A belated look at the coalition agreements

Things got a bit busy after the National-ACT and National-NZ First Coalition Agreements were released. 

A fair few things showed up in those agreements that we've been working on at the Initiative for rather some time, whether through reports, submissions, columns, panels and whatnot.

So that's been a bit busy, and I've been trying to clear through a few other bits before heading back to Canada and the US for a few weeks over the school holidays. So posting has been unduly light.

But I've been particularly pleased that these showed up in the agreements. 

A Rule of Two for Drug Certification

The government will require Medsafe to approve new pharmaceuticals within 30 days of them being approved by at least two overseas regulatory agencies recognised by New Zealand.

Loyal readers may recall series of tweets, blog posts, and columns from me on this one. I worked with a couple student teams at Canterbury to get a report up on the likely effects of a Rule of Two. 

It is in both coalition agreements and will be legislated. No "will investigate" or "will consider". It will happen. 

I am rather pleased about this one. 

Incentives for Growth

Weak incentives for councils to encourage housing development hasn't been the only problem blocking housing growth, but getting more housing despite current incentives requires heroes. And policy can't reliably depend on there being heroes around. The coalition agreements will introduce financial incentives for councils to enable more housing.

This has been core for the Initiative since before I got here. And now it will happen.

Easing Foreign Investment

The Overseas Investment Act will limit ministerial decision-making to national security concerns and make such decision-making more timely.

NZ has one of the OECD's most restrictive FDI regimes. Other places try to attract foreign investment; NZ does the opposite. 

Easing restrictions on FDI have been core for the Initiative since before I got here. Fingers crossed that the legislation interprets this as broadly as is implied by the text of the coalition agreements. 

Market Studies

Commerce Commission market studies will focus on reducing regulatory barriers to new entrants to drive competition. 

So far, ComCom has produced about one giant study per year. But the first-order problem is going to be in areas where ComCom has hitherto been precluded against poking around: matters falling under statutory exception. If a matter is authorised by Parliament, it doesn't get cartel investigation even if it is definitely behaving as a cartel. 

Instead of doing one giant study per year, ComCom would do a larger number of short studies focused simply on checking whether it is actually possible for a new entrant to get through NZ's regulatory and land use hurdles to provide potential competition. 

So here I disagree with my friend Donal Curtin. He worries about instances where the issue isn't regulatory barriers. Maybe I'll agree with Donal after the revised regime has run for a few years. But the low-hanging fruit simply is not going to be in places where ComCom has been able to use other tools. It will be in the place where they've been unable to shorten the way.

This shift in approach is something I've argued for in columns, submissions, at a CLIPNZ session, and in various conversations around town. 

Ben Hamlin and I have been, I think, the only ones really worried about the statutory exceptions. Ben's piece on it in the latest Law Review is very good; his gratuitous citing of my columns is inframarginal to that assessment. 

Monetary Policy

The Remit will be narrowed to focus only on price stability.

This too is excellent. In a normal environment, a dual mandate shouldn't matter. The long-run Philips curve is vertical. Maintaining price stability is the best way the bank has to ensure maximum sustainable long-term employment. 

We have worried about the broad Remit, which includes a preamble that encourages the Bank to give regard to basically the entirety of the government's policy agenda, for some time. 

Employment 

The government will consider setting an income threshold above which a personal grievance could not be pursued.

Our Chair, Roger Partridge, has been writing on this for some time. The measure would make it far simpler for firms to dismiss underperforming high-paid managers who really aren't the people that employment law protections should focus on anyway. 

Pseudoephedrine

The government will allow the sale of cold medicine containing pseudoephedrine.

This is another one that loyal readers may recognise. I think me and Twitter's @BoxcarJoey have been the only ones making the case for this obviously sensible move. And now it will happen. 

There's a lot of other stuff in the agreements, mostly good, some less good. 

As another bit of fun, the Dom Post put out its latest 'Wellington Power' list. I think it needs an accompanying 'Wellington Mystery' list so we can figure out whose power is exceeded only by their mystery, or vice-versa, or both, somehow, simultaneously. 

But in any case, I made the cut for inclusion this time. But only barely. And possibly only because I also write a column for them. 

45. Eric Crampton

The stocks of think tank New Zealand Initiative’s chief economist have soared, with the ascendancy of ACT into Government. The Canadian is a prolific report-writer and commentator, with a free market bent, and incoming ministers are sure to be paying attention to his sharp, original (and often witty) thinking.

Morning Roundup

The tabs...

• Australia considering changes in governance at the Reserve Bank, including setting a Monetary Policy Committee. Hope that they avoid the errors NZ made around unqualified Board members and ruling out monetary policy expertise on the Monetary Policy Committee.
• Regulations shifting toward open banking are coming. It seems in-principle a good idea.
• Vic Uni's Martien Lubberink with some cautions about attempts to tax bank profits.
• The government's delaying biofuel mandates. That's great, but better would be abolishing them. When tech and carbon prices make them a cost-effective way of mitigating emissions, fuel companies will pick them up to avoid paying for carbon permits. National says it would scrap any mandate - good!
• Jem Traylen at BusinessDesk points to a path through on Three Waters; includes a bit from me on revenue bonds. 
• Canada playing silly buggers with tariff-rate quotas under CPTPP to freeze out NZ dairy. It's going to arbitration. 
• Oliver Hartwich on collapsing education results. 
• Michael Reddell on RBNZ Governor appointments. Bottom line: better to find a Governor that has respect from all the main parties rather than either a short-term extension or reappointing the one who hasn't got it. 
• Geoff Mortlock on Orr's reappointment.
• Immigration NZ's computer systems remain a mess so the backlog in visa approvals gets worse. If that can't be fixed in a hurry, why not just ditch the rule banning non-residents from buying houses so that living here as a non-resident is less bad?

OCR and other tools

When Susan Edmunds emailed asking about tools other than OCR for controlling inflation, I asked her whether she was suggesting I say Voldemort repeatedly while hoping for the best. 

There are a lot of bad alternatives, some best not spoken.

First Union suggested taxes on the richest. It's the opposite of where you'd want to target taxes aimed at reducing aggregate demand if you followed Keynesian-style arguments around marginal propensity to consume. Stopped clocks, eh?

I noted that monetary aggregates used to be targeted, but increasing difficulty in defining the targeted aggregates, combined with changes in the velocity of money, pointed to price/inflation targeting rather than money supply targeting. I also noted that the Bank's LVR rules a decade ago seemed most easily explained as an attempt to shave the peaks off of asset price appreciation, but that I didn't think it was a great idea. 

An old Labour idea of having Kiwisaver contributions vary over the business cycle also got play. It never made any darned sense: you require higher contributions at the top of the cycle and lower contributions at the bottom of the cycle: buy when high, and buy less when low, doesn't seem like all that great a default setting for Kiwisaver funds. 

Bad times make people reach for bad ideas, which worsen overall economic conditions...

Morning roundup

Another closing of the browser tabs, including a couple from Auckland University's Prof Robert MacCulloch, who's caught a few things I'd missed.

• MacCulloch catches a piece from John McDermott, former RBNZ Chief Economist, criticising the Bank's recklessness. Adrian Orr likes to paint his critics as being some kind of right-wing extremists. Bit harder to do that with McDermott. But it's also worth noting that some of the decline at RBNZ happened under McDermott's watch. That's when research capabilities started being pushed out. 
• MacCulloch finds Shamubeel Eaqub's critique of ACT Party leader David Seymour's economics more than a little thin. Bottom line: it's off to paint Seymour's positions as 'illiterate' and 'lies' when plenty of economists agree with Seymour on that excessively loose fiscal policy can contribute to inflation when we're up against supply constraints. Perhaps some of is definitional? I'm generally happy to say that inflation is always and everywhere a monetary phenomenon, but if government is running giant deficits while facing a positive output gap, it's going to be pushing up prices by doing so. FWIW, here's Waikato's Prof Frank Scrimgeour also noting pointing to the consequences of the continued inappropriate fiscal push. 
• Under pressure over testing, Director General of Health Bloomfield told press "To improve our horizon scanning and considering new tests, we have established an innovation team... reviewing other countries' experiences with the use of testing technologies." There was no such team. What's the way of phrasing things in NZ that avoids defamation... the guy seems to have a habit of saying things that wind up having been entirely wrong, and that any reasonable person in his position should have known to have been falsehoods. 
  
• Things that are overdetermined are overdetermined. Queensland District Council refusing to provide a consent for Peter Thiel to build a lodge on his land: the normal Resource Management stupidity? Council just doesn't like the guy? Both?
• 2022 vs 2008
• Barriers to prescribing medicinal cannabis. 

Afternoon roundup

The afternoon's worthies

• Covid tests considered reliable enough to let you board a flight to New Zealand aren't considered reliable enough to be allowed to be imported into the country. We truly are run by Vogons. 


• Glad to hear that Michael Reddell is feeling better. On 7 March he posted that his household had caught Covid but all was well. On 29 March he posted that he'd been unable to maintain concentration for any sustained period: "Reading one 8 page memo bright and early yesterday morning completely did me in for the day." 28 April, he notes things are improving. I'm very glad that things are improving.  


• Parliament is scrambling to put some kind of enforcement regime around its stupid road user charge holiday. I feel bad for NZTA here. I expect they were blindsided on this one, that they told government that all of this was stupid, and they're stuck having to administer it. But I'll have to wait for the OIA results to find out. 


• David Dodge, former Bank of Canada Governor, argues for very large and rapid interest rate hikes. Stimulatory monetary policy in an overheated economy is a bad idea. Meanwhile, Adrian Orr assures us RBNZ has everything in hand and thinks his interest rate increases thus far are courageous. I miss the old Tui Billboard "Yeah, Right" campaigns.


• Darian Woods sings about GDP on this Planet Money episode. Very suitable for NCEA classroom use. Darian was in the same superstar cohort with James Graham (now teaching at Sydney) and Nick Sander (Bank of Canada). Good times. Here's an old RNZ piece on his album with Lucy Botting. 


• Russians supporting the current thing


• The Auditor General's worried about Covid spend. Treasury hasn't seemed really able to keep on top of this spend. And Treasury noted that it only likes the government's new debt ceiling if there's a focus on value-for-money in spending. So we have a new public finance regime that requires more vigilance from Treasury, an not a lot of reason to believe that Treasury is up to the bigger task. 
• Next time we're out near Dunedin, we'll definitely be checking this out for the kids: a 12 year old down there is running her own business, doing horse riding experiences for other kids. 


• A private backer was ready to sponsor Moana Pasifika - but the NZ government prefers to crowd out private investment. 


• Divorce rates are down, but largely on the back of marriage now largely being only chosen by those with strong preferences around being married. 51% of babies born in 2021 had married parents. Yikes.


• The convoluted ownership structures for the proposed amalgamated water entities might not even achieve balance sheet separation.  


• Hard to tell if this is the normal RMA stupidity, or bureaucrats sticking it to Peter Thiel just because. Either way it ain't great. 


• Monetary policy in pandemics. "If the activist policy was appropriate, by year end 2022, inflation will be on the way back down to 2 percent with an unemployment rate remaining near 4 percent. If the nonactivist policy would have been better, inflation would remain near double digits and would recede only with a recession."

Chronic confusion and disappointment

Looks like Canada is facing similar pressures around central banking and mission creep. Here's Steven Ambler, Jeremy Kronick and William Robson in Canada's Financial Times:

A more overtly inflationary recommendation is to add something else – usually a labour-market indicator, such as the unemployment rate, to the Bank’s framework. Proponents often argue that inflation control hurts jobs and, more specifically, that central banks have been too quick to tighten before the economy reaches full employment. But unemployment in Canada has been lower and less volatile since the two-per cent target came into force. And the blow-out jobs report last week just underlines the problem of determining what full employment actually is, especially after a major disruption like the pandemic.

As for other goals, such as reducing inequality and or slowing global warming, we need to keep people’s expectations about monetary policy in line with what it can actually do. Monetary policy is about short-term interest rates, the growth of money and credit, the pace of spending, and the results of all this for inflation. While the Bank must assess how inequality and global warming impact its ability to hit the inflation target, asking it to target the price of assets held mainly by the wealthy or favour credit for some industries at the expense of others will lead to chronic confusion and disappointment.

The two-per cent inflation target has been a signal success in Canadian economic policy for a quarter century. We know it is achievable, and with inflation currently running close to five per cent, we are getting a timely reminder that alternatives can easily be worse. It is time to reassure Canadians that their government and central bank are committed to low and stable inflation in the future.

Emphasis added.

Nick Rowe quips:

My biggest worry:
Dove vs Hawk Central Banks
gets replaced with
Woke vs Based Central Banks https://t.co/qwmVX5ky1M

— Nick Rowe (@MacRoweNick) December 7, 2021

 

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.

Preparing for the monetary rocky horror

Over at Newsroom (ungated), I discuss the importance of RBNZ being very clear about its intentions should it find itself in a position to pursue unorthodox monetary policy.

As Doctor Frankenfurter prepared to step up the reactor power input three more points and bring life to the Rocky Horror in the classic Rocky Horror Picture Show, he welcomed the assembled “unconventional conventionists” who would witness his triumph.

Unconventional monetary policy is a bit like Doctor Frankenfurter’s giant defibrillator experiment with the Rocky Horror. It could work, if the circumstances call for it. Preparing for those circumstances can make a lot of sense. But it probably should not be tried except as a last resort. And it seems a bit odd to assemble everyone for a throwing open of all the switches, including fiscal policy, when the projected output gap is positive over the medium-term forecast range.

...

But it would be rather nice were the Bank to provide a bit more guidance about just what it might do should the world become a bit more unconventional. In his interview with Bernard Hickey, Governor Adrian Orr noted the Bank’s advantage in being able to deploy capital a lot more quickly than traditional fiscal policy.

When restricted to the more conventional of unconventional policies, like ‘helicopter money’ payments to everyone in the country, that is certainly an advantage. When it comes to asset purchases, it would be nice to have a better idea of the sorts of things the Bank might contemplate.

The current remit for the Monetary Policy Committee begins with a preamble noting the Government’s Economic Objective of improving wellbeing and living standards and of moving towards a low carbon economy with a diversified export base.

During conventional times, where medium-term price stability contributes to any reasonable goal the Government might have, that preamble has little effect.

But if the Bank were deciding among assets to purchase, or investments to make, to get fresh cash into the economy through unconventional means, it might be tempted to read a bit more into that preamble and direct its asset-purchasing behaviour accordingly. This would be a substantial and potentially costly error, distorting investment and, worse, politicising an independent central bank. Where the Bank’s consultation document suggests Ministerial consent for RBNZ asset purchases other than government debt, concern about loss of political independence is not assuaged. 

Tell us what's in and out
It is, I hope, unreasonable to think that the Bank might be so-tempted. But where the Bank is taking a more expansionary reading of its remit around climate change, for example, and where the Bank has been a bit happier of late to surprise markets, a few statements noting just what is ruled out in unconventional policy would be welcome.

Preparing for unconventional monetary policy can make sense, even if it is far from the Bank’s current expected path. But we are nowhere near the point at which throwing open the switches on fiscal policy is desirable.

Doing so during these more conventional times should have the Bank instead move to counteract the effects – at least if the output gap were expected to further widen. And clear signals that the Bank has no intentions of waking certain rocky horrors would put a few minds at ease.

We also subsequently released a research note on the topic, joint with Prof Robert MacCulloch at Auckland Uni.

The Newsroom version contains Rocky Horror Picture Show content; the research note doesn't.

• 
  

Monetary policy needs mates?

Here's Brian Fallow at the Herald.

The European Central Bank and Bank of Japan are printing money, and while the US Federal Reserve has at least stopped doing that, it is apparently in no rush even to start lifting interest rates from the emergency levels it cut them to during the crisis. Such heavy dosages of monetary stimulus carry serious side effects. They have inflated asset markets around the world, including the Auckland housing market.

The IMF warns that "The main medium-term risk for advanced economies is a further decline of already-low growth into near stagnation, particularly if global demand falters further as prospects weaken for emerging market and developing economies."

Countries (such as New Zealand) which are not fiscally constrained and which significantly rely on net external demand should ease their fiscal stance in the near term, especially through increased infrastructure investment, it says.

Fiscal conditions in New Zealand are likely to become more stimulatory regardless of any policy change, simply because of the "automatic stabilisers" as unemployment rises and revenue growth slows.

But the IMF is right to call for more than that.

It is a bit too easy for the Government to leave the task of moderating the cycle entirely to the Reserve Bank.

That task, never easy, is especially difficult in the current international environment, governor Graeme Wheeler said in a speech on Wednesday.

As the saying goes, monetary policy needs mates.

Fallow's article could make sense if, say, NZ monetary policy were already near the zero bound and they'd not figured out how to run less conventional moves. But to the extent that monetary policy needs mates in New Zealand, it needs help in keeping Auckland house prices from spiralling ever upwards. It doesn't need help in any fiscal demand pushes. Fortunately, Chris Parker over at Auckland Council seems to be making some headway.*

With inflation having been below the bottom of the policy targets agreement bound for a heck of a long time, and interest rates nowhere near the zero bound, it isn't right to say that monetary policy needs mates in preventing unemployment. It's closer to right to say that monetary policy's barely been tried.

Mike Reddell raises a few pertinent points here. 


* Here's the nice part on Auckland:

Item 13: Housing Supply, Choice and Affordability: Trends, Economic Drivers and Possible Policy Interventions

Chris Parker, Chief Economist for Auckland Council, spoke to the committee on his recently completed report Housing supply, choice and affordability; Trends, economic drivers, and possible policy interventions, which was publicly released on Wednesday 30 September 2015.

The report identifies a range of levers on both the supply and demand side that could be considered to address the housing affordability problem in Auckland.

Following a recommendation in the report, the committee decided to endorse a target of bringing down the ratio of median home purchase price-to-median household income to five to one by 2030. The ratio is currently nine-to-one. [emphasis added]

It also agreed in principle to include the target in the forthcoming refresh of the Auckland Plan and noted that the council needs to continue to work in partnership with the Government if this housing affordability target is to be met.

Mr Parker says including this target in the Auckland Plan is a really positive step towards making housing more affordable. “It will help shape and focus our thinking moving forward. It will provide us with a tangible, achievable goal to frame up the decisions the council needs to make to create the world's most liveable city including affordable housing", says Mr Parker.

The committee also requested that the council progress the next stage of the Auckland’s housing affordability work by undertaking further analysis and advice on the issue of housing affordability in consultation with Government agencies, to be completed in February 2016.

The Chief Economist’s housing affordability report was commissioned by Mayor Len Brown and Deputy Mayor Penny Hulse. It is an independent economic think piece and is not council policy. However, it will help inform the council's ongoing strategy for action and advocacy. It is availableon council’s website.

Kudos to Chris!

Ultra Vires?

Michael Reddell, ex-RBNZ economist, has wondered whether the RBNZ's LVR rules really fit within its financial stability mandate. I had a piece in the NBR last month wondering the same thing.

Seems we're not alone.

In a briefing for Secretary to the Treasury Gabriel Makhlouf, officials said they agreed with the Reserve Bank that a pick-up on the Auckland housing market "could potentially pose a threat to financial stability" in the coming years.

"However, Treasury has been engaging with the RBNZ to suggest that although we accept that house price changes can have macroeconomic implications, the RBNZ's mandate is focused on promoting financial stability, and therefore the policy proposals should be reframed to focus more clearly on reducing systemic risk rather than asset prices."

The comments appear to suggest the Reserve Bank is being warned that it may be overstepping its role over financial stability, a claim made in recent months by Michael Reddell, a senior adviser to the bank who was made redundant earlier this year.

Reddell said the Reserve Bank's own stress tests released in late 2014 showed the major trading banks could withstand a 50 per cent house price fall in Auckland and 13 per cent unemployment without breaching capital requirements. Some could even continue to pay dividends in that scenario. Nevertheless the Reserve Bank had imposed lending restrictions requiring larger deposits on the ground that rising prices were a risk to financial stability, something Reddell claims the bank had not laid out an argument for.

"What they haven't done is make a compelling case that there's a threat to financial stability of the New Zealand financial system," Reddell said.

Reddell hit the topic again at last night's LEANZ meeting. He blogs on it here - his full talk is worth reading. Jenny Ruth at The NBR (gated) has more.

Meanwhile, the Finance Minister reminds the Reserve Bank that they're meant to keep inflation between 1 and 3 percent; they've been running a bit low.

Mr English’s criticism of Reserve Bank governor Graeme Wheeler’s conduct of monetary policy is a major departure from the government’s customary respect for the central bank’s independence.

“He’s been out of the zone for years now, below the midpoint for quite some time,” Mr English told the Bloomberg news service late last week.

“He’s meant to be following the Policy Targets Agreement,” Mr English said.
The PTA, an agreement between the finance minister and the central bank’s governor, requires the governor to keep inflation between 1% and 3% and to aim for 2% over the medium term.

“That’s the bit I look at and one day somebody will start asking the minister of finance questions about whether he’s actually following the agreement or not,” Mr English said.

That's pretty blunt.

Central Bank independence means independence to choose the appropriate methods, among those they're legislatively empowered to use, to achieve the inflation outcomes they're contracted to produce and to maintain financial stability.

It does not hurt central bank independence to remind them that there are targets they have to achieve. I don't like it when Finance Ministers and Prime Ministers speculate about the appropriate path for interest rates. But they have to hold the Governor to the targets. I think that failed in 2005/6 when Cullen let Bollard run too hot for too long. But I am a bit surprised that English's comments came after Wheeler started cutting interest rates, rather than a few months ago.

Green Money

There is a time and place for non-traditional monetary policy mechanisms.

In a world in which deflationary pressures are strong and the Reserve Bank has hit the zero-bound on interest rates, then standard monetarist macroeconomics and the new monetarists would recommend doing other things increase inflationary expectations. Standard theory tends to expect problems in worlds combining nominal wage rigidity and deflation. And if the Reserve Bank can't accommodate with nominal interest rate cuts, then things like quantitative easing - or money-printing - start being recommended. If you're keen on the debates around this kind of macroeconomics, start reading Scott Sumner, Stephen Williamson, Nick Rowe, and the macroblogs. Nolan at TVHE more frequently covers this too; I generally try to stay out of macro.

So "printing money", per se, isn't utterly insane. It can be a pretty mainstream response to a very particular and fairly rare set of circumstances. Not all macroeconomists agree about it, but it's within the mainstream for the set of circumstances that held in some parts of the world over the last few years. But not today's New Zealand.

While we're currently below the bottom end of the RBNZ's target range, that is not going to last. If the RBNZ thought it would, they could and would lower interest rates further. But they're not doing it. Why? Construction pressures are pushing up in the non-tradeable sector. Further, the depreciation that would come consequent to any serious monetary push, whether from printing money or from big interest rate cuts, would push up import prices and then put more pressure on inflation rates. They're targeting 1-3% over the medium term and seem on track to be there. iPredict has medium term inflation looking to be under 2%, but over 1%.

And so the debates over the Greens' "let's print money to pay for the earthquake" policy have been a bit disappointing.

First off, the Greens have been spectacularly wrong when they've argued that their policy can't be all bad because so many other places are running quantitative easing. Imagine a doctor prescribing a pretty aggressive chemotherapy treatment for a patient who only has a cold. When everybody says he's nuts, the doc replies "Well, Jim over there's on chemo, and it seems to be helping him!" There's a time and a place for aggressive chemotherapy and for quantitative easing; NZ right now isn't it.

On the other side, there's been a bit of overstatement claiming that it can never be consistent with standard macro to print money. But I did enjoy The Civilian's caricature.

Finally, rather than admit that they were really wrong, the Greens instead pulled back from their policy by saying they couldn't see getting sufficient support for getting QE through - like it's everybody else's fault for thinking that doctors shouldn't jump for chemothearapy for colds.

I hate how economic models prescribing particular corrective interventions for particular sets of conditions get used to justify those policies in every other state of the world. Keynes said to run deficits during recessions; politics turned that into running deficits all the time. Market failure theory says we might want Pigovean taxes for costs people impose on others; politics turns that into excise taxes for costs people impose upon themselves. And then there's Russel Norman.

UPDATE: I totally do not want to be slamming Russel Norman if he's changed his mind about the merits of QE under the current circumstances rather than the political feasibility of QE under the current circumstances. Any politician who changes his views on the basis of the evidence should be lauded for the change rather than condemned for U-Turns.

@Davidxvx points me to Wednesday's ODT:

Dr Norman supported money printing as devaluing the currency, as the United States and Britain had done, saying at the time that "New Zealand can no longer afford to be a pacifist in a currency war".

Asked if he still supported the policy, he said the consensus position was that while the official cash rate remained close to zero (it is 2.5) there was not a clear role for quantitative easing.

"But were the OCR to drop close to zero then QE would come back into the agenda."

In that circumstance he believed the Reserve Bank Governor would look at quantitative easing - as he actually can now.

If the cited consensus is that among economists that you don't run QE when at NZ's current position, and that he's reversed because that's what professionals who work in the area think, then I offer enthusiastic applause.

But I think that Norman is misreading international monetary policy. QE may have had the effect of devaluing the US dollar, but its purpose was to raise inflation expectations and to avoid a liquidity trap. And even places like Switzerland, which has run some active exchange rate targeting, have done it not to boost exports or make manufacturers happy but rather because devaluation can be a way of escaping from a liquidity trap. Devaluing is something you can do to loosen monetary policy at the zero bound. And, again, New Zealand is nowhere near the zero bound.

I wish that the NZ Greens would take a more interesting monetary policy position, if a Green party is determined to have a position on monetary policy. Imagine Russel Norman commissioning a few reputable academic macroeconomists to look at whether NGDP targeting would make sense in a small open economy, then just adopting whatever came of it. I'm not convinced that NGDP targeting would be much better than our current regime, but it's defensible. It's something potentially backed by a growing group of respectable macroeconomists. It can't be dismissed as simple money-printing. And it would give nice talking points about using monetary policy more actively to support the economy during downturns than we might expect in an inflation-targeting regime.

Inflation expectations

Bill Kaye-Blake notes the macroeconomic consequences of the delayed Christchurch rebuild, and wonders whether we consequently should have more stimulatory monetary policy:

First, I could see the logic in the plan. Austerity for reasons of national economic policy — reducing the debt, placating overseas money markets — while getting some Keynesian intervention through Christchurch. Secondly, it didn’t work. It became clear in 2011 that it wasn’t working. Nevertheless, the Government stuck with the plan longer than I think they should have, and longer than the state of the economy warranted.

He puts up graphs showing RBNZ estimates have been optimistic relative to experienced reality for the last several quarters, that core CPI has been low, and that unemployment remains high.

I'm happy to agree with Bill that the stalled rebuild had macro consequences, as well as the general awfulness for folks stuck in very poor housing. But let's have a look at some inflation expectations.

I'm here drawing from iPredict's quarterly markets on inflation rates. The table below has the risk of inflation outcomes above 3% and below 1%, based on the price of shares in the relevant markets.

Quarter	Probability inflation less than 1%	Median expected rate	Probability inflation greater than 3%
March 2013	84%	Less than 1%	1%
June 2013	23%	Between 1% and 2%	5%
September 2013	34%	Between 1% and 2%	10%
December 2013	15%	Between 1% and 2%	15%
March 2014	18%	Between 1% and 2%	19%

Inflation risks look pretty balanced over the medium term.

The markets are also expecting no change in the OCR in any quarter through the end of the forecasting horizon. The greatest likelihood of any change is a 21% chance of an 25bp increase in December 2013, though the markets also are pegging pretty stagnant GDP growth rates and an unemployment rate unlikely to drop below 6% before September quarter 2013.

You could maybe justify a small cut to the OCR on that risks currently should be weighted towards breaching the top rather than the bottom of the bound, and on that the median expected rate converges to a shade below 2% rather than a shade above it. But it's hard to see much case for that RBNZ has been grievously tight when they're targeting a medium term.

Paying for earthquakes

Matt Nolan walks us through why quantitative easing to pay for the Christchurch Rebuild isn't particularly good policy. If we need a monetary push, the place to start is interest rates - and then only if RBNZ thinks we're going to be below the 1% lower inflation bound over the medium term. If we need a fiscal push, which is highly debatable, doing it through earthquake spending might not be as helpful as the Greens might like - especially as regulatory bottlenecks and regulatory capacity constraints in Christchurch seem to be holding things up at least as much as money.

Let's recall how standard public finance says to pay for things like earthquakes. If the status quo ex ante had about the right mix of spending and taxation, then you cut spending in non-earthquake areas, increase spending on earthquake rebuilding, perhaps slightly increase taxes in the short term but definitely take on debt to spread the rebuilding costs over the longer term. This is bog standard public finance. Paul Krugman and Steven Landsburg agree. I walked through the argument slowly a while back.

What do we get if the government prints earthquake bonds and RBNZ prints money to buy them? Here's Nolan:

Now you may believe we should fund the rebuild with a one-off tax – that’s fine, in that case get the government to put a tax in place directly (or to directly cut spending from other place).  However, taxation by stealth of this sort is likely to be worse in multiple ways:

1. We have betrayed RBNZ independence for virtually no reason … understandably a sneak tax by the RBNZ would make people less likely to believe them in the future about holding to their inflation mandate.  As a result, we run into the time-consistency issue in monetary policy again, and it will become more painful for economy when the RBNZ tries to commit to its inflation mandate again.
2. We have a relatively rough redistribution of resources due to this.  By putting in our sneak tax through QE, we transfer resources to those with assets, those doing the rebuild, and those who can easily adjust prices/wages – while hurting those on fixed income, and those who have saved.  It is an inflation tax – pure and simple – and as a result, it will initially transfer resources from those who can’t protect themselves (generally the poor) to those who can (generally the rich).  If we introduce the tax through fiscal policy instead we can sort out these distributional issues a little better.
3. A country that is willing to introduce QE as a clear fiscal transfer – when there is no monetary policy reason – will destroy its credibility with international lenders.  People will scoff at this, but such a policy will increase the level of “inflation insurance” lenders ask for – increasing the cost of credit in New Zealand.

These are obvious and true costs, that have been seen from similar policies around the world for hundreds of years.  QE really isn’t anything new, and if we want a fiscal transfer of this sort just say it (as the Greens previously have to be fair), and do it through fiscal policy – it has nothing to do with the RBNZ.

I suspect Matt's "that's fine" at the start is more recognition that the policy at least is honest rather than that it's a good idea. Borrowing for major one-off capital expenditures is far better than a one-off tax.

Matt's also a little harsher about those peddling crank economics than he's usually willing to go:

The constant banging on about the exchange rate and the RBNZ shows a fundamental misunderstanding of the “issues” NZ faces.

The Greens, and Ganesh Nana, are wrong in stating that the RBNZ has failed.  Distinctly and totally wrong.

I approve.

Bernard Hickey was calling on Twitter last week for a review of the desirability of central bank independence. Matt and I got a bit testy. This is one of those issues where re-politicising whether the central bank should be independent has almost the same effect as removing independence: if RBNZ believes that its independence is conditional not on meeting the PTA but rather on making a mob of monetary cranks happy, then it might be tempted to start skewing its policy. And even if it doesn't, if people think it might be, that also starts wrecking expectations. There's reasonable latent public demand for bad monetary policy. Feeding and encouraging the trolls is a remarkably dangerous game. It's fine to debate what optimal monetary policy is. But suggesting that because RBNZ isn't following your preferred one, we ought reconsider central bank independence... that's intellectual vandalism on par with saying we should do away with Pharmac because you didn't like the Herceptin decision. In sum:

• Good: trying to convince RBNZ of your views on monetary policy.
• Bad: whipping up the hooples to break central bank independence.

Maybe we needed a bigger earthquake

Paul Krugman credits the Japanese earthquake/tsunami with high current Japanese growth rates:

Wait, what? Japan as star performer? What’s that about?

Actually, no mystery. From Bloomberg:

Japan’s economy expanded faster than estimated in the first quarter, boosted by reconstruction spending that’s poised to fade just as a worsening in Europe’s crisis threatens to curtail export demand.

So Japan, which is spending heavily for post-tsunami reconstruction, is growing quite fast, while Italy, which is imposing austerity measures, is shrinking almost equally fast.

There seems to be some kind of lesson here about macroeconomics, but I can’t quite put my finger on it …

I'm not a macroeconomist, so there are reasonable odds I've got things wrong. But I would have thought we'd have needed to think a bit more about how a fiscal push gets funded and about any likely reaction from the reserve bank.

Oughtn't there be a reasonable difference between a tax or debt-funded fiscal expansion and one paid by reinsurance inflows? I'm not sure that we can jump from "the Japanese government is spending a lot" to "Japan's growing" without looking at where the money's come from. A tax-funded spending programme will take money out of other parts of the economy; a debt-funded one might induce people to offset government spending with greater savings in anticipation of future taxes. Even if you think it's worthwhile, the effect of spending will be smaller than it would be where the money came as windfall in exchange for wealth reduction. A fiscal push paid for by domestic insurers selling off assets and by inflows from international reinsurers ought to look a little different from one funded by tax or debt; the GDP effects of tsunami-scale spending programmes in Italy or Greece might be comparable to Japan's if they were paid for by selling off little used assets, like some of Greece's uninhabited Adriatic islands.

New Zealand has its own earthquake rebuilding project: Christchurch. While 2012Q1 figures aren't out yet, fourth quarter 2011 had a year-on-year growth rate of 1.1%. And iPredict's picking quarter-on-quarter growth rates between 0 and 0.5% for most quarters all the way through to December 2013, with reasonable risk of bad outcomes for 2013Q4 - one chance in three of growth rates lower than -0.5%. New Zealand's perhaps making it look hard because of the morass of bureaucracy and insurance that's holding things up, combined with lingering worries that a one-in-four chance of another really big aftershock might mean we're best advised to wait on any big building projects anyway. I doubt that the problem was that the quake just wasn't big enough.

Further, any earthquake-related fiscal push also needs an accommodative central bank for expansionary aggregate effects. Here, a fast rebuild push would very likely push up wages and prices in related sectors, at least until we started being able to bid workers back from Oz. We'd also be pushing rents up for temporary workers, which would feed through into national rental markets as displaced Christchurch folks facing a short term vertical housing supply curve moved elsewhere. And then the RBNZ might start having to put the thumb down.

Bottom lines from a non-macroeconomist:*

• Earthquakes are hardly sufficient for macroeconomic stimulus. There's evidence that Canterbury's seeing decent growth relative to the rest of the country, but aggregate national figures are hardly rosy and construction hasn't been particularly helping things. December quarter 2011 had a 2.5% increase over the prior quarter, but only after substantially negative results for the prior three quarters (ie from the quake onwards). See Table 2 of the Excel sheet. Table 3 tells us construction's contribution to GDP is up in 2011 on 2010, but is still lower in real terms than in any year from 2006 through 2009. I suppose earthquake construction booms also operate with long and variable lags.
• Running a big fiscal push doesn't help anything if the Reserve Bank is then just induced to offset. And if you have to get the monetary authority onside, why not just run it as a monetary expansion in the first place? Cowen says the potential for monetary fixes is weakening, but I'd expect the same case to hold against broad fiscal AD pushes as well. And recall that what Krugman means by "austerity" is perhaps not what is commonly understood.
• It makes a lot of sense for New Zealand to borrow heavily to fund the earthquake rebuild and to divert some money from other useful projects, with longer term tax increases and spending shifts to make up the difference. That the coming budget is almost certain to do nothing about longer term structural issues like the retirement age isn't going to help make room for earthquake-rebuilding debt. 
• The quickest way to make room for the RBNZ on interest rates is getting legislation giving effect to the Productivity Commission's recommendations around housing and land use regulation. We're seeing housing prices ramping up again; Auckland median values are now well above the 2007 peak and aggregate values aren't far below it. Price inflation in non-tradeables like housing and fear of setting off another housing bubble could be constraining RBNZ against interest rate cuts. In the last housing run-up, from 2003 through 2007, year on year CPI measures in the "CPI less housing non-tradeable items" series is about twenty percent lower than the full CPI. RBNZ will have more room to accommodate where housing costs are less of an issue. This obviously matters for any monetary push but matters too for any fiscal stimulus because RBNZ moves last and has to offset fiscal moves that look set to push medium-term CPI above 3 percent.**

* Full disclosure: I was very seriously wrong about macro policy in early 2008 when I thought RBNZ was cavalier about a persistently high CPI when instead they had better foresight about the coming maelstrom; I'd calibrated around RBNZ responses to inflation rates circa 2005-6. So discount as you reckon appropriate.

** They've also been looking to other potential tools for damping housing price run-ups.

Dutch diseases, the dollar, and the MPS

Today's Monetary Policy Statement rightly notes that continued strength in the New Zealand dollar means there's less reason for increasing interest rates.* The Policy Targets Agreement requires that the RBNZ keep the inflation rate over the medium term between 1 and 3 percent. There seems to be no pressure on the CPI: iPredict forecasts through September quarter have it between 1 and 2 percent. At the same time, there's no prediction of interest rate hikes through the end of the year (though backing out cumulative probabilities from the sequence of quarterly "What will RBNZ do" forecasts isn't straightforward). I'd worried that the GST hike might have fed through into more wage settlements despite the offsetting income tax cut; that seems not much to have happened and forward-looking expectations are within bounds. Nice call RBNZ; I might just lose my bet with Matt.

The MPS has been interpreted as sending signals about the RBNZ's views on the appropriate level of the dollar; Alex Tarrant takes it as warning of interest rate cuts if the dollar stays high. And the MPS does wonder whether the recent appreciation is justified:

The New Zealand dollar has appreciated markedly since the publication of the December  Statement. This appreciation is difficult to reconcile with developments in New Zealand’s economic environment, having occurred at a time when export commodity prices have tracked sideways. Instead, the exchange rate appears to have been driven upward by a combination of an easing in global monetary policy and recovery in global risk appetite. 

The March projection assumes the New Zealand dollar TWI depreciates modestly over the next few years. Should this not occur, all else equal, the Bank would see less need to increase the OCR through this time. While helping contain inflation, the high value of the New Zealand dollar is detrimental to the tradable sector, undermines GDP growth, and inhibits rebalancing in the New Zealand economy.

But this doesn't translate into the RBNZ now targeting the exchange rate, even if Bernard Hickey wishes it were so. The high dollar automatically keeps the CPI down by pushing down the price of tradeable goods in the CPI basket. So if the dollar stays high, there's less need for RBNZ to do anything on interest rates. And if policy easing elsewhere is pushing up the New Zealand dollar, that might give reason for easing on our own part to avoid falling below the lower band of the PTA, if there's risk of falling below the lower bound. iPredict says 10% chance of inflation below 1% in either of the next two quarters, so it's not looking particularly likely. RBNZ, in my reading, is just reminding folks that its inflation target is bounded both from above and from below and using that to do a bit of jawboning on the dollar.

I'm less than convinced that a high dollar is such a bad thing. Even if dairy prices have been flat over the recent few quarters' dollar appreciation, it's hard to say whether that means that the dollar's current strength is unjustified or whether it means the weakness during the worldwide recession was a temporary thing. If the appreciation is due to "the increase in risk appetite, higher global commodity prices and further policy easing by major central banks", a decent chunk is just a return to the status quo ex ante, and perhaps only a temporary one with Greece looking more likely to have a messy default sooner or later and with reasonable concerns about malinvestments in China. But if the rest of the world is getting better, we're back to folks being willing to take on currency risk in exchange for relatively higher returns available in NZ.

Import-competing sectors face stronger competition when the dollar is high. But it's debatable whether some of those import-competing sectors should even here exist. Book retailing probably shouldn't survive here outside of a few niches in the long term when BookDepository can get books here from the UK, delivered, for a bit more than half of the current retail price. If the worry is that milk exports drive up the price of the dollar and hurt other manufacturing, that's not unlike the current situation in Canada where oil and commodity exports have strengthened the Canadian dollar. Stephen Gordon there is trenchant:

Firstly, the prospect of fewer Canadians making things for foreigners is to be welcomed: what matters for Canadian economic welfare is consumption by Canadians, not making things that will be consumed by non-Canadians.

The Dutch disease story also supposes that the employment losses in the export sector are not offset by employment gains in other sectors. This has clearly not been the case in Canada: the resource boom of 2002-2008 saw a steady reduction of unemployment rates to their lowest level since the Labour Force Survey started collecting data in 1976. Nor were these jobs systematically lower-paying: after stagnating during the 1990s, real median wages saw significant growth during the resource boom -- even in Ontario.

Real median wages here also increased substantially from 1998 to 2009 or so**, with nominal stagnation and some real decline during the recent period.

Commodity price driven dollar appreciation isn't as much a disease as a recommendation to shift resources to their more highly valued uses. We're shifting towards dairy manufacturing and away from other forms of manufacturing. I wouldn't call it a disease in need of treatment.

* Please take the strong caveat that I am not a macro economist. And, while I think I was right in criticizing the RBNZ back in 2005 for being too slack, they were very right and I was very wrong in early 2008 when I worried about their very rapid cuts in interest rates.

**This is a nominal series; CPI here for adjusting. Real median wages up about 18% over the decade.

Earthquakes and monetary policy

From today's Monetary Policy Statement, in which the RBNZ (as entirely expected, and as entirely reasonable) did not change the interest rate:

Repairs and rebuilding in Canterbury will have a substantial influence on the New Zealand economy.  Construction sector activity will be boosted for several years, creating resource shortages in the building industry and other parts of the economy more generally.

The eventual volume of repairs and rebuilding is highly uncertain. Since the March Statement, the Bank has based its projections on a working assumption of $15 billion of reconstruction in 2011 dollars. Recent assessments from the EQC and additional damage from aftershocks have highlighted upside risk to this working assumption. As a result the Bank has revised up its working assumption to $20 billion. The Bank will continue to update this assumption as more information becomes available.

While some properties have been repaired, so far only limited rebuilding has occurred. Continuing aftershocks have hindered planning and building, and made it very difficult to secure insurance for new buildings. It seems unlikely that construction sector activity will pick up as soon as was projected in the June Statement. The updated projections assume major aftershocks soon cease, allowing EQC contractors to step up repairs on moderately damaged properties from early next year. Furthermore, seismic stability would be expected to help free up the private insurance market. It is assumed that rebuilding of severely damaged properties gets under way from the middle of next year.

In terms of the influence on monetary policy, it is the pace of reconstruction and the resultant degree of pressure on resources, rather than the eventual magnitude of reconstruction, that will have the greatest influence on interest rate settings. It is unclear how rapid reconstruction will be.

Earthquakes do bring spending. But only with long and variable lags. Even leaving aside wealth and capital destruction, the unavoidable uncertainty induced by ongoing aftershocks imposes large costs. Nobody knows when they'll be able to rebuild. Add on top of the natural and unavoidable uncertainty the regulatory uncertainty induced by that Council's still deciding who will be allowed to rebuild where and subject to what building codes. Earthquakes just don't seem that great a Keynesian policy prescription.

There's a limit to the extent to which resource shortages in building will wind up generating resource shortages; at least some of the supply pressures in construction will likely be handled by importing workers from a flagging Australian construction sector. Wages will be bid up to the point at which Kiwi construction workers in Oz come back home.

I would like to revise one prior post where I had things partially wrong. I'd not been pleased that the Earthquake Commission's asset base consisted largely of New Zealand government securities and suggested foreign investments as preferable, or at least a portfolio the value of which ought to be higher after an earthquake: construction companies and the like. An earthquake large enough to require EQC's portfolio liquidation would, I'd thought, cause the Kiwi dollar to tank with an NZ credit downgrade. I'd missed that reinsurance inflows would push the dollar higher. So I'd retract the part where I suggested a strong foreign-bias in the EQC investment portfolio; reinsurance inflows for anything big are going to dwarf the currency effects of EQC portfolio liquidation. But it still seems a bad idea to have EQC having to sell off a couple billion dollars worth of NZ government securities at the same time as the government has to go to the debt markets to cover the parts of earthquake cost for which government has assumed responsibility.

RBNZ tracking

Is the RBNZ on track to keep inflation outcomes within its mandate over the medium term? All signs at iPredict point to yes. Inflation in September quarter is expected to be more than 4.5% and less than 5%, but the GST hike hits year on year CPI changes until September quarter. After that, we find:

• December quarter inflation expected to be more than 2% but not more than 3% (though there's still a 40% chance of the latter)
• March quarter inflation expected to be more than 2% but not more than 3% (and a 34% chance of the latter)
• And, all this despite that the RBNZ is forecast to leave rates alone this go-round and also to leave them alone in October. There's better than even odds of no change in December, but not by a lot; if we add in the chances of a hike in October (which could make a December hike less likely), we're probably looking at even odds of an increase by December. No change is the most likely outcome in each period, but the cumulative chances of no change get smaller. Perhaps more interesting would be a set of contracts on the level of the OCR at each period rather than whether the RBNZ moves.

So inflation hawks might want to head over and make some money if they think the figures are wrong. I'm not going to second guess both RBNZ and iPredict traders on this one.

iPredict also has trading on unemployment and GDP growth. It wouldn't take much to put the figures together for Sumnerean NGDP targeting. Scott Sumner wished that the government would invest a few million dollars in creating markets and subsidizing trading on NGDP futures contracts. I suspect that iPredict runs on a budget just a bit thinner than that. But I'd also expect that RBNZ would need contracts running farther into the future for them to be useful for targeting.

Weasel whacking

Inflation outcomes for this past quarter, while high overall, aren't that crazy once we account for the changes in GST, a few expected seasonal price effects on fruit and vegetables, and the ETS. So argued Matt over at TVHE. I'd commented there that I'm happier trusting to RBNZ's discretion this quarter. Back in 2005, I was (rightly, I think) incensed about the Bank's seeming to ignore its inflation mandate while seeing just how fast they could push the economy. Late 2007 and early 2008, I worried (very very wrongly, in hindsight), that RBNZ was again ignoring its mandate. Inflation outcomes were beyond threshold and were projected to be beyond threshold for rather some time; you had to average over a large number of quarters to get outcomes below 3% on average. But the folks at RBNZ had a closer eye than I had on what was going on in the international credit markets and saw some of the mess that was to come; tightening up then would have been a rather bad idea.

RBNZ will have to tighten, and hopefully before inflation gets embedded into wage expectations. 2005 left me in 2008 with the impression that RBNZ was happy to take any excuse to avoid its mandate; 2008 reminded me that their eye on the data is a hell of a lot better than mine. And so I'm happier to take RBNZ inaction as suggesting bad things on the horizon than that they're ignoring their mandate; I trust them more now than I did then. I have worried that ETS increases could get embedded into wage expectations; I expect that RBNZ is keeping an eye on things.

For a rather nice parable on the other side, here's Andrew Coleman hoisted from the comments over at TVHE. I, for one, wish he'd start his own blog rather than let gems like this languish over in comments sections:

Once upon a time there was a land where beautiful songbirds lived. The people in the land loved their songbirds, and tried to ensure the population kept increasing. Their efforts were undermined, however, by a population of weasels that would stalk and prematurely kill the birds.

The people put their heads together and decided to create a Department for Weasel Control, thinking that if they could minimize the death toll on the bird population the population would grow. The move was not uniformly popular, however, for efforts to kill weasels sometimes temporarily lowered the birth rate of the songbirds. Moreover, it was not clear exactly how the Department would work. In the end, it was decided that the Department would be left to its own devices, subject to being accountable for ensuring the general level of the weasel population was stable. A department head would be hired – popularly known as the chief weasel whacker – and left to get on with it.

The move was controversial. Some people said that the weasel population didn’t really matter if the song bird population was growing. Others didn’t like the reduction in the songbird population that occurred when a full-scale weasel eradication programme was in full swing. Others were enthusiastic, but warned that someone with a paranoid hatred of weasels should be hired as chief weasel whacker to ensure the department did its job well.

One day a new chief weasel whacker was hired, someone with a background in songbird appreciation. From the start he argued that it was both unfair and unnecessary to require him to make sure the weasel population was stable, all that was needed was a requirement that it didn’t grow too fast, maybe not faster than 3 percent in the medium term. The real objective was the increase in the population of songbirds, and the eradication of weasels was just a means to an end. In any case, the weasel population fluctuated naturally, and it was silly to hold him responsible for factors outside his control. Not all people were convinced, but he was good with songbirds.

At first, things weren’t too bad. The songbird population initially increased quickly, after the weasel control programme was eased. Not everyone was happy, as the population of weasels wasn’t stable at all but increasing at nearly three percent a year, but the songbird population increased at a steady pace. Then a major shock occurred, when a weasel disease crossed to songbirds and killed a few. The Chief Weasel Whacker put on hold efforts to control weasels until the songbird birthrate started to increase. Weasel control was neglected for several years

Soon debate broke out up and down the land. Should people be worried that the chief weasel whacker didn’t seem to go around whacking weasels? Or should they just monitor to songbird population? Did it matter that the weasel population had been growing at nearly 3 percent for several years? And what about the original intention of keeping the weasel population stable? It had increased by nearly 20 percent, and never shown any indication of falling. Matters came to head when one year the weasel growth rate couldn’t be counted on the fingers of one hand. The loony weasel haters emerged from the undergrowth making outrageous and funny claims about a world that would be overrun by the Great Weasel who would go around stealing human babies. Fans of the Chief Weasel Whacker denigrated the loons, but others could help but wonder if the original founders had it right after all. Perhaps if you let the weasels increase by a maximum of 3 percent a year, soon they would increase by 3 percent nearly every year. Maybe hiring someone with a paranoid hatred of weasels would have been clever. And maybe there might be a better way of controlling the weasel population than simply trying to whack them after they were born. Perhaps it would be useful to understand weasel physiology and psychology and see if their breeding patterns could be controlled……

Unfortunately I don’t know how the story ends but apparently it might be time to hire a new Chief Weasel Whacker soon, so the story is sure to be interesting.

I'll never be able to listen to this one the same way again...

Maintaining Bank Independence

When the Prime Minister starts musing about which way interest rates should go, or might go, folks who care about central bank independence should worry. Bloggers and journalists can carp about bank policy all they like, but they're not in a position to renew the Governor's job. Jawboning about which way interest rates should go can be seen as a signal about what's necessary for a Governor's appointment to be renewed. And so Members of Parliament, and especially the Prime Minister, really ought to know better.

John Key has been awful on this front. Maybe it's his background as a currency trader, but he just can't seem to stop himself from musing about what effect things are likely to have on RBNZ interest rate decisions. When he does, Matt Nolan over at TVHE gets mad. I get annoyed. So do David Farrar at Kiwiblog and Rob Hosking at the National Business Review. That seems to be about it. It's rare that anybody reporting on the PM's interest rate musings notes that he really really shouldn't be doing that. It's happened so often, that I've damn near given up on it. Matt still jumps up and down occasionally. The latest one, which I'd missed as I was still busy being an earthquake refugee:

A drop to the official cash rate -- after Treasury figures showing the massive cost to the economy of Christchurch's quake -- would be useful, Prime Minister John Key says.

Mr Key was asked this morning if the figures would make a reduction in the official cash rate this week inevitable.

"That's a matter for the Reserve Bank governor and it's for him alone to decide what happens on Thursday," he told Breakfast on TV One.

"But certainly the markets have factored in a likely cut in the official cash rate. You've got to say lower interest rates probably help the country, but that ultimately is a matter for the governor."

Mr Key said he was not attempting to influence the process but was stating facts.

"The question was would it be helpful, well low interest rates help."

If your boss tells the media that it would be helpful for the company if you did X, but it's really up to you, you might think that you kinda hafta do X if you want to keep you job. The Policy Targets Agreement gives RBNZ a bit of wiggle room around its inflation target:

4.b In pursuing its price stability objective, the Bank shall implement monetary policy in a sustainable, consistent and transparent manner and shall seek to avoid unnecessary instability in output, interest rates and the exchange rate.

It wouldn't be crazy to see Key's media statements as instructing the Bank about whether they'd be given a pass for leaning on 4.b and perhaps punished if they didn't.

The New Zealand Prime Minister makes statements that could easily be read as pressuring the Reserve Bank ahead of an interest rate decision, and nobody much cares that this puts central bank independence in jeopardy. And those who do care have largely given up.

Now turn to Canada.

Jack Layton is the leader of the New Democratic Party of Canada. What the NDP thinks about anything, at least at the federal level, usually counts for about as much as what I think about anything - about nil. But in the most exciting election since '93, the NDP has surged up while the Tories and Grits focused on bashing each other. They're now a reasonably close second to the Tories. Amazing. Here's what Layton said about interest rates late last week.

Challenging the role of the fiercely independent Bank of Canada -- and stepping into territory where politicians rarely venture -- Layton said the Bank of Canada should hold off on raising interest rates because doing so may slow job creation and too many Canadians are already unemployed.

The Canadian economics Twittersphere jumped. @StephenGordon, @KevinMilligan, @MikePMoffatt and @andrew_leach weren't pleased. Neither were journalists Andrew Coyne and Terence Corcoran. Stephen Gordon's piece hit EconomyLab at the Globe and Mail.

The Bank’s mandate from the federal government is to keep inflation at around 2 per cent a year. Extremely low interest rates are appropriate during recessions, but when the economy returns to capacity -- as the Bank expects it will with the next 18 months -- then they become inflationary. By ordering the Bank to set aside its judgment and to let inflation increase beyond its target, the government would be in effect abandoning a policy that had provided the low and stable rates of inflation -- as well as the low and stable interest rates -- that we have seen over the past twenty years.

It took fifteen years and two recessions -- both of which were more severe than the one we just had -- to get inflation under control last time. That’s not an experience we want to repeat.

As I was writing this, another story appeared, suggesting that Mr Layton was merely expressing an opinion about the appropriate path of interest rates, and not considering the possibility of ordering the Bank of Canada to keep interest rates low. Later, an e-mail from NDP headquarters assured that "New Democrats are committed to the independence of the Bank." I greet these clarifications with no small amount of relief.

Perhaps the most important lesson to be learned here is that Prime Ministers -- and those who would be credible candidates for becoming Prime Minister -- should be extremely circumspect when discussing monetary policy. Twenty years of hard-won credibility is not something to be tossed aside so lightly.

Read those last two paragraphs again. Canada's a strange place. Academic economists note the dangers of a Party Leader who's still unlikely to form the next government mouthing off about interest rates and enough folks get worried that the candidate backs down before Gordon can even finish writing his piece for EconomyLab.

Here, maybe a half dozen of us tops care that the Prime Minister leans on the RBNZ - certainly not enough of us to get any traction on the issue.

It's encouraging that Canada's NDP, after some backtracking, seems to show more sense on monetary policy than New Zealand's Labour Party. Fortunately, Labour has less chance of getting anywhere near the Treasury benches this year than has Canada's NDP.