Core funding ratios, monetary policy, and trade-offs

In a recent Herald article, Geoff Simmons discusses the core funding ratio.  I work near the GMI team, and I have a lot of time for their outside the box thinking on issues – however, this is one case where I will have to respectfully disagree with the conclusions.

What was the conclusion?  It was that the RBNZ should look at varying the Core Funding Ratio (CFR) at its next meeting in order to reduce inflationary pressures, instead of increasing interest rates.

Now it has been suggested that adjusted the CFR during the “extremes” of the cycle may carry weight – but here I want to get into the trade-offs involved, and why I don’t think it is appropriate now.

We can think of the logic behind a CFR sort of like a reserve ratio (RR) from back in the day.  [Note they are quite different, I just find this an easier way to describe their structural role]

These were greatly discredited due to the belief that “private agents (banks) will account for risk” – however, nowadays people realise that there are two issues that make a RR necessary:

  1. Moral hazard:  Retail banks know that the central bank will bail them out – and so will take on more risk then we would like.
  2. Information asymmetries and incentive schemes inside banks can lead to excessive procyclical risk taking.

By setting a structural RR, we ensure that the “doomsday” scenario is ruled out – and improve the stability of the financial system and general economy.

Very good.  However, in the article changing the CFR is suggested as a way of controlling monetary policy.  How does this work?

Impossible Trinity and capital controls

A CFR ensures that a certain proportion of any asset class held by a bank (a loan) there is a certain match in terms of the quality and length of the liabilities they have (the money they bring in to fund the loans).  By doing this, the central bank is partially dictating the type of risk banks can take on, and also ensuring that banks don’t always face the lowest “cost” when they try to lend out.

By increasing said “cost” of lending out, a CFR in turn increases interest rates in the economy and lowers lending – relative to the case where there is no ratio.

Now I get the feeling that the Herald article believes we can get a “free lunch” out of this.  By increasing the CFR we increase interest rates and lower lending, but since new “funds” from overseas can’t “flow” in we don’t get the increase in the exchange rate.  Huzzah, we have increased interest rates without pushing up the exchange rate!!!

This is only a partial story though.  Essentially the CFR increase is acting as a capital control in this context … this is an application of our good friend, Mr Impossible Trinity.

Since the exchange rate is not rising, in order to control inflation we either need a larger increase in domestic interest rates then we otherwise would have face (real underlying interest rates that businesses and households face, not the OCR) and a sharper drop in economic activity.  We stabilise our exchange rate by explicitly lowering our incomes by more than we needed to, in order to control inflation.

Let us not forget that by doing this, we are effectively blocking a whole lot of lending on investment that makes sense given economic conditions – if we are worried that a high exchange rate will “lower long-term growth” (debatable, as we need to discuss what is going on and why – and even then, a one-off boost due to tightening monetary conditions will likely be independent of these), we are trying to “solve” the problem by lowering investment … which will UNDENIABLY lower long term growth.

Conclusion and opinion

In the current context, where we are crawling out of a recession and where inflationary pressures are starting to manifest themselves we can all agree we are nearing the time when monetary policy must “tighten”.  However, I would disagree that changing the CFR makes sense as the way to tighten. Using the CFR will lead to a larger increase in domestic interest rates and/or sharper drop in output, just to keep the exchange rate stable.

There are two important additional points I must raise here:

  1. IMO, the only reason why we would use the CFR instead of the OCR for monetary policy targets is if we believe there is some “structural” break going on – such as an asset bubble in the exchange rate.  In this case we may wish that the CFR is at a higher level – but it should be justified on financial stability grounds – not monetary policy grounds.
  2. The idea that there are “hot flows” of money driving up the dollar vexes me a little.  It is true that there is some “infinite supply” of funds out there, but we need domestic demand for it as well!  If the CFR is binding, it link between the dollar and the exchange rate is not necessarily clear (as any increase in borrowing from overseas will need to be matched by some amount of domestic saving as well).  And if its not binding, then there isn’t an issue …

Update

I’ve been told that this is the way the RBNZ see’s CFR’s – and that it is consistent with my conclusion that rolling it out now would be a touch inappropriate:

Liquidity tools

Core Funding Ratio

The Core Funding Ratio is a tool that can help promote greater financial system resilience by requiring banks to fund credit using more stable sources than they might choose in the absence of the requirement. This discipline is particularly desirable during periods of rapid credit growth, when recourse to relatively cheap short-term wholesale funding rather than more stable longer term funding is more likely.

As a tool to actively lean against excessive credit growth, our simulations suggest that the Core Funding Ratio could, in some circumstances, play a useful supplementary stabilising role by requiring banks to always maintain a proportion of core funding which is typically more expensive than shorter-term wholesale funding. Alternatively, the Core Funding Ratio could be used as a counter-cyclical policy tool. Although the Core Funding Ratio could be a less effective anchor on credit growth during a global boom (when funding spreads become compressed), it would still be effective in its primary role of ensuring that banks resort to more stable funding sources.

From Allan Bollard speech in Mar 2011

 

  • Pingback: TVHE » Core funding ratios, monetary policy, and trade-offs | Articles about the world()

  • Pingback: TVHE » Damned if you do, damned if you don’t()

  • Hi Matt, your analysis is technically correct, but I believe limited by a narrow, short term view of the current problems we face.

    I am not trying to achieve the Impossible Trinity. I think the current orthodox Holy Trinity of free exchange rates, free capital flows and controlled inflation has failed us horribly, and it is time to start questioning that orthodoxy.

    Lets look at the achievements of the past two decades:

    – an explosion in bank fueled private sector debt which has only succeeded in creating a bubble in our property markets
    – increased amounts of profits and interest payments heading overseas such that our real gross national income per person has not risen since 2003.
    – low inflation (Hurrah!), achieved almost entirely by suppressing tradeable inflation, while inflation in non tradeables has been persistently above the target zone.
    – this suppression of tradeables has meant that our exports haven’t grown since 2005.

    I don’t think that this is a sign of great success for our current approach.

    You are right that capital controls will hurt short term growth, and that there are no free lunches. But I think capital controls have to be considered in the short term at least to break the pattern that has led to the problems above. In fact many of the things we need to do right now will hurt short term growth. Raising productive investment also hurts short term growth, because it drives money away from consumption. But the fact is that if we are to own any part of our country in the future we need to start earning foreign exchange, saving and investing. This is particularly the case in a world where other nations are already manipulating their exchange rate.

    I think the CFR deserves some strong consideration to help achieve that, amongst other ideas such as a tax on capital, and putting stronger limitations around lending on housing. If you disagree, I would like to hear your alternative way of solving the problem, rather than simply denying that a problem exists, and putting it all down to market forces.

  • @Geoff

    Hi Geoff,

    The issue I have here is that your comment is largely unrelated to what you have asked the Bank to do, which is what I was arguing against in this piece.

    You were saying the Bank should change the core funding ratio to achieve monetary policy aims – you were not actually discussing the structural reasons for a core funding ratio (which is why it was introduced in the first place).

    As you stated in the article:

    “That is why the time is nigh to use this new tool as an alternative to traditional interest rate rises.”

    Which is inappropriate in the current circumstance according to what I have written about. If you wanted to make the point that the core funding ratio is at the “wrong” level then that is fine – but saying that we should adjust it as a monetary policy instrument is not good policy.

    ….

    Now to discuss some of the other points you have raised.

    There is also the elephant in the room here – namely that the data behind the stylized facts you have mentioned above are consistent with the increase in the terms of trade we have experienced. Rather than indicating the economy is a basket case, it may merely suggest that we have experienced both a strong increase in our long-term income (true) and have experienced a housing bubble (which is largely deflated according to the data).

    A lot of the increase in the terms of trade is expected to persist in the future, and as a result it is unclear whether anything should be done in the face of it. On the income side RGNDI is actually above 2003 levels, even though we are below potential output – this is a great result from the best measure of income available to us.

    “I think the current orthodox Holy Trinity of free exchange rates, free capital flows and controlled inflation has failed us horribly, and it is time to start questioning that orthodoxy. ”

    I also disagree with this fundamental point. New Zealand has outperformed the world during this crisis – and the ability for monetary policy to respond as it has was a great boon.

    The core funding ratio itself was introduced to meet a perceived issue in the structure of the economy, as was the changes to the tax status of housing in 2010. These issues have been dealt with, and the economy look well on its way in terms of adjustment – this isn’t 2007 anymore, the economy has moved on now.

    “This is particularly the case in a world where other nations are already manipulating their exchange rate. ”

    This is something we should think about a little more – if other countries are “manipulating their exchange rate” we need to ask how, and why. Only once we do that can we talk about winners and losers.

    In the long-run you can’t influence the exchange rate by definition – unless you are fiddling fundamentals. So the long “devaluation” of the Chinese currency is akin to them building up savings and investing it overseas. By definition, once currencies “realign” they lose out due to the capital loss on their foreign currency holdings.

    Furthermore the “stimulus” to GDP for the fiddling country comes from them implicitly subsidising their exports – they are paying part of the price for consumption goods for the rest of the world. That is why consumption spending by New Zealanders has been BELOW its historic average proportion of income even though New Zealanders have been getting more goods and services – this is a fact.

    As a result, we currently have an imbalance in terms of real goods and services that is due to overseas factors – that imbalance is that we are being paid to consume. In this situation are we really the ones losing out? We need to think about these issues carefully before we decide to arbitrarily intervene.

    “If you disagree, I would like to hear your alternative way of solving the problem, rather than simply denying that a problem exists, and putting it all down to market forces.”

    So I can disagree as long as I don’t disagree with the fundamental issue – which I do, and I have for the last five years 😉

    The key point for me is that NZ is a small open economy – if the composition of our economy changes it is more likely to be the result of external factors than internal factors. That is exactly what we have seen during the last decade.

    I do not agree with the hot money argument – at all. It misses the demand curve that exists, someone actually has to borrow for the money to be loaned out. Given that borrowing does fall with the interest rate, we cannot turn around and say “higher interest rates lead to hot money flows” – especially when the CFR sets a proportion of domestic lending!

    When the Bank discusses “imbalances” they do not focus on the past ten years – they compare the economy in the 60s to now, and state that they believe there is some factor keeping the real exchange rate too high. Now this could be currency manipulation by China (which we may actually be beneficiaries of) or it could be that the government sector is too large (a cost we may be willing to take on if we care about redistribution). However, we should really be sitting down, seeing what the variation is, and trying to understand why – rather than blaming monetary policy which is weirdly receiving the wrap for any perceived imbalance at the moment.

    A small open economy is best served by an inflation targeting, flexible exchange rate, framework – for large economies it is not so clear (they tend to be fighting “prisoners dilemma” type games with each other). I have no problem with structural policy that helps to stabilise the economy during the excesses that do exist – but saying that we should adjust the CFR right now is not an example of this.

    Often when people tell me a problem exists and we have to do something I feel uneasy – even if a problem does exist, how do we know we have a sensible solution unless we understand the problem. I do not believe there is a problem, but I am willing to have policies in place (CFR) that provide some insurance – I am 100% certain that even if a problem exists, no-one understands it and can as a result provide active policy that will improve outcomes. Arbitrarily changing the CFR to meet monetary policy aims (which is what was implied by the article) comes into that last category.

  • Yossarian10

    Found your comments through Google. I note a year has passed; and the property bubble seems to have got worse; unemployment is up; and the current account deficit is very high and heading higher. So I wonder whether your perspective remains the same, that we don’t have a problem, and to the extent that we do, the OCR is a perfectly good tool to deal with it.
    Seems to me the debate to some extent is around what success looks like. You seem to define success as maximum consumption; which the current settings do deliver in the short term at least.
    If success looked more like higher employment (especially in higher productivity creating industries), or longer term growth in wealth; or retention of productive industries outside farming; along with some move away from an economy very focussed on increasing the nominal value of housing; then the current settings seem like a big fail.

    • “Success” is the highest time path of consumption discounted appropriately – so it isn’t about short-termism in the slightest. However, that is a slight digression.

      I have a series of other posts up on the blog discussing what is going on with property – this isn’t a bubble but an example of a situation where a binding lack of supply in Auckland and Christchurch has set prices in those areas at a very high level.

      http://www.tvhe.co.nz/2012/11/06/supply-or-demand-why-not-both/

      http://www.tvhe.co.nz/2012/11/09/circling-the-square-house-price-lift-and-high-unemployment/

      The high unemployment rate and low rate of inflation tells us that monetary conditions did need to be softer – and we know this surprise was due to the Chch rebuild being delayed, export prices falling further than expected, and the government tightening policy more rapidly than expected. Don’t get me wrong, I think this needs to be explained more explicitly:

      http://www.tvhe.co.nz/2012/11/10/institutional-status-report/

      But that is the crux of what has happened.

      I would add an additional point here – the CFR is non-binding at present, easing it won’t do anything. As a result, even if we were going to look at alternative instruments this doesn’t make much sense.

      Now, if we believe that something else has been set “wrong” – for example Gareth Morgan is suggesting that the risk weighting on debt is inappropriate and binding (from what I’ve heard its not binding, but we’ll take this as an example), there is scope for a change in other policies. But we then need to make that argument in practical terms rather than in the abstract.

      “If success looked more like higher employment (especially in higher
      productivity creating industries), or longer term growth in wealth; or
      retention of productive industries outside farming; along with some move
      away from an economy very focussed on increasing the nominal value of
      housing; then the current settings seem like a big fail.”

      This is completely unrelated to monetary policy though – so there is no reason to put this issue down to the actions of the RBNZ. Politicans like to, as they like to avoid responsibility for the structural policies they have put in place.

      If we decide we should subsidise industries, or punish people who are investing in houses we need to make that argument and then talk about the tax setting etc. Also, remember the economy is not a person – it isn’t focused on “doing” anything. We need to explain why the nominal value of the housing stock is so high, why the replacement cost is so high, and why the size of property has risen so much.

      • Yossarian10

        Thanks for replying very quickly, and thoughtfully.
        It seems to me our biggest economic problem is our very high total national debt, reflected in the cumulative current account deficit over many years, and now growing exponentially again. This effectively is an increase in indebtedness, or loss of wealth, which will have a significant impact on long term consumption- a key part of what success looks like to you. And past deficits are costing us ~$10 billion a year in investment costs to fund, so we are already feeling those effects on our ability to consume. So by your definition of success you must have a very low bar, or expectation of what NZ is capable of, if you think what we are doing now is as optimal as it can be.
        By definition this current account deficit is imports plus net investment costs, less exports. Imports require relatively little value add here; exports or import substitution of course do, and so lead to higher employment, all else being equal.
        The IMF suggests, (and it seems self evident) that a drop in the exchange rate of 15-20% would likely achieve balance in the current account, given their expectations of supply and demand elasticities. In other words exports and import substitution would increase relative to imports. This would grow employment here; and increase our wealth and reduce indebtedness. Granted there would be a short term reduction in consumption of foreign goods and services (hence my comment on what I perceived to be your short term focus); although it is moot whether this would be quickly replaced by consumption of NZ made goods and services, such that even short term consumption did not suffer, it was just of different things.
        And it seems to me the types of actions being undertaken around the world to keep their currencies competitive are very much in the realm of their central banks (and governments as well, to be fair); such that a position here that seems to suggest exchange rate management has nothing to do with the Reserve Bank seems false.
        Seems to me an important debate; looking forward if my hypothesis is correct, without a correction in the exchange rate, unemployment has nowhere to go but up. (possible short term ChCh rebuild apart, which in my view they should look through in any case) If the Reserve Bank and government think otherwise, then they will continue to be way out on their forecasts; and apply the wrong tools and measures, as they clearly have for the last year at least.

        (By the by, I contribute frequently enough elsewhere as Stephen L; that name was taken in the Disqus system a few years ago, when I first encountered it elsewhere)
        Regards

        • Hola,

          “It seems to me our biggest economic problem is our very high total
          national debt, reflected in the cumulative current account deficit”

          I very much agree that our persistently high current account deficit is a symptom of issues. And indeed, a high real exchange rate/high real interest rates exist in New Zealand – and have been running concurrent with the high current account deficit.

          However, this is the key – these are all symptoms of potential underlying issues in the New Zealand economy rather than causes!

          I discuss viewing monetary policy in relation to these issues in more detail here – it gave me an opportunity to link to a bunch of older posts from here which I still agree with 😉

          http://www.tvhe.co.nz/2012/09/20/reframing-the-monetary-policy-debate-some-notes/

          And recently the RBNZ has done research specifically on movement in the real exchange rate which has illustrated that even the short-term benefits people assume we can get out of them don’t seem likely:

          http://www.tvhe.co.nz/2012/09/24/what-has-been-driving-the-real-exchange-rate/

          The key thing is that we know the persistent current account deficit shows that we are savings less than we are consuming and investing. Understanding why, and dealing with the direct issues in terms of economic fundamentals is the way forward – and is something that many economists have been trying to push over the last couple of decades.

          • Yossarian10

            Thanks again. We are soon probably at the agree to disagree stage; but will nevertheless challenge some of your thoughts here, and in your linked posts. Glad we agree that the current account is a symptom of significant problems; and a real limiter of long term consumption ability, part of your key measure of success. You seem to see our over investment being in houses, and not flat screen tvs; and while I agree with you that we had a housing bubble- and in my opinion have another one now- paying each other too much for our houses doesn’t in itself affect the current account. But if the banks have sourced the money for the mortgages from offshore, then that process will have lifted the exchange rate. Whether they are doing that as a response to very high demand, or whether they are in fact starting the bubble by sourcing the money, and then aggressively marketing the mortgages is moot. I personally ascribe to the aggressive marketing being the prime mover; and even if it wasn’t, if the RB had other controls on such mortgages and/or foreign capital flows, then the demand would not have been met- not a bad thing.
            There are two negative resulting effects on the current account from this activity, in my view. The lift in the exchange rate from the capital flows; and its resulting encouragement of imports over exports. And somewhere in a lot of the housing chains, people who had sold, or who merely thought they were richer because their house was now worth more, went and bought the tv, or the new car, or the overseas trip.
            Separately, I believe you rightly blame governments with large current surpluses for pegging their currencies; rather than the countries who have undertaken QE- many of whom in fact have current account deficits, such as the US, or UK. By definition you accept that all these countries, including the US and UK are in fact affecting their currencies by their actions, whether doing so was the prime motivation of their actions or not. Most of their actions are managed by their central banks; so no free pass for the Reserve Bank I’m sorry. The UK for example, if it was merely looking to fix domestic demand, could have borrowed all its fiscal deficit from offshore, as we insist on doing.
            Your last paragraph sort of just puts your hands up, and suggests you don’t really have a realistic plan that will fix the current account. I would though be delighted to be wrong on this, and to see some of the specifics. Assuming you think the current government is somehow dealing with these fundamentals, even they admit the current account is heading further off the cliff. If you don’t think they are; what are some of the actions they should be doing, are they genuinely politically or economically manageable; and in first principles, how will they help and by how much in round billions, the current account?
            Alternatively, what I understand is the Greens’ plan, and in any case one that I would advocate, is taking steps to lower the exchange rate and or manage capital flows in, such that the exchange rate would certainly drop. That would certainly reduce demand for imports; and certainly make New Zealand exporters and import subtstituters instantly more competitive. What do you think of that plan?

            • Buenos dias,

              There is nothing wrong with agreeing to disagree – but its good fun talking over the issues, I find that’s how I learn 🙂

              Now lets split the issue into three parts. The first part is the part we have had a persistent long-term current account deficit since the 70’s. This is a long-term issue to do with the long-run real exchange rate and real interest rates.

              Monetary policy does not influence these things in the medium to long term, they are to do with underlying structural factors in the economy.

              As the RBNZ has been saying, this issue is to do a dearth of savings. This is an issue we need to try and understand, and that we need policy improvements for – but it is independent of monetary policy.

              Now secondly, lets discuss the lead up to the crisis.

              “You seem to see our over investment being in houses, and not flat screen tvs; and while I agree with you that we had a housing bubble- and in my opinion have another one now- paying each other too much for our houses doesn’t in itself affect the current account”

              This is very true, an excellent point – paying each other for houses doesn’t increase net debt at all … we must have spent the money on something!

              But it wasn’t flat screen TV’s an narrow “consumption goods”. Nominal consumption as a % of nominal GDP (spending on consumption out of income) actually bounced around at a relatively low level during the period we ran up debt! It is for this reason that I don’t buy into the narrative that we spent too much on pretty trinkets.

              In fact, what we were doing overall was spending heaps on building property – we spent alot on building houses. Now, at the same time we seem to have not enough property in Auckland, which seems strange. But this is because we’ve been building bigger better houses, rather than enough.

              So we seem to have spent a lot on building properties, but there has also been a misallocation. In this sense, the issues we’ve experienced in more recent times have been very due to structural issues in the housing market.

              Capital flows are an intermediary – we need demand for them to occur. It looks like the expansion of the CA deficit was largely due to a boost in demand to build big houses. This is interesting.

              Thirdly, lets discuss the exchange rate:

              It isn’t actually clear that appropriate monetary policy would lower the exchange rate itself – remember, if QE was put in place sufficiently in these countries to boost AD, then the expected future lift in economic activity and real interest rates would boost the value of the currency now!

              In fact, empirically it is very difficult to show the exchange rate responding consistently to anything.

              As I showed before, RBNZ research has shown that, even with their best estimates, it is hard to get the RER moving with monetary policy in the short term.

              http://www.tvhe.co.nz/2012/09/24/what-has-been-driving-the-real-exchange-rate/

              Furthermore, it is important for us to seperate out issues appropriately – the persistent current account deficit issue is a long-term issue. No-one has actually given a clear argument about why changing the way monetary conditions are run will impact on the long-term drivers of this long-term issue.

              And finally, I’ll discuss the conclusion.

              “Alternatively, what I understand is the Greens’ plan, and in any case
              one that I would advocate, is taking steps to lower the exchange rate
              and or manage capital flows in, such that the exchange rate would
              certainly drop. That would certainly reduce demand for imports; and
              certainly make New Zealand exporters and import subtstituters instantly
              more competitive. What do you think of that plan?”

              This sounds to me like it is effectively export subsides. The evidence on export subsides suggest that they are not in a countries best interest – even if other countries don’t respond by doing the same thing back. That means that export subsides aren’t even an example of a “prisoners dilemma”, they are just a straight inefficient transfer of resources to exporters.

              It is best to deal with any structural issues in NZ directly, rather than trying to paper over the cracks by subsidising exporters. We need to ask why real interest rates are persistently so high in NZ and work from there – as the savings working group asked (although I am not in full agreement with their conclusions – that logic was sound) 🙂

              • Yossarian10

                Buongiorno,
                I also enjoy learning a few things; including some different economic perspectives, even if I don’t fully agree with them.As I think you have noted elsewhere, the RB and government could do a much better job of explaining why they do what they do, or don’t do some other, on the surface reasonable, things. At least if their reasoning was clear, even if disagreed with, then it would be a little less frustrating for many, including me.
                On your points:
                1) Accepted that NZers on aggregate have been poor savers. There is at least a causal question whether we have allowed over investment from offshore, and that this has caused the lack of saving, them being the same thing. I think there are arguments that monetary policy (or at least RB policy) can limit investment in; which I believe would force saving to occur (or arguably even exports or import substitution to increase, increasing our GDP). 2009 was an interesting year as an example. World money transfers dried up nearly completely; and our current account deficit was the lowest for many years. Am not convinced the cause of that was NZers suddenly deciding to save; and losing the habit immediately the taps were turned on again the next year.
                2) Very pleased to learn that the CA deficit in 02-07 was largely driven by real improvements in housing. Given these improvements have long term benefits in enjoyment or living standards, then all good, and not for me to say people should have not done so. The same arguments on causality on capital flows as in 1 can apply. Does supply of capital flows drive the process; or demand for them? And even if it is demand for them; are we right at a macro level to encourage those flows, driving growth in private debt (and with harming effects on the exchange rate, which hurt productive businesses that were uninvolved in the housing decisions)?
                3) The least convincing part of your reply. The graph does show the TWI 20% over its indexed amount; presumably the long term average. That is a very big cost hit for any marginal export or import substitution business to try and absorb; and goes to the crux of my whole argument on failed current policies.
                It seems disingenuous to suggest that the QE and other monetary actions of the US, the UK, Switzerland, Japan, China and others have not given them a lower exchange rate than they otherwise would have. I can go away and compile evidence if you wish; but assume you may accept that is the case. If that is true, then their actions have caused us to have a higher exchange rate than we otherwise would have. And there are actions that central banks can take to lower their exchange rates. I accept there may be other consequences of those actions, but they could be forecast, end then debated as to which was the lesser of whatever evils may arise. To try and imply that it can’t be done- as the RB, and English and Key also state, is a clear cop out.
                4) (Your “furthermore”) If it was accepted that the exchange rate can be affected by monetary policy, and it was accepted that there are elasticities of supply and demand that would cause a move in imports relative to exports as a result, then that would more than hint at a long term solution to the current account deficit.
                5) The plan to lower the exchange rate to encourage exports over imports, and therefore less growth in debt. This is again, exactly the point.There is a current subsidy going on. It is by the Chinese, Japanese, Germans, Swiss et al, who are subsidising imports (loaning us money or buying up our assets, to help us buy their stuff). If we targetted a current account of zero, then that would imply no subsidy of imports or exports, and would level the playing field. Given you and I agree that the definition of an optimal economy is maximised consumption discounted for time, this subsidy by our creditors would be perfectly okay if it was a free gift. But it most definitely is not. It has a huge cost in terms of rent and interest, as well as loss of long term control of our own destiny. So future consumption is being severely compromised.
                The world is unlikely to react to a move by NZ to lower its exchange rate, by trying to lower theirs further. We are trivial in the scheme of things. Granted specific current creditors may be annoyed; although I think they’ve gone in with their eyes wide open. And its not obvious what they could do that would be really harmful.
                You still haven’t explained how you would otherwise fix these “structural issues”.
                Ciao

                • Hola

                  “I think there are arguments that monetary policy (or at least RB policy)
                  can limit investment in; which I believe would force saving to occur”

                  The key thing here is that, when we are talking about a long-term persistent lack of savings, we are also talking about persistently high real interest rates here.

                  Contrary to how it seems the RBNZ doesn’t really “set interest rates”. They have an inflation target, where inflation is related to expectations and where we are in the business cycle. They then set the OCR in a way consistent with the eqm interest rate! When we think about things in that way, we can see that the high real interest rate is due to underlying factors within the economy – rather than short-term monetary policy.

                  In terms of what happened during 2009 it wasn’t really a lift in savings – it was a sudden and sharp collapse in investment. Businesses and households just stopped investing in capital, it was pretty drastic 🙁

                  “Very pleased to learn that the CA deficit in 02-07 was largely driven by
                  real improvements in housing. Given these improvements have long term
                  benefits in enjoyment or living standards, then all good, and not for me
                  to say people should have not done so.”

                  A lift in expenditure on building housing – there has been capital improvements but we may not have done it in the most efficient way …

                  I agree with the sentiment though, the idea of borrowing to invest makes sense, and doing it when other people are providing credit cheaply also makes sense.

                  Also note that we are a small open economy, so we have access to efficiently infinte capital at the world interest rate (adjusted for risk). In that sort of world, it is investor demand within the country that is key.

                  “The least convincing part of your reply. The graph does show the TWI 20%
                  over its indexed amount; presumably the long term average. That is a
                  very big cost hit for any marginal export or import substitution
                  business to try and absorb; and goes to the crux of my whole argument on
                  failed current policies.”

                  Again, the key point here is the long-term real exchange rate – not what it does for a period of time. We need to ask why the exchange rate has been persistently high – and QE is an irrelevant part of that. According to the evidence the RBNZ put together, high export commodity prices are a key driver, which would be expected.

                  Now in terms of monetary policy we can use the exchange rate to discuss monetary conditions, that is where QE is relevant, but it is a separate issue from the long-run current account imbalance. Here, QE functions as a lower interest rate, increasing the relative interest rate gap between countries – in that environment we see a higher New Zealand dollar because the relative interest rates gap has increased, which is a function of higher expected growth! If the gap rose because we were seen as riskier the dollar would actually fall.

                  So if NZ/Australia’s growth prospects dwindle, we would expect the RBNZ to respond with a lower OCR, and the interest rate gap to close up a bit – this is why there were significant calls for the RBNZ to cut rates in late-2011 and early-2012 which they ignored … some people felt the underlying growth outlook was softer.

                  “I agree that the definition of an optimal economy is maximised
                  consumption discounted for time, this subsidy by our creditors would be perfectly okay if it was a free gift. But it most definitely is not. It has a huge cost in terms of rent and interest, as well as loss of long term control of our own destiny. So future consumption is being severely compromised.”

                  I do not agree here. I would note that if one country subsidises exports it is taking funds off its own tax payers and giving them to importing countries, so that is nice for us. In order to say that it is a bad thing, we need to say that the benefit of getting these cheaper goods and services is swamped by a loss in our “productive capital”, “institutional knowledge”, and all that jazz. And the evidence on that sort of thing is sketchy at best – especially for developed economies.

                  I’ll also reiterate that there are two seperate issues here – the long-term issue of persistent current account imbalances, and a concern about protectionism in other countries that has intensified during the crisis.

                  “The world is unlikely to react to a move by NZ to lower its exchange
                  rate, by trying to lower theirs further. We are trivial in the scheme of
                  things. Granted specific current creditors may be annoyed; although I
                  think they’ve gone in with their eyes wide open. And its not obvious
                  what they could do that would be really harmful.”

                  Another point here – the rest of the world has moved to inflation targeting in recent years. QE is about balancing these inflation targets (without them they would fail). In this environment the exchange rate represents the relative growth outlook. If we try to “change the exchange rate” in the short term there is a counterveiling cost – a drop in investment and loss in the efficiency of investment through capital controls, a transfer between borrowers and lenders and loss in efficiency in good markets by making inflation more random. Empirically and quantitatively, we don’t really know how to move around the nominal exchange rate – so even if we could make the argument (which I am not convinced by), we can’t clearly quantify it.

                  “You still haven’t explained how you would otherwise fix these “structural issues”.”

                  The structural issues are mentioned in other posts, but I try to steer away from saying how to fix things – I just want to mention trade-offs.

                  There are some clear things it would be encouraging to have though, treating all investments the same way in the tax system, reducing the cost of subdividing land, recognising that the entry of a third supermarket chain would be beneficial, explicitly recognising that the larger government is the higher our real interest rates will be.

                  For example, working for families was introduced but the full costs were not taken into account – the scheme helped to boost the real exchange rate and boost demand on non-tradable goods such as housing. However, we are trying to achieve social ends with that policy, so we may feel it is worth the cost.

                  The thing that irritates me is that policians put in these policies that have these macro costs, and then just pretend its someone elses fault – if we knew we were facing certain issues due to a government policy that we approve of, we may just accept them.

                  Adios

                • Yossarian10

                  Matt,

                  Thanks again,

                  The debate is getting long, and somewhat circular; so I will try and shorten this response, and leave many of the areas of debate above open.

                  You seem to have a faith in the “markets” that I do not share. Critical as they are, I have worked in enough of them to know they are full of lies, half truths, obfuscation and ignorance. National or tribal interest is a significant driver of interests and behaviour.

                  Taking the UK as just one example, I actually think the BOE has done a spectacularly good job since the GFC in saving British industry, in a way that has not increased its national (current account) debt materially; got on top of unemployment relatively quickly (its been declining ever since January this year and is likely to cross below NZ’s certainly rising number very soon). Their money supply has increased ~10% since end 2008 mostly sourced by BOE printing; our commercial banks have printed an extra 17%, pretty much all sourced offshore.

                  All this in the face of the implosion of its biggest, and by far most lucrative industry, being finance; despite its’ main trading partner, Europe, being in massive stress and recession; despite near bank failures, and a housing bubble/private debt as bad as ours.

                  They officially target inflation at less than 3%. They have clearly happily allowed it to go over 5% (Mervyn King is no fool, it wasn’t an accident); while devaluing sterling, and printing £400 billion give or take. The NZD was worth 36p when the Nats came to power; it is now worth 51p. They and you may see this as success. I don’t. We have had near the best terms of trade in our history; and we appear to have squandered them.

                  So all of that says to me the UK is not a fully open and free market. The BOE is rightly managing its affairs in the best interests of the UK. The surplus countries are also doing so, clearly. And the tribal instincts they all have will mean when one tribe or another needs to be favoured (like in where do we keep aluminium smelters open); it won’t be us, because we don’t own anything anymore.

                  Can separately challenge the implied criticism of working for families, and the needs and benefits of that programme. (the settings may or may not be right, but the principles are fine. The underlying cause is the very significant shift in share of overall net incomes to the top 1-10% of people; such that society cannot have its middle class frankly really struggling to clothe, feed and house itself. That is a practical issue, as much as an ethical one). There are separate questions on the size of government. I would say the benchmark is what percentage of GDP is spent on each main category, and how does that compare with international benchmarks. The important score is not therefore, how big is the deficit?

                  But I digress.

                  To change tack somewhat;

                  What if something like the Greens’ proposal was enacted, where they would effectively print money to pay for some or all of the Christchurch rebuild? In the end which bits of government expenditure were funded by such printing wouldn’t really matter. (The earthquake is clearly just some posturing to help sell it). Recently I understand the Treasury’s debt management office borrowed $2.5 billion from offshore to fund government expenditure. Apart from the interest costs that that will incur, the purchase of NZD by the foreign investors must have lifted the exchange rate, all else being equal. And elasticities mean that must favour importers over exporters (another subsidy by us to importers, poking the bear).

                  What if they had printed that money (or had the Reserve Bank do so)?

                  What effect do you imagine that would have had on the exchange rate; on inflation, on exports over imports, on the current account; on employment; on any capital losses? How would that be different to what we are incurring now?

                  I personally think those questions and answers are critical in the current debate, where some version of the Greens’ policy is on the table vs our current ideological free market, inflation targetting only, one tool only setup. Which policy would deliver the best outcomes for New Zealand and New Zealanders; forgetting the ideology?

                  ( I should say that our near agreed definition of success I would tweak. Fullish employment does deliver a happier society, even if total consumption was compromised; although usually they are of course complementary. Very unequal incomes are also a society issue. But I digress again.)

                  Sorry to interrupt again your day job.

                  Regards,

                • Hola,

                  I am not quite sure where the “faith in markets to be free” comment comes in per se – if that was the case I would be saying that the real exchange rate is either completely the result of government failure or represented some optimal change. And then I’d probably say something about free banking 😉

                  Inflation in the UK wasn’t 5% – annual growth in the CPI was, but not “inflation” … which is when a bunch of prices grow together. We would want to take out the increase in VAT that occurred, and we want to strip out changes due to one-off changes in the exchange rate etc.

                  And again just being a “surplus” or “deficit” country isn’t a good or bad thing – that is a merchantilist argument. We could throw different evidence at each other on that issue I am sure, but I would say the weight of evidence is still against them.

                  I completely agree with you that there is a size of government issue – in terms of us thinking “what size do we want as a society”. In NZ, I think we are pretty happy – but if society says it wants more or less government, that is up to society to decide, that’s cool.

                  However, both the size and the relative deficit position impact on the real exchange rate and real interest rates. And this should be admited by policy makers.

                  If we were to print money to buy bonds, and monetary conditions are set such that we are meeting our inflation target, then we are really just taxing now to pay for that government spending – but instead of introducing a tax directly, and targeting it, we are putting in an indirect inflation tax which is likely to be regressive. I have no problem with us discussing how we should finance the rebuild – that’s cool – I just don’t like us pretending we get a free lunch by doing it through money printing.

                  And I’d also note that flexible inflation targeting (targeting the forecast) is sensible – it has nothing to do with a belief in perfectly free markets etc. The central bank realises that they provide currency, and they are pinning down the growth in that currency so we don’t have arbitrary transfers occurring by the inflation rate flying around.

                  There are three reasons why we do this instead of targeting other things:

                  1) We can’t forecast how changes in monetary policy impact on things that aren’t inflation very well – in other words we don’t really know what it will do particularly well.

                  2) According to the estimates we do have, flexible inflation targeting (not strict inflation targeting which no-one has ever, or would ever, do) does the best job of using monetary policy to help smooth the economy.

                  3) According to theory, flexible inflation targeting does a very good job – close theories such as NGDP targeting and nominal wage targeting are a lot more similar than people give them credit for.

                  Also, I’m not saying that the government can’t institute policies based on the desires of society – we’re a democracy, and any policy can be justified given weightings on the trade-offs involved. When it comes to the narrower idea of a central bank managing cash and credit many things will change, but for the even narrower concept of inflation targeting all that should change (in my reading of the evidence) is that some countries that have messed up need to “do it right” in the future.

                • Yossarian10

                  I took your general support of the RB, and the resulting exchange rate/ current account position being largely set by the markets, as being a supporter of the markets alone deciding those outcomes. May have been wrong in understanding your position.

                  On your new numbers:

                  1) so the main reason therefore for not following something like the Greens initiative, is that we don’t know what it would do. Surely we can make an educated guess. Surely we could try it for $1 billion or so, and see what the outcome was. We may be pleasantly surprised. And I don’t see any real downside, other than the populist effect on the cost of overseas holidays.

                  2) Remember your target; maximum consumption over time. Not a “smooth” economy. If we are driving smoothly over a cliff (which a very high current account deficit seems to be doing), the fact it was a smooth drive doesn’t make me feel a lot better. I don’t think people losing their jobs think it’s all that smooth.

                  3) The theory is not working in terms of the objective. I could not be persuaded that our anaemic growth, where most of the growth benefits are in any case heading offshore, is really helping even our current lifestyles, let alone the future with a real erosion in national wealth. The theory has also been relatively well debunked, in terms of the perverse effects of solely inflation targetting.

                  Just one of many views here:

                  http://uneasymoney.com/2011/08/23/the-perverse-effects-of-inflation-or-price-level-targeting/
                  And that is in a relatively enclosed economy like the US. In a small trading economy, the exchange rate effects are even more perverse

                  Totally separately I have enjoyed the discussion, and certainly learnt more about current orthodox thinking, so thanks for that. Potentially some other sad souls may also enjoy reading it through; so if the opportunity arose I may point to it elsewhere. Are you comfortable with that? Don’t want to hijack your website and take you by surprise. If I do, I promise to be relatively neutral in pointing to it.

                  Regards

                • Buenas tardes

                  “I took your general support of the RB, and the resulting exchange rate/current account position being largely set by the markets, as being a supporter of the markets alone deciding those outcomes”

                  That is a description – not a policy position. Real interest rates and the such are set by the choices of individuals, given the set of institutions and policies that are in place. The RBNZ is just managing a fiat currency by insuring its value.

                  This is a key discintion which leads in here.

                  “so the main reason therefore for not following something like the Greens initiative, is that we don’t know what it would do”

                  Not quite, there is a key difference between cardinal and ordinal here. We can’t “forecast” output particularly well, we can’t really “control” GDP.

                  But we do know that when we use resources, there is a counterveiling cost. If we were to buy bonds, we are throwing in an implicit tax – we know its a tax.

                  If we really want to pay for it domestically instead of borrowing then we should just do it straight up and legislate a direct tax.

                  “Remember your target; maximum consumption over time. Not a “smooth” economy”

                  The two tend to run together – smoothing is the idea of managing a cycle. The policies of the RBNZ don’t “increase” the size of the economy – that is due to techonology and structural issues.

                  However, good point that I was loose with my terminology there. I think it would be a good issue to blog on.

                  “The theory is not working in terms of the objective. I could not be
                  persuaded that our anaemic growth, where most of the growth benefits are
                  in any case heading offshore, is really helping even our current
                  lifestyles, let alone the future with a real erosion in national wealth.
                  The theory has also been relatively well debunked, in terms of the
                  perverse effects of solely inflation targetting.”

                  This is untrue – but it is a sign of how much blogging occurs that seems to state this is the case.

                  The Eurozone is a complete mess, and no set of policies in NZ is going to fix that for us. Judging monetary policy on these grounds doesn’t make sense to me – if we turned around and half the population had died, blaming the RBNZ for the drop in GDP wouldn’t make sense 🙂

                  It is easy to debunk a strawman as well – the type of “inflation targeting” people criticise isn’t what central banks (the ECB excluded) actually do. Flexible inflation targeting means anchoring inflation expectations and then responding strongly in the face of a crisis – it doesn’t mean you ignore the broader economy at all. The is where the whole concept of the “New Keynesian Phillips Curve” comes in. Trust me, central bankers throught the ECB was mad during 2010/2011/2012.

                  Of course, economists are to blame as well because we can be poor at explaining these ideas – I wish I had a bit more time to be more precise here. It isn’t that we don’t think there aren’t lessons to learn – we are just keen to use any new information in conjunction with old information when forming an understanding. Policy will change, but the sort of policies being suggested by politicans are often unrelated and lack transparency.

                  “Potentially some other sad souls may also enjoy reading it through; so
                  if the opportunity arose I may point to it elsewhere. Are you
                  comfortable with that? Don’t want to hijack your website and take you by
                  surprise. If I do, I promise to be relatively neutral in pointing to
                  it.”

                  All good, feel free to do whatever you’d like. I enjoy talking to people who are willing to just put down their views in writing – its a pleasure. I’m all about learning from these discussions myself.

                • Yossarian10

                  I keep intending to leave you alone, but you always raise a couple of points that seem to need challenging, or questioning at least.

                  The RBNZ has managed the currency to be worth 60% more against the USD than it was at a low point 4 years ago. My whole point is that that is very poor management; and as bad as managing a 60% decline. Imagine the effect on an exporter or import substituter trying to compete against those cost headwinds. Smooth economics that is not; and it creates the subsidy by us of workers in Shenzhen, Osaka, Zurich, and Berlin that we have discussed above. We could let it perhaps slowly drift back down (or fundamentals to catch up); but that seems very sub optimal; and also discounts the thought that foreign countries or people are deliberately building up their wealth, so will buy up whomever will allow it; keeping our currency always too high.

                  We can forecast that a lower exchange rate will lift exports relative to imports; and that all else being equal will lift GDP. At least until we hit some capacity constraints. Rising unemployment; and before that inefficient underemployment, suggest plenty of spare capacity. Unfortunately for every factory that closes, or every young keen person that heads to Aussie, our capacity diminishes. So there is real urgency to take some action.
                  What is actually harder to forecast is playing around with interest rates- lifting them will diminish demand for money, but raise supply; and vice versa. Which will be dominant? What will the demand be used on- productive investment, asset building, or consumption? We do not seem to have been very good at managing those things at all.
                  Real tax, in logic, is when governments spend money. How they fund that spending is then how they spread the cost around between sections of society, and between generations. So printing money is not in any way a tax, assuming we did not spend more than we otherwise would, although I accept governments may be tempted to do so. I would not advocate any extra spending just because of printing. In my view our status quo is a massive tax on future generations, for the benefit of foreign workers and the banks, with little extra to show for it.
                  Regs again,

                • Hola,

                  Why stop having discussions – its always good fun 🙂

                  There are two points here when talking about the exchange rate – first the idea of a persistent overvaluation, then the idea of “variability in the exchange rate”. They need to be looked at seperately.

                  For the first bit we can say that the exchange rate between two countries is a price, an asset price of sorts, that moves around due to trade in the currency. So when we think about its movement we need to think of it as an asset.

                  Given that the central bank doesn’t actually set the fundamental rate of interest, that this is set by underlying economic conditions, then the real reason that the currency can be seen as “overvalued” is because of these underlying structural issues.

                  On the second bit, why are we happier to have variability in the exchange rate than to have variability in other prices. That is a fair point, and the justification for looking at it that way stems from three things:

                  1) We don’t think central bank actions could reduce volatilty in the exchange rate relative to what is optimal

                  2) We don’t know what the fundamental value of the exchange rate is, and therefore we don’t know whether the movements are actually telling us something about changing conditions or not

                  3) Exporters and importers can hedge cheaply – which implies they are not as exposed to the variability. Households cannot hedge against inflation that is “random” in the same way – or at least not as cheaply.

                  The level and the variability arguments are seperate.

                  “We can forecast that a lower exchange rate will lift exports relative to imports; and that all else being equal will lift GDP”

                  A lower real exchange rate – and that is determined by fundamentals. Note if we tried to do this through just monetary policy we would destroy the lift in “competitiveness” through changes in the price level.

                  “What is actually harder to forecast is playing around with interest
                  rates- lifting them will diminish demand for money, but raise supply;
                  and vice versa”

                  We are a small open economy, the supply at the world interest rate is infinite. It is entirely demand driven.

                  “Real tax, in logic, is when governments spend money. How they fund that
                  spending is then how they spread the cost around between sections of
                  society, and between generations. So printing money is not in any way a
                  tax, assuming we did not spend more than we otherwise would”

                  We are using printed money to buy up bonds – it is direct seniorage, and so will be an inflation tax.

                  This is another way of thinking about an “inflation target” – it is a promise that we will keep inflation at a certain level and not try to engage in seniorage, thereby transfering resources. Doing additional monetary policy when you are already doing enough is equivalent to violating that – and it is a tax.

                  That is why this idea seems so weird to me – why should we be taxing the poor and those on super to fund the rebuild of Canterbury? This is the logic of the policy.

                  “In my view our status quo is a massive tax on future generations, for
                  the benefit of foreign workers and the banks, with little extra to show
                  for it.”

                  Again, we have to talk about each issue seperately – you are throwing a lot of different things that are incomparable together.

                  So with the idea that, in China, they are subsidising exporters. Relative to this not happening they are sending us income, that is nice of them. Their logic is that they have very very little capital and they want to focus on building it up and try to build up “infant industries”. When we look at a capital rich economy like NZ this is quite different.

                  We can take this logic a bit further – at the moment we know that manufacturing is super competitive because countries like China are just super hungry for certain industries. Comparative advantage theory doesn’t tell us to copy them – it tells us that we would be best to focus on our own comparative advantage. This is consistent with the facts – the sharp lift in our TOT, the incredible lift in productivity in agriculture in NZ. It is an unsung story, but we haven’t just been getting more money for what we do, we’ve (as an economy) got a hell of a lot better at doing it!

                  Now lets think about the financing of the Christchurch rebuild. We could tax now to pay for it, we could use QE which is an inefficient way of taxing now to pay for it, or we could view it as investment and fund it from long-term bonds – so that the people who get the benefit of the new city are also the ones paying for it. That makes sense.

                  Also we need to be careful, we cannot simultaneously say credit is “too cheap” and that we are getting destroyed by credit being “too expensive” – again we borrow at an interest rate because of the view of people in NZ about their private return from investment.

                  And that insight is ESSENTIAL, as it brings into focus one of the areas where we will massively overborrow – in situations where the social benefit of the investment is lower than the private benefit. The way we inconsistently tax assets in the tax system, the way we favour housing, these are factors that help to drive borrowing … the same factors that economists of all stripes have been raising and talking about in NZ for over a decade 😉

                • Yossarian10

                  Matt,
                  Have reflected on our discussions over night, and I cannot get away from the view that you are stuck in something like the same ivory tower paradigm that the Reserve Bank is.
                  Namely that only one target and one tool is the right and only role for them.
                  On the three numbered points:
                  1) Then you are not thinking hard enough. You’re obviously a bright guy. There is nothing the central bank can do to contribute to fixing the current account and its consequent loss of wealth? There is nothing they can do to manage the exchange rate?
                  2) Again, you are not even trying, if you can’t come up with a hypothesis that says here is the x outcome we would like in the current account, or employment, or GDP or whatever, and given the interest rate mix, that will likely need this y exchange rate. You are stuck in their orthodox paradigm.
                  3) Ivory Tower again. No they can’t hedge, not really, not if the currency is perpetually overvalued. The best they can do is hedge at any one time that it won’t get worse. At best, they can occasionally guess at a bottom, and have a go. Import substituters, or tourism are nowhere with hedging.

                  Conceding manufacturing to the Chinese is very defeatist; there are no doubt many things we will never make in any numbers here for different reasons: e.g.cars, electronics, clothes. But to your point on comparative advantage; there are many areas where we do make products for ourselves and maybe Australia, and these can either be grown, or lost, and a 20% cost differential one way or the other, along with home market head office, is critical to win some of those.
                  My reflection was going to concede that in theory, an important caveat, you are probably correct that the RB one target, one tool are optimal policies. Except for the debunking of even that policy. A desired easing drops interest rates, which increases demand for money (given you think it’s all about demand, with an infinite supply), which raises the exchange rate, which has the opposite effect of the intended easing. Without even going back to whether that money is then well used in the economy.
                  But even if in theory it were correct, in practice it is helping deliver a very unsatisfactory outcome. Very high national debt; with loss of wealth and assets, absolutely compromising your and my definition of success.
                  In business, and maybe not in ivory towers, we have the concept of “workarounds”, which most businesses deal with on a daily basis. That is not letting the perfect get in the way of the good; or of saying we have a real problem, Houston, but we haven’t got the time or resources or will or competitive environment to implement the ideal solution. (And we are clearly there with the fundamental or structural solutions that you think theoretically exist, whatever they may be. They haven’t happened for 30 years, and don’t seem about to any time soon, especially since we don’t even know what they are).
                  So let’s see what we can do to fix the problem with whatever tools we have. Often that is a short term solution until the optimal one can be put in place.
                  My particular workaround may not be the best workaround. But its trying to be one. By all means come up with better ones.
                  The Reserve Bank does not give the impression of even trying. Its just not their job. Demarcation dispute.
                  Between them and people like you, there needs to be some effort to think through fixing this long term problem in whatever way is best for now.
                  Further reflection says its not just a communications problem. Many failed businesses first sack the marketing or PR manager because they are not getting the message across. A marketing manager or two later they realise there is a fundamental problem with the way the business works.
                  Between the government and RB, that’s where we are.
                  And the persistent current account deficit is the smoking gun.

                  A last word. From your photo, I am certainly older than you, which doesn’t in itself make me more or less likely to be right.
                  .
                  But I will share that I am old enough that at times I have been stuck in a significant conventional paradigm of thought, that has either evolved to have real alternatives, or has had a shock to force alternatives.
                  Am not certain you are there in such a paradigm; but I put it to you that you just may be; and the RB may be as well, and some real reflection on their part whether there are alternatives would be a good thing.

                • Hola again,

                  I am always happy to discuss these things – but I think at this stage it is clear we need to define “why” and “how” things happen, as that is likely where our disagreement lies.

                  We agree that we want what is best for society, and we no doubt agree that there is a scope for monetary policy and government to both exists as independent from the purely free market – but I suspect we differ because the mechanisms we see these things pushing through differ.

                  For example, the idea of “conceding manufacturering” doesn’t seem to follow in those terms. Yes, I can conceive of a situation where we stopped manufacturing of the goods and services produced by China entirely – as we are trading with them, and focusing on the things we are relatively better at. Economies are dynamic and as long as people have the ability to innovate and secure property rights, we have the opportunity to push towards whatever it is appropriate for people to produce.

                  I am always drawn back to the story of agriculture – and in many ways large chunks of manufacturing are experiencing the same change that we saw when agriculture got mechanised. We need increasingly fewer workers to make a large number of manufactured goods – this is why the price of services (eg the wages for football players and actors) is heading through the roof.

                  Now to me this isn’t all good – in a strict service based industry, there are large areas where the “winner takes all”, and inequality will climb inappropriately. On top of this people ex-ante wastefully invest in skills. These are issues that need to be worked on all over the globe – but they are a digression from what we are discussing here.

                  When it comes to discussing structural issues that exist in New Zealand I do not understand why arbitrary indirect solutions are superior to dealing with the issue directly – and I would again note that there is little empirical evidence that a central bank can change the real exchange rate for a particularly long period of time. As the NZIER report on exporting mentioned today, there are underlying factors that drive this – and surely dealing with them would make sense.

                  http://nzier.org.nz/sites/nzier.org.nz/files/Lifting%20export%20performance.pdf

                  I don’t think our difference in opinion stems solely from some sort of ivory tower business – in fact I think that might insult academics who would think I spend too little time reading academic literature and too much time going round meeting with clients 😉

                  Instead we fundamentally differ on what we think a central bank can do, and what we think specific policies do. That is a good point to raise, and when I get a chance I should make a more concerted effort to explain my views regarding “how” things happen and “why”. Things are significantly less clear than they seem when reading what journalists say, or how the economy looks when you are working within a single business – the economy does not function as a business, and economists do not help to clarify things by relying on metaphors that make it sound like this 😉

                  Cheers