Tuesday, 17 November 2020

AFR on the RBNZ

Harsh stuff from Grant Wilson at the Australian Financial Review ($):

Even with the RBNZ flagging macro-prudential tightening next year, via the reimposition of loan-to-value ratios, house prices are now a de facto constraint on monetary policy.

The "least regrets" formulation also assumes that the RBNZ’s approach to unconventional monetary policy, which was first articulated back in 2018, holds up.

While we agree that the first round of LSAP, in conjunction with other measures announced in March and April, was highly effective in lowering the local term structure of interest rates, the jury otherwise remains out.

We highlight (again) that the RBNZ’s expectation of LSAP imparting downward pressure on the NZD via the portfolio balance channel is in doubt.

In contrast to their pass-through model, non-resident holders of local bonds have not sold to the RBNZ.

Their percentage of ownership has fallen sharply this year (from 47 per cent to 30 per cent at end September), but the stock of holdings has remained steady, in a range of NZ$35 billion to NZ$40 billion.

Speaking plainly

Beyond these substantive points, there is the RBNZ’s communication strategy.

Back in May we noted that Governor Orr is known for speaking plainly, including his questionable comment that direct government financing was "achievable", and that there is "no right and wrong".

Assistant Governor Hawkesby managed to top this in mid-October, saying that preparations for negative rates were "not a game of bluff".

Perhaps not. But certainly the RBNZ over-represented its hand (in poker terms).

The result was seen on Wednesday, with the local money market strip abruptly repricing higher (and from negative to positive yields), by fully 30 basis points.

Then on Thursday, Hawkesby made perhaps the most asinine comment we have a seen from a central banker this year, in suggesting that the repricing was due to sell-side banks revising their forecasts, rather than the RBNZ’s decision.

As any intraday chart will illustrate, this was a daft thing to say. It belongs in the domain of alternative facts.

Journey ahead

Looking ahead, the RBNZ has its work cut out. It will need all the institutional credibility it can muster in tapering the LSAP program and in cooling the increasingly parabolic housing market.

Rather than continuing to emphasis the downside, the RBNZ would be well advised to contemplate the upside.

This includes the tourism sector, where Australians comprised nearly half of international visitor arrivals prior to COVID-19.

The RBNZ does not need to be the hero of the hour. It just needs to do its job.

I'm not a macro guy, and I'm certainly not one who watches the mechanics of these markets. 

It seems obvious that the Bank's policies have had the consequence of inflating house prices. If the supply side were less constrained, Bank easing would help fund more construction. The Governor is certainly right that the supply side needs addressing. Monetary policy needs mates, as they say. But given the constraint, it would be nice to think that the Bank views what is happening in housing prices as an unfortunate consequence to be mitigated.

I don't think the Bank should be blamed for having gloomy forecasts earlier in the year. Erring on that side seemed a lot less bad than what could have happened instead, and everything then looked horrible. Being unintentionally contractionary when the velocity of money plummets isn't good. 

Despite everything the Bank has pushed on, inflation expectations over the next two years seem firmly planted in the 1-2% range. If pushing the throttle to the floor keeps the speedo constant, is it because the engine's broken, because you're in the wrong gear, or because you're driving up the Otira Viaduct and Friedman's thermostat is running?* If it's the former, you might want to check into what's going on. A broken engine spraying oil all over the housing market without moving the speedo otherwise isn't the greatest. If it's the latter, shifting into neutral before cresting risks rolling downhill. And if it's because you're in the wrong gear, running a QE policy rather than implementing negative interest rates, well, I'm not enough of macro guy to know.

I do wonder whether there's anything the Bank could be doing to mitigate flow-through into asset prices though. 

* For those unfamiliar with Friedman's thermostat, here's a bit from Nick Rowe from the link:

And it bugs me even more that econometricians spend their time doing loads of really fancy stuff that I can't understand when so many of them don't seem to understand Milton Friedman's thermostat. Which they really need to understand.

If the driver is doing his job right, and correctly adjusting the gas pedal to the hills, you should find zero correlation between gas pedal and speed, and zero correlation between hills and speed. Any fluctuations in speed should be uncorrelated with anything the driver can see. They are the driver's forecast errors, because he can't see gusts of headwinds coming. And if you do find a correlation between gas pedal and speed, that correlation could go either way. A driver who over-estimates the power of his engine, or who under-estimates the effects of hills, will create a correlation between gas pedal and speed with the "wrong" sign. He presses the gas pedal down going uphill, but not enough, and the speed drops.

How could the passenger figure out if the gas pedal affected the speed of the car? Here's a couple of ideas:

1. Watch what happens on a really steep uphill bit of road. Watch what happens when the driver puts the pedal to the metal, and holds it there. Does the car slow down? If so, ironically, that confirms the theory that pressing down on the gas pedal causes the car to speed up! Because it means the driver knows he needs to press it down further to prevent the speed dropping, but can't. It's the exception that proves the rule. (Just in case it isn't obvious, that's a metaphor for the zero lower bound on nominal interest rates.)

2. Ask the driver. If the driver says that pressing the gas pedal down makes the car go faster, and if the driver says he wants to go at a constant 100kms/hr, and if you see the car going a roughly constant 100kms/hr, then you figure the driver is probably right. Even more so if you ask him to slow the car to 80kms/hr, and he says "OK", and then the car does slow to a roughly constant 80kms/hr. If the driver were wrong about the relation between gas pedal and speed, he wouldn't be able to do that, and it wouldn't happen, except by sheer fluke. (Just in case it isn't obvious, that's a metaphor for inflation targeting.)

3. Find a total idiot driver, who doesn't understand the relation between gas pedals and speed, and who makes random jabs at the gas pedal that you know for certain are uncorrelated to hills or anything else that might affect the car's speed, and then do a multivariate regression of speed on gas and hills. But you had better be damned sure you know those jabs at the gas pedal really are random, and uncorrelated with hills and stuff. Which means this can only work if you are certain that you know more about what is and is not a hill than the driver does. Or you are certain he's pressing the gas pedal according to the music playing on the radio. Or something that definitely isn't a hill. Are you really really sure your instrument isn't a hill, or correlated with hills? And if so, why doesn't the driver know this, and why does he jab at the gas pedal in time with that instrument? You had better have a very good answer to those questions. And no, Granger-Sims causality does not answer those questions, or even try to.

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