Last week they issued three papers in this vein (all carrying standard disclaimers that the views presented are not necessarily those of The Treasury itself, let alone the government).
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The first one (long, and I haven’t read it yet) appears to be a fuller and final version of something presented at the 2021 conference. The second, quite short, is Sahm’s report (how much did the taxpayer pay for it?). The focus of this post is the third paper.
In the interests of full disclosure, the author is a former colleague and was my first substantive boss decades ago at the Reserve Bank. We have ongoing connections through the troubled Reserve Bank superannuation scheme, where Bruce has been a dogged campaigner for the trustees (appointments of most controlled by Orr/Quigley) to do the right thing, fixing some pretty egregious historical errors, and he was for a time a trustee himself. We have spent many many hours over the decades debating issues around macro stabilisation, in the 20+ years our Reserve Bank careers overlapped and since.
It is a 40 page paper covering multiple decades and so I’m not going to try to review the entire document, but rather to pick out a few themes that struck me, including revisiting my ongoing scepticism about Treasury (or Treasury staff/consultants) bids for a new and bigger role. Doing core fiscal policy, and associated analysis, seems quite challenging enough – and if ever that was in doubt the last couple of years should have brought it back into focus. Sticking to your knitting (and doing your own core job excellently) is typically good advice for government agencies.
Particularly if you are young, or haven’t followed New Zealand macro policy developments closely, there is useful background material in Bruce’s paper. It is easy for detail and institutional context to be lost as time passes, memories fade, (and embarrassing episodes – think the Monetary Conditions Index – are quietly swept under the carpet, the place the Reserve Bank would probably now like the LSAP losses to disappear to).
But I’m inclined to think that the paper is mis-titled. On my reading of things – and I was reasonably close to macro policy from the inside for much of the period – there was very little of what could properly be described as “fiscal – monetary coordination” over the last 35 years. That was mostly by design, and in my view was (and is) mostly a good thing. There have at times been tensions, but that isn’t necessarily a bad thing, but not usually much coordination. It generally hasn’t been needed. The approach was, and is, pretty standard among countries of our sort. So the paper is more of a retrospective on the parallel developments in each of fiscal and monetary policy, with some added thoughts on whether, and if so how, there might be room for more in future.
Contrary to one claim in White’s paper, active monetary policy isn’t new. But for a long time, in those countries that had central banks (we didn’t until 1934), interest rate (and related instrument) policy adjustments were mostly about defending exchange rate pegs (Gold Standard or simply fixed exchange rate choices). In the post-war decades fiscal policy sometimes played a part in that (think of prominent episodes like the 1958 “Black Budget” or adjustments following the wool price collapse in 1966), and through those decades in New Zealand both fiscal and monetary instruments were directly in the hands of the Minister of Finance.
Floating the exchange rate (in 1985) and making the Reserve Bank operationally independent in conducting monetary policy (formalised in law from 1 February 1990) opened the way for what we call the “consensus assignment” of tasks. The Reserve Bank would focus on delivering inflation at or around target, and in the process – and particularly in the presence of demand shocks – would do something towards leaning against big swings in real economic activity. And the Bank would be accountable for its stewardship. Fiscal policy would be made as transparent as reasonably possible (so that the Reserve Bank could properly take fiscal developments into account), but that fiscal policymakers (ministers) could concentrate on doing stuff voters expect with the public purse (schools, hospitals, Police, Defence, roads or whatever) while keeping debt to tolerable and sensible levels. There were, of course, the “automatic stabilisers” (mostly, the fact that taxes are proportional or progressive, and so government revenue shares some of the gains/losses when times are particularly buoyant or subdued) but they operated in the background, not overly strongly. Any macro stabilisation dimension was an incidental nice-to-have (eg we don’t pay unemployment benefits to try to keep GDP up, but because we don’t think people should simply be left to their own devices and whatever private charity can offer when times get (perhaps very) tough).
The separation was pragmatic and practical in the world New Zealand has chosen. People will rightly point out that fiscal choices can, in the extreme, end up dominating monetary policy (hyperinflations are always political – and fiscal – phenomena), but not when government debt as a share of GDP is in the sort of ranges it has been for (say) the last 80 years in New Zealand.
And so it has largely proceeded, really since the late 1980s (ie before the changes to the Reserve Bank Act or to the Public Finance Act (or what was initially a standalone Fiscal Responsibility Act). Sometimes the stance of fiscal policy has been working in the same direction (affecting demand) as monetary policy, and sometimes in opposite directions. Sometimes those similarities or differences have been helpful, sometimes not. But there really hasn’t been much co-ordination, in the sense of the Governor and the Minister of Finance getting together and agreeing which party (which policy) would do what when.
In his paper, White often conflates “working in the same direction” and “co-ordination”. He recognises that it is his definition, but I genuinely don’t find it helpful and, if anything, I think that usage muddies the water.
For example, if there is a really big earthquake at a time when the economy is badly overheated, you’d expect the aggregate effect of the resulting fiscal choices and pressures to be adding more to demand/activity but at the same time would expect that monetary policy would be acting to dampen overall demand (in practice, squeezing out some private sector spending/activity to make room for the post-earthquake repair and rebuild spending). That is a good example of both sets of policies doing what they do best, within a policy framework recognised by both the Minister (and her Treasury advisers) and the Governor (and his MPC colleagues). There is no particular for any further coordination because both parties know how things work. You might – as always – expect that Reserve Bank and Treasury officials would be exchanging notes (understanding respective models and analytical frameworks, and ensuring the RB is well aware of the fiscal plans, including timing) but the ground rules are clear.
And if the huge earthquake happened to come when there was a great deal of slack in the economy then we might have a very stimulatory fiscal policy (all that rebuild spend) but monetary policy might still need to be expansionary (just less so than otherwise). Policies now look like they are both working in the same direction, but in fact it is exactly the same framework – no more or less coordination – with the only difference being the (macro) starting point. I was bit surprised that in his account of how fiscal and monetary policy have operated over recent decades, including following shocks, there was little no reference to output gaps (or, less technically, to the starting point, whether of excess demand or excess capacity). It really matters: in 2007/08 for example the Bank’s best estimate was that economy had been badly overheated and thus contractionary monetary was required, whatever fiscal policy was doing, while by 2010/11 (earthquakes) economywide excess capacity was again a thing. But neither earthquakes nor pandemics (or foreign financial crises/downturns for that matter) can be counted on to conveniently time themselves to the state of the NZ business cycle.
White covers what is probably the closest example of fiscal-monetary coordination over the 30+ years he looks at.
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It is good for governments to be conscious of where their fiscal choices might put pressure on monetary conditions but…..as both Brash and White note…..it often isn’t a particularly robust basis for making fiscal choices. Macro forecasting is notoriously challenging.
I don’t think the exercise has been repeated in quite that way. And perhaps, for various reasons, it is better not to. One could think of this year’s tax cuts for example. The government knew that, all else equal, tax cuts would put a bit pressure on demand and inflation but actually neither they, nor their Treasury advisers, nor the Reserve Bank knew whether by the time any cuts came that would be particularly problematic or not. And to, in effect, invite the Reserve Bank to exercise a yea/nay call on whether the political promise of tax cut proceeds seems to risk undesirably politicising the Bank.
White structures his discussion of history around four sets of shocks: the Asian crisis in 1997/98, the “global financial crisis” of 2008/09, the Christchurch earthquake(s), and the Covid pandemic.
I wasn’t fully sure how helpful this was. Discretionary countercyclical fiscal policy really didn’t play a material role in either of the first two episodes. In the late 00s, fiscal policy had moved into a quite expansionary mode but that had more to do with politics (Labour’s position was slipping, and large surpluses over many years had become an appetising opportunity for the Minister of Finance’s colleagues) and a rather belated – and, it turned out, erroneous change of heart by Treasury, which advised governments that revenue had moved sustainably high – than anything designed to be deliberately countercyclical. As it happened, fiscal policy was expansionary into the recession, but that was more by chance and poor forecasting than by design. Beyond the 2008 Budget, the Crown offered guarantees (for retail deposits and new wholesale bank funding), and that was an area in which the RB and Treasury worked closely together, but the overwhelming bulk of the macro policy discretionary adjustment was monetary policy. We ended up with one of the very largest cuts in our Tpolicy rate of any advanced economy (partly because our economy had been more overheated, and inflation more troublesome, than many other advanced economies).
Treasury officials (and advisers/consultants) seem more enamoured with the earthquake and pandemic stories. I don’t think either has much to offer in favour of more coordination. The series of earthquakes from September 2010 created fiscal obligations (legal and political), for spending that needed to happen over a succession of years. At the Reserve Bank, we knew that the earthquakes (especially from February 2011 on) represented a substantial positive shock (positive in a “pressure on resources” sense; serious earthquakes are themselves not positive events) over several years. It wouldn’t have made sense for the government to have tried to hold back the repair and reconstruction effort because there was going to be pressure on whole-economy resources; rather they got on and got things done, and the Reserve Bank was left to manage economywide pressures (and all the uncertainty around them) to keep overall inflation more or less in check. As per the earlier discussion, as it happened, the output gap was negative and the unemployment rate was high at the time, so the OCR stayed pretty low. But bad earthquakes can happen in badly overheated economies too.
What of the pandemic? Officials are – probably rightly – proud of the fact that they could roll out the wage subsidy scheme so quickly. They needed to. Their political masters had decreed that we all had to stay home for weeks on end – likely time initially unknown – and thus that many people would have no way of earning an income. The wage subsidy scheme was (largely) an income replacement scheme, with a leavening of “keep existing firms together as far as possible”. The point was not to maintain GDP, or to avoid people being (in economic substance) temporarily under or unemployed (not actually working) – the sort of traditional countercyclical stabilisation goals. If anything, the goal was to shut down a lot of the economy for a while, but to ensure not too much damage (including to individual ability to feed their kids and pay their mortgage) was done in the meantime. It was probably a worthy goal (certainly a politically necessary one) but it really does not have implications for countercyclical stabilisation policy. After all, if the pandemic had struck when the economy was grossly overheated (eg the 4.5% positive output gap the Bank now estimates for late 2022) no serious person would have said “oh never mind about a wage subsidy, it is a good chance to get inflation down”. Any more than we cut off unemployment benefits at the peaks of booms. They are instruments and tools for particular purposes (eg some sense of fairness), but those purposes just aren’t primarily countercyclical macro stabilisation. We have monetary policy to do that.
The pandemic is also a good example where the “both pulling in the same direction” approach to coordination is flawed. With hindsight it is pretty clear that the best policy mix in March/April 2020 would have been a stimulatory fiscal policy (the macro effects of the measures governments needed to take to assist the populace – notably the wage subsidy) and a contractionary monetary policy (a higher OCR). Again, that wouldn’t have been a case of policy being at odds, but of the framework working – governments being free to do what the circumstances demanded (and having the balance sheet capacity to do it), while not having to worry about what if anything it might mean for inflation because the Reserve Bank had that covered. (As it is, both the Reserve Bank and The Treasury misread the macro situation and what was really warranted from monetary policy, but that doesn’t change the conclusion. But just think if the Reserve Bank had done its job better – and been raising the OCR in mid 2020 – how much pressure they might have come under from the fiscal – political – authorities, had their been a more-formally coordinated model.)
You could imagine a half-respectable case being made back in 2019. Back then, the public finances were in reasonable shape and (after far too long) inflation was also back to around target. If someone had been doing a scenario exercise around a pandemic it would have been easy to talk about fiscal policy: yes, we can do something quickly (timely), temporary and targeted. And, as noted earlier, on the narrow issue of the wage subsidy they did. But what happened to fiscal policy subsequently? It was thrown badly of course, and we now sit here in 2024 – having come thru post-Covid booms and busts still with not the slightest idea as to when the operating balance might be returned to surplus. There was a decent case for some big fiscal outlays in 2020 and 2021, but…..we are years on now, and nothing of the fiscal predicament is directly caused by Covid. But the legacy is still problematic, and the record suggests that Treasury advice was (to put it mildly) not always helpful in that regard. Officials don’t seem to have been focused on the basics – getting back to balance. As a matter of realpolitik it is simply much more difficult to change track on fiscal policy than it is on monetary policy. The Reserve Bank did badly over recent years, but by late 2022 monetary policy was on a contractionary footing and inflation has now largely been beaten. As for fiscal policy, this year’s Budget was still expansionary and no one knows when we might next see a surplus. How much riskier if we were to empower ministers and officials to use fiscal policy more routinely for countercyclical purposes (in reality, almost inevitably, much more enthusiastically to boost demand than to restrain it)? The temptation should be resisted by officials, not encouraged.
If there hasn’t been much fiscal and monetary policy coordination over the years, that doesn’t mean there haven’t been tensions between them, and between ministers and the Bank. It also doesn’t mean there haven’t been times when reasonable people have argued that a different fiscal policy might help ease some of the burden on monetary policy and monetary conditions. Decades ago, before the RB become legally operationallly independent, I ran a small policy team that wrote a monthly memo to the Minister of Finance on monetary policy and conditions: every single one of them ended with what became almost a ritual incantation that faster progress in reducing the fiscal deficit would ease pressure on monetary policy. I doubt our view ever made much difference – it was hard enough to get the deficit down just focused on fiscal issues and associated political constraints.
White notes that one of the big presenting issues over the years was the exchange rate. Intense upward pressure on the exchange rate would reawaken these issues: all else equal, a tighter fiscal stance would mean slightly lower interest rates and less pressure on the real exchange rate. It was an issue for decades, until it wasn’t. One of the little appreciated aspects of the last decade or more is how much less volatile our real exchange rate has been than it was in the period from 1985 to about 2010 (for reasons that I don’t think are that well understood by anyone).
The last such period of angst was in about 2010. After the recession the exchange rate rebounded very strongly, and there was quite a sense of “oh no, here we go again”, including among senior ministers. At about that time, then private citizen Graeme Wheeler encouraged the government to move faster on fiscal consolidation, to take pressure off the exchange rate, citing experiences from 1990/91. It came to nothing much, but did prompt me to write a paper for my colleagues on that earlier experience. After I left the Bank I OIAed that document and wrote about it here.
Over the years, there was angst on both sides of the street. Don Brash was well known (to his colleagues and others) for his hankering for “tweaky tools” – things that might ease the exchange rate pressures. After his departure, Michael Cullen became increasingly exercised about the exchange rate implication of our tightenings in the mid 00s, to the point where we and Treasury were commissioned to provide a joint report on Supplementary Stabilisation Instruments, and then a follow-up report on a scheme for a Mortgage Interest Levy (taxing mortgages to keep down the extent of OCR adjustment). I wrote about that episode in a post on Cullen’s autobiography. Very late in his term, Cullen became quite vocal – even talking of overriding the RB – and in particular was exercised by our public view that expansionary fiscal policy was exacerbating pressures on interest and exchange rates (his claim was that this could not be so since the budget was still in surplus, but it is changes in balances not the levels of them that matter for these purposes). An open clash of view culminated in a two page box in the December 2007 MPS, articulating our approach to these issues.
The established framework does rest partly on the willingness of the Reserve Bank to identify honestly fiscal pressures as they arise. A couple of decades ago The Treasury developed the fiscal impulse measure specifically for the Reserve Bank, to help provide a common framework. Over the last 18 months there have been signs of considerable slippage. I wrote last year about how the Bank had suddenly stopped referring to overall fiscal balance measures and fiscal impulse type indicators, and had switched to focusing on just one part of the overall fiscal mix, the level of real government consumption and investment spending. OIAs revealed, unsurprisingly, no serious analytical basis for such a switch, and the most likely story seemed routed in opportunism: government spending was projected to fall as a share of GDP (including from Covid peaks), which distracted attention from the fact that last year’s Budget was really quite expansionary (as the IMF pointed out in public even as the Reserve Bank refused to) and this year’s was also modestly expansionary. Those are political choices open to the politicians, and we shouldn’t expect the Reserve Bank to make a song and dance about them (whether the budget is in surplus or deficit) but we should expect some honest, balanced, and calm analysis of fiscal pressures on demand (as for any source of pressure). We aren’t getting it at present.
This has ended up being a long post and only partly focused on the White paper. My view remains pretty strongly that both the Reserve Bank and the Minister/Treasury should continue to specialise; that countercyclical macro stabilisation is best assigned to the Reserve Bank (for various reasons, notably around reversibility, but illuminated by the dubious record of the last 2-3 years), and with the Reserve Bank held to account for its performance in that role. One of the developments of the last half dozen years was the addition of a Treasury observer (formally the Secretary but usually a deputy) on the MPC, as a non- voting member. I championed such a move and welcomed the change that Grant Robertson introduced. That said, I have been struck over the years by the lack of any evidence in the record of MPC meetings that the Treasury observer or the Treasury presence has made any difference (positive or negative) whatever. Perhaps that is just about how the record is written, but perhaps not either. And yet the presence of senior Treasury officials in the MPC meetings must, at the margin, fix them with some sense of ownership for the resulting policy, and in turn impede their willingness and ability to ask hard questions of the Bank – when things turn out poorly, as they have in recent years – and to be part of supporting the Minister of Finance in holding the Bank to account.
Tantalising as it might be to Treasury officials to be more active in the countercyclical space, it isn’t a good idea. They have quite enough to do in just sticking to their knitting and doing that excellently.
Michael Reddell spent most of his career at the Reserve Bank of New Zealand, where he was heavily involved with monetary policy formulation, and in financial markets and financial regulatory policy, serving for a time as Head of Financial Markets. Michael blogs at Croaking Cassandra - where this article was sourced.
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