Grant Robertson on housing

Michael Reddell Housing

The Deputy Prime Minister and Minister of Finance hit the weekend current affairs shows to make the case for the government’s housing/tax package.

I watched both the Newshub Nation interview – the one in which the Minister of Finance refused to rule out bringing in rent controls (a move which would, among other things, simply accelerate a trend towards the government itself being the main provider of rental housing) – and the one on Q&A. Perhaps because the latter is fresh in my mind – I only watched it this morning – but also because it was a better interview, I want to focus here only on the Q&A interview. For those who haven’t seen it, the whole thing seems to be available here. Incidentally, it was interesting that the government chose not to send out its Minister of Housing for these interviews.

What I found most striking was how this very senior minister, now with 3.5 years in office under his belt, floundered when asked about the effects of the government’s measures. It wasn’t, apparently, for him to say what the effect on house prices would be. Not only that but officials had apparently offered quite a range of views, (if so suggesting they didn’t really know either). He didn’t know what the effect would be on private rents either. This was, we were told, “highly contested territory”. Really all he was willing to say was that any effect on house prices would be to moderate the recent pace of increase, which he kept calling “unsustainable” – without apparently recognising that things that are unsustainable typically come to an end anyway. So if annual house price inflation slows to only 10 per cent per annum this year – under the influence of all sorts of possible influences – will the Minister of Finance be claiming this as a win for last week’s package? I don’t any serious analysts, let alone potential first-home buyers, will be. The Minister meanwhile claimed only to want to see an end to the “big big jumps in house prices”.

If you were a serious government, mightn’t you have adopted a package that you – and ideally your officials too – were confident would lower both house prices (actually the bundle of the house and the land under it) and private rents? After all, New Zealand real house prices have more the tripled in the last 30 years, and yet houses are little more than a combination of land (abundant in New Zealand), labour, and a bunch of tradables materials (timber, taps, pipes, gib board etc). General tradables inflation has been – as the Reserve Bank often points out – quite a bit lower than general CPI inflation for a long time. There aren’t any natural obstacles to (much) lower house prices. Just policy ones.

Or what about rents? Real rents fortunately have not tripled. The current SNZ rents index has data since 2006

Total percentage increases
Rents-stockCPI
2006 to 201012.213.1
2010 to 201516.35.4
2015 to 202017.78.4
Full period (06 to 20)53.229.2

So that is about a 20 per cent rise in real rents over 14 years, which might not sound so bad, except that over that period one of the key drivers of equilibrium rental yields – long-term interest rates (which are not only a financing cost but, more importantly, a return on a key alternative asset – have plummeted. Real 10 year government bonds yields were about 3.3 per cent at the end of 2006, 2.2 per cent at the end of 2015, and about -0.3 per cent at the end of last year. Rental yields have plummeted – and as the data show tenants have benefited from that – but real rents have not, because successive governments have adopted policies that drove real prices sharply up.

And don’t go blaming interest rates for the house prices, as the Minister tries to do (waving his hands and suggesting here are lots of things outside his control). Did you know that, even now, real interest rates in most of the advanced world are even lower than those here (in the US, for example, the real 10 year government bond yields is about -0.7 per cent)?

And, talking of the US, this is real house price inflation in (a) New Zealand as a whole (cities and towns and villages) and (b) the 20 or so metropolitan regions all with populations in excess of a million people that had house price to income ratios of less than 4 in the most recent Demographia report. You might not want to live in some or even most of these places, but plenty of people do (from memory, population growth in Columbus and Atlanta for example has exceeded that of New Zealand).

us and nz house prices

Of course, there are other US metropolitan areas where the picture has been less good, a few even where prices have been allowed to get as out of hand as they are in New Zealand. But in a sense that is the point. The entire US has the same interest rates – typically a bit lower than those in New Zealand. The entire US has much the same banking system, and even the same odd federal interventions in the housing finance market. The tax systems are much the same across the country. But the house price outcomes – even for similar population growth rates – differ hugely, consistent with a story about the importance of land use restrictions.

One might tell a similar story in Canada where the Demographia report has data for price to income ratios for six metropolitan regions each with a population of more than a million people. Same interest rates across the country, and fairly rapid population growth in both Toronto and Edmonton, yet Edmonton and Calgary have price/income ratios around 4 and Toronto and Vancouver 10 and 13 respectively (Ottawa and Montreal between 5 and 6).

So this should have been perhaps the cheapest time in history (rents relative to income) to be renting – here and abroad – and yet real rents have been rising, and the government cannot even manage a package that they, and their officials, are confident will lower rents. It really is hopeless.

In both weekend interviews the Minister did say that he would like to see the price/income ratios fall (suggesting that on a nationwide basis that ratio is now about 8. But even then, pushed by the interviewer, he wasn’t going to be pinned down or offer any hostages to accountability. He has “no number in mind”, said he “can’t tell what an affordable price is”, and butted away the interviewer’s suggestion that a ratio of 3 was not a uncommon benchmark in discussion of these issues, and wasn’t even willing to suggest that a ratio of 5 might be something to aspire to. He played distraction by suggesting that he would like to see incomes rise – which, of course, would lower the ratio – but has no policy to do anything about changing (improving) the future path of average/median income growth.

On Twitter on Saturday I did a quick exercise and pointed out that if house price inflation slowed to a long-term average of 1 per cent and incomes rose 2.5 per cent it would take almost 20 years for the price/income ratio to get to 6.

In the longer-term, incomes are likely to be driven by trends in nominal GDP per hour worked. That won’t be the only influence – people can work more (or fewer) hours, governments can run deficits in ways that put more in household pockets (or surpluses that take more out of household pockets), and relative returns to labour can change. But over a 20 year sort of horizon, nominal GDP per hour worked seems like a reasonable starting point: in New Zealand, the labour income share hasn’t changed much in 30 years, and while this government is doing a bit more redistribution governments come and governments go.

Nominal GDP per hour worked in turn reflects three broad factors:

  • general inflation (eg something like the CPI)
  • changes in the terms of trade
  • productivity growth (change in real GDP per hour worked)

The Reserve Bank has an inflation target of 2 per cent, which it hasn’t consistently met for a decade, but it is probably reasonable to think of something a bit above 2 per cent as towards the lower end of what average incomes might grow at over several decades. On other hand, productivity growth in New Zealand has been lousy for a long time, and nothing in what this government is doing – or what National is offering instead – looks set to improve that. And the best guess of a future real relative price like the terms of trade is today’s value. So I’ve done scenarios in which incomes rise anywhere between 2.25 per cent per annum and 3 per cent annum. Over 20 years, actual could still be better or worse than those numbers, but they seem like a plausible range. Over the last five or six years, actual growth averaged about 2.6-2.7 per cent (whether or not 2020 is included).

What about house price growth. Robertson and Ardern refuse to even talk about flat house prices, let alone falling ones, so I’ve used 1 per cent per annum as the lower end of the range of scenarios. And I ran the numbers for 2, 3, and 4 per cent. 4 per cent house price growth wouldn’t seem super low to most New Zealanders after the experience of recent decades, but there is no point running higher house price inflation scenarios because…….even at 4 per cent annual house price inflation price/income ratios keep rising forever.

If house price inflation slowed to 1 per cent per annum, year in year out and incomes rose by 2.6 per cent per annum, in 20 years time the nationwide price/income ratio would be 5.85.

If house price inflation averages 2 per cent per annum, and incomes rise 2.75 per cent, in 20 years time the price/income ratio is still 6.9 per cent.

If house price inflation and incomes grow at 2.5 per cent…..then of course, the price/income ratio never falls at all.

And it is no trouble at all to generate undemanding scenarios in which the price/income ratio just keeps lurching upwards – these things never happen steadily (every single year), but the long-term trend is what dominates.

And if by some chance you think a price/income of 6 doesn’t sound too bad. well (a) you’ve just too used to latter day New Zealand, and (b) check the table on page 15 of the Demographia report for the metropolitan areas (most of them) with ratios lower than 6, in lots of cases much much lower. New York – never really thought of as a cheap place to live – shows at 5.9, Montreal at 5.6, Manchester (UK) at 4.8, Nashville at 4.2, Edmonton at 3.8, and on downwards.

But the government has simply done nothing about freeing up the land, facilitating again aggressive competition among potential vendors on the periphery and in the intensifying centre and suburbs, which is the sure and reliable way of getting house prices (land prices) and rents down. And doing so quite quickly, because although it takes time to build, it takes very little time for expectations to change, and markets trade on expectations.

I could go one, but I won’t except to highlight the Minister of Finance’s desperate attempt to defend the spin – the lies really – that claimed that interest deductibility for rental property owners was a “loophole”. The interviewer challenged Robertson on whether the government would be removing deductibility for all businesses, and Robertson denied that was on the cards while doubling down on his loophole spin, claiming that property was a loophole because owner-occupiers couldn’t deduct their interest cost. Not even bothering to get into the point that the owner-occupier has no assessable income from the house (and under the government’s ringfencing change a couple of years ago could get no benefit from deductibility anyway), the interviewer asked the Minister about the purchase of a computer. The financing costs of such equipment (or a car) are deductible for businesses, but not for households. Was this a distortion the Minister was asked. He was floundering by this point simply reduced to asserting again that there was a “loophole” when it came to property. Only in the fevered imaginations of ministers and their spin doctors (and even they no doubt know better, they just take the public for fools).

It really was a poor performance by one of the government’s most senior ministers. And in that sense told you really all one needed to know about last week’s package: utterly unserious when it came to addressing the core issues (land use, and probably some construction cost issues thrown in) but simply a heavy dose of the politics of distraction, all while further messing up the tax system and the housing market itself.

(And lest anyone suggest this is partisan commentary, the unnatural disaster of the New Zealand housing market has been the responsibility of successive governments led by each of the main parties. But when you hold office you hold responsibility. Ardern and Robertson have held office for 3.5 years and now have a parliamentary majority that – for good or ill, per the New Zealand system and its limited checks and balances – would allow them to do almost anything they wanted. But they refuse to do anything that would, with confidence, lower house prices and rents, or to even suggest that lower house prices would be a desirable outcome. There are words for that sort of political betrayal. Mostly not terribly polite ones.

Messing around with housing

Michael Reddell Uncategorized

And so yesterday we got the long-awaited government package in response to the latest surge in house prices. As a reminder, it is just the latest surge in the more than trebling in real New Zealand house prices over the last 30 years.

BIS real house prices

We know it wasn’t really a serious policy designed to fix the housing market, not just because it didn’t even address the core issue (land use regulation etc) but because the Prime Minister still can’t bring herself to say that she would like to see lower house prices – not even just reversing the rise of the last few months – and the Treasury’s Regulatory Impact Statement is headed “Tax measures to moderate house-price growth”. Add to that I’ve seen reported that Treasury expects the extension of the so-called “brightline test” to boost government revenue, when a package that actually did something about fixing the market would see that specific revenue line almost evaporate for many years to come.

There is a lot that is odd about yesterday’s announcement, including the Treasury claim (in the RIS they published) that they opposed the deductibility rule change because they hadn’t had time to properly analyse it. Even if this was a last minute idea dreamed up by someone in the Beehive – and Richard Harman’s newsletter this morning suggests not, that the idea had been under consideration at least since November – what does it say about the loss of accumulated expertise in The Treasury that they could not offer robust analysis at short notice on almost any of the myriad possible housing tax changes that have been proposed and analysed at various times over the last 20 years? Surely (a) this is core capability (especially in a New Zealand with longrunning housing policy dysfunction), and (b) the analysis involved would have been qualitatively similar to whatever advice and analysis Treasury provided on ring-fencing rental income losses only a couple of years ago?

There are two tax components to the package; the extension of the brightline test to 10 years, and the removal of the deductibility of interest expenses for residential rental landlords. The latter is the more significant measure, but I’ll come back to that.

The only good case, ever, for the brightline test was what the name implied. Using time rather than intent (hard to prove) to determine which sales of investment property were subject to tax was easier, clear and simple. If, instead, you want to tax investment asset appreciation more generally, you’d introduce a capital gains tax. Such a tax would capture all investment assets (not just a particular class the government of the day doesn’t like), and it would provide for loss-offsetting arrangements. A proper CGT is somewhat akin to the government becoming an equity partner in your assets; ups and downs (although not generally in a fully symmetrical way). You might or might not agree with a CGT, but (a) no serious person/government ever thought one was the answer to house prices (and if any did experience should have long since disillusioned them), and (b) there is no sign in New Zealand house prices (and unsurprisingly) that the initial introduction of the brightline test, or its more recent extension, made any material difference to New Zealand house prices. So there is little reason to suppose this change will either (contrary to Treasury who claim to believe it will make a difference even in the “medium term”, albeit perhaps not the long term). It will, of course, change some transactional behaviour, reinforcing a lock-in effect for some investors (and thus reducing the efficiency of the housing market), but that is a different matter than any sustained impact on prices.

One aspect of the brightline test extension I haven’t seen referred to – and is not mentioned at all in the RIS – is the interaction with inflation. Over a 10 year horizon – let alone the 20 years Treasury favoured – a significant chunk of any house price increases will be general CPI inflation (if the Reserve Bank met its target the CPI would rise by 22 per cent over 10 years). There is little serious case anywhere for taxing general inflationary gains (as distinct from increases in real asset prices/values), and the issue is reinforced by the increases in the maximum marginal tax rate to 39 per cent. Suppose the government’s policies finally got on top of growth in real house prices and the only increase in house prices was from general CPI inflation. Someone selling just before the 10 years would be paying 8.5 per cent of the value of their asset in tax even though they had had no increase in real purchasing power at all. That would be a straight confiscatory tax, even more so at the horizons Treasury favoured (where it is harder to avoid by delaying sale). And yet Treasury regards a longer brightline test horizon, with full nominal gains taxed at a higher rate as both fairer and more efficient! A capital gains tax should tax either real gains or, much less desirably, tax nominal gains at a reduced rate. For the scapegoated sector we now have nominal gains taxed at a high (and rising) rate.

What of the deductibility policy? This is, as announced, a simply bizarre policy, not helped by the egregious spin – really bordering on lies – from the government suggesting that the ability to deduct interest from gross income in calculating the owner’s tax liability is a “loophole”. It is simply standard practice, a deduction open to any business. Except, very soon, operators of residential rental businesses. In many firms, in a wide variety of sectors, interest is a cost of doing business.

I can think of three bases on which a policy change around deductibility might have made sense. There is a decent argument that, for tax purposes, no interest paid should be deductible and no interest earned should be assessible. But that would involve universal application. There was an argument that some (from memory including Don Brash) used to advance that with no tax on capital gains, perhaps interest on investment property should not be deductible. But extending the brightline test to 10 years substantially undermines that argument for houses…..leaving it more potent for other assets (eg farm land) to which deductibility has not been limited. And that argument that I find most appealing – and which from memory the Reserve Bank used to favour – was that some proportion of interest deductions were really just inflation compensation, and didn’t really amount to a real expense (just maintaining the real value of capital). But that would argue for a symmetrical treatment of interest income and interest outgoings, and for a comprehensive approach, not just one picking on a current government scapegoat. Had the government been serious about rigorous reform that improved, not worsened, the tax system they could have foreshadowed that sort of change. At present, with interest rates so low, it probably would have reduced by about half the extent of interest that could be deducted.

(The “loophole” argument appears to be based on the fact that owner-occupiers cannot deduct interest. It should barely need saying that owner-occupiers are also not assessed for tax on the imputed rental value of living in their home – nor, of course, (generally) are they subject to the “brightline test”. Whenever there have been serious suggestions of taxing imputed rentals it has been recognised that interest deductibility would need to be introduced as part of any such mix. )

There seems to be a range of views around about what impact the deductibility change will have, especially on house prices. Westpac appears to mark out one end of the range, suggesting in a bulletin yesterday that house prices could settle 10 per cent lower over the longer-term with the potential for “much greater effects” in the shorter-term.

As they note, the Westpac economics team – their chief economist is currently on secondment to The Treasury – have long been advocating a model of house prices in New Zealand that emphasises the power of tax policy and tax policy changes to affect house prices. I’ve long been sceptical of that sort of story (and to refresh my memory dug out notes I’d written on the specific role of tax while at both the Reserve Bank and the Treasury). A paper with a very similar approach to the Westpac one was published as a Reserve Bank discussion paper some years ago, and it has a useful table (page 14) looking at the way in which various variables, including tax ones, affect the price various classes of potential purchasers (leveraged, unleveraged, investors, owner-occupiers) will be willing to pay for a house.

I’m no more convinced this time that tax (or regulatory) changes will have a large effect on prices (and a 10 per cent longer-term effect is quite large) than on previous occasions. One might expect some difference in what type of entity owns the property, but even then it is as well to be cautious. Just a couple of years ago, the ability to offset rental losses against other income was removed, and I’ve seen little in the way of analysis or argument suggesting that had very much effect at all, in prospect or in realisation. But if we go back further, there was little sign that the increase in the maximum marginal tax rate in 2000, foreshadowed with certainty for at least a year, gave a big boost to house prices (as the model predicts, because interest deduction is more valuable) or that the reversal of that increase a decade later cut house prices. The arbitrary removal in 2005 of the ability to deduct depreciation – on houses (as distinct from land) – didn’t seem to have a discernible sustained effect. The PIE regime, which worked against individual landlords, had little obvious effect. And going back further there is even less sign of such effects as decades earlier maximum marginal tax rates rose to 66 per cent, and then fell again, when inflation raised nominal interest rates (increasing the value of the interest deduction) or when ring-fencing was abolished in the early 80s and reinstated in the early 1990s. I’m also sceptical because we can see the huge divergence in house price outcomes in US cities, with fairly similar tax codes and banking practices across them, in ways that point to land use restrictions – and the long-run supply price of new houses – as the more important explanatory factor.

Perhaps this time will be different (although, almost inevitably, we will struggle to know, trying to unpick all the competing influences. Presumably some holders of investment properties will take the opportunity to sell now. Quite probably yesterday’s changes will help bring forward the temporary pause, or perhaps even pullback, that was always likely before too long (with no population growth, much tighter LVRs, perhaps a (irrational) ban on interest-only lending, perhaps even some lift in term mortgage rates etc). We’ve seen such pauses before and will no doubt see them again. But the supply/land issues have not been tackled.

It is worth noting that under the sort of model Westpac (and the Reserve Bank, see above) used, the purchaser willing to pay the highest price for a house was………..not the highly-leveraged investor but the unleveraged owner-occupier. That was so back in 2008 (when the RB analysis was done), reflecting the fact the imputed rental income is not taxed (and such purchasers have no interest payments). The difference is greater now – even prior to yesterday’s announcement – because owner-occupiers don’t have to worry about the brightline tax, while any investor – even if iniitally intending to hold for more than five years, rationally has to factor in a probability of seeling earlier.

Perhaps a little surprisingly (my notes record that it was so to me) is that the group next most willing to pay is the unleveraged investors. They do pay tax on their rental income, but – like the owner-occupiers – they have to think about the opportunity cost of their money, which has to be invested somewhere. Deposit rates are typically a lot lower than mortgage rates, and one will pay a price to avoid being stuck in deposits. Heavily-geared landlords (and remember, they can now borrow only 60 per cent from banks) come in only third. Of course, there may be times when highly-leveraged landlords are key marginal players – quite plausibly the last few months, especially when dealing with a temporary lifting of financial repression targeted at such people – but it wasn’t the general case, even pre-brightline.

One of the uncertainties, of course, is to what extent rents rise in the wake of this change. There is a lot of headline coverage of that, but the honest answer is that we don’t really know (although, again, the nature of the effect should be similar to that for ringfencing, albeit potentially on a larger scale). I’m a little sceptical as to how large the effect will be – notwithstanding the buffering the Accommodation Supplement provides – because if leveraged landlords were able to recoup all/most of their increased costs, that would leave excess expected returns on offer for unleveraged landlords (who are not directly affected by the loss of deductibility). Owner-occupation certainly hasn’t got easer – relative to six months ago LVR controls are back and prices/deposit requirements are higher (or even on Westpac’s take no lower) so I’d expect the biggest difference to be a shift over time from more heavily leveraged landlords to less-leveraged or unleveraged landlords, perhaps with a relatively modest (sustained) rise in rents.

This is, of course, then a policy that skews opportunities away from those needing debt finance (it explicitly no longer treats debt and equity similarly, previously one of the strengths of the NZ tax system) and they tend to be….the new entrants and more-marginal players. In favour of old money, institutional investors etc – who have pools of money that need investing. Now if you are a central banker you might think less leverage was “a good thing” (although that is what capital requirements are for) but it isn’t obvious that is so more generally, given the rigged land market. As Adrian Orr used to say – back when we were analysing housing options at the Bank 15 years ago – many of the leveraged investors are people like (his example) firemen, with a modest salary and using leverage – where it is available with good collateral – to get into an investment property, doing maintenance etc on their days off, getting a foot on the ladder (and some “forced savings” too). It was like that for a long time, whether or not real house prices were rising strongly.

Officials and ministers – especially Labour ministers – really don’t seem to like those sorts of people, and the sort of housing supply that results. Over a couple of decades now policy seems to have been set increasingly in ways that will have the effect of driving these small, initially quite leveraged, players from the housing field. In some cases that has seemed deliberate – including from some who really think home ownership isn’t something people should reasonably aspire to, and that long-term renting is some sort of Germanic ideal – in others just a side effect, but the direction is pretty clear: they favour institutional savings, not individual, and institutional (or large scale) rental providers not individual ones. And so the policy system – which 30 years ago treated these groups neutrally – no longer does. PIEs are taxed less heavily than individuals. Increased regulatory burdens (as ever) favour large players not small. Taxes based on realisations favour large unleveraged players, since they are less likely to be forced to sell, and have future gains to carry forward losses against). And now this egregious new distortion favouring equity over debt in rental housing. I don’t have any problem with institutional and corporate providers of rentals, but it should be an outcome of choice , enterprise, opportunity etc, not regulatory and tax distortions secured in their favour. Worse still, of course, is that if this latest package really does impair the availability of private rentals it will just strengthen the argument on the left that the state should be a much larger rental provider. There is a role for state rental dwellings, for a very small minority of troubled people, but in a functioning land and housing market there would simply be no market failure justifying such an intervention.

And a functioning land market – where there is aggressive competition among land providers/owners and genuine choice for potential purchasers between options on the periphery and options at greater density – is how unimproved outer-urban land prices should once again be somewhere near the price at the best alterative use (mostly farming presumably), not driven higher by artificial regulatorily-supported interventions. But such a market is what the government seems utterly uninterested in providing. The alternative – increasingly messy interventionist version of the status quo – appeals to the Greens and the statists, but it shouldn’t appeal to New Zealanders who care about their children becoming self-sufficient and able to meet the simple aspiration – readily achievable in a land-abundant country – of being able to purchase a basic house in their 20s.

Sadly, whatever was going to happen to house prices over the next three to five years anyway, it is hard to think that after some initial disruption, yesterday’s package will make very much sustained difference to prices at all. But I guess it will buy some political time and ease the headlines; today’s substitute for serious courageous leadership. Fixing the land market (and indexing the tax system) is still an option for some real leader, some day. If only.

Questions

Michael Reddell New Zealand economic performance, pandemic

I’m a bit puzzled as to quite what has gone on in the New Zealand economy over the last year.

Of course, to some extent Statistics New Zealand must share that puzzlement. On their two real GDP measures – and there is no particular reason to favour one rather than the other – they aren’t sure whether by the December quarter last year real GDP was a bit higher or a bit lower than it was a year earlier. One measure shows a 1.2 per cent increase, and the other a 0.9 per cent fall. I tend to average the two measure, so a best guess now might be the GDP in December 2020 was about the same as in December 2019.

two GDP measure

The difference in the New Zealand GDP measures is almost the least of my concerns. Unfortunately there is always some difference in these two measures (trying to measure the same thing) and things have been a bit more difficult than usual during 2020 (especially so in the June quarter). We’ll keep getting that history revised for several years.

In Australia, the (generally highly-regarded) ABS reconciles their two real GDP measures: according to them Australia’s real GDP in the December quarter was 1.1 per cent lower than in the December 2019 quarter. On the face of it, such a difference seems plausible. We both had closed international borders, but Australia had more intensive sustained closed internal borders, and a few more Covid restrictions in place. (As it happens, if one looks at 2020 as a whole the falls in real GDP in New Zealand and Australia were more similar, reflecting our horrendous June quarter.)

But dig a little deeper and things get more curious. I’m really interested in labour productivity, and have regularly run here charts of labour productivity growth (and lack of it). So I checked out the hours data. We have two measures in the New Zealand: the HLFS measure of (self-reported) hours worked, and the QES measure (based on sample surveys of firms) of hours paid.

According to the QES, hours paid in the December 2020 quarter were 0.3 per cent higher than in the December 2019 quarter. That didn’t sound too implausible, especially if GDP (see above) hadn’t changed much over the period as a whole.

Unfortunately, the HLFS reports an increase of 3.9 per cent in hours worked over the same period. And while there are always differences in the two measures (a) over a full year they aren’t usually anywhere near that large, and (b) there was nothing like such a difference in the first year of the 1991 and 2009/09 recessions. Oh, and if one was going to expect a difference in 2020 one might have thought hours paid would have held up better than hours worked (between government wage subsidies, employers trying to hold onto staff, and public servants (eg immigration and biosecurity staff who don’t have much to do, but who couldn’t be laid of, by government decision). And since the HLFS employment rate – reported by the same people – fell by 0.8 percentage points over the year (and the unemployment rate rose) it really doesn’t seem very likely that the hours worked really jumped by 4 per cent.

In Australia, by contrast, the employment rate also fell by 0.8 percentage points last year and hours worked fell by 3.5 per cent. Which sounds fairly plausible: some job losses and a wider group of people working fewer hours than previously.

So what does all this mean for productivity? In the ABS official series, real GDP per hour worked rose by 2.5 per cent from December 2019 to December 2020. That seems plausible, not because Covid and closed borders were good for productivity but because tourism and related sectors (including eating out) have been particularly hard-hit, and those are typical low wage/low productivity sectors. Even if no individual worker is any more productive, the temporary loss of those lower-skilled jobs/hours will have averaged up real GDP per hour worked over the whole economy. A clue that this is what is going on is that the lift in average reported productivity was much larger in the June quarter (more Covid restrictions), unwinding to some extent subsequently,

What about New Zealand? I usually report an indicator of labour productivity growth calculated by averaging the two GDP series and the two hours series. If I do that for last year, we experienced -2.1 per cent average growth in real GDP per hour worked. And I simply do not believe that. But even if I just use the QES hours paid measure, we end up with a 0.1 per cent fall in real GDP per hour worked for the year, much worse (on those estimates, which will be revised over time) than Australia.

Closed borders etc should be bad for productivity. If we had true estimates, adjusted for changes in capacity utilisation, we might expect to see a fall in both countries. But there isn’t really a credible explanation for New Zealand doing quite so much worse than Australia last year (in December on December comparisons), other than problems with the data.

But then I’m also left with doubts about the GDP numbers themselves. Partly because in putting together quarterly estimates of GDP – and they really are just estimates at this stage – Statistics New Zealand needs to have some sense of how many people are here, as something to calibrate their sample surveys with. And there are oddities there too, highlighted by comparisons with Australia.

Recall that both countries have had largely closed borders since about this time last year. In the year to December 2019, Australia’s population was estimated to have risen by 1.5 per cent, while ours was estimated to have risen by 1.9 per cent. And yet in the year to December 2020 our population is estimated to have increased by 1.7 per cent, and Australia’s by 0.7 per cent. Both countries have rates of natural increase, that don’t change much year to year, of currently about 0.5 per cent per annum.

Of course, as we know people have continued to cross the borders, but in greatly reduced numbers. In New Zealand, for example, a net 39000 more people left New Zealand from the end of December 2019 to the end of February 2021 (more than the natural increase over that period). There have been net outflows (mostly quite small now) each month since March last year (125000 outflow from March to February). And yet the SNZ estimate is that the official (resident) population measure has grown almost as rapidly in 2020 as in 2019. Now, of course, lots of holidaymakers went home/came home – they were always “resident” at home, wherever they were spending at the time. Lots of temporary dwellers went home/came home. But the rate of population increase SNZ is reporting doesn’t make very much sense. Again, especially relative to Australia, which has had a 180000 net outflow over the twelve months to February (and presumably quite similar dynamics to New Zealand – lots of people leaving and really only Australian citizens and permanent residents coming in).

Perhaps both numbers are right, perhaps one country’s is and the other’s isn’t. Both are using (what I thought were similar) model estimates. But on the face of it, the Australian change in resident population looks a lot more plausible than New Zealand’s (and I’m not even reporting here GDP per capita numbers).

It isn’t obvious that we have any really good, timely, independent checks on these New Zealand numbers. I’m not offering answers, just highlighting questions and uncertainties. Unfortunately it might be a few years yet until we have a really good steer on what went on last year (if ever re the June quarter specifically) and what the new emergent trends are, including re relative productivity performances of Australia and New Zealand.

Free up the land

Michael Reddell Uncategorized

I suggested on Twitter yesterday that the Green Party’s new housing policy – as articulated on BusinessDesk here by Julie Anne Genter – was absolutely right about the urgency of the issue (actually reform has been overdue for the best part of 30 years) and the need for boldness, but quite wrong about proposed policy responses, which seemed to tackle symptoms while failing to get to the heart of the matter. BusinessDesk invited me to submit a piece offering my solutions. That column came out this afternoon, and is here (not behind the paywall).

Since people tend not to click on links, and I haven’t given the copyright to BusinessDesk who published it a couple of hours ago, I’ve set out my full text below.

Bear in mind that I had only 800 words. That meant I had no chance to do anything much more than set out the key points of my own proposal – even then briefly – and in particular could not defend claims like “Banks aren’t the problem, and the tax system isn’t the problem either.   Nor are those popular scapegoats, “landlords” and “speculators” “, or elaborate on a whole variety of points, and qualifications, that a fuller treatment of the issue would warrant. I’ve dealt with many/most of those points here over the years, often at length, but might take the opportunity next week to do a further post, with commentary on each paragraph elaborating (or where necessary qualifying) various points and arguments.

In a way, my bottom line is in the second to last paragraph. With structurally record low real and nominal interest rates, houses and housing (two different things) really should be cheaper than ever in real terms. That they aren’t is the choice – active and passive – of successive waves of central and local government politicians. The current wave is currently responsible, and sadly they – especially the Prime Minister, who has the most say (and an absolute majority) – show no serious interest in the sort of better, much cheaper, outcomes – sustained over the longer-term – that are quite possible.

Free up the land

Real house prices have more than trebled in the last 30 years.  The most recent surge is just the latest in a series that result directly from the choices of successive central and local governments.   And what choices mattered most?   Land use restrictions, in a country with so much land that our urban areas cover only 1 per cent of it.    When people talk about real house prices having skyrocketed, mostly what they really mean is that the price of the land under the house has gone crazy.

Unfortunately, all indications are that the sorts of the things the government and the Reserve Bank  are considering will just paper over a few more of the cracks and not address the real issues.  Banks aren’t the problem, and the tax system isn’t the problem either.   Nor are those popular scapegoats, “landlords” and “speculators”.

One way of seeing this is to look at the United States, where the regions all have much the same banking and tax systems, but often quite different land-use regulatory regimes.   Some big growing cities there are among the most expensive places on earth – like Auckland and Wellington – while others have price to income ratios that are low and haven’t changed much over several decades.  They also tend to be the places with the highest rates of owner-occupied housing.

 So, what urgent steps should the government be taking?

First, legislate now to establish a presumptive right for any landowner to build as many single or two storey dwellings on any land they own, anywhere.    Aggressive competition among landowners on the fringes of our cities and towns, scared that they will miss out and that development will happen elsewhere, is what would underpin much lower urban land (and house) prices.

Second, empower groups of existing landowners in built-up areas (perhaps at a block or individual part of a suburb level) to determine – by super-majority vote (perhaps 75 per cent) – how much, if any, additional density they want to permit on their land.  Vote for greater density and they can capture any gains from land made more valuable as a result (which might not be large outside central city areas if new land can easily be brought into development). If not, respect those groups of landowners’ preferences.  

Third, the Prime Minister needs make it a personal priority – featuring prominently in all her communications – that house and urban land prices should fall very substantially and stay down. Serious reforms happen, and are followed through on, when Prime Ministers believe in them and commit their skills and political capital to making them happen.  We can’t have any more of senior political figures (both sides of politics) feeding a narrative that house prices should always trend up.  They shouldn’t. 

Asset markets trade on expectations, and no smart purchaser one is going to be keen to pay ever higher prices today when there is a serious chance, by actual reform now and evident political commitment, that the asset will be much cheaper a year from now.   

Fourth, as too many ordinary families – just wanting a place to call their own – have been caught in this government-facilitated mess, establish a partial compensation scheme for owner-occupiers (only) who have bought in the last decade and who sell in the next decade.  It won’t be cheap, but neither are the economic and social costs of the mess governments have got us into, that among other things has young people convinced that what should be a normal aspiration – buying a first house in your 20s – is now some unattainable aspiration, reserved for the offspring of the rich.  Stabilising prices now and hoping low inflation does the job over decades is no adequate substitute for proper reform.  Our young people deserve much better.

Real interest rates having been falling for decades, and are now at lows not seen persistently in a very long time, if ever.  If we had functioning markets in land and housing, that should mean houses and housing that are cheaper, in real terms, than ever.  It takes time (and a lot of money) to develop subdivisions, it takes time to build houses, and the interest costs of doing so are lower than ever.  Rents are the cost of using a long-lived asset for a period of time, and the alternative investments (bonds, term deposits) now yield less than ever. And yet because governments make land artificially scarce, house/land prices continue to push ever higher, and rents themselves are unconscionably – utterly unnecessarily – high.    

Reform should be about getting housing/land markets functional again, partly compensating some of the losers, and making housing once again something that young people don’t need to worry much about, all without messing up access to finance.  It is about fixing injustice now, and rooting out the systematic disadvantage, working against the young and the poor, that governments themselves created.

What the IMF has advised

Michael Reddell IMF

Following on from yesterday’s post looking at what the IMF had advised the government on housing issues in the Concluding Statement from the recent Article IV consultation, I got curious about how that advice had evolved over the years. I could recall some bits and pieces, but I thought something a little more systematic might be in order.

I had hoped to look at the Concluding Statements going back 20 years, to encompass at least the house price surge in the 2000s, but the Concluding Statements I could find on the IMF’s website go back only as far as the (March) 2009 consultation. But at least starting from there encompasses a full economic cycle. In March 2009 all the attention was on the recession, the global crisis pressures, and so on. House prices had been falling, but not dramatically so and so got little attention.

Productivity issues are not the focus on the IMF, which is supposedly primarily about macroeconomic and financial stability issues, but I’ve had a bit of a bee in my bonnet over the years about the way the Fund often comments anyway, often without much depth, and – so it seemed to me – often just reflecting back not much more than the political priorities of the government of the day.

So I went through the 11 Concluding Statements from 2009 to 2021 (there was none in 2016 or 2020) and pulled out all the references I could find to housing (house prices, housing finance, taxation of housing, housing debt vulnerablity, housing policy) and, separately, all the comments that fit, explicitly or not, under a productivity heading. The resulting document, composed almost entirely of cut and paste paragraphs, organised by year (housing at the front, producitivity later), is here.

IMF concluding remarks on NZ housing and productivity 2009 to 2021

What impressions did I take from this exercise?

On housing, the first impression is how event-driven their advice seems to be, except perhaps around the underlying level of household debt (relative to income/GDP). There really isn’t much in the first few years, when house prices weren’t doing much but the underlying structural policy failures around housing hadn’t changed. Then as house prices rise they express concern, and as house price pressures ease so do the expressions of concern. That is the stuff of newspapers, not detached independent analysts supposedly with a long-term vulnerability-based perspective.

There is plenty of evidence in the early years of the Fund endorsing what was then the Reserve Bank’s view – that our banks were adequately capitalised, that our approach to risk weights etc was more conservative than in most places. Then came Graeme Wheeler who, in a radical departure from decades of New Zealand financial system regulation rushed into imposing LVR controls. And the Fund’s advice suddenly thinks such controls are a good and proper thing, albeit to be exercised temporarily and sparingly. Remarkably – well, perhaps not, but the vision (of Fund surveillance) is supposed to be of free and frank external advice – not once do they cast doubt on any of the numerous iterations in aspects of LVR policy (not even, for example, the politically-driven exemption for new builds, even when the Fund must know such developments tend to be riskier than existing dwellings). And then a few years ago when the Bank gets keen on DTI limits, suddenly (but not before) the Fund is very keen too.

And whereas the advice had been that – as the Reserve Bank had stated at the time – that LVRs should be used temporarily and sparingly, the IMF becomes increasingly reluctant to see any easing of such restrictions, even years on. Not coincidentally, that seemed to be the Orr position (he has increasingly talked of such restrictions being a permanent feature).

Of course, they also flipped on capital requirements – essentially the stance at the time of the Bank itself; praising the cautious conservative approach in earlier years, and then flipping to favour Orr’s aggressive planned increases in capital requirements. Never, of course, addressing their earlier view.

What about housing policy itself? There is probably some continuity in Fund advice around favouring a capital gains tax but – whatever the tax policy merits of such a regime – no suggestion in any of the mentions of countries where a capital gains tax had made a sustained material difference to house price outcomes.

For the rest, they talk up Kiwibuild when the government was….and then it quietly disappears. From time to time they mention land taxes, but typically not with any conviction. Again, there is probably an underlying theme – mostly echoing back what officials and ministers tell them – about liberalising supply and land use (but, of course, they have no expertise to evaluate specific claims).

And then this year….quite out of the blue…..we get the proposal for a stamp duty on houses – never before mentioned in New Zealand, and something the Fund has favoured (eg) the UK and Australia getting rid of.

They used to favour neutral policy instruments but by this year’s report you’ll recall that they were dead-keen – echoing the government – on singling out “investors” for much harsher treatment, tackling sypmtoms not causes. Could the Fund have imagined itself – all while still suggesting the financial system is sound – recommending a decade ago the sort of discriminatory measures they proposed in this year’s report?

Now in the Fund’s defence one could argue that housing policy itself is not really part of their mandate: macroeconomic and financial stability is their thing. But it is the Fund itself that repeatedly chooses to step beyond the narrower dimensions – how robust are the banks and the government finances – the housing policy, housing tax policy, policies on the sectoral allocation of credit (the latter I’m sure they’d have censured firmly 40 years ago).

What of productivity? Again, even though this is a longrunning New Zealand policy failure, it isn’t really that close to the IMF’s remit. One can be poor and stable, rich and stable, or – now New Zealand’s story – upper income and stable. Or unstable in all those states of income/productivity.

But again, at times the IMF chooses to offer its tuppenceworth (although in four of years I looked at they focused more narrowly and had nothing to stay on wider structural policies – some of that may be about the interests/style of individual mission leaders). But what of what they did say? A decade ago they were keen on lower income taxes. This year, there is not a mention of the government raising income tax rates. A decade ago they were keen on welfare reform with a focus on encouraging the unemployed back into work. This year, they explicitly welcome permanent increases in unemployment benefit rates. Three years ago they got brave and raised some doubts about increasing minimum wages too much – mentioning specifically downturn risks – but this year, no mention of steadily higher real minimum wages at all, even as they rightly highlight ongoing macro risks.

There is some continuity, but where it isn’t surprising or controversial (among officialdom and the main parties). They like foreign trade and preferential trade agreements – even as they have almost nothing to offer on why trade as a share of GDP remains so low in New Zealand. They are generally keen on facilitating foreign investment (which I welcome) and are reasonably consistently keen on R&D subsidies. A couple of years ago they were keen on the Provincial Growth Fund and even fees-free tertiary education but we must assume they were simply reporting and endorsing the ministerial preferences of the day. This year, of course, we have green and inclusive growth, but with no analysis, evidence or reasoning in support.

Of course, to some extent I am being a little unfair. These Concluding Statements are typically only two or three pages long, and you can’t put everything in that sort of space. I could – but won’t at present – go through the fuller Article IV reports and do a similar exercise. I’m pretty sure what I would find would be no more consistency through time (or across countries) but a bit more reasoning in support of some of the positions IMF staff happen to hold that year.

Does any of this matter? Not a great deal, at least if you start from a view that the IMF has no useful role in today’s world. But given that the institution exists, employs a lot of able people, and has access to the perspectives and experiences of a very wide range of countries (much more readily so than any one here, government or private, does) it seems a shame we don’t get something better. The IMF should be able to bring two things to the table: independence and a willingness to speak in a free and frank way into the local discussion, and the benefit of really good cross-country comparative perspectives and insights. As it is, we are mostly getting neither, mostly just getting reflected back the preferences and inclinations of the day’s ministers and officials, with perhaps a few (nearly random) asides, some marginally useful, but more often not.

Housing, house prices, and the like

Michael Reddell Adrian Orr, Housing, IMF

We’ve had a couple of widely-reported contributions to discussions on housing policy in the last few days.

The first was the Concluding Statement from the staff mission responsible for conducting the latest International Monetary Fund Article IV consultation with New Zealand (usually a physical mission here from Washington, but presumably done remotely this time). These statements are not formally the official view of the IMF management, let alone the Board, but you don’t get to be a mission leader without demonstrating your soundness and ability to run a line that won’t upset the Board and management. That doesn’t mean the messages are typically consistent either across time or across countries, but it does mean the final report (and the Board review of it) won’t be materially different. Of course, it helps that New Zealand isn’t a very important country (to the IMF – we don’t borrow from them, we pose no threat to global or regional stability etc) – and that the New Zealand authorities don’t these days typically pay much heed to the IMF (in some countries, including a bigger one west of us, authorities have been very very concerned that never is heard a discouraging word from the Fund).

I used to have quite a bit to do with the Article IV processes, both from an RB/Treasury perspective, and in the couple of years I spent representing New Zealand on the Fund’s Board. Specifically, I used to be regularly involved in the final meeting between the Fund mission and Treasury/RB senior macro people on the drafts of the Concluding Statements. I guess it must have been different at times, in countries, when the Fund thought the authorities were going rogue, running reckless or dangerous policies, but if New Zealand has at times offered puzzles for the Fund, it has also been run with pretty cautious macro and financial policy approaches (low public debt, focus on balanced budgets, low inflation, stable banks, high capital requirements and so on). So whatever the Fund has to say tends to be pretty marginal or incidental anyway, and in many topics they touch on the mission team don’t actually have much specific expertise (they are mainly macro people, often very able to that narrow space). So the Fund team tended to be quite accommodating of Treasury/Reserve Bank preferences around what was said in any Concluding Statement, with a focus on “what would be helpful” to the authorities at that time. And this, of course, is only the end of days and days of meetings – often some wining and dining too (although I guess not this year) – in which staff are fully appraised of “sensitivities” and what officials (and the Minister) would prefer the Fund did or didn’t say. No doubt there are limits, but most often the remarks are about issues at the margin – either shades of policy in core areas, or matters on which the mission team doesn’t have much expertise, authority or mandate. Not often then will the Concluding Statement be troublesome for the authorities. (In fact, this is one of the downsides of the move to near-full transparency around the IMF Article IV processes in recent decades.) Favoured mantras will often, quite conveniently, be repeated back to the authorities, as little more than mantras: an example this time is “inclusive green growth”, whatever that means.

In this post I wanted to focus on housing, a rather central issue in current policy and political debate in New Zealand, arguably even a source of potential financial sector instability. What did the Fund have to say on the subject? There were several references, the first from the summary bullet points

  • The rapid rise in house prices raises concerns around affordability and financial vulnerabilities. A comprehensive policy response is needed, including measures to unlock supply, dampen speculative demand, and buttress financial stability.

Surging house prices have supported household balance sheets but amplify affordability concerns for first home buyers and financial stability risks.

“Affordability” has certainly been stretched (to say the least), but it isn’t clear there is any greater threat to financial stability at this point. After all, as the report notes, household balance sheets as a whole have improved – not worsened – and if some marginal borrowers have taken on new debt at very high valuations (a) they are the marginal players, and (b) both banks and the Reserve Bank have imposed new and demanding LVR standards. Private lending standards have tightened – over the whole of the last year – not loosened. But it will have suited the authorities to have these references included.

Then we start to get to policy. The first reference reads as follows

Surging house prices should be addressed primarily through fiscal, regulatory, and macroprudential measures, though monetary policy may have a role if house prices pose risks to the inflation objective.

FIscal (tax?) measures as the main way to “address” house prices? On what planet does the Fund think this would be anything more than papering over cracks, and distracting from the core issue? But it will have suited the authorities to have it. And when they say “macroprudential measures” what they really mean is just new waves of controls. After all, the rest of the report suggests no particular reason for concern about the soundness of the financial system. It might have been nice to have seen “deregulatory” instead of “regulatory”, but I guess we can let that pass.

And what about monetary policy? Remarkably, there is no mention at all in this Concluding Statement of the government’s recent change to the Reserve Bank’s monetary policy Remit – the one that seemed designed to create the impression monetary policy was going to do something, even as the Reserve Bank itself said it wasn’t (an impression that at some international audiences have also erroneously taken). And that final half sentence? Well, it just looked like pandering as the Statement had already indicated the team’s macro view that monetary policy is likely to need to “remain accommodative for an extended period”.

They then get a little more substantive

Tackling supply-demand imbalances in the housing sector requires a comprehensive approach.

· Achieving long-term housing affordability depends critically on freeing up land supply, improving planning and zoning, and fostering infrastructure investments to enable fast-track housing developments. Steps taken to support local councils’ infrastructure funding and financing would facilitate a timely supply of land and infrastructure provision. The reform of the Resource Management Act is expected to reduce current complexities in land use that restrict infrastructure and housing development and contribute to efficiency in strategic planning. Increasing the stock of social housing also remains important, and the Residential Development Response Fund’s plans to deliver 18,000 public houses and transitional housing space, undertake rental housing reforms, and provide assistance to low-income households are welcome.

I guess the government will be quite happy with that. Suggest it is all big and complex and will take years to come to much. Oh, and that final sentence which would appear to be pure politics – you might agree, or not, with building more state houses or handing out more money to low-income people, but it bears no relationship at all to the Fund’s macro mandate, let alone to fixing the housing/land market that regulation has rendered dysfunctional. Smart active (but big) governments are clearly the thing.

But the broad thrust of that paragraph isn’t really that objectionable. Where it gets really problematic is the next paragraph.

· Mitigating near-term housing demand, particularly from investors, would help moderate price pressures. Introduction of stamp duties or an expansion of capital gains taxation could reduce the attractiveness of residential property investment. The authorities should differentiate in these approaches between first home buyers and investors, while continuing to provide selective grant and loan assistance to first-time buyers.

and this one

The deployment of macroprudential tools to address housing-related risks is welcome. The reinstatement of loan-to-value ratio (LVR) restrictions in March and further tightening for investors from May 2021 will help mitigate stability risks. Additional tools, including debt-to-income ratio limits, caps on investor interest-only loans, and higher bank capital risk weights on mortgage lending, are under consideration and could play a useful role in addressing housing-related risks.

Of the first of those paragraphs, really the less said the better. Price freezes dampen reported CPI inflation, wage freezes dampen reported wage inflation. Lockdowns reduce effective demand for, say, restaurant or cafe services. And so on. All sorts of daft, dangerous and inefficient mechanisms can be deployed to try to suppress symptoms, but most of them never should be. And nothing in that first paragraph stands up to any serious (macroeconomic, or really housing market functionality) scrutiny at all. But it must have gone over quite well in the Beehive, where “investors” seem now to be scapegoats for all ills, almost in the way that Jews were often so tarred in eastern Europe etc 100+ years ago. Just an attempt to distract from the real issues, the real policy failures.

The IMF – once concerned with functioning markets and more efficient policy regimes – is now actively touting policy interventions that differentiate by type of buyers, even though this advocacy seems to rest on no analysis whatever. And take as a particularly egregious example the mention of a stamp duty. These sort of transaction taxes are widely disliked in the economics literature – since they impede the functioning of the market directly affected and impair, for example, labour market mobility. In fact, they used to be firmly disapproved of by the IMF – which within the last five years has again recommended to the Australian and UK authorities (with very similar housing markets) that they move away from using stamp duties. So where did this suggestion come from? Either the Fund itself – in which case, serious questions should be asked about consistency of advice – or from The Treasury or the Minister of Finance? Is this an option that they are considering – perhaps (as the Fund phrasing talks of) just for the despised “investors”? The government made those idle pledges about no new taxes, but the “two minutes hate” now routinely directed at “investors” might suggest the government could get away with such a (Fund-supported) fresh distortion, at least among their own base.

And what about that “while continuing to provide selective grant and loan assistance to first-time buyers”? Surely the Fund knows – they’ve told countries often enough – that such interventions tend to flow straight into prices? And what does any of it have to do with the Fund’s macro or financial stability mandate (let alone any focus on economic efficiency?) But no doubt it went down well with the government: was “helpful to the authorities”.

I have heard a suggestion that perhaps what the Fund might have had in mind was a “temporary” stamp duty – whether just for investors or for everyone. If so, they should have said so. But if so, what planet are they on? All manner of taxes have been introduced “temporarily” over the years in many countries. Few get removed very easily – governments become addicted to the revenue, and/or happy to continue to deal with symptoms not causes. And the Fund itself – at least those of its officials with any sense of political economy – knows that.

And then there is the financial controls paragraph. These days the Fund really likes LVR restrictions, and the tighter ones still to come. In none of this is there any hint of the efficiency dimension. In none of it is there any hint of the analysis of risk (let alone of the interaction with the demanding new capital requirements – which don’t mess up the allocation of credit across sectors – the Fund has previously favoured), And having favoured very stringent LVR controls there is then no discussion about what, if any, the residual systemic risks (related to housing) might be. Instead, they allow themselves to become a channel for communicating, and apparently endorsing, the Reserve Bank’s own interventionist aspirations. If the Fund favours, for example, banning interest-only mortgages to “investors”, how does it square that preference with a regulatory restriction that already requires investors to have a 40 per cent deposit? One or other restriction might, in some circumstances, make sense. Both combined just seem like giving up on the market allocation of credit, papering over symptoms, and returning to the control mentality of ministers like Walter Nash. All ungrounded in that statutory goal that the Reserve Bank must exercise its regulatory powers over banks towards: promoting the soundness and efficiency of the financial system.

(Oh, and if the IMF believes that higher risk weights are warranted on housing, it will be interesting to see any argumentation they can advance in their final report – surely there will be none – for how the Reserve Bank has previously got it wrong: the same organisation the Fund repeatedly praised over the years for its cautious (emphasis on risk) approach in setting capital requirements, including for housing.)

If one had any doubts about the direction in which things are heading, there was the Q&A interview with the Reserve Bank Governor yesterday. It was a seriously soft interview by a TV1 political reporter, who displayed (a) no sign of any understanding of the legal framework the Bank operates under, (b) no sign of any real understanding of the housing market, and (c) no interest in doing anything but helping the Governor run his message, even feeding him loaded phrases in the questions. There was not a single serious challenging question. Not one. (Not even – an obvious question for a political reporter – about the recent change to the MPC Remit, talked up the Minister of Finance and then talked down – to the point of being almost dismissed – by the Bank.)

Orr went on and on about investors purchasing housing, but never once noted that if the land market were sorted out – and he did in passing acknowledge supply issues – the entire environment would be different: not only would houses/land not be expected to appreciate in real terms, but owner-occupier affordability would be that much greater (and without LVR restrictions it would also be easier for first home buyers). He made no attempt to tie the fresh interventions he and the government seem to be cooking up to the soundness of the financial system. In fact, he almost disavowed that as a consideration, claiming that the Bank had previously focused on systemic stability (whole financial system) but now had a new mandate that would enable it to focus on a specific asset class. Here he appeared to be referring to the direction issued to be the Bank a couple of weeks ago under section 68B of the Reserve Bank Act. It reads

 I direct the Reserve Bank of New Zealand (“Reserve Bank”) to have regard to the following government policy that relates to its functions under Part 5 of the Act.

Government Policy

It is Government policy to support more sustainable house prices, including by dampening investor demand for existing housing stock which would improve affordability for first-home buyers.

As the Governor himself noted in a speech just a few days ago, no one really knows what “have regard to” (the statutory phrase) means. The Act itself provides no further guidance. But what is clear is that this direction provides the Bank with (a) no additional powers it had not already had, and (b) no change (broadening or narrowing) in the statutory goals the Bank is required to use its Part 5 (banking regulation) powers towards. Those powers must be exercised for these purposes (only):

The powers conferred on the Governor-General, the Minister, and the Bank by this Part shall be exercised for the purposes of—

(a) promoting the maintenance of a sound and efficient financial system; or
(b) avoiding significant damage to the financial system that could result from the failure of a registered bank.

It might be all very interesting to know that an incumbent left-wing government really doesn’t like non owner-occupiers buying housing, but what of it? If such activity threatens the soundness of the financial system the Bank should (have) acted anyway, and if it doesn’t well….they can’t. And any such interventions are all-but certain to detract from the efficiency of the financial system, a (statutory) consideration one never hears of from the Governor (except perhaps when he thinks banks don’t lend to people he thinks they should – but that is no definition of efficiency).

There is just nothing in the Act that allows the Bank to focus on the soundness or health or performance of anything other than the financial system (as a whole). And yet they appear to be lining up new restrictions on interest-only mortgages (see above) to help the government out politically, and pursue’s Orr’s own political agendas, not to underpin the soundness and efficiency of the financial system. (As he noted, using debt to income restrictions – which he is legally free now to deploy, if doing so would support the soundness and efficiency of the system, already buttressed by very high capital requirements – would almost certainly cut further against the government’s bias towards first-home buyers.)

Policymaking in this country has been going backwards for years. We see examples of it all the time (another recent one is of course the Climate Commission’s secrecy around its modelling, Treasury’s secrecy around relevant analysis), but the housing market and housing finance markets seem particularly egregious examples, where more interventions keep on substituting for addressing issues at source, adding ever more inefficiency and papering over the cracks (hoping prices will level off for a while and the political heat will recede) rather than cutting to the heart of the problem. It is bad enough when governments and government departments do it, worse when autonomous agencies like the Reserve Bank weigh in beyond their mandate, pursuing personal and political agendas. And whatever limited value an independent international agency like the IMF might have brought to the policy debate, is severely undermined when – supported by no analysis whatever – they just weigh in largely echoing the preferences of the moment of domestic political playersa.

Negative rates, and the option of more

Michael Reddell Monetary policy, zero lower bound

Last week the International Monetary Fund released a paper prepared in its Monetary and Capital Markets Department by five researchers (one a former RBNZer). The title? Negative Interest Rates: Taking Stock of the Experience So Far. It isn’t an official IMF view, but it seems unlikely that a paper of this sort would have been published if the senior management of the department were not broadly comfortable with the messages it contains. There is an accessible summary of the paper on the IMF’s blog.

As the authors note, a number of these sorts of survey papers have been done over recent years, but recent is almost always better when (a) the experiments with modestly negative interest rates are really quite recent themselves, and (b) there is a steady flow of new papers attempting to get or other angle of how negative (policy) rates might, or might not, have worked. And with policy interest rates now lower than ever – in New Zealand too – it is not as if the issue has no continuing relevance. Even if we get through this pandemic downturn without any more countries deploying negative policy rates, who knows when the next more-economically-founded downturn would be.

I won’t claim that the paper is an easy read for someone coming new to the issue, but by the standards of such papers much of it is pretty readily accessible, and there is plenty of summary material (arguably to the point of repetitiveness).

There seems to be quite a range of views among central bankers themselves on the potential of (mildly) negative policy rates, even across pairs of economies and financial systems that are otherwise very similar. In New Zealand, this was the latest from the Reserve Bank, in last month’s MPS.

rb neg rates

Just a shame they hadn’t used the previous decade to sort out operational readiness to deploy the tool.

On the other hand, the Reserve Bank of Australia (and apparently especially the Governor) has been really quite dismissive on the possibility of a negative policy rate tool, for reasons that they have never really sought to articulate.

So what do the authors of the IMF paper have to say? These paragraphs are from their Executive Summary

IMF 1a
IMF 2a

It is not without nuance, and as the authors note in the text unpicking the effects is rarely easy, but overall it is a pretty story. It was music to my ears, having been championing the case for having negative rates in the toolkit here, and generally consistent with the (subset of the) papers that I had read and conversations I’d had, but I was still quite pleasantly surprised to see it in an IMF paper, especially perhaps when taken with the final paragraph of the Executive Summary

imf 4

You might not like negative policy rates, but you might not have much choice. I found that conclusion particularly interesting because the authors are more confident than I am that central bank large scale asset purchase operations have had a material and useful macroeconomic stabilisation effect.

I’m not fully persuaded by some of the authors’ stories. For example, they claim the flow-through into corporate deposit rates has been greater than that for household deposit rates because “it is costlier for companies to switch into [physical] cash”. I don’t really buy that argument. You or I might find it easy to hold an extra $200 in our wallets, but storing securely $50000 or more of cash just isn’t that easy, and it is really the conversion of large scale holdings (as distinct from transactions balances) that is at issue here. By contrast, for big investment funds conversion to physical cash would be more feasible if central banks pushed policy rates “too deeply” negative. We don’t actually know how deep is “too deep” here, but as the authors note there has, so far, been no sign of large scale physical cash conversions yet. There has been a hunch that it would be unwise to push beyond about -0.75 per cent, but no central bank has yet been willing to push the point to find out. My own interpretation of why household deposits rates mostly haven’t fallen below zero is some mix of (what the authors report) material increases in fees charged by banks on household deposits, and (perhaps not unrelatedly) a sense that it isn’t worth facing the aggro that might come from charging a negative interest rate on household deposit when, at most, it is a few tens of basis points involved. Threshold effects sometimes matter.

The idea of a “reversal rate” has had some play in the literature and debate on negative rates, including being touted by some bank economists here. This is the idea that a move to a negative policy rate might actually have the paradoxical effect of tightening overall monetary conditions, perhaps by tightening lending margins and reducing the willingness of banks to lend. Generally, the IMF authors are not persuaded that this theoretical possibility has been a real world outcome in the countries (euro-area and Denmark, Japan, Switzerland, and Sweden) that have run negative policy rates. And some evidence has suggested that whatever banks do, corporates sitting on large deposits facing negative rates have been encouraged to increase physical investment (transmission mechanism working as one might hope).

Reflecting on the IMF paper and the wider issue of negative policy rates, three points strike me:

The first is a reminder of just what small changes in rates are being dealt with when researchers try to unpick the effects, and how few changes there are to study. The Swiss National Bank’s policy rate of -0.75 per cent is the lowest anywhere. By contrast, as the IMF researchers note, in studying the effect of cyclical swings in monetary policy we are often dealing with policy rate fluctuations of 500 basis points or more (RBNZ in the last recession -575 basis points), and whereas policy rates used to be adjusted quite often, there just have been many changes in the last decade. Somewhat related to this, one negative rate is not necessarily quite like the other: the various central banks that used the tool have also typically introduced tiering-type regimes to attentuate the effect (especially on returns to core holdings of settlement cash by banks). With a handful of countries, unavoidable selection bias in the choice of those countries, small adjustments and infrequent fluctuations, any conclusions are inevitably going to be provisional.

The second is to note that over the 12 months or so since Covid became an issue, although almost all central banks claim to have done quite a lot with monetary policy (a) no central bank that had not already had negative policy rates has moved to introduce them, and (b) none of the central banks with negative policy rates have cut them (even though all other advanced country central banks have cut their policy rates). I don’t purport to know why that is, and really hope some smart and careful researcher in the area has a paper in the works on the subject. In the case of the already-negative central banks, perhaps it really is that they think they have already reached the effective lower bound (ELB) and that, although cuts so far have been useful and stimulatory, any further cut at all would be too risky, and either ineffective or counterproductive. That might make some sense, although the IMF researchers nicely illustrate the absence of any systematic shift to physical cash thus far (although in New Zealand, coincident with the cut in the OCR to near-zero currency in circulation was 13 per cent higher in January than in January 2020). A year ago I would not have believed an “operational unreadiness” explanation for no further countries moving to use negative rates – given the 10 years or so advance notice they have all had – but the revealed failure of the RBNZ to be ready (even when amenabe to using the tool), and the Bank of England even now, suggests there might be more to this story than I had thought plausible. Another interesting piece of research for someone would be to dig into the experience of the negative rate countries and find out how, and how quickly, they came to have systems that were operationally ready.

The third and final point is related to the first. The greatest extent of negative policy rates is really only playing at the margin. Central banks that have used negative rates appear to have found them useful, and (for example) the IMF survey tends to back up such a view. And yet a decade on, not one central bank (or government – and it is likely to be in effect a joint responsibility) – appears to have taken any steps at all to remove, or sharply reduce/attenuate, the effective lower bounds, by a wedge to preventless the limitless conversion at par from settlement cash balances to physical cash. There is no sign any central bank had done so in the 2010s, and there has been no hint of any fresh urgency in the year since Covid dispelled any wishful thinking that macroeconomic conditions would mean rates could really only rise from where they had got to.

The issue here is not about deciding to cut the policy rate more deeply, but about optionality. If macroeconomic circumstances – weak inflation, probably hand in hand with above-normal unemployment – meant that much more macro policy action was warranted do monetary policymakers have all possible tools at their disposal. And do markets (and firms and households) believe they have? Believe in the efficacy of asset purchase programmes all you like (I don’t, especially when- as in New Zealand – it just comes to swapping one government liability for another) but no one has ever deployed a programme that purports to be as effective as 500 basis points of policy rate cuts, and it would be exceedingly rash to believe such recessions will never happen again. Perhaps the world’s central bankers are now all big fans of fiscal policy – not just as short-term income relief – but (a) even if so, they can’t ensure fiscal policy is used, and they still have macro stabilisation responsibilities, and (b) if they really want to give up on monetary policy they should probably surrender their autonomy and simply become operational branches of finance ministries. It seems negligent to have done nothing about easing an obstacle to using monetary policy that exists only because of a rather arbitrary series of state interventions in the first place (banning private notes, and the innovation that probably would have come with them, while insisting on invariant conversion at par between central bank notes and central bank deposit liabilities).

I’m genuinely puzzled why nothing has been done, either in the quiet times – the idea time to socialise these ideas and new rules and procedures – or in the difficult conditions of the last year. There is no obvious good explanation, leaving either subtle ones (too secret for the public to know) or negligent ones.

As it happens, our Reserve Bank came a bit closer to addressing the issue openly than I’ve seen from others. In a speech given a year ago yesterday – at a time when the Bank was still oblivious to the wave about to break over them, Orr included this in a discussion on tools under consideration

orr 2a

That second sentence was right to the point (and I recall welcoming it at the time). But we’ve heard not a word more from them either, even though only recently (see above) they have reaffirmed their view that a negative OCR has a valuable place in the toolkit. If a modestly negative OCR does, why not the possibility of a deeply negative one? Convince people that you have a credible tool of that sort, and would be willing to act aggressively to deploy it, and you are less likely ever to need it, since expectations will do some of the work for you. If you fail to do so, you risk recessions lingering longer than they need to, something inconsistent with the thrust of inflation targeting whether in its 1989/90 articulations or this government’s (cosmetically different) new one.

No idea apparently, probably not much interest

Michael Reddell Productivity, Productivity Commission

Over the three and half years that Jacinda Ardern has been Prime Minister and Grant Robertson Minister of Finance it has become increasingly obvious that not only do they have no serious ideas for turning around decades of productivity growth underperformance, and no intention of doing much on that score, but they have no real interest either.

Appointments are among the things that help reveal priorities. A couple of years ago they had the opportunity to look for a new Secretary to the Treasury who might revitalise the agency and start generating serious credible advice on fixing that economic failure – with all its ramifications for opportunities in other areas of life. They chose to pass up that opportunity.

More recently – and the focus of this post – there has been the Productivity Commission, set up a decade ago with some vision that it might offer medium-term analysis, research, and advice focused on reversing that economic failure. It hasn’t done a great job at that over the years, partly because the Commission is heavily constrained to work on specific inquiry topics that the government of the day determines. Neither government has really been interested in tackling the decades-long failure.

Late last year the government had the chance to appoint a new chair of the Commission – the key position in this (small) organisation. They could have found someone serious: someone with wide credibility on these issues, and preferably not seen as a partisan figure. As it was, they appointed Ganesh Nana. I wrote a bit about the appointment at the time.

Nana took office on 1 February. There was always the hope that reality wouldn’t be as bad as I (and others) had feared. Unfortunately, this week we’ve had two public contributions from Nana – an introductory statement, and a first on-the-record speech – that suggest reality is at least as bad as feared.

Take first his introductory statement, posted on the Commission’s website the other day. I described it elsewhere as just another marker in the sad decline of the Productivity Commission. In 1000 words there was not one hint of any insight on New Zealand’s productivity challenges just – in the style of the modern public sector – lots of Maori words, together with straw men (as if any government – or person – ever has cared only about GDP). It wasn’t much more than, as one other observer put it, a “word salad”. Perhaps it warmed the hearts of parts of the Labour Party and places further left, but it was almost entirely substance-free. He just doesn’t seem that interested in the medium-term performance of the economy – for which productivity is a key marker.

Perhaps more disconcerting was his speech yesterday at a Waikato University event called the 2021 New Zealand Economics Forum (which continues this morning), an event focused on the longer-term economic challenges New Zealand faces, especially in the wake of Covid. The organisers seem to have attracted a reasonably impressive array of speakers. After a welcome and introduction from the Waikato Vice-Chancellor, Nana – newly inducted head of the Productivity Commission – was the first speaker. It would seem like a forum and topic tailor-made for a powerful and insightful speech from the Chairman.

You can watch the whole thing yourself – about 45 minutes into the recording of yesterday’s event here. It was quite remarkable for how little there was there (and in fact how low-energy it all was). His title was “Challenges and opportunities for inproving productivity in a post-Covid world” but I heard not a single serious idea and hardly any supporting analysis. He did acknowledge that New Zealand’s productivity performance for the last two decades “and probably longer” (as if there is any serious doubt on the matter) had been “sobering”, and that productivity growth had been slowing. But that was about it. And if one of his messages was intended to be “you can’t keep on doing the same thing over and over again and expect different results” well, I’d agree. But that was really it. And when he suggested -in the body of his talk – that perhaps tourism shouldn’t come back to the way it was pre-Covid, it was supported by precisely no analysis at all, nor any suggestion as to where – if his idle prognostication or wish came true – the earnings and employment that tourism has generated might be replaced from. Perhaps someone might ask the Minister of Finance, the Minister of Tourism, or the PM what they think of their new Chairman’s perspective.

To be clear, I do not regard international tourism as the sort of industry likely to lead us back to first world economywide productivity performance – there is no country I’m aware of that it plays such a role – but them I’m not the only idly, but publicly, as head of a significant government agency, suggesting that the industry might usefully shrink. There seemed to be no mental model behind the comments, no research, and no policy prescriptions. And, of course, no cross-country comparative analysis or perspectives, and no sense of how far behind the productivity leaders we now are. It was as if he really wasn’t that interested.

There was quite a bit – none insightful – about the “Four capitals” Treasury likes to go on about. And just to reinforce the doubts that Nana has little or nothing useful to say about productivity, and not even much interest, in the question time we got a comment about how while the Commission would continue to publish its annual statistical report on productivity, he didn’t really like to pay too much attention to productivity. There was a fair point – but one that no one disputes – that productivity is really a medium-term thing and that he doesn’t pay much attention to a couple of quarters (to which I’d add, among other things data revisions reinforce that point). He described it as akin to a “profit and loss” measure, while he preferred to look at the “balance sheet” – those four capitals again, which might perhaps sound good to some but (a) for economic assets, the value is in the returns they generate (or credibly could generate, but (b) by comparison with labour productivity for which there is a good time series data, and reasonable cross-country comparisons, most of the “lets value the capitals” approaches offer neither. If, of course, there is a well-understood, long accepted, point that simply raping and pillaging the environment is, all else equal, a less valuable form of economic growth than income that does not do so, it doesn’t help in the slightest address the issues of New Zealand’s economic failure.

But perhaps that is the point. Robertson and Ardern have no interest in doing so – simply in cutting a small pie a bit differently – and so why bother appointing a chair of the Productivity Commission who might lead some hard thinking on the issues and offer options that might improve productivity – and wider “wellbeing” that stems from productivity possibilities. Easier simply to handwave and feel good.

Shame about the prospects for our country.

Not that good really

Michael Reddell Monetary policy

The Reserve Bank’s Monetary Policy Committee yesterday ambled back from their extended summer break and delivered the first monetary policy communication for the year – no speeches, no sign of any substantive interviews, but we did finally get this OCR review and Monetary Policy Statement. Having given themselves 3.5 months one might have hoped for something very good and insightful – there has, after all, been a lot happening, and the Bank has the largest concentration of macroeconomists anywhere in the country, generously funded at taxpayers’ expense.

I didn’t have that much trouble with the policy bottom line. If they were never going to cut the OCR and scrap the LSAP (as I suggested on Monday would have been warranted), at least they weren’t carried away with the “inflation risks mounting” sentiment that seems to be sweeping markets. In fact, I rather liked Orr’s response to a question in which he reminded listeners that central banks – the Reserve Bank more than most – had been too ready after the 2008/09 recession to want to raise interest rates and get back towards “normal” (a favoured line of his predecessor Graeme Wheeler), nicely and rightly adding that no one now knows what is “normal”, at least when it comes to interest rates. If medium-term forecasting is a mug’s game (on which more below), the Governor/MPC look to be right in suggesting that OCR increases are unlikely to be warranted any time soon.

On policy, there was an interesting framing in which the MPC said that they would keep policy “stimulatory” “until it is confident that consumer price inflation will be sustained at the 2 per cent per annum target midpoint, and that employment is at or above its maximum sustainable level. One might argue that that framing – especially that “and” – was (a) ultra vires (since the Remit subordinates the employment dimension) and/or (b) not entirely consistent (if employment is above maximum sustainable levels (as estimated) it is less likely that the Bank will be able to satisfy itself that inflation will remain “at” 2 per cent. Perhaps we should read it a little dovishly, but it remains a little disconcerting that after all these years of undershooting the target midpoint, the Bank is still giving nothing to ideas like the average inflation targeting the Federal Reserve has adopted for the time being. “At or above 2 per cent” might have been a preferable formula, and if that required a change in the Remit well…..as we discovered subsequently the Minister was already in that game. And it should remain a little troubling that with all the stimulus the Bank claims to be throwing at the situation, on their forecasts it is still 2.5 years until core inflation gets back to 2 per cent. Not much sign of the least-regrets framework really being acted upon, as distinct from cited.

In that context, one of the oddities about the Bank’s forecasts is that 2-3 years hence the Bank tells us it thinks there will be a positive output gap of 1.4 per cent (output running ahead of potential) and yet they also think the unemployment rate by then will be no lower than 4.6 per cent. On the face of it, that suggests they think the NAIRU-equivalent unemployment rate will by then be in excess of 5 per cent. Perhaps they do (perhaps those higher minimum wages really do cost jobs?), perhaps they don’t, but we don’t know because the Bank doesn’t explain.

Which is another of the oddities of the document. I’m not a big fan of medium-term macroeconomic forecasting, and was openly sceptical of its value for years when I was inside the Bank (it is too long ago to recall whether I was so sceptical when I ran the forecasting function) but the Bank purports to believe. A lot of effort has typically gone into doing and writing up the forecasts. And if you go to the formulaic pages at the front of the MPS, we are still told of a threefold approach to policy.

strategy

Which seems to put a lot of emphasis not on the conjuncture (current situation) but on the outlook (projections, forecasts surely?). And yet when we got to chapter 5 of the MPS – devoted to the outlook – there is much less than a full page of text, and then a two page bullet point table which contains no economic analysis at all, and which doesn’t appear to add anything beyond the numbers in the table. This appears to be a new approach – there was much more text in November – and it isn’t obviously an improvement. We have the Bank’s numbers, but almost nothing at all about the thinking, analysis, and research that lies behind them.

Perhaps – given my scepticism on medium-term forecasting – that might be more pardonable if there was lots of really high quality analysis of the current and recent past situation. In times like the present, perhaps one really can’t improve on a decent understanding of where we are now, and what we are learning from incoming data. But there isn’t anything very serious on that score either. For example, there is no sustained analysis of the housing market – which seems all the more extraordinary in light of the Minister’s intervention this morning – no sign that the Bank has done serious work on unpicking the various factors driving it, or influencing their quite optimistic forecasts. There is, for example, reliance on a story about returning New Zealanders last year. Perhaps it is a big part of the story, but argumentation is never developed, alternative hypotheses are never tested, and there is barely any mention of the rather large reduction in the number of non-citizens arriving (as it happens, it also isn’t that clear what they are assuming about net migrations as and when borders reopen).

Similarly I didn’t see any serious analysis of why the Bank thought it had been so surprised about recent developments. Of course, they weren’t alone in that surprise, but they set monetary policy, and they have all those resources at their disposal. Was it that monetary policy had been surprisingly potent – whether OCR or LSAP? Was it that resources and consumption were just much more flexible than they thought? Was it housing? (but if so, an authoritative analysis of the housing market is all the more important surely?) I don’t know the answers, and am not pushing particular stories, but shouldn’t we expect fresh and authoritative insights from the Bank? But there is nothing there – and nothing in the comments of the Governor and his senior staff at the press conference yesterday. There are lists, there are charts (some moderately interesting), but little or no insight or analysis – and there have been no speeches etc offering it either. It is the weakness of the institution – they might get some individual calls right, but one can’t have any confidence that they really know what they are doing and deserve deference for their insights, research and authoritative insights and judgements. Instead we get things like populist digs at banks for not, in the Governor’s view, having lowered their lending rates “enough’ – as if he was either a politician or perhaps a competition regulator. Oh, and in a document of not much more than 30 pages of text, devoid of much serious analysis on core issues, there is three pages devoted to one of the Governor’s pet playthings – the “Maori economy”. Can we expect one on the Catholic economy, the lefthanders’ economy, or the Labour-voters economy next? Each would be equally irrelevant to the Bank’s macroeconomic monetary policy – one economy, one instrument – statutory focus.

But the MPS was yesterday, and then this morning – safely after the FEC had had its chance to question the Bank – we had the real monetary policy initiative of the week, with the Minister of Finance announcing that he had changed the Remit to which the Bank works. He can do that, and had signalled back in November that he might make such a change. The new Remit is here.

It is a pretty shoddy affair on the Minister’s part. The new Remit was dated 22 February – Monday. Presumably the Bank was well aware of it. But the Minister kept it quiet until today, and the Governor made no mention of it yesterday – when the journalists had their quarterly chance to grill the Governor on monetary policy topics (next time not until late May). From a government that used to talk of being the most open and transparent ever, from a central bank that likes to claim it is highly transparent, it was like a sick joke, designed to avoid serious scrutiny and have all the reportage based on press releases – the Minister’s puff piece, and the Governor’s fluff.

It was typical Robertson (and perhaps Orr too). Robertson has never shown any sign of being serious about better monetary policy or a better institution (if he had, for example, he wouldn’t have banned people with an active research interest in monetary policy from being considered for the Committee) but he is very assiduous about having it look as if he is making a difference. That remains the best way to understand the first round of Reserve Bank reforms, and is the best way to see today’s announcement. The government is under pressure for doing little or nothing on housing. The Minister knows that monetary policy has little or nothing to do with the New Zealand housing market policy disaster, but he needs to look as if he is doing something, win a news cycle or two, and perhaps even fend off a few of his left-wing critics who do blame the Bank.

If you doubt that interpretation, look at the specific changes the Minister has made. At the front of the document there is woolly political paragraph about the government’s wider economic goals. It has no binding effect on anyone, but to that long list Robertson has added

An effective functioning housing market is a critical component of a sustainable and inclusive economy and promotes the maintenance of a sound and efficient financial system.

Well maybe, but even if you, I, the Governor or the MPC agreed it is simply a statement of faith, and anyway the Reserve Bank – especially with its monetary policy hat on – has no impact in delivering “an effective functioning housing market”.

And then later in the document the Minister has added some words. The first ones are in a section that does bind the Bank. There is a list of things that, in pursuing price stability and supporting maximum sustainable employment the Bank is required to do. There is longstanding stuff about avoiding “unnecessary instability in output, interest rates, and the exchange rate”, about looking through one-off price shocks, and having regard to “the efficiency and soundness of the financial system”. To that list the Minister has added this

assess the effect of its monetary policy decisions on the Government’s policy set out in subclause (3

and that “Government’s policy”? It reads thus

The Government’s policy is to support more sustainable house prices, including by dampening investor demand for existing housing stock, which would improve affordability for first-home buyers.

How wet is that? So the MPC is only required to “assess” the impact of its decisions on the government policy, not act in pursuit of that “government policy” (which might well be ultra vires anyway). A Reserve Bank action will no impact on a government policy: government policy will still be what it will be. At most that is another paragraph in each MPS. And quite how monetary policy decisions will affect the mix between the despised “investors” and other potential buyers will be a mystery to almost everyone (the Bank has financial regulatory interventions that it can use – although borders on the ultra vires to do so – that might have an effect but…..this is monetary policy.

It was a feeble effort. On the one hand we should be glad that the Minister sees sense and doesn’t ask the Bank to pursue house prices – doing so would simply push unemployment higher than it needs to be – but much better if he’d simply done nothing on monetary policy – and he and his colleagues concentrated on the real issues – rather than this limp effort in performative display, stage-managed to minimise the risk of serious immediate scrutiny. The Governor was, I guess, much too diplomatic to point out the emptiness of today’s announcement, but how he’d have answered faced with a sceptical press conference would have been interesting. And how MPC colleagues might have answered if they were ever allowed to speak openly, if appointments had not simply been based on who met certain political and gender criteria, who wouldn’t ever make life awkward for the Governor.

(Oh, and if the Minister and Governor really weren’t trying to avoid scrutiny, the obvious thing would have been to have released the Reserve Bank advice, the Treasury advice, and any Cabinet paper when the new Remit was announced. Of course they didn’t.)

Monetary policy

Michael Reddell Monetary policy

Having taken their long summer break – not heard from since 11 November – the Reserve Bank’s Monetary Policy Committee will be out with their Monetary Policy Statement on Wednesday. Much has changed in the economic data and indicators, here and abroad, since then, and it will be interesting to see what the Governor and has committee have made of it all. There are some genuine surprises and puzzles that the Committee should have been grappling with – and most other macro economists and commentators too, but the rest of us don’t get to set monetary policy. And if the strength of the economic rebound is a surprise – and it would appear to have been to the Bank too – how resilient is that rebound likely to prove, and under what conditions?

I’m somewhat sceptical of the idea of a resilient rebound this year – and with more than a few questions/puzzles about quite which data we can really count on at present – but without a compelling explanation for last year, one has to be even more hesitant than usual about backing a view about the future (macro forecasting is mostly a mug’s game anyway).

My own approach to monetary policy would probably be the one – “least regrets” – the Bank has repeatedly articulated over the last couple of years, if rarely followed in practice. That is especially so because the last year has made me more sceptical than I was about attempting to use fiscal policy for macro stabilisation (as distinct, say, from income relief amid a lockdown). Interest rates are the prices that balance savings and investment intentions, and monetary policy is about allowing interest rates to do that job.

And so even if the level of economic activity – even in per capita terms – is now back to something like it was at the start of last year, we still have

  • a central bank that has done nothing to reduce the (true) effective floor on the nominal OCR (even if they have very belatedly ensured that banks can cope with modestly negative rate),
  • core inflation that is still (a little) below the midpoint of the target range, not having been at or above that midpoint for the best part of a decade),
  • inflation expectations (surveys and market prices) that are still typically below the target midpoint, often by quite a long way (and this is so even though there has been quite a –  welcome –  lift in recent months),
  • the unemployment rate (inevitably measured less precisely than usual) is still non-trivially above reasonable guesses at where a NAIRU might be,
  • most other countries’ economies are doing less well cyclically than New Zealand’s and if vaccination programmes are well underway in a few of them, anything like normality still seems quite a way away, 
  • there is a great deal of uncertainty (inescapable, unavoidable) about the environment in which firms and households will be operating, and uncertainty tends not to encourage either consumption or investment spending, and
  • if the US is having another fiscal splurge, more generally across advanced countries the pressure in the next year or two is likely to be towards fiscal consolidation –  not necessarily dramatically so, but certainly in contrast to last year.  There isn’t much sign New Zealand will be any exception to that (nor, in my view, should it).

And then there is the wider backdrop. Even if we recover from this unusual Covid recession more readily than many had expected, the issue that has increasingly dogged monetary policy over the last decade has not gone away: nominal policy interest rates in more and more countries (now including former high interest rate countries New Zealand and Australia) are now near zero leaving rather limited monetary policy capacity when the next serious recession – grounded in economic developments not infection ones – comes along. That might be 10 years away, but it might be only a handful. The best thing monetary policy can do to help ensure there is some policy leeway next time is to err strongly on the easing side at present, generating inflation (and inflation expectation) outcomes that are – for a change – in the upper part of the target range. The Bank could articulate something like the Fed’s average inflation targeting approach – or, since the Minister is the one supposed to set the target, the Minister could tell them to – but a decent start would be to start acting as if they would be totally comfortable if, by chance, core inflation averaged say 2.3-2.5 per cent over the next five years. That doesn’t require actively targeting such numbers, but it does require recognising that central banks (including our own) have consistently over-forecast inflation over the last decade, and still don’t adequately understand why they’ve made that mistake. So by being actively willing to embrace higher inflation outcomes, perhaps the Bank and the MPC might just give themselves a better chance of delivering outcomes around 2 per cent – what successive ministers of finance have asked them to do.

If it were me, then, I would still be cutting the OCR, perhaps to zero this time. It would add a bit more macroeconomic stimulus, and would also be more realistic – since we don’t know the future – than idle pledges to keep the OCR where it is for some arbitrary length of time (recall that their last, hawkish as it turned out, arbitrary commitment only expires next month). And I would continue to express a willingness to take the OCR negative – and not a grudging willingness, but a genuine “do what it takes” approach to getting the economy back to full employment and inflation back to target.

And what of the Large Asset Purchase programme? If it were me, I would discontinue it now. That isn’t inconsistent with my macro stance (see above) because as regular readers know I’ve long been of the view that the LSAP was not making much macro difference at all (even if it may, at the margin, have helped a little in stabilising bond markets in the couple of weeks of global flurry last March), while it continues to (a) act as distraction (enabling the Bank to look and sound as if it is doing more than it is, and (b) has led some people to believe that somehow monetary policy, notably the LSAP programme, is greatly exacerbating that unnatural disaster of the rigged New Zealand housing market. Scrap the LSAP and nothing of substance will change around the housing market – access to finance, access to (use) land, supply of finance, demand, or even the shorter-term interest rates that are relevant to most mortgage borrowers. (And, of course, more generally the unnatural disaster has almost nothing to do with monetary policy – and even for those who want to “blame” interest rates, bear in mind that very long-term market rates, that central banks have little direct hold over most of the time, have been falling for decades.)

Now I don’t for a moment suppose that the Bank will do anything of that sort, on any of what I’m suggesting about monetary policy. But I hope they do give us some sort of serious framework outlining the sorts of specific factors that might eventually lead them to discontinue the LSAP. It is, for example, hard to see how they could justify continuing it if (a) they now believe banks can adequately cope with negative interest rates, and (b) if they get to a point where they think the risks are no longer skewed to the downside.

On such things, I’ve been reading over the last week a new book by the British economist Jonathan Ashworth on the experience this century with central bank asset purchase programmes (it is 20 years next months since the Bank of Japan first launched its quantitative easing). Quantitative Easing: The Great Central Bank Experiment was published last year and clearly was completed on the very eve of Covid – a couple of 2020 references, but no mention of the Covid recessions/interventions at all. It is a really nice summary treatment and documentary record of the activities in this area of the Fed, the Bank of England, the ECB, and the Bank of Japan, up to and including the Fed’s partial withdrawal from QE, as it finally raised interest rates after 2015 and wound back the size of its balance sheet. Although the publisher – launching this new series of books on aspects of the global financial system – describes the approach of the series as “resolutely heterodox”, in fact the book is strikingly orthodox. It is, therefore, quite a nice summary of the likely way the Reserve Bank and The Treasury were seeing the possibilities, and limitations, of quantitative easing when they were advising the government at the start of last year. It is also a good single point of reference if, like me, memories of some of these programmes grow somewhat hazy over time. And for anyone wanting a good introduction it is a fairly accessible read.

The orthodox view tends to be that asset purchase programmes have had some, perhaps significant, macroeconomic benefits. The case is probably strongest in the midst of the 2008/09 crisis when both the UK and US launched such programmes (although with important differences between those programmes) although Ashworth seems to favour interpretations in which later programmes have also had useful effects. I’m more sceptical, for a variety of reasons. Much of the work in this area rests of event studies around the announcement of programmes, and so it is a shame that Ashworth does not engage with (for example) the published work of former senior St Louis Fed researcher Dan Thornton who has critically reviewed claims in that are (see, for example, this journal article, and this policy piece). Ashworth rightly highlights how wrong were the people who claimed a decade ago that the asset purchase programmes would lead to a huge upsurge of inflation (much the same claims are made in some quarters on the right about the latest asset purchase programmes) but doesn’t really probe deeply questions as to whether a large scale asset swap can really make very much sustained macro difference. He doesn’t, for example, engage with the idea that things might be different if a central bank was buying bonds yielding, say, 10 per cent, and paying zero interest on settlement cash balances (as would once have been the norm) than if the central bank is purchasing assets yielding under 1 per cent (sometimes under zero) and paying the full policy rate on the resulting settlement cash balances. And although he usefully looks at the Fed’s balance sheet wind-down pre-Covid, his conclusion that that policy choice had little or no macro impact doesn’t seem to lead him to reflect afresh on whether the earlier policy interventions really had as much sustained effect as many central bankers prefer to believe. (One of my own sceptical arguments over they ears has been that there was little sign that bond yields had fallen further relative to policy rates in countries that used the LSAP tool – say the US or UK – than they had in countries that did not – say New Zealand or Australia.)

One point Ashworth does usefully highlight – and which I hope the RB will touch on on Wednesday – is the stock vs flow distinction. If QE has an effect, it is from the transactions in the market at the time (the flow) or from the accumulated withdrawal of bonds from the market (a stock effect). He notes that the literature tends to favour the stock story. If that is correct – and if QE has much effect at all – then, for example, the Reserve Bank could discontinue the LSAP now and continue to assert that the stock of bonds they had purchased was continuing to have a material stimulatory effect.

And just in case you think that LSAP-scepticism might just be some Reddell idiosyncrasy, I can leave you with a couple of quotes, The first is from the body of the book, from Paul Krugman, quoted in 2015 observing of the unconventional monetary policy tools “the bad stuff [presumably inflation risks] unpersuasive, the good stuff maybe, but not really compelling, this has just not turned out to be the game changing policy too that people had expected”. The other quote is from the Foreword to the book by the eminent academic and former central banker, Charles Goodhart (also a former colleague of Ashworth’s). Goodhart clearly likes the book, and commends it to readers, but notes that his own view that beyond intense crisis periods – in which bond purchases can respond to liquidity and market dysfunction stresses – the direct effect on the real economy via interest rates [ and recall that Orr claims the LSAP works by affecting interest rates], either actual or expected, and on the portfolio balance, was of second-order importance. QE2, QE3 and QE Infinity are relatively toothless”.

As I’ve noted previously when you have a tool that largely involves swapping one lots of (longer-term) government liabilities for another lot of (shorter-term) government liabilities – both paying low but market interest rates – and when your swap doesn’t even displace many existing holders of the long-term assets, it is inherently unlikely that you could use such a tool to generate large or sustained macro effects. My best read of the experience to date – abroad, nicely described in the book, or at home – is that we’ve seen just what we should expect, but with lots of central bank handwaving (the need to be seen to be doing something) that has distracted people into thinking that the tool is much more powerful – for good or ill – than it actually is.