Back in 2020 and 2021, in and around the straight economics and economic policy posts, there were quite a few on aspects of the Covid experience in New Zealand, particularly in a cross-country comparative light.
More recently, you see from time to time suggestions that New Zealand’s experience may have been so good that in fact excess mortality here since Covid began might actually have been negative (in which case, fewer people would have died than might have been expected had Covid never come along.
A couple of alternative perspectives on that caught my eye in the last couple of months, both from academics, one from a physicist and one from an economist.
The first was a very very long Twitter thread from Professor Michael Fuhrer at Monash in Melbourne. His thread starts with this tweet
and after reviewing the evidence, and granting that
he concludes that
All of which sounded plausible, at least having read the entire thread.
For New Zealand, one of the biggest things that changed over the first 2.5 years of the Covid era was a dramatic slowing in the population growth rate, not because of Covid or other deaths but because net migration went from a hugely positive annual rate to a moderately negative rate. Pre-Covid – and probably again now – migration is the biggest single influence on the year to year change in New Zealand’s population. He includes this chart
Here is Gibson’s abstract
It is a short paper, and easy enough to read, so I’m not going to elaborate further, and will simply cut and paste the final page.
It is a shame he hasn’t labelled all the other countries, but his text tells us that the countries to the right of New Zealand on that bottom chart are Luxembourg, Canada, the Netherlands, Iceland, Israel, and Australia. Note too that several countries just to the left of New Zealand have estimated excess mortality barely different from that estimated for New Zealand.
Across the entire grouping of countries New Zealand still rates fairly well (there are many other things we might reasonably hope to be in the best quartile for but are not; this one we are), but as he notes for the three years to the end of 2022 even in New Zealand there does appear to have been positive excess mortality in the Covid era.
I have no particular point to make, but found both Fuhrer’s thread and Gibson’s note interesting notes, providing some useful context to thinking about the New Zealand experience. Since one still sees claims (including reportedly from David Seymour just a couple of days ago) that there have been no excess deaths in New Zealand over the Covid period, is it too much to hope that some media outlet or other might give some coverage to what appears to be careful work by, in particular, Gibson, a highly-regarded New Zealand academic?
The incoming Australian Labor government last year established an independent review of the Reserve Bank of Australia’s monetary policy functions, structures and performance. The review panel (chaired by a former Bank of Canada Deputy Governor) reported a few weeks ago and their full report is here. Periodic reviews of this sort aren’t uncommon, and are often triggered by episodes of discontent around the performance of the respective central bank (in New Zealand, the 2001 review conducted by Lars Svensson was an example).
There is no clear-cut single preferred way to organise policy functions that society (as represented by government and parliament) wishes to delegate decision-making responsibility to. That is true whether one thinks globally, or just of the subset of advanced economies that countries like New Zealand and Australia usually use as benchmarks or experiences/structures that might offer insight.
If this proposition is true generally, it is no less true of monetary policy specifically. And that shouldn’t really be surprising, including because monetary policy is really quite a recent thing. In New Zealand and Australia the transition to a market-based financial system and a floating exchange rate is not quite yet 40 years old, and even among larger economies floating exchange rates more generally date back only 50 years or so. Modern monetary policy is a cyclical management function (leaning against cyclical macroeconomic fluctuations subject to a constraint of keeping the inflation rate in check), and yet our data sets are really quite limited (since 1984/85 New Zealand has had 4 or 5 business cycles, and the creation of the euro means there are really only perhaps 15 or so advanced-country monetary policy agencies). We simply do not know with any degree of confidence that one form of monetary policy governance etc structure will produce better results over time than another. Instead we (all, including the RBA review panel) argue from small select samples, from specific historical incidents (where multiple influences are always likely to have been at work), and from the mental models we carry round (some likely to have achieved a professional consensus, others not).
None of which is to suggest that such reviews should not take place. Of course they should, and with good people and a government that is interested in good future structures (as distinct, say, from just being seen to having had the review – there were dimensions of the latter around the review then then New Zealand government commissioned from Lars Svensson) useful insights, outcomes, and reforms can often emerge. There will always be aspects of current practice or legislation than benefit from someone standing back and concluding that it is really time for an update, even if in practice the old arrangements were working tolerably adequately.
But one should also be cautious about expecting too much from any particular review or any particular set of reforms.
The current RBA model is not one anyone would prescribe today if they were setting up a central bank from scratch. A fair bit of the legislation dates back to the founding in 1959, including this
It has been interpreted, stretching language and concepts to a considerable extent, as encompassing the way monetary policy has been run for the last few decades, but really it was written for an age of (among other things) fixed exchange rates. No one would write it that way now.
And the governance? The Reserve Bank of Australia Board makes the monetary policy decisions (back in the day in practice the Treasurer did) and is much as constituted decades ago. The Governor, Deputy Governor, and the Secretary to the Treasury are ex officio members and there are six non-executive directors appointed by the Treasurer. The non-executive members have typically been (often quite prominent) business figures, but over recent decades it has been normal for one of the six to be a professional economist. It is a very unusual model these days for the conduct of monetary policy, although note that the sort of people appointed as non-executive directors is a matter of political choice (successive Treasurers) and I can’t see anything in the legislation that would have prevented six technical experts being appointed.
If the relevant bits of the legislation haven’t changed a lot over the decades, practice has. Monetary policy decisions are clearly made independently by the RBA, in pursuit of a target that is in practice agreed in advance with the Treasurer, they are announced transparently, there are minutes of a sort published, as well as the quarterly Statements on Monetary Policy. Senior managers appears before parliamentary committees and have fairly extensive and serious speech programmes. The RBA is a modern inflation targeting advanced country central bank, but operating on quite old legislative foundations. As an organisation, over the decades it has had considerable strengths, including typically a strong bench of very capable senior managers, and people coming up behind them. Successful organisations in many fields tend to promote mainly from within: that has been the RBA approach (and is very much in contrast, say, to the RBNZ). Note here that promoting from within is not itself a basis for a successful organisation, simply one feature that already successful organisations, continually refreshing themselves, often display.
I was an admirer of the RBA for a long time, and 20+ years ago when the Svensson review was underway (when I was both part of the small secretariat and a senior manager at the RB) thought that New Zealand should look to adopt elements of the structure and culture of the Reserve Bank of Australia. They tended to produce more stable outcomes, produce better research, communicate more effectively, and have a stronger sense of legitimacy than our “Governor as sole decisionmaker” system had achieved (or than Svensson’s preference, of a small internal decision-making committee (of which the position I then held would have been a member) was likely to be able to achieve. The RBA on the other hand saw us as somewhat strange, not always entirely fairly. I recall a time when Glenn Stevens as Assistant Governor and he came over to observe our monetary policy and forecasting week leading up to an MPS (shortly after we had started publishing forward interest rate projections), and he emerged from the week genuinely surprised that our approach was far less mechanical, nay mechanistic, than he had been led to expect. Or a visit from David Gruen, then head of research at the RBA, suggesting that the fact that our interest rates averaged higher than those in Australia suggested we had monetary policy consistently too tight (in fact prior to 2009 New Zealand inflation typically averaged in the top part of the target range).
Over recent decades, Australia has enjoyed a reasonable degree of macroeconomic stability (the review report includes a table showing the standard deviation of real GDP growth less than for any other country shown), this in any economy exposed to very big swings in the terms of trade. As noted above, the samples are small but there is nothing obvious to suggest that overall the Australian approach to monetary policy has delivered worse than other advanced country central banks. But there have been troubling episodes, notably including the one in the years running to Covid when Australian core inflation ran consistently well below target (much more so than anything seen at the time in other countries, including New Zealand where core inflation by then was getting close to the target midpoint). There are also more recent episodes of concern – about specifics of the RBA Covid response and latterly about the sharp rise in core inflation – but through that period it is perhaps hard to differentiate the RBA’s failure (underperformance) from that of a wide range of other advanced country central banks (themselves with a wide range of governance models).
This was one of the things that troubled me about the review report. The first substantive chapter is focused specifically on these recent episodes. It is easy to highlight areas where things could have been done better in (almost any) specific episode – and some of the material cited is pretty disconcerting – but that is almost certainly true of every central bank, and there is no attempt I saw in the report to illustrate that anything would have been very much different with a different governance/committee structure. We might hope it would have been, but the panel offers little reason (and realistically they couldn’t offer more) that it would have been. New Zealand, after all, has introduced a committee, and the panel notes favourably (too favourably) the expertise of its members relative to RBA external board members, but many or most of the same mistakes or weaknesses the panel highlight in Australia over the last three years were also evident in New Zealand – as far as we can tell, as less material has been released here than there, us not having had a recent external review and the Reserve Bank’s own review was largely defensive and unenlightening in nature). Should there have been a proper cost-benefit analysis, and serious questioning from the Board, before the RBA bond-buying programme was launched? No doubt (and the review report is properly critical about the absence, and the likely weak case) but there is no evidence of anything even slightly better in New Zealand. Or, as far as I’m aware, in any or many other advanced countries. Perhaps the RBA case was less excusable, since they started bond buying a lot later, rather than in the heat of the crisis, but the practical difference ends up being slight.
The review panel proposes a new model with these important features
monetary policy decisions would in future be made by a Monetary Policy Board (with a separate RBA governance board, and the existing Payment Systems Board),
the MPB would have nine members, the Governor, the Deputy Governor, the Secretary to the Treasury, and six expert non-executives appointed for non-renewable terms of five years, extendable for up to one year)
non-executive members would be expected to devote about one day a week to the role (around eight monetary policy decisions a year)
there would be a press conference for each decision,
votes would be disclosed but not attributable (ie a decision might be made 7:2, but the two would not be identified by name)
non-executive members would be expected to do at least one public engagement or speech a year,
non-executive vacancies would be advertised, but recommendations to the Treasurer (who would make the final appointments) would be by the Governor, the Deputy Governor and a third person (presumably to be chosen – altho by whom, Treasurer or the officials? – from time to time).
If you were starting from scratch, one could think of worse systems. But this proposal seems to have a number of weaknesses and reason to suspect that unless a strong political consensus developed early around making things work really differently (rather than differently in appearance) it is far less good a system than could have been devised. Even then, I would not be overly optimistic. More generally, my impression is that the report tends to underweight the relative importance of the Governor and very senior management to how central banks operate.
Starting with the small stuff, as the report notes it is highly unusual for the Secretary to the Treasury to be a full voting member of a central bank monetary policy decision-making body. It was one thing in 1959 – at that time New Zealand also had the Secretary to the Treasury as a full member of the (largely toothless) central bank board – but it is 2023. Other countries – including the UK and New Zealand – have preferred the model of a non-voting Treasury observer, which seems bit suited to (a) the desire to ensure at the highest levels that information flows freely between monetary and fiscal agencies) and (b) the Secretary’s own primary responsibilities and loyalties. The report proposes amending the legislation to make clear that the Secretary is voting his/her own judgement, but if so that tends to defeat the purpose of their place on the Board (being there solely ex officio), and in times of tension – and one should build system for resilience in tough times, not for when everyone is getting on fine and everything is going swimmingly – will likely complicate the Secretary’s own position (including as adviser to the Treasurer in holding MPB members to account for performance).
In general I am in favour of a model in which external members outnumber executives, but 6:3 in a nine person board doesn’t feel right (even if it parallels current numbers). 4:3, with the third executive being the Assistant Governor responsible for economic policy, seems a better size overall, and also more realistic about the ability of the system to continue to generate a steady stream of able people to fill (only) five year non-executive terms. And a 7 person committee is more likely to limit the risk of free-riding by individual non-executives.
It is difficult to see how a “day a week” model is likely to work IF the goal really were one having a powerful role, including as expert counterweight to staff, if non-executives were devoting only one day a week to the role. I am not aware of any precedents for such a small contribution, which seems to sit closer to the current RBA Board model (might such board members devote 2 days a month to the role, one to the meeting, one to the papers?) than to other advanced country MPCs. At the Bank of England MPC, probably still the best model, non-executives are paid for 3 days a week work, and at a rate that (least by academic standards would be a reasonable fulltime income). On a day a week model, not only is the actual amount of time any member can devote to RBA matters limited, but the remuneration would that for any non-retired person it would have to be just one part of the member’s employment/income. Most plausibly, they would be current academics, who might otherwise not spend a vast amount of time keeping track of data or of the literature in the specific fields relevant to central banking. We might assume that people will not be disbarred (as is NZ) for doing ongoing research in relevant fields, but even in Australia the numbers of such people are not limitless. One day a week looks like a recipe for an ongoing dominance of management and staff. Consistent with this, while the report suggests that externals should have direct access to staff, if they do not have dedicated analytical support staff of their own their ability to make a difference and shape what is in front of the MPB is likely to be limited. This is, incidentally, one argument for a quite different system – as in Sweden or the US – in which outsiders become full insiders while they are MPC members.
The appointment process is also a concern. One of the weaknesses of the New Zealand MPC system is that the Governor exercises considerable effective control on who serves on the MPC. A really good Governor would have a strong interest in promoting genuine diversity of view and real ongoing intellectual and policy challenge. Real world bureaucrats, running their own bureau, perhaps less so. No doubt there will be arguments about “fit” etc, but the value of outsiders is often in the extent to which they are willing to bring fresh thinking and not be easily deterred by management flannel and weight of paper. With a strong “third person”, perhaps it would work out okay, especially if a Treasurer was clearly committed to viewpoint diversity, challenge etc, but many potential “third persons” might be inclined just to defer to the perceived expertise of the Governor and Secretary.
Accountability does not appear to be a key element in the RBA reform proposal. That seems unfortunate – perhaps especially coming hard on the heels of the massive financial losses central bankers have run up and the scale of their inflation forecasting and policy mistake. If as a society we delegate great discretionary power to unelected officials – and that is what we do in MPCs – accountability is a key counterbalance, including in maintaining the long-term legitimacy of the model. At very least, MPB members should be required to have their named votes recorded and disclosed. Ideally – but it is probably only an ideal – people should be able to be removed from office for non-performance. In fact, one of the other weaknesses of the proposed single term model for externals is the complete absence of accountability. Their views don’t have to be disclosed, their votes don’t have to be disclosed, and since they can’t be reappointed, there is really no accountability at all. Lack of accountability doesn’t exactly encourage members to devote intense energies to getting things right. Some no doubt will, but it will be all too easy to defer to management and treat membership of the MPB as a prestige appointment (like being on the RBA Board now), this time narrowed down to being for economists, rather than a role in which one will make a difference and expect to be held to account.
As I said earlier, there is no one ideal structure. In the end, one is trying to combine technical expertise, experience, judgement, ability to communicate, and something around accountability to produce good policy outcomes taken in ways consistent with our open and democratic societies and under structures that are resilient to bad times and to bad people All in a field where uncertainty is pervasive.
Many of these requirements might well be met with no outsiders at all. You won’t see it highlighted in the review report but the Bank of Canada is one in which, formally and legally, the Governor himself wields the monetary policy powers (akin in that feature to the RBNZ system pre-2019). But in practice the BoC has built a strong internal culture and an effective system where a Governing Council of senior internal managers makes monetary policy decisions by consensus. I don’t think it is ideal – there is no individual accountability except (presumably) to the Governor – but the BoC has built partially compensating mechanisms with extensive research programmes, self-review programmes, and extensive engagement with academic and other wider communities. Indeed, the Bank of Canada model – which I do not champion – highlights just how important the quality of staff and internal processes are. It isn’t necessarily a problem if decisionmakers typically defer to staff and management expertise – in fact it is what you would expect in a normal corporate board – so long as those decisionmakers can continually assure themselves that staff and management have robust and resilient processes in place, including those that encourage, generate and accommodate, genuine diversity of view and openness to alternative perspectives. In that sort of context, some expert external MPC members can be very helpful (especially if they are familiar with, engaging with, perhaps contributing to) emerging literature, but they aren’t the only type of member who could add value. The willingness to actually ask the idiot question, and never to be content with management bluster, is valuable in any governance context. Thus, in an RBA context, one might wonder whether it is really worth having a whole new Board (especially when the RBA is not a “full service central bank” (doing prudential supervision)), when one could have left the RBA Board responsible for monetary policy but with a requirement say that several members should have directly relevant professional expertise. One could argue that being a board member, responsible for all the RBA functions and governance, might make for a person better able to contribute effectively as a monetary policy decisionmaker (and note that there is plenty of role for outside expert advisers anyway, and the report does suggest a more active macro research programme for Australia generally). And of course, in all our systems Ministers of Finance – rarely very expert at all – make major contentious economic policy decisions in climates of extreme uncertainty, drawing on expert advisers but rarely handing decision-making power to such experts.
Overall, I can’t help feeling that if the Australian government goes ahead and legislates all these changes, none of them (not all taken together) will matter quite as much as who gets appointed as Governor, and the sort of internal culture and people, the Governor (and his/her successors) build. That is a critical choice – in Australia, in New Zealand, probably anywhere – and is likely to far outweigh any potential difference that a few day-a-week academics, cycled through the decisionmaking system on five year terms, might make. A great Governor (and we can’t build systems that assume one) will build and maintain a culture that delivers most of what the review panel (often rightly) seems to be looking for.
This post has gone on long enough. It is about someone else’s country so why my interest? Two reasons I think. First, it is a significant report on a central bank in the midst of troubled times, and there are few of those yet. And second because the choices Australia makes are always likely to be an important backdrop to any future reforms in New Zealand. We have had extensive reforms, clearly designed to look different rather than be different, and any new government needs to look to do over quite a few of the aspects of the New Zealand model.
I was going to engage specifically with the AFR article last Friday by Ian Macfarlane, former RBA Governor, criticising the review (and I thank the two readers who sent me copies). Time and space is limited, so I won’t. It is worth reading, and he makes some fair points (some less so), but it is perhaps worth remembering that Macfarlane was Governor at the peak of the RBA’s past standing. The starting point now is less favourable.
Finally, one of the background papers for the review was commissioned from Professor Prasanna Gai at Auckland University (and ex BOE). Gai currently serves on the FMA board, but probably should be one of those considered for our MPC, but……he would be disqualified by our Governor and Board on the grounds of an ongoing active interest in areas the MPC would actually be responsible for. Anyway, his paper is quite a good read on international models around the governance of monetary policy, and he pulls few punches about the weaknesses of the New Zealand model.
On Monday I wrote about the MPC membership of Caroline Saunders, whose four-year term had expired on 2 April 2023 and who appeared to be continuing to serve only at the day-to-day pleasure of the Minister of Finance. The Reserve Bank’s website on Monday said that her term had expired, and there was no statement from the Reserve Bank or from the Minister of Finance to the effect that she had either been reappointed or told to go away. That all seemed less than desirable (fact, and lack of transparency).
As I noted in that post, it all seemed rather odd. The election is approaching and the Minister of Finance had already last year reappointed one member, Peter Harris, to a term expiring in October. Under the conventions around elections, no new appointment could be made by the current government when the new term would start smack in the middle of the election period. It seemed reasonable to expect that at some point the Minister would use the statutory power to extend Harris’s term for one final six month period into early next year (by law, having served two proper terms he cannot be reappointed).
But there had been nothing to stop the government reappointing Saunders for up to a further full four year term. And given the (on paper) importance of these MPC positions it seemed careless at best, and a bit disconcerting, that the government had not got on and made a permanent appointment (whether Saunders of someone else – although there had been no evidence of any open search process).
But this morning a piece on Business Desk drew my attention to the fact that decisions had been made on both Harris and Saunders. Naturally, one looks to the Minister of Finance Beehive page for an announcement – these are, after all (and in principle) powerful or influential macroeconomic policymakers at a time when inflation is miles outside the target range the MPC was supposed to be delivering – but there was nothing. There was no press release from the Reserve Bank either, but when I checked the Bank’s website page for the MPC sure enough, there it was:
and
The suggestion being, at least in the new Saunders description, that this might have happened a few weeks ago and neither the Minister nor the Bank had thought fit to tell us.
And so then I turned to the repository of all official appointment announcements, the Gazette, where there is this
which is all good and official, but not many macroeconomists and Reserve Bank watchers routinely read the Gazette.
I have no more to say about Harris specifically. He never should have been reappointed for a short term ending in election season, but given that he was an extension to early 2024 was pretty much inevitable (although a short period with a vacancy also wouldn’t have been a problem).
But what of Saunders? She could have been appointed for a full four year term but has been given only 15 months or so. Was she reluctant and had to have her arm twisted to take an extension. Was the Bank’s Board reluctant to recommend her? Was the Minister really not so keen (having, from the papers, first appointed her mainly for her sex). And why was none of its sorted out months ago well before her first time expired. It is hardly a ringing vote of confidence in a macro policymaker, amid a serious policy failure, to be reappointed for such a short period only, especially as the result of her appointment is the end of the external member terms (and all will have done two terms and have to go) are now bunched quite tightly: Harris finishes on 31 March next year, Saunders’ term finishes on 30 June, and the third member (Bob Buckle) has a term finishing on 31 March 2025.
If there were to be a change of government later this year, this combination looks opportune. I wrote a post last year about what a new government could and couldn’t do quickly if they were serious about overhauling the Bank and MPC. They can’t get rid of the Governor (who has just started a second, but final, five year term. But they would be able to (would have to) replace all three external MPC members in fairly short order. It would be an opportunity to insist on a quite different approach (eg the repeal of the blackball on anyone with ongoing macro analytical and research interests and output).
Which from a National Party perspective looks good of the current government. But one is still left wondering why Robertson left things this way. He could have reappointed Saunders for four years, or could have replaced her with someone he was comfortable with for a four year term. Instead, he is leaving the way open for the other side if the election does not go his way.
As I noted the other day, I have several OIA requests in around these appointments, which may (or may not) shed some light. They are perhaps unlikely to tell us why the Minister, the Governor, and the Board chair were so reluctant to let us know about the appointments of these (supposedly) powerful macro policymakers. Perhaps they’d have struggled to craft an honest press release on the achievements of these policymakers in their four years so far, when – for the first time in decades – inflation blasted well away from target, and none of them was prepared to front up with a good story about the inflation outcomes they’ve delivered, let alone the massive financial losses their choices resulted in for the taxpayer.
Perhaps some journalist might seek comment from Robertson, from Orr, from Quigley or from Saunders. Or perhaps even from Nicola Willis who no doubt expects to be in a position to make all those MPC appointments before too long.
Over the last few days I’ve been reading a few pieces on UK monetary policy and high inflation. The first was a speech from the Deputy Governor responsible for economics and monetary policy, Ben Broadbent (over there senior central bankers actually give serious and thoughtful speeches on things the Bank has responsibility for), and the second was a new paper by long-term adviser, analyst and researcher Tim Congdon. There is a lot of overlap because Congdon’s paper is broader (“Why has inflation come back”) but his analytical approach has tended to emphasise the monetary aggregates, while Broadbent’s speech which is narrower in focus is specifically on the question of what information value for monetary policymakers there is (or isn’t) in the monetary aggregates over the longer term and in the specific context of the inflation of the last couple of years. Both are worth reading.
My own view on the monetary (and credit) aggregates is, I think, pretty much the same as that of most central bankers these days, that the indicator value of these aggregates is typically fairly limited in the world we inhabit (low or – at present – moderate inflation), that any really serious breakout of inflation (think, eg, Argentina) is likely to be accompanied, in some sense or other, by rapid growth in the quantities of money, and that for now while one should never ignore any indicator there isn’t much about inflation developments of the last couple of years that is best explained through the lens of monetary aggregates. Specifically, if bond-buying programmes like the LSAP did anything much to boost inflation, it was not primarily (or at all) through a monetary quantities channel.
Here is some New Zealand data (and an RB chart) on the growth rates of the monetary and credit aggregates over the period since September 2002 when the current inflation target was adopted.
At the Reserve Bank we always used to put more weight on credit developments than on money measures, and credit growth dipped quite materially in the early months of the pandemic, but no model using either monetary or credit aggregates is isolation would have given policymakers (or other forecasters) reason for serious concern about an outbreak of core inflation to rates unprecedented for decades, Indeed – and since we don’t run a price levels targeting system, and thus bygones are treated as bygones – an analyst looking solely or mainly at these indicators would have noticed by mid 2021 that all the annual growth rates were back to around 5 per cent. No one was going to be sounding inflation alarms if their analysis was based largely on those growth rates. Even in the short period when annual money growth exceeded 10 per cent, the growth rates were not very much higher than had been seen not infrequently over 2011-2016 when core inflation was materially undershooting the target.
Each country’s data and experiences are a bit different but as a general proposition I’d be surprised if many central bankers have become any more positive on the short-term indicator value of the monetary aggregates in the last couple of years.
As one final money aggregate chart, here is the level of the New Zealand broad money series relative to the trend over the pre-Covid period since the 2 per cent inflation target was set. Over that almost 18 year period, core inflation averaged 2.2 per cent. At present, broad money is sitting below the trend, and although views currently differ on how much disinflationary pressure is now in the system I’m not aware of anyone who thinks we are about to have a 8-10 per cent drop in the price level, to get back to price levels consistent with long-term average inflation of around 2 per cent.
The UK has become a bit of a poster boy for bad inflation outcomes. Some of the headline numbers have been very bad (up around 10 per cent), but some of that is what happens when a gas price shock hits you (and no monetary policy framework tells a central bank it should try to offset the direct price effects of such a shock). But if we use a common measure of core inflation (CPI ex food and energy), the UK is far from the worst of the advanced economies and has a bit less-bad core inflation outcomes at present than New Zealand (or Australia).
If their central bank hasn’t done a great job, ours has done a bit worse. And the diverse outcomes in this chart remind us – as Congdon explicitly does in his paper – that inflation outcomes are ultimately national in nature, choices by central banks and (by default usually) their political masters. That we have similar core inflation to several countries on the chart – but quite different outcomes to sound and responsible countries towards either ends (Switzerland, Korea, Sweden, Czech Republic eg) – speaks more to similar mistakes made by respective central banks than to anything that was out of the control of the Bank of England or the Reserve Bank of New Zealand.
Two charts in Broadbent’s speech caught my eye. The second (which I’ll come to in a minute) was directly relevant to the inflation mistake. But this was the first on the interest rate effects of central bank bond purchase programmes. The Bank of England, like the RBNZ, believes that QE has macroeconomic effects primarily through interest rate effects (rather than the quantities of fully-remunerated settlement cash balances that are created in the process).
Broadbent reckons that bond purchase programmes have a material announcement effect (what is measured here) when markets are very illiquid. That is no surprise, and probably everyone would agree. But what caught my eye was those “Other QE announcements”. The average of the interest rate effects of those nine announcements is close to (and not significantly different from) zero. Perhaps this particular estimation is wrong, but wouldn’t it be nice if our central bank was producing such charts, and the research supporting them, rather than just handwaving estimates of large number effects, that often conflate March 2020 (and the effects of what the Fed was doing at the same time) with the rest of their highly risky and costly programme?
The other Broadbent chart that caught my eye was this one
Broadbent is using it primarily to make the point that the BOE actually forecast growth in real private consumption stronger than would have been implied by a model incorporating data from the monetary aggregates. But what interested – surprised – me was that they had ended up materially over-forecasting real consumption growth (from the point where the UK’s last lockdown ended). Normally, over-forecasting a key component of domestic demand would probably have been associated with over-forecasting inflation. But not this time (and the biggest error was before, not after, the severe adverse terms of trade shock associated with the Ukraine war)
That got me wondering about the Reserve Bank of New Zealand’s forecasting.
Here are their successive MPS forecasts for real private consumption, starting from the August 2020 MPS which was done after the first and worst national lockdown was over.
The errors in the forecasts for 2022 being made in late 2020 are really huge (for consumption, which is not a particularly volatile component). By mid-2021 (when those BoE forecasts above were done) there were still quite big errors, but not so much about the medium term forecasts but about what the level of consumption spending was at the time the forecasts were being done.
What about real residential investment?
Their forecasts for late 2020 and 2021 undertaken in late 2020 were miles off the mark, substantially understating the level of activity happening already and in the following few quarters. More recently, actuals have undershoot the forecasts done in the second half of the period, probably because of the much higher interest rates that proved to be needed relative to what the Bank had expected a couple of years ago.
And here is real business investment
The Bank was badly misjudging the recent and contemporaneous situation in their August 2020 forecasts. That gap had closed substantially by the November 2020 MPS (a key date because the Bank then had such extremely low medium term inflation forecasts), but as with the private consumption chart shown earlier the forecasts for 2022 were still miles too low. Those errors probably go together, since high consumption demand and activity is typically likely to support high business investment spending. What is interesting is that business investment continued to surprise the Bank on the upside right through to the forecasts being made early last year.
I won’t clutter the post with a comparable GDP chart, but will quote just one illustrative number. In May 2021 I found myself in the curious position: for the first time in a decade, I had become more hawkish than the Bank. With hindsight it is abundantly clear that they should have been raising the OCR by then (and earlier). But their GDP forecasts made in May 2021 for December 2022 proved to be off (under-forecasting) by almost 3.5 per cent. Those are big mistakes.
If there is some mitigation for the BoE in having actually over-forecast the private consumption bounceback (one would want to know more about other components on demand) there is nothing like that in the New Zealand numbers. The Reserve Bank simply misjudged (badly) the strength of key components of domestic demand (and you’d see something similar in for example the unemployment rate forecasts and outcomes), and with it core inflation. One could fairly point out (and I have in previous posts) that many (perhaps almost all) private forecasters made similar mistake. But we – taxpayers and citizens – don’t employ private forecasters to keep core inflation near target; we employ and mandate the Reserve Bank (Governor and MPC) to do so, and they failed.
Which brings me back to those UK papers that started this post. One of the best bits of the Congdon piece was the call for some serious accountability for central bankers.
No one forced top central bankers to take their jobs (most would probably have had little problem getting other roles), and if they thought the mandates they had been given (in both the UK and NZ the finance minister sets the goal) were unachievable or unrealistic they were free to have said so and, if they felt strongly enough, to have resigned. Nobody was compelled to take on a task they believed was simply unachievable. And yet we’ve ended up with (core) inflation well outside target ranges in quite a wide range of countries, including both the UK and New Zealand, with no apparent consequences for any individual central bankers
Congdon proposes (in the UK context) that when inflation is sufficiently far outside the target range, both the Governor and the Deputy Governor should be required to offer their resignation. He doesn’t say so explicitly, but I presume he must mean this as more than the sort of pro forma charade one could imagine it descending to (“of course, I have to offer my resignation but we all know you Chancellor have no intention of accepting it”), involving actual departure from office. And one could, and probably should, broaden the expectation of real sanctions to include all the MPC members. There is (a lot) more scope already in the UK model for individual MPC members to express and record their disagreement with the majority view, but there is room for more, and the serious threat of sanction helps to sharpen incentives to think differently and not simply to (as is an easy incentive in any committee context) to hide behind the committee, and the (in recent cases) badly wrong consensus or majority view. In New Zealand, we have no idea whether any MPC member ever seriously questioned where the Bank’s forecasting and policy were going in 2020 and 2021. We should.
Perhaps what grates most about central bankers (and their masters, who go along with this behaviour) is the utter refusal of almost all of them to ever accept any serious personal responsibility. Here, Orr has repeatedly run his “no regrets” line and when he occasionally departs from it it is just to say that he is sorry New Zealand faced a pandemic and the Ukraine war (ie nothing about anything he or his colleagues are responsible for). He and his chief economist have also tried the line that they couldn’t have done much different – of course raising the OCR one meeting earlier wouldn’t have made much difference, but that isn’t the appropriate test – and there is quite a hint of that sort of defence in Broadbent’s recent speech (where he uses a straw man alternative of looking at what it would have taken to keep headline inflation at target, when the policy focus has never been primarily on headline).
The other day someone sent me a column from a UK newspaper in the wake of various recent BoE comments. The column ended thus
In the spirit of openness that an independent Bank of England is supposed to represent, it should offer a full and frank apology for letting down the British people.
Well, quite. And exactly the same could be said for our Governor and MPC. They made a really big and costly series of mistakes, which cost us (but not them particularly) a great deal of disruption and real economic loss. They failed in a mandate they had voluntarily chosen to accept (and been well-remunerated for). I’m a Christian and so contrition and repentance are pretty central to my world view, and whatever mistakes have been made in the past contrition and repentance go a long way. In public life – and nowhere more than among central bankers – it now seems alien and inconceivable that people could simply front up and acknowledge their mistakes, acknowledge the costs and consequences of those mistakes, and ask for forgiveness.
Instead, we pay the price – massive redistributions, big fluctuations in real purchasing power, overfull employment and then a probable recession, (oh, and don’t forget the $10bn of LSAP losses – an amount that would otherwise have more than covered the Crown’s recent cyclone costs) – and the central bankers just sail onwards enjoying their position, status, salary and so on, not even offering a serious accounting, let alone serious engagement, or any personal loss . Great power (which is what central banks wield) misued with no personal consequences whatever is a very long way from the model of delegated responsibility and accountability that shaped the design of both the UK and New Zealand central banking reforms in recent decades. In New Zealand, that isn’t just the responsibility/failure of Orr and the MPC, but of the Bank’s Board (appointed by the Minister supposedly to serve the public’s interest), the Minister of Finance, and ultimately – as with everything important in a system of government like ours – the Prime Minister.
Decades ago I worked for a central bank in another country. I woke up one morning to learn that the Governor had been sacked, and by the time I got to work he was clearing his desk. He hadn’t done a bad job – and was one of the more inspiring people I ever worked for – but had fallen foul of the government (Minister of Finance and his colleagues/bosses). The law as it was meant that Governor could be removed whenever the government felt like it. for whatever reason the government felt like. It wasn’t a good model.
In the numerous attempts to capture just how independent various central banks are, one of the dimensions that usually appears is something around the dismissal provisions for key decisionmakers (in these days of committees and board, not just the Governor). Many older pieces of central banking legislation make it very hard to remove the Governor (in particular), removal often requiring things like the bankruptcy, severe mental or physical breakdown/incapacity, or imprisonment (and perhaps even a vote of Parliament). The Reserve Bank of New Zealand Act 1989 was quite unusual for its time, in that it made it easier to remove the Governor, but not because the Minister didn’t like the Governor’s policy calls (and all power was vested in the Governor personally) but if the Governor had failed to deliver on the policy targets he had agreed with the Minister that the Bank would pursue. Under the Act (and rightly so) the Bank didn’t get to define its own goals: the Governor got independence at an operating level to pursue an agreed policy target, and could be removed (at least in principle) if he did a poor job of using the operational independence. The Governor could not be sacked simply because the Minister got annoyed with him, or because the Governor had been appointed or reappointed by a ministerial predecessor of a different party.
That is pretty much as it should be. You can argue (and I long have argued) that even with a well-written law it is hard to make such accountability effective, and the dismissal of a Governor on policy grounds is almost inconceivable (reappointment could, in principle, be another issue) but the balance on paper is probably more or less right.
But these days we have a Monetary Policy Committee to make monetary policy decisions. The government chose to adopt a model in which several external members serve on the MPC, and I’m pretty sure it would not be hard to find speeches from the Minister of Finance championing this innovation and the important contribution people with a diverse range of views and experience would bring to monetary policy decisionmaking.
In principle, appointments to the MPC are at a considerable arms-length from the Minister (the Board proposes candidates and the Minister can’t substitute people he or she prefers). On paper, members of the MPC can’t be removed because the Minister doesn’t like them or because they advocate monetary policies the Minister doesn’t like. It is hard to remove an MPC member
(Actually doing monetary policy in accordance with the Remit is one of the “collective duties”.)
What is more, at least on paper MPC members can only serve two terms, so if there is a bit of an incentive to stay on the right side of the Minister in the run-up to reappointment, at least any such period shouldn’t last long.
If you believe in an operationally independent central bank (and, on balance, I still probably favour one), the basic framework looks good. The Act does actually allow the Minister to explicitly override the Bank on monetary policy, but that has to be done openly and formally, not by the dangling threat of dismissal.
But then the Caroline Saunders term came to end (or so it appeared) and we were sent back to check the statute books. I wrote about it here. There we were reminded that there was a provision for an MPC member to have their term extended for up to six months. This appeared to be a more or less sensible provision given that election timing sometimes interferes with the making of permanent appointments or reappointments to significant government roles (although other than for the Governor hardly a vital provision given that there are seven MPC members in total, and the MPC could probably function just fine for a few months with 5 or 6 members), and it was quite similar to a position in the UK central banking law.
What probably few of us noticed was that the law also contained a provision under which when an MPC member’s term of office ends they can simply remain in office unless or until the Minister of Finance actively appoints another person or tells the person whose term in ending to go.
Caroline Saunders’ first term as an external MPC member expired a month ago and she is still in office (it is now May and the Reserve Bank website shamelessly continues to describe her term ending in April). There has been not a word from the Minister of Finance or the Bank (Board or Governor) as to what is going on. In effect, the Minister of Finance has transformed Saunders’ position from one that looked like an explicit fixed term one to one in which she serves from day to day at the pleasure of the Minister of Finance. Just like my story in the first paragraph. It is a terrible way to be doing things (and a month on is clearly a conscious and deliberate choice by Robertson, not a matter of a few days until last minute reappointment loose ends could have been tied up).
To be clear:
there is nothing to have stopped the Minister of Finance formally reappointing Saunders to a further full four year term (at least, so long as the Minister’s handpicked underqualified Board was willing to recommend here),
there would have been nothing to have stopped the Minister formally extending Saunders’ term for up to six months (seems not to even require a Board recommendation), a term that itself would have been short but fixed.
But there is no sign that the Minister or the Board have put in place any process to reappoint or replace Saunders (although I have various OIAs in which may shed some light), and instead the Minister has setted for a de facto “dismissable at will, serving at the pleasure of the Minister” model. It has got no coverage, but it should have, including because it sets a terrible precedent.
Since he has said nothing,and has been exposed to no media or parliamentary scrutiny, I have no idea what is going on in Robertson’s head here. I don’t really believe that he has done it to exert policy leverage over Saunders (“keep voting a way I’m comfortable with or you’ll be gone tomorrow) both because no one believes the external members wield or attempt to wield any clout, and because Saunders has a day job in other fields (she doesn’t really need the MPC role). It is also odd because the election is approaching and you’d have assumed this government wouldn’t want to risk leaving an open seat for an incoming Minister to fill early on (they will already be unable to appoint pre-election a replacement for another external MPC member, Peter Harris, whose term expires in October). Perhaps I’m being too charitable, but whatever the explanation (a) we should be getting one, and (b) if small things are allowed to slide it opens the way to more serious abuses and pressure by others later. MPC members simply should not be dismissible at will, and at present Caroline Saunders is. The current situation reflects poorly on the Minister, but also on the Board and the Governor (who have presumably gone along), and actually on Saunders, who if she cares at all about operational independence for monetary policymakers should have insisted that she be reappointed formally or, if not, should have walked (which she could have done with no drama whatever). An incoming government that was serious about fixing the deficiencies in Robertson’s legislative reform of the Reserve Bank should simply repeal the “serve at the pleasure of the Minister” provision (I am not aware that comparable advanced country central legislation elsewhere has that sort of provision, especially when there is already statutory provision for a short fixed-term extension to deal eg with election timing issues).
Changing tack, I stumbled on this call for papers on the Reserve Bank website the other day
Were it the website of a university sociology department or policy centre it might all be rather unexceptional, but this is the central bank.
The Reserve Bank of New Zealand Act, freshly minted, sets out objectives for the central bank and functions for the Reserve Bank. I won’t bore you with another big cut and paste. Suffice to say, neither of those sections mention, or even hint at, “financial inclusion”. In fact, the words don’t appear in the Act at all.
Now, the Reserve Bank would no doubt point out the under the new Act there is a new document, the Financial Policy Remit. The first one is here. But the legislation itself makes it clear that whatever the Minister puts in the Remit, it is all about the exercise of the Bank’s statutory powers, fulfilling its statutory functions and purposes. It isn’t licence for the Bank to go spending public money and scarce management focus on just anything it, or even the Minister, might like.
. Much of the Remit wouldn’t get too much argument from most people, and the government’s “desired outcomes” are well within a reasonable range of possible emphases, as guidance for how prudential and crisis management powers should be exercised.
“Inclusive: does get a passing mention there, but over the page under “Other government policy priorities” we get this (1 of 4)
You might, or might not, think that sensible, but…..it has got nothing to do with anything the Reserve Bank has statutory responsibility for, or powers (which can only be exercised for statutory purposes). If there was a policy role for any agency, you might expect them to be turned to MBIE (ministry of subsidies) or The Treasury.
The Reserve Bank got a huge budget increase a few years ago (although the surprise inflation they inflicted on themselves and the rest of us means the real increase is less than they thought), so you might have thought that the Bank had money, time, and staff galore to throw at hosting symposia. In fact, they seem not to have had the resources or the interest in hosting workshops, symposia or conferences on issues they are actually responsible for – including ones where there have been major recent puzzles and failures.
They have a Seminars and Workshops page. Here are the events of the last few years
Readers of a charitable disposition – shouldn’t we all be? – might look at that top entry and think “well, that is clearly topical and something they were responsible for”. Unfortunately, it is also almost two years ago (before either the inflation or LSAP losses were much in focus at all), and as my write-up of the event records, it was much more of a Treasury event with little on monetary policy and no serious policy contribution from any Reserve Bank figure.
Since then, basically nothing. The Bank is currently finalising its advice on the next Monetary Policy Remit, and although they took public submissions on that there has been no workshop or conference or call for papers. Late last year, the Bank published its five-yearly review of the MPC’s conduct of monetary policy, and there has been no workshop or conference or call for papers on any of that. Serious speeches on monetary policy (let alone financial regulation and supervision, which most Bank staff now work on) are all-but non-existent. And the Bank publishes no research itself on financial stability or regulatory matters, and hardly any on things relevant to monetary policy. Lose $10bn of taxpayers’ money and have core inflation blast well beyond the top of the target range, and we get….well, almost nothing. Not even an apology, let alone some serious engagement, scrutiny and critical review and analysis.
But…..indigenous financial inclusion is apparently where the Governor and Board have decided to establish their research/workshop priorities.
Of course, many other central banks these days hare off down paths that seem barely relevant to the purposes they were established for (that entire Central Bank Network for Indigenous Inclusion fits that bill – and won’t anyone think of the Icelanders) but I can’t spot one whose only conference or serious workshop in several years is on something they have no serious responsibility for at all. Among the almost-countless such events hosted by bits of the ECB or the Fed (yes, they are big economies) the best known is of course the annual Jackson Hole symposium. These are the topics from the last few years
The Reserve Bank of New Zealand doesn’t have those sorts of resources or the pulling power. We are a small and not very wealthy country. But in such countries, scarce public resources should be being used in ways ruthlessly aligned to institutional priorities and statutory functions. The Reserve Bank’s workshop, by contrast, has the feel of management and the Board plundering the public purse to pursue personal ideological whims and interests. The same management and Board that displays no interest whatever in serious scrutiny or engagement or research on things they are actually responsible for, where they have made big calls in recent years, some of which have already proved deeply costly.
Jackson Hole it ain’t.
Here, you can go four years and not hear a speech or a paper from even a single external MPC member – members barred from doing any further research or analysis themselves. But never mind I suppose they say, it is only taxpayers’ money.
It must be relatively unusual for a political party in office to change tax law, and provide extra budget funding, to enable research to be done towards that party’s next campaign manifesto. But such it appears to be with the High-wealth Individuals research project, the report on which was released yesterday, loudly championed by the Minister of Revenue, David Parker. Not many government department research papers – and that, we are told, is all it is – get a Foreword from a senior Cabinet minister.
Whether or not there was a strong case for doing the research in the first place using the coercive powers of the state, and whether there is – in the broad – anything very surprising in the report (I don’t think I’ve yet seen/heard anything), no doubt there will interesting tables and charts that flesh out our understanding of the selected facts at least a little.
Perhaps the first snippet worth paying attention to is this
That is quite a lot of money in total – measured, by chance, at the very peak of a huge asset price boom – but what struck me was that only 155 families had estimated net worth in excess of $106 million. Quite possibly no readers of this blog fit that category, but in the grand scheme of global wealth NZ$106 million (measured at the peak of an asset boom) was if anything less than I might have expected.(By contrast, at his talk yesterday Parker told us he’d asked some of his rich mates to guess what the average number would be and none had gone for a high enough number).
Perhaps not unrelatedly, it is worth remembering that we don’t tax families, we tax individuals, and most of the families studied in this report included two spouses/partners. The median individual wealth is going to have been quite a bit lower than $106 million.
All of which seems consistent with the fact that the New Zealand economy has not exactly been a staggering success in recent decades. Setting the tax debate to one side for the moment, in a successful economy one might have hoped that there would be many more really wealthy families, at least if that wealth had arisen from the creation and development of new businesses/products. Few begrudge Bill Gates the wealth created via Microsoft.
But there is some important stuff that wasn’t in the report, or in the political framing of it. Thus, David Parker made much of the poor put-upon wage and salary earner who pays tax on every dollar of earnings, in contrast to the 300 rich families. It was all such an evidently unfair system we were told.
There were some comparative OECD charts in the minister’s presentation. These two weren’t among them
Tax on property – as a share of GDP a bit above the OECD median – is defined here as
This chart was also missing (NZ second from the right). It includes any tax levied on business capital gains.
And, of course, in the minister’s framing there was no mention of the fact that New Zealand over the decades has had relatively low rates of investment (relative to OECD averages for countries with our sort of population growth) in land development, in building new houses, and in business investment more generally. What one aspires to have more of one generally should not seek to tax more heavily. And IRD even seems to recognise in the report that what one taxes more heavily one will get less of, noting in the Summary
For the Project population, much of their income is derived from business entities that they control. Failing to tax forms of income that are earned predominantly by those who are better off …… is also likely to impose other economic costs through influencing the pattern of investment in the economy.
The IRD is keen to assert that what they are doing in this study is measuring “economic income”, in their own words “items…that increase individuals’ economic resources and, therefore, well-being”
In principle that is fine. I have no problem with the notion that unrealised real capital gains add to the economic resources and future purchasing power of the owner (whether or not those gains should be taxed is quite another question). But increases in asset values that simply keep pace with general inflation do not add to future real purchasing power and are in no meaningful economic sense (including the Haig-Simons approach IRD is fond of) economic income. We don’t have an inflation-indexed tax system at present, but the point of this study was not to describe the current system, but to use analytical tools to get a sense of real gains to purchasing power.
Now, most capital gains in the period under study were well in excess of the general CPI inflation rate, and inflation itself was relatively modest (but inflation cumulates, and even 2 per cent per annum inflation is about 22 per cent in total over a decade), so adjusting for inflation – which could relatively easily have been done – might not have changed many of the headline-grabbing numbers very much. But it was just knowingly dishonest of IRD not to have made the adjustment and to have presented as real income what no economist will regard as real income. But it will have suited their political masters (and perhaps reflected their longstanding institutional unease with an indexed tax system). And, as readers will be well aware, inflation will have made a great deal bigger difference to the numbers for 2022 and 2023.
David Parker’s approach to tax is – perhaps in line with prevailing New Zealand orthodoxy in recent decades – that all forms of real economic income should be taxed alike (at his talk yesterday he even seemed attracted to a capital gains tax on unrealised gains, something I’m not aware that any country does on any sort of comprehensive basis). If you believe in that approach, I guess yesterday’s research results will be troubling (or grist to your political mill).
I don’t, and to the extent it matters (if one cares about productivity and wider economic performance over time) generally economic theory tends not to back such an approach either. Not only do I think there is a good case for taxing returns to labour much more heavily than returns on capital (one example of my advocacy is here) but there is also a good case for a consumption-focused approach to tax (tax people on what they spend not on what they produce/earn, ideally through a progressive system). Frame your research in terms of tax as a percentage of “economic income” and you will get one set of answers, but frame it as a percentage of consumption and you will get quite another. If I was looking for a “tax switch” in New Zealand – David Parker implied that he was, rather than looking to increase total revenue – I’d be looking to substantially reduce New Zealand’s ranking on that taxation on corporate income chart above (and yes, I do know about dividend imputation, so this isn’t a statement of detail but of direction – but more foreign investment, and foreign investors are most affected by NZ company tax rates, would generally be a good thing).
For all that, I am not one of those who is adamantly opposed to a capital gains tax in principle. It wouldn’t affect me personally, I don’t mix in the circles of the 300, and I fully accept that there are elements of a “fairness” argument to be had. I’m certainly not someone who would change my vote on the matter. In general, I summarise my CGT position as one of profound ambivalence. One could be put in place, but a well-designed and politically realistic one would not raise much revenue over time, all while adding to the structural procyclicality risks around fiscal policy (sucking in most revenue when revenue is abundant and drying up almost completely when times are tough and other revenue is depleted). And since most of the political angst around capital gains in New Zealand is not about the likes of Bill Gates (or Rod Drury) but about escalating land values, those issues could – and should – be dealt with directly by systematically freeing up land usage and collapsing the artificial scarcity central and local government restrictions have created. As it happens, in this government the minister of land use rules in also the Minister of Revenue, but does one hear David Parker advocating policies that would collapse peripheral urban land prices to the best alternative agricultural use price? No, he (and opposition parties) will run a mile for the very idea) and experts tell us that the legislation he is now piloting through the House may actually worsen the situation. The rigged land market is scandalous, a true moral evil. But governments refuse to fix that.
And then there is the political conundrum. Most real-world CGTs emphasise realised gains, but if you do that then the people you hit are the asset holders most likely to be forced to sell at some point. As Parker himself recognised, the richer you are – and the bigger vehicles you hold your wealth in – the more likely you are to be able to defer a CGT almost indefinitely. In his younger days, Adrian Orr used to regale us with tales of mates of his who were firemen (or the like) with a couple of investment properties. A realisations-based CGT – actually like the extended brightline test – will catch them, but it will bear much less heavily on Parker’s 300 families.
Perhaps that means Parker will be trying to get his Labour colleagues to run with a wealth tax or death or inheritance taxes. They don’t have the particular problems that go with a CGT, but they have others (personally, I have no real problem with a moderate inheritance tax with fairly high thresholds, but I’d be really surprised if such a tax were to raise much money – although perhaps for advocates the revenue would not be the point).
Rather than run through afresh all the issues around good CGTs – loss-offsetting, double-taxation, efficient markets approaches to asset pricing etc – I’m going to end by cutting and pasting from a 2017 post, which I also used when the TWG reported in 2019.
Rather the block quote it, all that follows to the end of this post is direct from that 2017 post:
Going through some old papers to refresh my memory on capital gains tax (CGT) debates, I found reference to a note I’d written back in 2011 headed “A Capital Gains Tax for New Zealand: Ten reasons to be sceptical”. Unfortunately, I couldn’t find the note itself, so you won’t get all 10 reasons today. But here are some of the reasons why I’m sceptical of the sort of real world CGTs that could follow from this year’s election. Mostly, repeated calls for CGTs – whether from political parties, or from bodies like the IMF and OECD – seem to be about some misplaced rhetorical sense of “fairness” or are cover for a failure to confront and deal directly with the real problems in the regulation of the housing and urban land markets.
Anyway, here are some of the points I make:
in a well-functioning efficient market, there are typically no real (ie inflation adjusted) expected capital gains. An individual participant might expect an asset price to rise for some reason, but that participant will be balanced by others expecting it to fall. If it were not so then, typically, the price would already have adjusted. In well-functioning markets, there aren’t free lunches. It also means that, on average, capital losses will be pretty common too, and thus a tax system that treated capital gains and losses symmetrically wouldn’t raise much money on average over time. A CGT is no magic money tree. And there is no strong efficiency argument for taxing windfalls.
if you thought, for some reason, that people were inefficiently reluctant to take risk, there might be some argument for a properly symmetrical CGT. In such a system, the government would take, say, a third of your gains, but would also remit a third of your losses (the overall risks being pooled by the state). The variance of an individual’s private after-tax returns would be reduced, and they might be more willing to take risk. But, in fact, no CGT system I’m aware of is properly symmetrical – there are typically tough restrictions on claiming refunds in respect of capital losses (one might only be able to do so by offsetting them against future gains). There are some reasonable base-protection arguments for these restrictions, but they undermine the case for a CGT itself.
All real world CGTs are based on realised gains (and losses to an extent). That makes it not a pure CGT, but in significant part a turnover tax – if you never trade, you never pay (“never” isn’t literal, but tax deferred for decades discounts to a very small present value). And that creates lock-in problems, where people are very reluctant to sell, even if their circumstances change or if a new potential owner could make much more of the asset, for fear of crystallising a CGT liability. In other words, introducing a CGT introduces a new inefficiency to asset markets, making it less likely that over time assets will be owned by the parties best able to utilise them.
Basing a CGT on realised gains will also, over time, bias the ownership of assets subject to CGT to those most able to avoid realising the gains. A long-lived pension fund, or even a very wealthy family, will typically be better able to count on not having to sell than, say, an individual starting out with one or two rental properties, or some other small business, where changed circumstances (eg a recesssion or a divorce) might compel early liquidation. Large funds are also typically better able to take advantage of loss-offsetting provisions. The democratisation of finance and asset holding it certainly isn’t.
CGTs in many countries exclude “the family home” altogether. In other countries, they provide “rollover relief”, enabling any tax liability to be deferred. Most advocates of a CGT here seem to favour the exclusion of the family home, even though unleveraged owners of family homes already have the most favourable tax treatment in our system. Again, a CGT applied to investment properties but not owner-occupied ones would simply trade one (possible) distortion for another.
In practice, most of the arguments made for a CGT in New Zealand have to do with the housing market. But, on the one hand, all major (and minor?) parties claim that they have the fix for the housing market (various combinations of RMA reform, infrastructure reforms, changes to immigration, restrictions on foreign ownership, state building programmes or whatever). If they are right, there is no reason to expect significant systematic real capital gains in houses. If anything, real house prices should be falling – a long way, for a long time. Of course, prices in some localities might still rise at some point, if unexpected new opportunities appear. But “unexpected” is the operative word. Enthusiasm for a CGT, at least at a political level, seems to involve a concession that the parties don’t believe, or aren’t really serious about their housing reform policies.
Oh, and no one I’m aware of anywhere argues that a realisation-based CGT applied to (a minority of) housing has made any very material difference to the level of house prices, or indeed to cycles in house prices.
In general, capital gains taxes amount to double-taxation. Think of a business or a farm. If the owner makes a success of the business, or product selling prices improve, expected profits will increase. If and when those profits are achieved, they would, in the normal course of affairs, be subject to income tax. The value of the business is the discounted value of the expected future profits. It will rise when the expected profits rise. Tax that gain and you will be taxing twice the same increase in profits – only with a CGT you tax it before it has even happened. Of course, at least in principle, there is a double deduction for losses, but as noted above utilising losses (whether of income, or capital) is a lot more difficult. If you think that New Zealand has had less business investment than might, in some sense, have been desirable, you might want to be cautious about applauding a new tax that would fall heavily on those who took business risks and succeeded.
Perhaps double taxation of expected business profits doesn’t bother you. But trying reasoning by analogy with wages. If the market value of your particular skills has gone up, your wages would be expected to rise. When they do you will pay taxes on those higher wages. But by the logic of a CGT, we should capitalise the value of your expected future labour income and tax your on both that “capital gain” and on the later actual earnings. Fortunately, we abolished slavery long ago, but in principle the two cases aren’t much different: if there is a case for a CGT on the value of a business, it isn’t obvious why one shouldn’t have one on the value of a person’s human capital.
(I should note here, for the purists, that there are other concepts of double-taxation often referred to in tax literature, none of which invalidate the point I’m making here.)
Real world CGTs also tend to complicate fiscal management? Why? Because CGT revenue tends to peak when asset markets and the economy are doing well, and when other government revenue sources are performing well. CGT revenue doesn’t increase a little as the economy improves and asset markets increase, it increases multiplicatively. And then dries up almost completely. Think of a simple example in which real asset prices had been increasing at 1 per cent per annum, and then some shock boost asset prices by 10 per cent. CGT revenue might easily rise by 100 per cent in that year (setting aside issues around the timing of realisations). And then in a period of falling asset prices there will be almost no CGT revenue at all. Strongly pro-cyclical revenue sources create serious fiscal management problems, because in the good times they create a pot of money that invites politicians to (compete to) spend it. If asset booms run for several years, politicians start to treat the revenue gains as permanent, and increase spending accordingly. And if/when asset markets correct – often associated with recession and downturns in other revenue sources- the drying up of CGT revenue increases the pressure on the budget in already tough times. It is easy to talk about ringfencing such revenue (mentally, if not legally) but such devices rarely seem to work.
None of this means that I think there is no case for changes in elements of our tax system as they affect housing. The ability for business borrowers to deduct the full amount of nominal interest, even though a significant portion of that interest is simply compensation for inflation (rather than a real cost), is a systematic bias. It doesn’t really benefit new buyers of investment properties (the benefit is, in principle, already priced into the market) but it is a systematic distortion for which there is no good economic justification Inflation-indexing key elements of our tax system is highly desirable – at least if we can’t prudently lower the medium-term inflation target – and might be a good topic for a tax working group. In the process, it would also ease the tax burden on people reliant on fixed interest earnings (much of which is also just inflation compensation, not a real income).
Of course, at the same time it would be desirable to look again at a couple of systematic distortions that work against owners of investment properties. Houses are normal goods and (physically) depreciate. And yet depreciation is no longer deductible. Perhaps there was a half-defensible case for that when prices were rising seemingly inexorably – but even then most of the increase was in land value, not in value of the structures on the land – but there is no justification if land reform and (eg) new state building is going to fix the housing market. Similarly, when the PIE system was introduced a decade or so ago, it gave systematic tax advantages to entities with 20 or more unrelated investors. Most New Zealand rental properties historically haven’t been held in such entities. There is no good economic justification for this distinction, which in practice both puts residential investment at a relative tax disadvantage as a saving option, and creates a bias towards institutional vehicles for holding such assets. Institutional vehicles have their own fundamental advantages – greater opportunities for diversification and liquidity – but it isn’t obvious why the tax system should be skewing people towards such vehicles rather than self–managed options. As noted above, any CGT will only reinforce that bias. Funds managers, and associated lawyers and accountants, would welcome that. It isn’t obvious why New Zealand savers should do so.
I see that there are more than 10 bullet points in the list above. I’m not sure it covers all the issues I raised in my paper a few years ago, but it is enough to be going on with.
And in all this in a country where we systematically over-tax capital income already. I commend to readers a comment on yesterday’s tax post by Andrew Coleman, of Otago University (and formerly Treasury). As Andrew noted:
“Somehow, New Zealand’s policy advising community decided it would restrict most of its attention to the ways income tax could be perfected rather than question whether income taxes (which are particularly distortionary when applied to capital incomes) should be replaced by other taxes. It is almost as if we have the Stockholm Tax Syndrome – fallen in love with a system that abuses us.”
A broad-based capital gains tax would just reinforce that problem.
There is an op-ed on the Herald website this morning on “The role of corporate profits in inflation”. It is written by Max Harris, a lawyer and political activist. He was campaign manager for Efeso Collins in the Auckland mayoral race last year, which should give you a sense of how far to the left he sits on the political spectrum.
Harris is a smart guy, and it is evident from the article and his tweets that he has read a number of papers that have emerged recently from overseas academics and some central bankers suggesting that corporate profits might have some distinctive role in explaining the recent surge in inflation. I say “distinctive” because in the same way that nominal GDP can be decomposed into price and volumes, it can also be decomposed into returns to labour and returns to capital. In a demand-driven surge in inflation it would entirely normal to see all four of those items growing at above-average rates. And since both wage rates and employment tend to be stickier (slower to adjust) than profits – which are the residual, what is left over after other business expenses have been met – it shouldn’t be unexpected to see profits rising and falling earlier and more markedly than, say, wages. That wouldn’t tell you that profits were “to blame” for the inflation in any meaningful sense.
I’m not going to devote this post to unpicking the entire literature on profits and this cycle. Instead, I just wanted to present a few New Zealand charts.
One of the few things I agree with Harris (in this article) on is that New Zealand economic data is not really fit for purpose. There are significant gaps, in coverage, frequency, and timeliness, which really should be remedied. There aren’t (m)any votes in good economic data but it is the sort of thing good governments should be spending on nonetheless.
All that granted, it was striking that there was only one New Zealand specific number in Harris’s article
Now, to be fair, op-eds don’t provide for a limitless word count. But it isn’t hard to do much better than that one number.
I found a description here as to what Ed Miller had done (note that his calculation was done nine months ago) and replicated his number. Using the Treasury monthly tax database, sure enough you find that company tax revenue (whether including or excluding refunds) for the year to March 2022 was 39 per cent higher than it had been in the year to March 2021.
But here is some context
For the 12 months to February 2023 net company tax revenue was up 7.5 per cent on the 12 months to February 2022. The most recent nominal GDP data is only up to December 2022, but nominal GDP in the 12 months to December 2022 was 8.5 per cent higher than in the 12 months to December 2021.
But perhaps the key point is that company tax revenue is very volatile (in the 12 months to April 2017 the annual growth had briefly reached 50 per cent), with deep troughs and high peaks. That isn’t just because profits can be volatile, but also because of loss carry-forward provisions (when your firm makes a loss one year IRD won’t send you a cheque, but you can credit those losses against future profits (if/when your firm returns to profit). When those losses are exhausted, revenues can jump up very quickly even if profits themselves are less variable.
In this specific case, of course, the year to March 2022 (which Harris cites) followed the year to March 2021, a year in which net company tax receipts had been down 17 per cent.
We could dig a little deeper on the same Treasury spreadsheet. Treasury breaks out income receipts from NZSF and GSF, which are really just branches of the central government itself.
NZSF (the big dollars here) was only set up 20 years ago, so the initial figures were mostly small. These days it is large and has quite volatile returns (and, it appears, tax liabilities). Here is what the corporate tax line looks like with NZSF and GSF income tax removed (which is one of the adjustments Treasury does to get to core Crown measures of tax)
The recent peaks and troughs are even larger. (Note that when, as they did in the 12 months to March 2021, tax revenue from this source falls 30 per cent it then needs to rise by about 42 per cent just to get back to the starting level ($m).
Strangely, we rarely hear much from people like the Green Party when company tax revenue is falling sharply.
One of the gaps in New Zealand’s macroeconomic data is a full quarterly income measure of GDP. However, SNZ has made steps in that direction in recent years, and we now have a quarterly nominal income measure of GDP and a compensation of employees component of quarterly nominal GDP.
As context, here is the annual data showing both compensation of employees and operating surplus/mixed income up to the year to March 2021
The labour share of GDP (at least the bit going to employees) has fallen a bit in the last decade, but then it has risen a bit more in the previous decade (profits and mixed income share vice versa).
The quarterly data only start in 2016 but are right up to date (December 2022 quarter)
The Covid wage subsidies muddy the picture (sharp shortlived dips in both 2020 and 2021) but over 2022 as a whole the compensation of employees share of (adjusted) nominal GDP was higher than it had been pre-Covid. The picture may be clearer simply as a share of nominal GDP
That isn’t particularly surprising. It isn’t that wage rate growth has run ahead of general inflation or nominal GDP growth, but that the number of people employed, the number of jobs, has increased very rapidly, and the labour market has been running very tight (really on whatever measure you choose to look at). As a reminder if the wage share of nominal GDP has risen a bit amid the inflation surge, that means the other components of GDP (profits and mixed income) have…..shrunk a bit as a share of nominal GDP.
None of this to suggest that pro-competition reforms would not be welcome in New Zealand. They would (although in many cases we could expect the Green Party to oppose them), but the presence or absence of such restrictions is unlikely to materially explain developments in inflation of the scale we – and many other countries, many with more liberal competitive markets – have experienced in the last couple of years. Prima facie, responsibility still looks to rest – as it usually does when such things happen – with monetary policy, either having actively poured fuel on the fire, or (more usually) not having recognised and responded to emerging demand-led inflation anywhere early or aggressively enough.
Readers might also find useful a new column on The Conversation by a professor of economics at Waikato. He puts more weight on that brief Treasury analysis than I did (see previous post), but ends up in a very similar place.
Occam’s razor isn’t always the most useful approach, but when one has had highly expansionary monetary and fiscal policy and have had unprecedentedly low unemployment rates (and general difficulties finding staff), the onus would appear to be on those who want to explain anything very much of New Zealand’s core inflation (in particular) by factors other than the conventional macroeconomic ones. Harris’s column doesn’t credibly make such a case, or point to other New Zealand specific work that does. But, yes, in demand-led booms (especially the early stages) profits will tend to be strong. That doesn’t shift the responsibility off central banks, any more than would be the case when there is a surge of wage inflation, again reflecting unsustainable excess demand for labour.
UPDATE:
To be clear, I am not (repeat, not) suggesting that all of the rise in company tax revenues in the year to March 2022, as cited by Miller, was simply a reversal of the fall in the previous year. About half of it was (company tax revenue was down 17% in the previous 12 month period). My wider point that is an unexpected surge in demand – and it was totally unexpected by macro forecasters – will show up first in profit growth.
As a grossly oversimplified illustration: the local fish and chip shop might have half a dozen staff rostered on on a Friday night. If a lot more people turn up than usual for a Friday night, (not only will wait times be longer but) profits for the day will rise a lot. Wage costs won’t have changed – rosters and wage rates were set in advance – rent won’t change, lighting costs won’t change, but there will be an increase in the cost of goods sold (materials – fish, chips, perhaps oil). If demand remains stronger for longer, you might expect more people to be rostered on, perhaps their wage rates to rise, and so on. Revealed preference suggests workers generally prefer to shift short-term risks – upside and downside – onto firms, and profits will fluctuate accordingly.
One comes to take for granted the gross inadequacies of the Official Information Act, including the systematic under-resourcing of the Ombudsman’s office, which just reinforces the incentives on officials to play fast and loose with the spirit of the law, banking on the fact that if their agency ever loses at the Ombudsman it will be so far down the track that most people – possibly including the requester- will have lost interest in whatever it was the agency didn’t want to release.
But just occasionally it still gets to one. No doubt many requesters have this sort of experience.
I had an email this afternoon from the Ombudsman’s office
It didn’t sound like much of an update – “we are writing to tell you that we have still done nothing about your complaint and have no idea when we will”. I couldn’t even remember what I’d made a complaint about or when. On checking, I found that my complaint was lodged on 3 February. This was the complaint
The original request had been lodged with the Reserve Bank on 10 November 2022
10 November was the day the Reserve Bank released its first five-yearly review of the conduct of monetary policy. They took the best part of three months themselves to withhold almost everything deemed relevant. They did release three documents, which contained almost nothing of substance (that being the point), including this one
which doesn’t really appear to be in scope at all.
As a reminder of the context, this five-yearly report came out amidst inflation having burst well beyond the target range, the MPC having lost taxpayers the best part of $10 billion on the LSAP, and as the MPC was racing to raise the OCR to get inflation back in check.
As I noted in my complaint, one of the oddities of the five-yearly review provision in the Act is that the Bank (management, and I suppose the Board) get to do the review, and yet the MPC is the entity that sets monetary policy, and the MPC includes the three external members who don’t formally answer to the Governor. We know from the finished report what the Governor thinks of the MPC’s stewardship – and as a reminder management has the majority of the votes – but we know almost nothing at all about what the external MPC members thought. Did they reflect differently on the Covid period than management did? Or did they perhaps not reflect very seriously at all? Did their views or input (if any) have any impact on the substance of management’s report?
You might have thought that disclosing MPC members’ views, or input to the report, might be the very least sort of effective public accountability for the considerable power they helped wield, the considerable and hugely costly the mistakes they helped make.
Perhaps one day we will get an answer. But the Reserve Bank – like so many government agencies around town – knows that it only needs to say no, and if the requester can even be bothered complaining that it could be 12-18 months or more before there is any hope of the Ombudsman getting round to addressing the complaint. Meanwhile, the external MPC members (and management) go on wielding their power and collecting their salaries.
But it does remind me that I had overlooked lodging a complaint with the Ombudsman about the Bank’s bare-faced obstructionism in the matter of the appointment of the chair of the majority owner of a large bank being appointed to the board of the Reserve Bank, an appointment almost certainly done with the acquiescence (or worse) of the Governor.
In that post I noted that while the LSAP was still running, the monthly line item on the Reserve Bank balance sheet recording the Bank’s mark-to-market claim on The Treasury under the indemnity was a reasonable proxy, on prevailing market prices, of the direct fiscal losses the LSAP programme would result in. And it was an official number.
The Reserve Bank published its monthly balance sheet for the end of March. The Bank’s claim under the indemnity as at 31 March stood at $7821 million.
However, as I also noted in Saturday’s post, this number is no longer even an approximate estimate of the direct fiscal losses from the LSAP programme. It is still a best guess, on market prices, of the unrealised losses on the bonds the Bank is still holding.
But the Bank’s holding of bonds are now much lower than they were at peak. In the programme as a whole, the Bank purchased government bonds with a face value of $53480 million and LGFA bonds with a face value of $1735 million. All of those purchases were covered by the indemnity.
However, since July last year the Bank has been selling back to The Treasury each month government bonds with a face value of $415 million. Total sales to date – most recently a parcel on Monday – total $4150 million. The resales programme is starting with the longest-dated (most risky) bonds, on which the largest percentage losses will typically have been made. As those bonds are sold back to The Treasury the Reserve Bank’s losses are realised, and their claim on the indemnity is met each month by The Treasury. (In addition, as the table below records, there were some payments from the RB to Treasury in the period before resales began, which may represent higher coupon payments to the Reserve Bank exceeding the Reserve Bank’s (OCR) funding costs during the very low OCR period.)
There appears to be no easy place to find the monthly indemnity payments (I have suggested to Treasury that in the interests of transparency it would be good if they or the Bank provided such a table), but there were some hard numbers, and some indications, in a November 2022 Treasury paper that I drew from in Saturday’s post
Actual market rates have changed since then, but the total payouts to date could be almost $2 billion.
In addition to the sales back to The Treasury, some of the bonds the Reserve Bank purchased have matured in their hands.
On the LGFA side, $216m (face value) matured in May 2021, $250m in April 2022, and another $250m this month.
In respect of government bonds, $1300m matured in May 2021 (and on those bonds the Crown appears to have roughly broken even from having done the LSAP purchases – the OCR, the Bank’s funding cost, having been 0.25 per cent throughout the period the May 2021 bonds were held), and another $7471 million (face value) matured a few days ago, 15 April 2023.
Whatever claim the Reserve Bank had in respect of the April 2023 bonds will presumably drop out of the reported indemnity claim balance sheet item in the next balance sheet and will have been met by Treasury in their monthly payment.
Total LSAP bond purchases were $55215 million (face value). Maturities and resales mean that the face value has been reduced by (face value) $9487 million [correction $13637m – the original number was just maturities]. The monthly reported indemnity claim item on the Reserve Bank’s balance sheet captures only the market-implied loss on the bonds still held. But the total direct fiscal losses on the programme – not reported very transparently – include the substantial realised losses already settled by The Treasury. Each month – while market bond rates remain high – the realised losses will mount and the indemnity claim item (while fluctuating from month to month) will be trending down. When the last bonds mature or are sold (several years away yet on current plans), the Reserve Bank balance sheet indemnity item will drop away to zero. But large losses will have been met by the taxpayer – on what we know at present, probably something like $10bn of them.
I was on Newstalk ZB this morning to talk about the ASB recession forecasts and this article on the Herald reporting some recent statistical analysis from Treasury staff that attempted to provide another perspective on what has caused New Zealand’s high inflation rate.
I don’t want to add anything on the ASB forecasts other than to say that (a) their story and numbers seem quite plausible, but (b) macroeconomic forecasting is a mug’s game with huge margins of uncertainty and error, so not much weight should be put on anyone’s specific forecast ever (with the possible exception of a central bank’s forecast, which may be no more accurate than anyone else’s but on which they may nonetheless act, with consequences for the rest of us).
The Treasury staff analysis was published a couple of weeks ago as a 2.5 pages Special Topic in their latest Fortnightly Economic Update. You can tell from the Herald headline why one of their political journalists might have latched onto this really rather geeky piece
But there is less to the analysis than the headline suggests. The term “government spending” doesn’t appear in the Treasury note at all (I think “fiscal policy” gets one mention). The focus of the paper is an attempt to better understand the relative contributions of demand and supply factors to explaining inflation, and while fiscal policy is one (at times significant) source of demand shocks and pressures, there is no effort in the paper to distinguish the relative roles of fiscal and monetary policy (or indeed, to distinguish either of those policy influences from other sources of demand pressures). That isn’t a criticism of the paper. The technique staff used, introduced for those purposes a few months ago by a Fed researcher (his paper is here), isn’t designed for that purpose.
Loosely speaking, the technique uses time series modelling techniques to look at both prices and volumes for (most of) the items included in the CPI. When there are surprises with the same sign for both a price and the corresponding volume that is (in their words) suggestive of a demand shock (increased demand tends to lift prices and volumes) and when the surprises have opposite signs this is taken as suggesting a supply shocks (disruptions in supply tend to see lower volumes and higher prices go together). It is a neat argument in principle.
But it doesn’t look to be a very good model in practice. Here is The Treasury’s summary chart. the source of the line that (on this analysis) demand and supply shocks may have contributed roughly equal amounts to inflation over the last year, and that demand shocks were more important back in the early stages of the surge).
Not only is a large chunk of recent inflation not able to be ascribed to either demand or supply shocks, but there have been periods even in the quite short span shown here when the identified demand and supply shocks don’t explain any of the then-current inflation at all (eg 2019).
This is even more evident with some of the sub-groups they show results for. Thus, home ownership (which in the CPI is mostly construction costs)
For most of the decade, neither (identified) demand or supply shocks explain the inflation, and that is so again in the most recent data. And if the model suggests that sharp rises in construction cost inflation in recent times have little to do with demand at a time when house-building has been running at the highest share of GDP in decades, so much the worse for the model.
Services make up a large chunk of the economy, and a fair chunk of the CPI too. Here is the chart for that group
Not only are there periods when neither demand or supply shocks (as identified by the model) explain any of services inflation, but how much common-sense intuition is there is the idea (which the chart suggests) that for most of the period what services inflation can be explained is all either supply shocks or demand shocks and not some combination.
The Treasury paper notes some overseas comparisons, in particular that for the US
The results for New Zealand show lower supply-side contributions to inflation than estimates for the US and Australia. In the US, supply-side drivers account for about 60% of the annual change of the PCE deflator that the model can explain (Figure 7).4
(the footnote is to the original Fed paper)
and they show this US chart which I assume comes from the same model
Note, first, that the PCE deflator has a materially different treatment of home ownership – using imputed rents – than either the NZ or US CPIs.
But perhaps more importantly, in the original Fed paper there is this line
And here is a relevant chart from the same paper (grey-ed periods are NBER recessions)
Not only does it show the entire period since 1990 (one of my uneases about the New Zealand work by Treasury is showing only the last 10 years), but it also illustrates that, as defined for the purposes of these models, both supply and demand factors are large influences, almost always positive, over the entire 30+ years. In other words, if there is anything unusual about the current situation it is not the relative contributions of supply and demand influences but simply that inflation is high (both demand and supply influence). It simply doesn’t seem to add much value in making sense of why things unfolded as they did over the last couple of years. (Although it is interesting how different the last 10 years of the chart look for the US, as opposed to New Zealand in the first chart above.)
What these US charts also illustrate is that supply and demand shocks/drivers here don’t mean the same as they typically do when thinking about monetary policy. Monetary policymakers will (rightly) talk in terms of generally wanting to “look through” supply shocks – the classic example being spikes in world oil prices, which not only flow through to the CPI almost instantly (faster than monetary policy could react) but also make us poorer. The focus instead is on whether these headline effects flow through into generalised inflation expectations and price-setting more broadly. Climate-induced temporary food price shocks (from storms or droughts) are seen in the same vein.
Those sorts of shocks are generally thought of as being as likely to be negative influences on headline inflation as positive ones. Oil prices go all over the place, up and down. Much the same goes for fruit and vegetable prices. These are the two main things excluded in that simplest of core inflation measures, ex food and energy. Some of the Covid-related disruptions are probably more one-sided: there aren’t really obvious favourable counterpoints to severe supply disruptions (even if such disruptions themselves generally unwind over time). But even taken altogether they aren’t the sorts of things that will produce positive influence on core inflation over single year for over 30 years (as in the US core inflation chart immediately above).
When macroeconomists think of inflation they often do so with a mental model in their heads in which this period’s inflation is a function of inflation expectations, some influence from the output/employment gap, and then any residual (supply shock) types of items. Those supply shocks can run in one direction for a couple of years in succession (and probably did in the last couple) but the expected value over long periods of time is generally thought to be pretty close to zero. Monetary policy determines core inflation – monetary policy shapes expectations and influences and responds to developments in the output (or employment) gap. Of course, monetary policy takes account of trend supply developments – adverse shocks may not only raise headline inflation, and risk raising inflation expectations, but can lower both actual and potential output (many positive supply shocks work in the opposite manner).
I don’t want to be particularly critical of The Treasury. We should welcome the fact that their analysts are trying out interesting different approaches and keeping an eye on emerging literature, and even that they are making available some of that work in generally low-profile publications. That said, Treasury is not some political babe in the woods, and I’d have thought there should have been some onus on them to have provided a bit more context and interpretation in their write-up. For example, whereas the US is often treated as a closed economy, New Zealand clearly isn’t. I don’t have a good sense as to how general imported inflation – or that reflecting exchange rate changes – is going to affect this sort of decomposition. If, as I believe, a wide range of central banks made very similar policy mistakes, we’ll be seeing more inflation from abroad (if our Reserve Bank takes no steps to counter it) not tied to demand pressures in particular domestic sectors. I’m also not really clear how the lift in inflation expectations that we observe in multiple surveys fits into this sort of decomposition exercise.
Oh, and it was perhaps convenient that of the CPI groups Treasury showed, motor fuels was not one of them. Headline inflation currently is held down quite a bit by the NZ Cabinet shock – holding down petrol excise taxes etc.
My own approach to the question of where the responsibility lies for core inflation (and note that Treasury focuses on headline not core) tends to be simpler. When this century the unemployment rate has dropped below about 4 per cent core inflation has tended to become quite a serious problem (mid-late 00s and now). The Reserve Bank itself has been quite clear in its view that employment is running above the “maximum sustainable employment” (itself determined by other government policies), and thus, by implication, the unemployment rate – at near-record lows is below sustainable levels. That is a function of excess demand relative to the ability of the economy to supply. Core inflation – the bits we should most worry about, because we could usefully do something about them – is an excess demand story, risking spilling over into embedded higher inflation expectations.
And when ZB’s interviewer asked me this morning whether Mr Robertson or Mr Orr was to blame (fiscal or monetary policy), I was quite clear that the answer was monetary policy (Orr and the MPC). That isn’t because monetary policy loosenings in 2020 were necessarily the biggest source of stimulus to demand, but because the model is one in which (a) fiscal policy is transparent, and (b) monetary policy moves last, with the responsibility to keep core inflation at/near target. You might think (I certainly do) that less should have been done with fiscal policy, but it isn’t up to the MPC to take a view on that, it is their job simply to have a good understanding of how the whole economy, and the inflation process in particular, works, and to adjust monetary policy accordingly. In extremis, fiscal policy can overwhelm the best efforts of central banks, but that wasn’t an issue or a risk here, or most other countries, in recent years. Central banks simply got things wrong. (They had company in their mistake, but they were/are paid to get these things right.)
croaking cassandra 