That’s it, I’m done: RBNZ takes the path of discretion
A paper from the latest RBNZ bulletin.
It has always been clear that the aim should be to increase the resilience of the system to adverse shocks, but is it possible to be more ambitious? The traditional prudential approach has had a strong focus on shock-absorbing capacity; for example, increasing capital requirements so that banks are better able to absorb loan losses. This approach largely takes movements in credit and asset price cycles as a given, and aims to provide an adequate safety net should systemic risks be realised. A more ambitious approach is to try to reduce the amplitude of the financial cycle – in a sense lopping off the extremes of the cycle. Swing low but not too low; swing high but not too high. The potential benefits of this approach are obvious but it is also much more demanding, as it requires the authorities to answer some difficult questions.
Hmmm. This seems to be saying that simply ensuring the resilience of the financial system is not enough, the central bank should be trying to exert direct, and discretionary, control over what financial markets do and where investment heads. Fine tuning at its finest. It does appear that policymakers here have been strongly influenced by Borio.
That’s me, I’m done with writing about macroprudential policy in New Zealand. If you want to know why, read below the flap 😉
The Bank is moving away from its mandate with actions like this. They say that additional action beyond ensuring shock absorbing capacity in financial markets makes sense as:
a disorderly unwinding of a credit boom to impose substantial losses on the financial system, leading to an adverse feedback cycle with the real economy and substantial damage in the form of lost economic output, jobs and wealth
But the entire point there is “disorderly”. If prudential policies are focused on ensuring that the banking system has a sufficient buffer against adverse shocks, the wind down of a credit boom is not “disorderly”. This entire story is a red herring.
Standing against deteriorating lending standards, ensuring banks are holding sufficient equity/capital, that is accepted widely and I’m on board. But that doesn’t mean we should be chasing around asset prices driven by a ‘credit monster’. If there is a “bubble” when lending standards are unchanged and financial markets are not at risk, there is NO ROLE for central banks. Central banks are not there to pick who the winners and losers of transfers are. Central banks are not there to determine investment decisions for individuals firms and industries. That is a central planner – the two are spelled differently.
I suppose this change in tack from the Bank makes “sense” if we think about some of the recent talk. For some strange reason the Bank has suggested that LVR (loan-to-value mortgage) limits could be in place for years – even though real estate agents and second-tier lenders are trying to undercut the regulations before they have even begun. If the Bank’s goal is to create a unregulated shadow banking system, then sure keep LVR limits in place for years. They have also seemed incredibly willing to use transfer and equity/fairness arguments when it is not their role (here and here).
The level of discretion they are suggesting staggers me. Here:
We do not see macro-prudential instruments as ‘set and forget’ tools; once deployed, there will be on-going assessments of their effectiveness, which will condition their use and their eventual release
There is a positive way to read this – namely that they are building capabilities and an understanding of the efficacy of the tools. That is positive. But in conjunction with their objective, this sounds like macroprudential tools based on discretion rather than rules – violating the points raised by Cochrane.
And what exactly does the Bank think this means for their future independence? They seem to be including the price of assets, including housing into their mandate. Furthermore, they are taking responsibility on investment going to the “right” places … eg:
instruments such as the SCR or LVR restrictions could be targeted at particular problem sectors, such as housing or agriculture, or specific borrower segments such as housing investors
If that is the way they want to communicate their new tools and their innovative thinking to the public, then I think it is fairly obvious we should start having open democratic elections for the RBNZ governor – that or just wrap it straight back into central government.
No doubt many think I’m being over the top here, but when thinking about the justification for macro-prudential policy I had firm limits on how this would fit within the mandate of an independent central bank. And the RBNZ feels justified to go beyond that. This is me just putting on record that they’ve overstepped what seems appropriate 😉
Note: When I read papers like that, I see a central bank wanting to “solve every problem” and even seeing it as their purpose. It is not. They are there to deal with issues which the government cannot commit itself to – namely monetary policy. They are also supposed to be financial market regulator, which involves dealing with stability of the financial system.
However, they believe they have found a new task – helping us help ourselves, credit constraining us when we get too excited and easing that constraint when we are scared. I do not have the faith in their knowledge of social value, nor do I think they can successfully keep credibility about monetary policy while following such a discretionary path with monetary policy consequences with other tools. To quote Bernanke again:
In the United States, the heyday of discretionary monetary policy can be dated as beginning in the early 1960s, a period of what now appears to have been substantial over-optimism about the ability of policymakers to “fine-tune” the economy. Contrary to the expectation of that era’s economists and policymakers, however, the subsequent two decades were characterized not by an efficiently managed, smoothly running economic machine but by high and variable inflation and an unstable real economy, culminating in the deep 1981-82 recession.
To the Bank I have one question – what is your implied welfare function that involves you trying to second guess individuals choice of where to invest and what in? Is it based on a presumption that you simply know what is good for people better than they do, has their been some actual consideration in terms of normative economics. I bring this up primarily because, if you are going to get involved in the game of justifying direct policy interventions like a central government you need to be able to justify them in the same ways, with the same sort of CBA measurements, and with the same level of certainty.
Side note: Since I genuinely don’t plan to post about macroprudential policy again outside of “interest links posts”, I have to note I also agree with Lars Christensen in this link:
So I remain skeptical about the usefulness of macroprudential policies – in fact I believe that an over-reliance on such policies could lead to an increase in the volatility and fragility of the global financial system rather than the opposite.
When the policies become discretionary, and the Bank focuses on micromanagement, the actual goal of stability can be compromised.
Matt, the key issue I take with the RBNZ approach is the discretionary aspect, like you. Especially as it is without a clear and transparent framework and a comprehensive cost benefit analysis. Happy to be corrected on this if someone can explain it to me. I will even buy you a beer.
It is funny how history is neatly side-stepped, in implying that the tools identified in macro prudential tools havent really been seen in action before. I am pretty sure there were very tight and explicit controls on minimum deposit requirements, maximum share of income spent on interest, etc. But the key difference was that they were explicit and transparent – so that borrowers and investors could make decisions based on those parameters.
By introducing discretion in the regulatory process, the burden of gauging future lending conditions and standards now falls on investors, who have imperfect information. Head scratcher…
I’ll be honest, this line was the one that made me throw my hands in the air “The potential benefits of this approach are obvious”.
I only usually hear things termed “obvious” combined with a lack of recognition of costs when people are uncertain and are trying to cover themselves …
Given the line followed an explanation justifying discretion every inch of faith I had left in the process abandoned me!
Yup, its ‘obvious’ that the outcome will be great if we can have a Goldilocks economy, the just right porridge. But the costs and benefits of the regulations, discretion, information asymmetry etc are real.
I am pretty sure their regulatory impact assessment carefully maps the relatively uncertain efficacy of the tools in question.
Have you noticed how none of these talk about actually increasing the amount of common equity banks hold? Its obvious to me that would reduce credit growth 😉
The other good point you make is on governance. Take the LVR stuff. We dont have good information on:
-the target (no published data on new lending, only a broken series of the share of new lending that is high LVR)
-additional thresholds, knockouts or triggers that define the banks reaction function for each instrument (what is the ‘right’ level of house price or credit? Or what else are they looking at?)
-ambiguity of messages; the regulatory impact assessment is far less emphatic than the Bulletin paper and the messages from Wheeler and Spencer seem different
Whats the RBNZ’s skin in the game? Who makes sure they make the ‘right’ decision. The Board alone? At least with monetary policy we have a transparent process and there is a huge amount of scrutiny from private sector economists, politicians, businesses and the public in general.
Oh and that dilbert was from here: http://criminaldefencebarrister.files.wordpress.com/2013/07/dilbert-lacks-all-common-sense-on-a-job-interview.jpg
Is that character based on Trotsky? It looks like him, and it sounds like him!
This all sounds a bit like the RB is getting into the game of picking winners… surely the slipperiest of slipper slopes…
That is indeed my concern – adding the fact that it seems to be inadvertent, and that they aren’t democratically elected, it actually smells a bit worse though 🙁
Interesting post. I remember half a year ago watching Olivier Blanchard give warnings about the possibility of creating a “democracy deficit”, and wondering about the risks of central banks overstepping reasonable boundaries with macroprudential policy. About a minute after the linked time: http://www.youtube.com/watch?v=yxDW6CL-Qvw#t=31m10s
Sad to hear RBNZ may be heading down this dangerous path. Do you know what other central banks are doing? Have you heard of any dissent or disagreement within RBNZ? From memory they were after feedback on their proposals earlier in the year. I wonder if many people showed concern or of this is something only a few are talking about. If the latter, maybe this should not be your last post Matt.
Cheers for the link, I’ll be sure to have a look!
I’m being a little bit cheeky suggesting that I’m stopping discussing macroprudential policy because of this – in truth things are a bit different. I am moving towards a focus on income data and as a result I won’t have the time to keep up with the literature on macroprudential things – so I will be shifting what I write. I am trying to find people to write on macroprudential matters here – so the subject should still be alive, I just wont be the one writing 😉
Easy option to get useful information as well as share good stuff with good ideas and concepts.Great job and great blog.
The RBNZ’s approach makes much more sense if you consider that ‘NZ’ is actually more ‘NZ Inc’ than is commonly accepted. In large corporations there are dedicated teams (Strategy/Finance) that spend their time analysing what the best use and allocation of the corporation’s capital is. By analysing these ‘portfolios’ of capital and creating scenarios for each, these teams then set about moving the corporation in that direction (business planning + budgeting).
If you consider that the NZ residential housing market is simply one portfolio of allocated capital in ‘NZ Inc’ the RBNZ strategy/finance team has through its analysis has determined that too much capital has been allocated in this portfolio and through the only tool (regulation) it has available to it is directing NZ Inc’s employees (oops I mean citizens) to adjust their planning and finances accordingly which in time will shift capital (and in a sense risk) to other areas of NZ Inc. A fanicful scenario? Not when there are around 2 dozen corpoations larger than ‘NZ Inc’ that do indeed conduct this very sort of exercise all the time….
Even if we were to accept the analogy – the RBNZ is not mandated to determine the “direction of NZ Inc”. That is one of the key points I take issue with here!
If we add in the fact I take serious issue with the NZ Inc analogy in the first place:
http://www.tvhe.co.nz/2013/08/16/thinking-about-aaron-inc/
Then the reason I find it inappropriate is fairly clear 😉
If the government intends to run New Zealand as a corporation, I would be concerned. If an unelected technocratic body decides it wants to have a go at running elements of NZ as a corporation I am very concerned!
As am I!
I guess I was looking for some kind of analogous structure that would explain all of this behaviour beyond the simple explanation of “financial stability”… Hence, the corporate planning analogy.
I look forward to many more musings on this and the other macro tools I am sure! 😉
Good point – it is always best to try to give an argument its strongest airing to figure out whether we agree on it or not!
From what I can tell, their current view is based on the fact that there is some type of “financial cycle” above and beyond the economic cycle, and that this needs to be dealt with actively and separately. This is the Borio view:
http://www.economist.com/blogs/freeexchange/2012/12/reforming-macroeconomics
http://www.voxeu.org/article/measuring-potential-output-eye-financial-cycle
Contrary to what he says – his advice appears incredibly ad hoc to me, and I’m very far from convinced.
I also think that if we have the Bank trying to do both active monetary and financial stability policy in this way – they need to be split into two organisations:
http://www.tvhe.co.nz/2010/02/24/seperation-of-monetary-and-financial-stability-issues/
Still, definitely an interesting issue!