Kiwibank chief economist Jarrod Kerr says as central banks continue grappling with the impacts of the Global Financial Crisis, governments could be doing more to help

Kiwibank chief economist Jarrod Kerr says as central banks continue grappling with the impacts of the Global Financial Crisis, governments could be doing more to help

By Gareth Vaughan

There has been a lack of government response internationally to the Global Financial Crisis (GFC), says Kiwibank chief economist Jarrod Kerr, as he highlights the possibility of the Reserve Bank cutting the Official Cash Rate (OCR) below 1% next year. 

Kerr issued a report on April 3 in which he puts a 40% chance on the OCR dropping to 0.75% next year, and predicts a volatile decent for the New Zealand dollar this year, potentially below US60 cents. His report is entitled Blood, Sugar, Brex-Magik: markets high on risk, and was written up here by David Hargreaves.

Speaking to interest.co.nz in a Double Shot interview, Kerr says a decade on from the height of the GFC interest rates around the world remain low. This means governments could still be more active in trying to help resuscitate economies than they have been.

"What I think has been missing in this post crisis world has been a lack of government response. Normally when you see interest rates drop this low, governments come out and start building and expanding and taking over the reins and saying; 'Right if we are going to have a healthy, productive, high growing economy, we need to start building some stuff now for 10, 20 years down the track.' And we just haven't seen it. We're trying in New Zealand, but we haven't done enough. And I think that's the disappointment globally, is that monetary policy has done everything it can and fiscal policy hasn't done much," says Kerr.

Governments could be building infrastructure by borrowing money at interest rates that are "ridiculously low," he argues.

"A 10-year government bond rate at 1.80%, that's the lowest we've ever seen. The government could issue billions of dollars at that rate and I think just about every construction worker in New Zealand could come up with a project that could easily cover that very, very low hurdle with interest. And we desperately need a lot more infrastructure in this country."

"The way we dealt with the crisis was lowering interest rates [and] quantitative easing. So inflating assets. And that generally helps the owners of assets. Income growth outside of that has been quite weak for the general public. Our wages growth for the last 10 to 15 years has actually been quite weak. So the asset owners, the rich, the wealthy, have done okay, and everyone else has either just stayed the same or got relatively worse. That's your widening inequality," says Kerr.

"How do you deal with that? It's a tough question and it's one that I think will take decades. But you really need to focus on education because the wave of automation and AI [artificial intelligence] that's coming through could potentially exacerbate that even further. You need the infrastructure so that poorer areas in your country have access to the major cities, have access to employment opportunities. There's a lot that needs to be done but it costs money."

'It's a double edged sword when you are cutting interest rates'

Meanwhile Kerr says the balance of risks globally is deteriorating and some of the stronger economies, such as the US, have lost momentum.

"And then you look at Europe and parts of Asia and growth that we're seeing out of that part of the world is also disappointing. So in terms of looking ahead it's a bit more clouded than we'd thought [it would be]. So I think we're in a position here where the central bank is looking at our economy and saying 'business confidence is clearly weak and there's something going on there, our currency's quite high and maybe we should take a bit of insurance out in the next month or so, cut the cash rate 25, 50 basis points and then see how we go from there'," Kerr says.

"Because cutting the cash rate in May, June, August type area you're not going to have an immediate impact. Monetary policy lags mean you're really trying to take out insurance on growth towards the end of this year and into next year."

"You're trying to ease up financial conditions a little bit more and if you look at what the banks have done with their mortgage rates recently, you've seen mortgage rates falling as wholesale interest rates have fallen. And we have actually seen a decent tick up from customers in response to that. So there is still a response to falling interest rates," says Kerr.

"So if the RBNZ wanted to put a firestarter there, cut 50 basis points, a large part if not all of it will be passed on to both mortgage rates but also to term deposits. So savers will also get hit here. It's a double edged sword when you are cutting interest rates. You can cut the borrower rates but you're also cutting the saver rates."

OCR cuts would increase the gap between the OCR, currently at 1.75%, and the US Federal Funds Rate, currently at 2.25% to 2.50%, adds Kerr, and get closer to other countries with lower rates, meaning there's less need to" hunt for yield" in NZ.

"International investors literally look around the world for high interest rates. And if we take some of that advantage away it reduces some of the flow into kiwi dollars," Kerr says.

"If we find ourselves in six months or a year's time where the currency has gone from 68, 69c today to [US]60c, that's great. That's a win for us, it's a win for our exporters, it's a win for our economy as a whole. So the need to then cut [the OCR] further is significantly reduced."

NZ Government bond rates

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Fiscal policy is the answer to most problems. The government should be running a deficit when there is a downturn. The Government does not need to borrow money to spend it can create its own. And that will not cause inflation any more than borrowing the same amount would. Cutting the interest rate does not help anything other than house prices and companies merging and acquiring other companies. Encouraging Jo Blogs to go into debt is self defeating. What happens when the Jo Blogs of the world are paying all their income to the Banks as interest payments?

The Anglosphere wants its cake and to eat it too: govt stimulus spent on infrastructure to support the economy and no deleveraging in asset prices. We want to do what Japan has done with public spending, but we want asset prices to remain elevated. Well there's a few issues there. Japan has massive public debt, but they also a net creditor to the world and have massive industrial capacity and productivity. If NZ increases public debt, that means that more money should flow into the private sector. That does not mean that private debt will fall and it does not mean any deleveraging. The attitude in the Anglosphere is that private debt is not an issue. Only time will tell whether that is right or wrong.

JC - talk me through the sectoral balances you would expect to see if the NZ government embarked on say a 3% deficit spend next year.

Now lets say

G-T=S-I - (X-M)

Now lets approximate the current balances for now (% GDP) - government surplus=private domestic deficit - current account deficit.
-1=-4+3

How would a switch to a 2%/gdp deficit spend play out in sectoral balance terms in your view? Would the deficit spend go completely to widening the CAD? If the government is in deficit the private sector has to save by definition. In your view it would go completely to the foreign sector?

Have you read Bill Mitchell on Twin Deficits?
http://bilbo.economicoutlook.net/blog/?p=11527

I would argue that given the ongoing current account deficit, to sustain income, if the government runs a surplus, the private domestic sector has to run a deficit.

I'd be very interested to know exactly how you'd think a switch to deficit spending would play out.

How would a switch to a 2%/gdp deficit spend play out in sectoral balance terms in your view? Would the deficit spend go completely to widening the CAD? If the government is in deficit the private sector has to save by definition. In your view it would go completely to the foreign sector?

Not sure I understand what you're saying. Current account deficits are perennial because we fund our debt externally. Correct me if I'm wrong.

If the government sector is in deficit the private sector has to be in surplus. The private sector consists of foreign and private domestic sectors. My question is do you believe there would be no improvement in the private domestic balance from a discretionary government deficit? A deficit would not help repair private domestic balance sheets by increasing private domestic savings via incomes?

Flow of funds and sectoral balances
http://bilbo.economicoutlook.net/blog/?p=32396

Define 'S' for us in your little equation there, and then explain why it is strictly positive.

S is private domestic saving - not National Saving

Okay, cool.
Now tell us what your understanding of (S-I) is. And how you might be confusing exactly what "net saving" is.

Saving is income not spent. S-I is private domestic saving less investment. The private domestic sector balance within a period based on the flow of spending is S-I. In NZ it is currently negative reflecting the fact that the private domestic sector spends more than it earns. This cannot go on indefinitely. Private sector debt cannot grow forever. It has limits. As we saw in the GFC.

Private domestic saving is saving by households and businesses. In NZ business saving is currently positive and household saving a bit negative. Private domestic saving tends to be the mirror image of government surpluses/deficits. When governments save, private domestic sector dissaves and vice versa. Of course the current account balance is another sector in the equation.

Cool. Now we have established the problem. You propose MMT on the basis of an aggregate accounting tautology - This, btw, is the most simplistic of Keynesian macroeconomic relationships.

The MMT model breaks down as soon as you start to question the causal foundations of those identities at the micro level. You also have to throw away any notion that wealth is underpinned by productivity or make the absurd assumption that you can grow real wealth at the rate of inflation or pay of all current debt in (effectively) your own currency.
MMT is for the dreamers of society - think AOC in the USA. It is not a genuine solution to the mountain of debt we are accumulating.

Of course the sectoral balances are based on accounting and are true by definition. And you can tell various stories about the interaction between them. However, I find the sectoral balances MMT "story" about the GFC and balance sheet recession quite compelling. I say that when the private domestic sector is wanting to deleverage you need to accommodate that to sustain demand at full employment level. Imposing fiscal austerity will cause recession/stagnation.
See Scott Fullweiller on using the sectoral balance framework as a better model of aggregate demand than ISLM
http://neweconomicperspectives.org/2009/07/sector-financial-balances-mod...

Exactly. Government doesn't need to "borrow". Bonds are for interest rate management not spending. Deficits are not bad, they are usually essential as a govt deficit is a private sector surplus and vice versa. Monetary policy is too slow, untargeted and usually ineffective. Government spending is almost immediate and focused (even if you don't agree with its intent, efficiency or consequences). Seems to me MMT and especially a Government Job Guarantee that pays a minimum wage to anyone who wants to work regardless of their personal circumstances or location offers the best counter cyclical response to un/under employment, poverty & inequality. Money isn't a scarce commodity that the private sector magically creates and the Government taxes and spends. It is a creature of government and should be used for the public purpose. Politics is about what that purpose is

Seems to me MMT and especially a Government Job Guarantee that pays a minimum wage to anyone who wants to work regardless of their personal circumstances or location offers the best counter cyclical response to un/under employment, poverty & inequality.

Maybe. Plenty of people say that deficits do matter. The MMT paradigm has its opponents. However, you're correct in that govts are not constrained like h'holds.

Money isn't a scarce commodity that the private sector magically creates and the Government taxes and spends

Wrong. Money is lent into existence by retail banks. It is "magically created" to a large extent.

Banks create "credit money" in the act of lending but there is an obligation to pay it back, and as it is payed back it is destroyed. It also requires a willing borrower. Governments create money in the act of spending with no obligation on the other side beyond tax. Deficits are just an accounting observation that less has been taxed back than spent in any given period. Only government spending can increase the nett money supply. It is spend then tax or there would not be the funds in the system to pay tax.

Banks create "credit money" in the act of lending but there is an obligation to pay it back, and as it is payed back it is destroyed.

It's "destroyed", but it's "created" primarily for mortgage lending. Saying that it's "destroyed" does not mitigate the fact the money is "created" in the first place and is a primary reason why future generations have to exchange more of their labour than those before them to put a roof over their heads.

The government does not need the private banks to create it money in order to spend. It spends by crediting bank accounts with reserves and it has limitless power to create reserves as they are created via keystroke - not dug out of the ground. That's not to say it should use that limitless power unwisely. And when private banks buy government bonds they use reserves to pay for them. Who created the reserves?

Yes broad money is endogenous. But the government isn't dependent on private banks for its money supply.

Since the RBNZ embarked on its epic OCR course commencing in June 2008, the stock of home owners has increased by 48200, about 4000 a year. At the same time the stock or those living in rental accommodation has increased by 129400 or about 11000 a year. Home ownership rates are plunging when mortgage rates have never been lower. During that time mortgage debt has blown out by an additional 103 billion.

Yes. It's only the lower interest rates that have kept the ponzi going. I am changing my view. Cutting the OCR further will have limited benefit. The govt needs to get much more active with fiscal stimulus.

The man speaketh the truth. I do believe I've been saying this for quite a while now - ha ha.... (next step for him is MMT).
But you see mainstream economics dominated by conservatives up to this point has often - not always - been banging on about NZ becoming Greece or Argentina, leaving our children an unsustainable debt burden and the severe dangers of borrowing from "foreigners" (who quite like to give us real stuff like iphones in exchange for our bits of paper). Hence the public has deep public debt paranoia. And even a progressive coalition government stubbornly refuses to spend because it wants to pay down debt at all costs - even huge forgone GDP costs. At this rate we'll have an economy way below potential with little productive investment, a decaying society and so on - all in the name of refusing to create the private sector some safe financial assets. I hope that economists can start a shift in public opinion over this so we don't have another election based around who can be the most scrooge-like. I'd like to see an election where National and Labour fight it out over the best way to deficit spend and stimulate the economy.

At this rate we'll have an economy way below potential with little productive investment, a decaying society and so on - all in the name of refusing to create the private sector some safe financial assets.

I have an issue with this. How do you know public debt drives and generates productive investment? In my example of Japan, yes, their infrastructure is far superior to ours, but there has also been a lot of waste: bridges to nowhere, etc. Furthermore, as I mentioned earlier, Japan has massive productive capacity and power globally. If NZ public debt blew out, wouldn't that be risky? Japan is a price setter for its imports because of the size of its economy. NZ doesn't have the same power over imports such as oil.

Except an interest bearing debt based system has an inherent flaw, it will ultimately direct capital away from productive enterprise to rent seeking activity.

Excellent article. He's right.
Nz is going to be caught out. The government should by now have become much more ambitious on house building, for example. By the time the construction sector slumps by the end of 2019, it will be too late.

This Rockstar doesn't appear to have any legs to perform again without a hit of MMT no that's not MethaMpheTamine.

"If we find ourselves in six months or a year's time where the currency has gone from 68, 69c today to [US]60c, that's great. That's a win for us, it's a win for our exporters, it's a win for our economy as a whole. So the need to then cut [the OCR] further is significantly reduced."

How is that a win for our economy when fuel and transportation costs go up by 15% cost of imported items increase by 15% plus the additional cost to import them.

Isn't that going to increase inflation which would normally be dealt with by OCR increases.

I agree with fiscal projects but not OCR cuts until they become vital.