types of people (tax incidence arguments aside), rather than by monetary policy squeezing out other private sector activity to make way for the government (in a fully-employed economy they are the only two options, there are no free lunches).

This has gotten rather rambly and I’m going to stop here, except to point you to this interesting table at the back of the Treasury report.

LTFS 2021 2

I noted:

  • the sharp drop in the long-term assumed birth rate (largely reflecting recent developments presumably)
  • the reduction in the assumed improvement in life expectancy
  • the significant reduction in assumed long-term productivity growth, and –  unlike the others, substantially a policy matter, 
  • the substantial increase in the assumed long-term annual rate of net inward migration

Inconsistent with the scale of the challenge

A few weeks ago I received an invitation from the OECD to this (Zoom) event

Going for Growth is one of the OECD’s flagship economics publications in which, among other things, they identify for each member country what their indicators and models suggest should be structural reform priorities. As the title suggests, the focus is – or at least used to be – productivity, labour market utilisation and the like. The latest New Zealand note, released in May, is here. There is often a fuller treatment in the OECD’s Economic Survey for each country, which they are working on now, having done the rounds (by Zoom) of New Zealand officials and other people (me included) a couple of months back.

Yesterday’s event had potential. The Director of the OECD’s Economics Department spoke, as did one Productivity Commissioner for each of New Zealand and Australia, and then three non-government economists (two from Australia, one from New Zealand), followed by questions from the audience. I wasn’t able to stay to the end, but heard all but one of the presentations (and the one I missed was by an Australian bank economist, presumably focused on Australia). They said that a recording of the event will be posted on the OECD website but as of this morning it didn’t yet appear to be there.

First up was Luiz de Mello from the OECD. With the New Zealand note having opened highlighting how far behind productivity lags in New Zealand one might have hoped for far-reaching policy suggestions. Instead, we got a boringly familiar list, most of which make sense but – realistically – none (individually or collectively) offer the prospect of dramatic macroeconomic change. De Mello was speaking about both New Zealand and Australia, and given how far behind Australia New Zealand average productivity lags that probably further limited the value. Anyway, his list was as follows:

  • he highlighted a component of the OECD’s Product Market Regulation (PMR) indices, suggesting that for both New Zealand and Australia licences and permits (presumably cost or timeliness) were much more of an obstacle than in the top 5 OECD countries (Australia worse than New Zealand),
  • he highlighted the bad scores both countries get on the OECD FDI restrictiveness index (New Zealand worse than Australia)
  • he highlighted the variance in PISA scores, which is higher in New Zealand and Australia than in most small advanced countries and the UK (having, somewhat to my surprise given our slide down the PISA rankings, noted in the report itself that New Zealand “educational achievement is high on average”.
  • he highlighted how high housing expenditures are relative to the OECD for the bottom quintile, and
  • he highlighted the OECD’s view that too much of greenhouse gas emissions in both Australia and New Zealand were “underpriced”.

Beyond that, they seemed keen on a large social safety net –  addressing “child poverty” directly, and smoothing the income of the unemployed.

Most commentators in New Zealand probably think the government has done little useful structural reform –  with a growth/productivity focus –  but the OECD begs to differ, talking in their final paragraph of the “significant actions” taken in recent years in key priority areas.  Weird housing tax measures, for example, seem to win favour from an organisation that used to favour neutrality in the tax system.

So the session wasn’t off to a great start at this point.  Whatever your view on pricing emissions, increasing those prices is not going to boost incomes and productivity, and the other four items – while each no doubt pointing towards useful possible reforms –  are simply not likely to be game-changers.

The next speaker was one of the New Zealand Productivity Commission members, Gail Pacheco.  She too started with a bow to history, highlighting our decades of languishing productivity performance.  She chose to pick up some points from a couple of the Commission’s recent reports.  From the Future of Work she noted, reasonably enough, that New Zealand probably did not have enough technology and that a successful New Zealand economy would see more technology adaptation and diffusion, but she offered no thoughts on what changes in the economic policy environment might create conditions in which firms would find such investment worthwhile.  She seemed more interested in the Commission’s social insurance idea –  now being picked up by the government –  which would pay more to people unemployed at least in their first few months of unemployment.     There might be a case for such a policy – I’m pretty ambivalent –  but in a country where it is not that hard to close business and lay off staff, it has never been obvious (and Pacheco made no effort to elaborate yesterday) how this had anything to contribute to creating a climate supporting higher business investment and stronger productivity growth.

She then moved on to the recent Frontier Firms report and briefly ran through a list of things she thought would help, including

  • significant (government?) investment in a handful of chosen focus areas/sectors,
  • coordinated effort across government
  • everyone working together across the wider community,
  • transparent and adaptive implementation,

all of which, she claimed, would lead to (the current government’s mantra) a “more sustainable, inclusive and productive” economy.

Now, in fairness, each speaker did not have a great deal of time, but there was nothing in Pacheco’s speech that suggested that she had got anywhere near the heart of the issue, had any real sense of the market and private sector, or saw the answers as anything more than well-intentioned (we hope) ministers and Wellington officials trying more (seemingly) smart interventions, preferably without pesky disagreement or robust accountability (she talked of long-term predictable policies).

Pacheco was followed by one of the Australian Productivity Commissioners, Jonathan Coppel, who seemed to have a rather more robust grasp of the economy.    Interestingly –  to me anyway, it wasn’t his point –  he opened with a chart using new historical estimates suggesting that New Zealand’s decline (relative to both Australia and the US) can be dated earlier than Pacheco suggested or than the previous Maddison estimates suggested.  His point was that Australia has made no real progress in closing their (smaller) productivity gaps to the US –  US 30 per cent ahead of Austraia – repeating a line often heard out of Australian recently that the 2010s were the worst decade for Australia –  growth of GNI per capita –  for six decades.  He seemed keen to stress the importance of building on the reforms of the 80s and 90s, rather than discarding them, but it wasn’t that obvious how his suggestions – reduced reliance on income taxes, good regulatory practice, and a focus in post-school education/training on competition and lifelong learning –  were likely to be equal to the task.   He did stress the idea that economists needed to do more communicating with, and persuading the public, re the case for change, not leaving everything to the politicians. 

The next speaker was an Australian private sector economist, Melinda Cilento who –  she spoke very fast –  had a long list of things she wanted in Australia, almost all of which seemed peripheral re longer-term productivity, and several of which were simply out and out redistribution (for which there may or may not be a good case in Australia).

The final speaker I heard was Paul Conway, formerly of the Productivity Commission and now chief economist of the BNZ.  HIs was perhaps the most promising of all the presentations, even if he seemed implausibly optimistic when he talked of the “once in a lifetime opportunity” to fix the New Zealand economy, end its “muddling along” performance, and (the government mantra again) deliver a more “sustainable, productive and inclusive economy”.  He didn’t point to a single sign that either the government or their Opposition were interested in anything serious along those lines.

But he did highlight the need to think carefully about policies that “fit us here” including taking explicit account of our remoteness. He called for a much deeper understanding of the problem, for a priority on good economic research, for the development of credible narratives that explain our underperformance and ground sold recommendations for policy changes. Much of this reflected Paul’s efforts at the Commission, including the narrative he drove (and wrote) –  which I wrote about here.   In some of his work, Paul has expressed sympathy for aspects of my story around immigration policy, and noted that he welcome the current Productivity Commission inquiry.

Some of his specifics I’m less convinced of, and he noted that his own views have a lot of overlap with the OECD’s Going for Growth proposals (see above for how limited they are) –  while noting that he had been involved in the very first Going for Growth, back in 2005 when he worked at the OECD, and the ideas mentioned for New Zealand then were much the same as those now.

Conway ended with a call for specifics, for work with policy people and lawyers, and for a lot more emphasis on communications and doing the “hard sell” to our “lawmakers”, claiming that as he had got older he was increasingly convinced that the task was mainly marketing good ideas –  “we know what needs to be done” – and building consensus, rather than devising new ideas.

And at that point I had to leave.  Perhaps the follow-up questions generated some startling insights, but probably not (and I have no idea how many New Zealand focused people were even in attendance).  My biggest criticism is for the OECD –  which, after all, put the event on and their ideas on the table –  who seem simply inadequate for the task pf offering serious, analytically and historically grounded, advice to New Zealand authorities (or others here who might want to champion actually doing something about decades of failure) on making a dramatic difference to economywide productivity outcomes here.  It must be more than a decade now since I attended a workship in Paris where OECD staff presented modelling suggesting that on their standard prescriptions New Zealand should be much much richer and more productive, which suggested that there was something quite seriously wrong with their model, at least as applied to (really remote) New Zealand (I’ve long held the view that –  unsurprisingly – the OECD has model and mentality that probably primarily adds value in small European countries (a lot of those in the OECD).   One might argue that it doesn’t matter, since no politician here is serious about change (at least for the better, the current government is pursuing paths likely to worsen things) but that isn’t really the point of the exercise.   As various speakers noted yesterday socialising ideas, persuading people, showing what might be possible are all a significant part of a prelude to action (just possibly one day).   I disagree with Paul Conway that there is consensus about what needs to be done: there clearly isn’t, and may never be, but we might expect an entity with the resources and expertise of the OECD to be offering a lot more insight, a lot more recommendations commensurate with the scale of the failure, than we are actually getting.

As for the New Zealand Productivity Commission, they seem to be on a downhill path, more interested in cutting pies differently than growing them, too confident in politicians and officials, and more inclined to wishful thinking than serious analysis indicating what might really lift our productivity levels back towards the top tiers of the OECD.    I guess there is cause and effect at work, but it is no wonder politicians aren’t serious about change when the advice they get from high-powered official and international agencies is so thin.  It is a lot easier to just cut the pie differently and dream up more announceables, but reversing the relative productivity decline is really what matters for our future material wellbeing –  those at the top and those at the bottom –  ours, our children, our grandchildren.  If we don’t fix it, exit will remain an increasingly attractive option for many.