Tuesday, 2 August 2022

LSAP Review?

Geoff Mortlock lays out what's needed for a review of what the RBNZ has been up to, in an open letter to Finance Minister Grant Robertson, cced broadly. 

Jenny Ruth reported on his first open letter at Business Desk:

Reserve Bank governor Adrian Orr is performing an increasingly political role, risking the credibility of the central bank and hurting rather than helping the New Zealand economy, according to former central banker Geof Mortlock. 

In an open letter to finance minister Grant Robertson and RBNZ chair Neil Quigley, Mortlock particularly takes issue with Orr’s “favourite theme of portraying the RBNZ as the Tāne Mahuta of the financial landscape”. 

Mortlock, who spent 24 years at RBNZ through to 2007 and five years at the Australian Prudential Regulation Authority through to 2013, and who has consulted for the World Bank, International Monetary Fund and KPMG Australia, said Orr’s continued prominent references to Tāne Mahuta “have become a source of considerable embarrassment”.

I copy Mortlock's most recent missive here, with his permission:

Dear Mr Robertson,

In a recent open email to you, I made a number of criticisms of the Reserve Bank's performance, governance and management. As you are aware, I am not alone in making these criticisms. Many people with deep knowledge of central banking, economics and financial sector policy have made similar criticisms. The focal points of these criticisms have included:

-  the inadequate quality of governance and management at the RBNZ by reference to relevant foreign benchmarks (e.g. Reserve Bank of Australia, Bank of England, Bank of Canada);

-  the extraordinary preoccupation of the governor with largely irrelevant maori cultural issues, as opposed to doing the job of governor to pursue an effective approach to monetary policy and financial sector regulation;

-  the very costly LSAP program, with a growing taxpayer burden via the government indemnity of the RBNZ;

-  the highly questionable use of macro-prudential policy and the distortions it is creating in bank lending to the housing market when compared to the alternative of using more granular (but less distortionary) risk-weighted capital ratios;

-  the lack of robust cost/benefit assessments of RBNZ policy initiatives, including the major increase in bank capital ratios to levels not seen in comparable countries and which will inevitably exacerbate recessionary pressures next year and possibly beyond; 

-  the extraordinary loss of highly qualified and experienced staff from the RBNZ and the resultant erosion of its intellectual capacity; and

-  the lack of robust performance metrics and independent performance monitoring of the RBNZ.

In this open email, I want to put forward some suggestions for how these failings can be addressed.

LSAP review

In the case of the LSAP, there should be an independent review to assess the matter. It should not be left to an internal RBNZ assessment, given that this would lack sufficient objectivity and independence. My suggestion is for the Minister to appoint one or two persons, suitably qualified and non-conflicted, in consultation with the Opposition parties, to evaluate the efficacy and cost-effectiveness of the LSAP. This should be done in a constructive way to draw out key lessons to guide future policy. Such a review would sensibly include an assessment of the following matters:

-  Were the rationale for and objectives of the LSAP sufficiently thought through and precisely specified at the point of its conception?

-  Was the proposal for the LSAP subject to sufficient independent cost/benefit assessment (external to the RBNZ) before a decision was made to implement it?

-  Was the LSAP sufficiently targeted at reducing interest rates at specific time horizons on the yield curve (e.g. as per the RBA version of the LSAP), as opposed to the broader-based asset purchase pursued by the RBNZ?

-  Could the desired interest rate reductions have been achieved more cost-effectively (at much lower cost to the taxpayer) by simply reducing the OCR further than the RBNZ did reduce it, rather than through the LSAP?

-  What is the estimated impact of the LSAP on economic activity relative to what would have prevailed had the LSAP not been used and the OCR reduced further?

-  Were the potential externalities associated with the LSAP adequately assessed - e.g. the potential for the LSAP to contribute to house price inflation to a greater degree than might have occurred had the RBNZ solely relied on the OCR as the monetary policy lever?

-  Would the RBNZ have embarked on the LSAP, and if so, by as much, in the absence of a government indemnity? In that regard, did the indemnity reduce appropriate disciplines on the RBNZ in the design and implementation of the LSAP?

-  Did the Treasury undertake a cost/benefit analysis of the indemnity before a decision was made to implement it, including taking into account the extent to which the indemnity might have reduced RBNZ incentives for appropriate caution in the use of the LSAP?

-  To what extent did the non-executive members of the Monetary Policy Committee engage on the LSAP, and did they raise concerns?

-  Is the proposed exit from the LSAP the most cost-effective strategy, given the alternatives?  Would it have been better for the RBNZ to begin the sale process at an earlier point, such as when the information available to it suggested that there would be a need to raise interest rates?

These are the kind of issues that need to be properly assessed by an independent, objective and transparent review process, overseen by the FEC.

Review of the functioning of the Monetary Policy Committee

It would be timely to review the functioning of the MPC given the experience of the last two years or so. Again, this should be done by an independent review process and not within the RBNZ. The issues that need to be assessed include:

-  Is the composition of the MPC appropriate in terms of executive versus non-executive members?  Would it be more effective if a majority of its members were non-executive (as in several advanced countries with MPCs)?

-  Do the non-executive members of the MPC have sufficient knowledge, experience and capacity for judgement to be effective in their role? It is worth noting that, while the three non-executive members are all able people in their own right, not one of them had significant experience, in-depth knowledge or standing in monetary policy issues upon their appointment. In contrast, non-executive members of the MPCs in other comparable countries are generally selected on the basis of their specific knowledge, skills, experience and capacity for discerning judgement on monetary policy and macroeconomics.

-  Should the qualifications for appointment of non-executive persons to the MPC be lifted to a higher standard, and better anchored to the role that the MPC performs?

-  Is the level of transparency of the MPC sufficient by reference to international standards? It is striking that there is very little information that is publicly released on the views expressed by the members of the MPC and no speeches are given by any of the non-executive MPC members. By comparison with other comparable countries, the MPC lacks transparency and accountability.

-  To what extent do non-executive members of the MPC constructively challenge the views of executive members of the MPC in their deliberations on monetary policy?  To what extent do they seek to avail themselves of supplementary information and views from parties outside the RBNZ to better equip them to perform their duties?

-  What performance assessment framework is applied by the RBNZ Board and by the NZ Treasury, respectively, in assessing the performance of the MPC, including in respect of the performance of the MPC itself, assessments of forecasting accuracy (relatuive to forecasts made by other entities at the same time), model dependency, and the weights accorded to price stability versus employment considerations?

Board membership

I and many other observers have expressed concern at the lack of sufficient skills, knowledge and experience on the RBNZ Board given its new responsibilities. In particular, it is remarkably lacking in persons with the expected level of knowledge, experience and capacity for discerning judgement in banking, insurance (other than the one director with a limited level insurance connection, who is arguably conflicted), financial markets, and macroeconomics.

By comparison to the boards of functional equivalence in central banks in comparable countries, the RBNZ Board appears to have a remarkably shallow pool of the relevant experience.  This is concerning.  It is also ironic, given that the RBNZ has made much (rightly) of high quality governance in banks and insurers, and yet has failed to lead by example.

I recommend that additional directors be added to the Board to lift its capacity to the required level, with a particular need for suitably experienced persons in banking, insurance, financial markets and macroeconomics. In addition, there needs to be much stronger focus on the structure of its board committees (including risk management, remuneration, audit and prudential policy) and the frameworks they will use to help the Board perform its governance role. Greater transparency and accountability are needed in these areas.

I also recommend that consideration be given to the establishment of a Prudential Policy Committee as an advisory committee to the Board, comprising non-executive persons with expertise in prudential policy and regulatory issues, who are not conflicted, with therse persons being appointed by the Minister of Finance.  (Why an equivalent of the MPC for financial sector policy was not incorporated into the RBNZ Act is also a question that should be addressed when the Act is reviewed.)

Performance assessment of the RBNZ

For many years the RBNZ has operated largely as a self-contained domain. There has been very little meaningful external monitoring and assessment of the RBNZ Board, senior management, and RBNZ performance of its functions. Treasury has done very little in this area. Successive finance ministers (including yourself) have also been content to leave the RBNZ to do its own thing, with little in the way of structured scrutiny and performance assessment. In this regard, there has been a worrying lack of recognition of the fact that, with operational independence comes the need for robust external performance assessment, transparency and accountability. The greater the operational independence a government agency has, the greater is the need for robust independent performance assessment and associated accountability. There has been plenty of operational independence but very little in the way of effective independent performance assessment, meaningful transparency, and accountability.

What is needed now is a much more focused role by the Treasury in assessing the performance of the RBNZ across all of its functions, including the effectiveness of the Board, the governor and the senior management team. This needs to be done on the basis of transparent performance metrics that are set by the Minister (not by the RBNZ), in consultation with the RBNZ. The performance metrics should be comprehensive and cover in meaningful detail all of the functional areas of the RBNZ and should be anchored to the statutory and policy objectives for each functional area. The performance assessments should be transparent, being tabled in Parliament and subject to robust scrutiny by the FEC.

The work being undertaken in Australia, through the Financial Regulator Assessment Authority, provides a good example of how regulatory agencies (APRA and ASIC in Australia's case) are subject to regular, independent performance assessments. Other good examples of central bank and regulatory agency performance assessment can be found in many other countries, including the United Kingdom, United States, Canada and several EU and Asian countries.

New Zealand needs to lift its game in this area - not solely in the case of the RBNZ, but also in respect of other key agencies, including the Financial Markets Authority and the Commerce Commission. More generally, performance metrics and performance audits need to strengthened across the public sector. There is a woeful lack of rigour in this area, with the consequence that New Zealanders continue to suffer from under-performing government agencies and public sector inefficiency.

I urge you and colleagues to take note of the points raised in this email and take appropriate actions to address the concerns I have raised.


Geof Mortlock

International Financial Sector Consultant


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