How To Protect Monetary Policy From A Labour/Green Government

It is not clear that John Key will be able to keep the external image of National together until the election. If we look at the policies of Labour, Greens and likely coalition party NZ First on monetary policy, anyone who cares about central bank independence should be extremely worried.

How can we protect monetary policy from a Labour/Green government when the Reserve Bank is producing a lot of content and policy that is making it easier and easier for Labour/Green to sell the idea that the Official Cash Rate decision should be made by committee?

A starting point would be highlighing the ridiculousness of the US Federal Reserve when it comes to clear communication around quantitative easing. What journalists often gloss over is that each individual “Fed” has its own Governor whose opinion counts for a lot because they vote!

There is a hierarchy in the Federal Reserve system – with the Federal Reserve Bank of New York holding the position of power as it carries out the open market transactions the committee decides on and because New York is the centre of the US financial system.

If the Reserve Bank moved to a committee form, then monitoring the Reserve Bank would be costlier. Instead of keeping track of what Graeme Wheeler and occasionally Grant Spencer say, in order to arrive at some indication of where the RBNZ’s thinking is I’d have to follow every single committee member.

If these committee members were unionists, businesspeople, farmers or other non-economists then the monitoring costs would be even higher. What this does is lower the credibility of the Reserve Bank in carrying out its core function – price stability.

It also makes it a target for politicians because it would face more “top down” pressure for “targeted interventions” the committee thinks need attention. Also, there are officials at the Reserve Bank and Treasury pushing for more “targeted intervention”. As their notes and publications are released they need to be carefully examined by the economics blogosphere.

My non-negotiable position on the Official Cash Rate is that the Governor of the Reserve Bank is the only person who communicates the Reserve Bank decision and intentions.

There must be no committee! Obviously the Governor has a team of close advisors who help him out, but the unintended consequences of committee decision making would be horrendous.

Clarity of communication is far more important than many people realise. Imposing costs on everyone in New Zealand because your favourite sector can’t compete in a global marketplace is not acceptable, and over the next few months I’m planning to do some longer posts on monetary policy.

Citi’s William Buiter On Central Bank Forward Guidance

Here is a long note from Citi’s William Buiter on central bank forward guidance. It is a good overview of how forward guidance can be “cheap talk” and in order for markets to take central banks seriously, contingent changes to monetary policy (like inflation or unemployment at certain thresholds) are the only serious option.

The best approach to signaling longer-term policy intentions in an operational manner typically has three components.

First, commit to the regular publication and updating of longer-term forecasts of the target variables, of any additional nominal or real thresholds, knockouts or triggers that define the central bank’s reaction function for each of its instruments, and of the instruments themselves.

Second, reach an agreement that at most one member of the monetary policy making committee, presumably its chair, speaks or writes publicly about the likely future paths of the policy instruments – rates, QE, or whatever. The other members can of course still discourse in public about the principles of monetary policy and the history of central banking.

Third, give the central bank skin in the game by requiring it to issue or purchase material amounts of financial instruments on which it will lose money if interest rates depart from the forward guidance-consistent levels – financial hostage instruments. If possible, link the pay of the monetary policy makers at least in part to the performance of these instruments.

Hat tip to FT Alphaville who wrote about this yesterday.

It is interesting that despite Buiter thinking that policy rate changes by committee is a good idea, he still thinks that only one person – the chair or governor should be communicating this stuff.

The US Federal Reserve has a whole lot of people making public comments – all of the regional governors for example – and I’m not sure that’s optimal.

Different Federal Reserve Banks have different ways of looking at the world, and if market participants can cherry pick forward guidance from who they like on the Board of Governors that’s problematic.

With respect to the hostage instruments he talks about, I don’t think that’s appropriate. The people best equipped to deal with these sorts of strategies are on trading desks, not on the capped salaries of the public sector.

It would be far too much to expect there to not be significant losses on the learning curve of those sorts of policies, in the vein of massive foreign exchange market intervention losses that have occurred in the past when countries tried to defend fixed exchange rates and went broke.

I think New Zealand is doing OCR changes the right way – the buck stops with the Governor and he is also the person who fronts the press conferences. It’s a shame they’re anointing themselves as arbiters of what loans are good and what loans are bad though.


Is The Reserve Bank On A Mission To Lose Its Independence?

The role of a central bank is to implement monetary policy. The role of a central bank is not to act as an arbiter of what credit allocation decisions are good and what credit allocation decisions are bad.

Matt Nolan has a very good overview of the issues around the level of discretion the Reserve Bank is claiming mandate for with respect to macro-prudential policy.

I’d point out that on top of the level of discretion the Reserve Bank is engaging in, the Basel III framework which includes provision for unexpected losses, is just as discretionary and distortionary when it comes to capital allocation decisions in the economy.

The idea that a bunch of officials can forecast market tops better than private industry is hilarious. If they could they’d be hired by hedge funds in the US straight out of graduate school and would never set foot in a central bank because the opportunity cost in terms of wealth accumulation would be too high.

Even though I’m still just an economics student, I follow the literature and blogosphere closely. I know that since the global financial crisis, a lot of the stuff the Reserve Bank talks about in its bulletins has been dealt to by private actors.

How so? Banks are only going to give large mortgages to large earners in stable careers. If you run a business or are self-employed, you are subject to credit rationing because banks have been burned so often. Although Rob Hosking is correct in saying that LVR restrictions will save some people from themselves, the unintended consequences of discretionary policy are where the real welfare losses lie.

At the heart of the housing affordability issue is that in 2008 a lot of banks prematurely pulled the plug on residential development funding that was plugging the supply and demand deficit in Auckland and other places around the country.

New Zealand is a poor country – someone on wages is unlikely to be able to save up enough capital to take a risk on a speculative property development so banks need to match up developers with loans. It’s risky – but it’s a societal benefit because without this activity, there would be no downwards pressure on house prices.

In the most cynical of analyses, I think the RBNZ could be pre-empting the possibility of a Labour / Greens / NZ First coalition government ripping up the already expanded memorandum of understanding and throwing in a whole lot of additional policy objectives for the RBNZ to achieve.

Are they on a mission to lose their independence? It sure seems that way. I’m not convinced that there is enough discussion about the trade-offs involved in making arbitrary decisions on what sort of lending is good and what sort of lending is bad.

In terms of efficiency, risk should be managed by those closest to the coalface. I think there has been a bit too much hysteria over the finance sector and not enough examination of how substantial changes in how they do business in light of their regulatory changes makes the Reserve Bank’s new clothes an awkward fit.

Leave The Reserve Bank Act Alone David Cunliffe

Now that David Cunliffe is leader of the Labour Party, a defence of the Reserve Bank Act has to be mounted.

Inflation targeting has worked, price stability is a whole order of magnitude better than it was pre-inflation targeting and our central bank is remarkably transparent.

I am skeptical over the introduction of macro-prudential tools. They require Reserve Bank officials to make judgments about where we are in a business cycle. That’s risky business.

But I am definitely against a rewrite of the Reserve Bank Act. When you make wholesale changes to something that has been working exactly as intended, there will be unforeseeable consequences.

David Cunliffe has been a key driver of the left wing derp on monetary policy, he is almost as bad as Russel Norman and that’s saying something.

Leave the Reserve Bank Act out of your policy proposals Mr Cunliffe. Monetary policy is not some plaything with which to achieve objectives better left to fiscal and regulatory policy if you so choose and the electorate votes you in.

Economic Communication To The Public At Large On Monetary Policy

The Green Party leader Russel Norman has wandered into monetary policy again.

This press release has so much derp it is disturbing that this man could be a key figure in a coalition government that would fetishise manufacturing.

We know that forecasting is nigh on impossible.

We also know that over time, the Reserve Bank’s inflation targeting policy has led to price stability in areas where there are not crazy supply side restrictions like housing.

Furthermore, we also know that pretty much no one understands what the Reserve Bank of New Zealand actually does, how the banks actually fund their balance sheets and why foreign exchange volatility is a good thing in terms of rapid adjustments in response to adverse shocks.

I think that because Russel Norman is engaging in so much derp, it would not be inappropriate for a senior Reserve Bank staffer to be seconded to his office until the next election.

It really is the level of derp that could damage central bank independence and set the New Zealand economy on a path away from the silent recovery.

While the Governor has full accountability for the Official Cash Rate decision, there are more than 1 employees at the Reserve Bank last time I checked.

Economic communication to the public at large on monetary policy must be crystal clear. The influence of derp must be stopped at all costs. I mean, surely there is a Green-leaning economist in Wellington who can calmly educate Russel Norman on second-order effects of monetary policy derp?

Labour, Greens and NZ First Is Scary

Matthew Hooton writes another interesting NBR column where he argues that the latest polling data make a Labour/Green/NZ First alliance the frontrunner for the next government.

He’s titled his column “Dump those rental properties now“. He argues that under the troika arrangement the Reserve Bank Act is in line for some tinkering.

He also predicts some interesting policy options for the threesome – electricity regulation, price controls, major building programs and the like.

That would lead to all manner of problems, but not what Matthew Hooton thinks they’ll be. The housing crisis has just as much to do with supply restrictions as it does looser lending standards.

The “anti-foreign bias” present in the New Zealand electorate will make populist tinkering with the Reserve Bank Act extremely palatable. No one likes making higher mortgage payments.

But if the Reserve Bank is forced to put more emphasis on kooky objectives like full employment (a fantasy) or intervening in the exchange rate (money down the drain) the implications for New Zealand’s situation are dire.

The cost of all of these populist policies is an acceleration towards sovereign default. We have no idea how we’re going to get out of our current economic malaise.

The National government hasn’t taken any aggressive moves towards retraining and upskilling. They’ve actually taken steps to make it harder to earn higher qualifications.

We don’t have optimal monetary policy or fiscal policy. But we have some of the “least terrible” monetary policy in the world.

The Greens think that quantitative easing doesn’t have side effects. They think that green jobs are good even when they cost $100,000 a job or more.

Labour wants to make superannuation more affordable, perhaps retaining their policy of raising the retirement age to 67. How will that go down with NZ First?

NZ First is victim to mercantilist thinking, worshipping exports at the expense of everything else. They’re also the party of the no-longer-productive but substantial voting bloc.

In combination, the combination of these three parties when it comes to managing an overhaul of the Reserve Bank Act is scary.

They have literally no comprehension of how trying to do what voters want will be punished mercilessly by the marketplace. They’ll send the cost of borrowing sky high, destroy supply chains increasingly optimised for a higher NZ dollar and set a self-fulfilling prophecy of higher inflation in motion.

I really hope that I have saved up enough money to leave permanently before this comes to pass. National are no better, but at least their major mistakes (Canterbury rebuild overlordship, failure to address unemployment, non revenue neutral tax cuts), they’ve not torn up the Policy Targets Agreement.

It really is the one thing that stops the government from acting crazily and forces some hard decisions on where it spends taxpayer money.

I think economists call that an “automatic stabiliser” or check and balance on the power of government.

Despite what you might think about the housing crisis or unemployment, tinkering with the Reserve Bank Act to achieve whatever policy objective you come up will lead to a lot of secondary consequences.

We can’t predict how badly this could turn out for New Zealand in a world where ratings agencies and bondholders have an enormous amount of power.

Hong Kong’s Exchange Rate Stability

Since 1983 the Hong Kong dollar has been linked to the US Dollar at a rate of HKD7.8/USD1.00. The Hong Kong Monetary Authority, through the Currency Board, has maintained this stable exchange rate through a plethora of macroeconomic shocks and against rising prosperity in Hong Kong that could easily justify a significant appreciation against the US Dollar.

While Hong Kong can be hurt by changes in US monetary policy, strong economic growth and a reduction in the rate of inflation has been achieved during the peg’s lifetime.

Hong Kong has unique characteristics including substantial assets with which to defend the peg, but in an age where dogmatic adherence to the idea that floating exchange rates are ultimately the best idea, countries with their act together (i.e. NOT New Zealand) are capable of choosing different tools to maintain exchange rate stability and reduce risk for importers and exporters alike.

Because the fundamentals of Hong Kong are strong, any revaluation of the Hong Kong dollar will see substantial increases in purchasing power for Hong Kong residents and firms with assets denominated in Hong Kong dollars.

Why Time Consistent Monetary Policy Matters

The other week I explained why Bernard Hickey is wrong about the likelihood of the Greens, NZ First and Labour changing the Reserve Bank’s mandate and reducing central bank independence.

One of the reasons why central bank independence is important is because it affects inflation expectations. When inflation is expected to be higher, the nominal interest rate will increase to account for inflation lowering the real value of money lent to the government.

What this means for the New Zealand government’s finances is that the cost of servicing debt will rise. This means that in exchange for chasing after kooky policy goals like full employment and lowering the exchange rate, there is an increase in the risk premium on New Zealand government debt.

Time consistency of policy is an economic concept that in order for the government and Reserve Bank to be taken seriously, they have to commit to a policy in advance and not suddenly change their tune.

The Reserve Bank currently does this through their regular statements that accompany Official Cash Rate decisions and a plethora of working papers, articles and market updates throughout the year that give a clear indication of what the Reserve Bank thinks on topical monetary policy issues.

If the troublesome troika get their hands on rewriting the Reserve Bank Act after 2014, a substantial rise in the risk premium payable ultimately by taxpayers through lower government spending and higher taxes, is inevitable.

The independence of the Reserve Bank and provisions of the Public Finance Amendment Act mean that the New Zealand government can borrow to finance deficit spending but nowhere near to the extent that many other countries can.

In effect, there is a built in dilution effect that means kooky ideas cannot run their true course. A Greens/Labour/NZ First coalition would not be taken seriously by market participants. When that scenario becomes likely as John Key’s popularity subsides, forward interest rates and exchange rates will reflect that.

Any step towards reducing the Reserve Bank’s independence runs the risk of far higher debt servicing costs for the government. This means less money for things New Zealanders care about like welfare and hospitals, and a widening revenue gap needing to be plugged by higher taxes.

Bernard Hickey Is Wrong About Market Reaction

In the Herald over the weekend, Bernard Hickey argued that because Labour, NZ First and the Greens have realised the importance of monetary policy and its relationship to key macroeconomic variables, they will undermine how the Reserve Bank conducts monetary policy.

The problem with our system is that we think that all opinions are equal. The intellectual deficits present in Labour, NZ First and the Greens have been truly exposed with their calls for kooky ideas that are completely unjustified and have been proven in the real world to cause terrible side effects. Arguing for exchange rate intervention is an example of the stupidity we could expect if politicians had more influence on how monetary policy operates.

I am pleased that Graeme Wheeler has made it clear what job goals as Reserve Bank governor is – using inflation targeting as the monetary policy tool of the day and eschewing calls to intervene in the exchange rate and monetise government debt. Complaining that the Reserve Bank doesn’t make decisions by committee is childish in the extreme. Almost every other central bank in the world is worse than the RBNZ. They are extremely credible and a central reason for that is their strict adherence to their statutory mandate in the Reserve Bank Act.

There is no doubt that monetary policy is linked to our housing bubble in the 2000’s and a resurgent housing market. But to adjust monetary policy now by adding slippery targets on unemployment numbers, what the exchange rate should be and how much house prices should be defeats the entire purpose of having a reasonably independent central bank. Gareth Morgan’s comments that they should all be fired for incompetence are so far off the mark it’s not even funny.

With respect to housing, while increased M3 has enabled banks to lend more on housing, that’s them simply responding to incentives. There is an enormous demand for housing loans, there are severe supply restrictions on housing and loan-to-value ratios are not regulated so poor people who have no business buying a house easily qualify for 95% mortgages.

Did we not learn anything from the sub-prime debacle in the United States? One of the key drivers behind lax regulation around new mortgage lending was the “housing affordability” and “owning a home makes you a real American” nonsense. Just because many people can’t afford to buy a house doesn’t mean that the OCR should be lowered to stimulate more investment in housing. A lot of that extra credit will sit on bank balance sheets for their own risk-free carry trades.

If the markets really were spooked about the possibility of Graeme Wheeler having the Policy Targets Agreement rewritten by a troika of populist politicians, they would be pricing that risk in now. The 3 year bond rate would have spiked some time after October 26 and the drama-filled select committee meeting. Using the data at we see that since the 26 October speech by Graeme Wheeler the change in bond rates has been negligible. And here’s a nicer chart from Westpac that fits out time frame just nicely:

The risk premium for New Zealand debt has barely changed either. So what gives? If there was any likelihood of economic kooks coming to power, that risk premium would have shot up. So would the price of NZ government debt CDS swaps. If expectations were that the exchange rate would be lower then that would be reflected in the March 2014 NZD/USD futures. They’ve barely dropped a cent over the past month.

Non-residents own about $28 billion of the $72 billion of government debt on issue. If what Bernard Hickey is saying was credible – the risk of lower yields in future – why was there no rapid capital flight? We have extremely free movement of capital these days and if overseas institutions wanted to they could drop billions of dollars in NZ government debt in an afternoon.

The truth is that if market participants were thinking like Bernard Hickey, there are about 4-5 different things they would have done to lower the risk of any changes in monetary policy impacting on the capital they have invested in New Zealand.

Bernard’s column is sadly unique in that no one actually thinks Labour, NZ First and the Greens will get anywhere near destroying the independence of the Reserve Bank. In not arguing that the policy changes Labour, NZ First and Greens are proposing fall into the category of kooky economics, he is ignoring the reality that quantitative easing reinforces inequality, makes housing affordability even worse and lowers real money balances.

If the market starts pricing in the possibility of kook monetary policy being implemented, I’ll revise my opinion. Needless to say I’ll be watching the yield curve and forward exchange rate numbers with interest.



Are Jobless Recoveries The New Norm?

This week at Vox EU an interesting piece by Henry Siu & Nir Jaimovich argues that jobless recoveries, at least in the United States, are the new norm. It’s called “Jobless recoveries and the disappearance of routine occupations“.

They talk about job polarisation where there is an increasing division between high skill and low skill jobs, with the “middle” jobs that are routine and can be automated or mechanised are no longer needed. The reduced reliance on labour-intensive production methods in manufacturing and increased reliance on software and robots to perform routine tasks is an example of this trend.

To examine this against they data they constructed a counterfactual scenario – if routine employment rebounded after a recession the same way as it did before job polarisation started happening, what would total employment look like?

In the 2001 recession:

For the global financial crisis:

They conclude:

The loss of routine jobs in recent recessions has given rise to jobless recoveries. Aggregate employment struggles to rebound following recessions since middle-wage, routine occupations no longer recover. Moreover, employment growth following recent recessions has been unevenly distributed across pay, concentrated in high- and low-wage occupations. A recent report by the National Employment Law Project (2012) indicates that the recovery from the Great Recession has been particularly lopsided, with the majority of jobs added being low-paying jobs.

What does this mean for New Zealand’s unemployment crisis? If the US situation applies to New Zealand then we should be very concerned indeed. We already suffer from low levels of labour productivity and rising labour costs. More flexible hiring practises including the 90 day trial period have not made any difference in net job creation.

It means that we need to think careful when thinking about who is unemployed. Are they unemployed for cyclical reasons – because their employers failed due to lower demand for the goods and services they produced? Or are they unemployed because their job is no longer needed or they no longer have the skills necessary to perform a similar job in the same industry?

If the structural changes in the labour market are not addressed promptly, hysteresis will set in and the long-term unemployed from the past few years will be permanently locked out of the labour market. The urgency of addressing this problem is clear – if workers aren’t supported through the retraining and adding skills process they will not be able to participate in any recovery in the labour market.