Is our monetary policy stance right?

Having indulged in a little flight of fancy in my previous post about a stonking easing of monetary policy, it's time to get realistic again. So here's my latest occasional update to the actual stance of monetary policy - that old warhorse, the Monetary Conditions Index (the 'MCI'), which combines the level of interest rates and the level of the NZ$ into an overall measure (based on the RBNZ's monthly figures up to January, and current market levels for February).

Turns out, the flight of fancy may not have been so fanciful after all. Monetary policy, on this measure, is slightly on the tight side of average, and that doesn't seem to make a lot of sense at the moment: it's meant to be "accommodative" (as the RBNZ put it in the latest review of the Official Cash Rate). Unless as a central bank you're very confident in your call that everything's hunky-dory over a medium-term perspective, and that inflation will get back to around 2% on present monetary policy settings, you'd think the lesson from this graph is that policy should be starting to ease.

Which is also where the ANZ Bank has got to in their latest Market Focus, where they now think the RBNZ will cut the OCR by 0.5% this year (the publication isn't up on the ANZ website yet, but interest.co.nz have a commentary and a link to the publication itself). Interestingly, ANZ have their own 'financial conditions index', which is a different way of assessing the overall policy picture and which includes house prices, credit spreads and the NZ$: it's saying the same thing as the old MCI, namely that conditions have tightened recently. However you get there, the analysis is pointing towards the need for a lower OCR.

A modest proposal

The Reserve Bank has been taking some stick recently about not getting inflation up to 2% - you have your choice of posts on Michael Reddell's blog, for example - and yesterday Stuff's Vernon Small weighed in with 'Monetary policy is bust, so why are we still banking on it?'

So here's a modest proposal to get us back on track.

First, we cut the Official Cash Rate to 2%, the same level as the Australian policy rate. Nice big demonstration effect right there, with a 0.5% move instead of the usual 0.25%, plus it would be a genuine surprise (the futures market has only one 0.25% cut in the pipeline).

Second, we signal we'll match any future cuts in the Aussie rate (the futures market figures the RBA will cut by 0.25%, some forecasters think there are two cuts on the way).

Third, we do some quantitative easing (QE). The RBNZ buys enough government stock to drive down our current 10-year yield (3.04%) to the level of its Aussie equivalent (2.40%). It would help if Treasury cancelled its scheduled bond tenders and instead placed Treasury bills direct with the RB.

At that point, no sensible investors will pick New Zealand over Australia (the Aussies have a slightly better credit rating, so if the interest rates are the same, you'd pick them). Investors in New Zealand will clear off, and the currency will depreciate. It wouldn't hurt to give it a judicious nudge with some thin-market currency intervention.

If that doesn't get us nearer 2%, well maybe Vernon's right, and nothing ever will, but we'll never know unless we give it a go.

Course, the Auckland housing market will have turned incandescent, but you can't have everything, can you?

More seriously, I can't help feeling that it's theoretically possible, in the current collapsing-commodity, competitive-devaluation, out-QE-the-other-guy world, that there may be no feasible or desirable setting of local monetary policy that is consistent with 2% local inflation.

I've had a go in the past at trying to put this into some kind of formal framework (if you don't mind some simple graphs). My conclusion back then was that, if there was overseas monetary policy loosening (and a great deal more has happened since I wrote in 2013), and the RBNZ wanted looser policy but would prefer if it didn't exacerbate the housing market, then something had to give:

the Bank's got a bit of leeway: it doesn't have to keep inflation strictly at 2%. It's got a band of 1% to 3% to work with (on average aiming at a longer term average of 2%). Where the logic of things leads you to, though, is this: in current markets, the Bank will need to use this leeway, and let inflation undershoot 2% for some time.

It's possible that the sub-2% undershoot that we have indeed experienced isn't such a bad result, in the round. It could be the best we could realistically achieve in current world market conditions - or at least the best we could achieve short of having slavering buyers stampeding from auction to auction to snap up the last house under $3 million.

Sovereign irresponsibility

There was a fine article by Deborah Hart, the executive director of the Arbitrators' and Mediators' Institute of New Zealand, in Monday's Herald, making the sensible case that the supposedly controversial 'Investor State Dispute Settlement' (ISDS) process within the Trans Pacific Partnership (TPP) is actually a good idea. Read it for yourself: the gist is that ISDS "will work well for NZ" and that "Investor-state dispute settlement is therefore not something to be afraid of. It's part of being a trading nation in a globalised world".

What's baffled me most about the strong opposition to ISDS is the notion that "national sovereignty" is something that is sacrosanct, not to be jeopardised, diminished or traded away. If national sovereignty really trumps everything else, Dachau would still be open, apartheid flourishing, and every Tutsi in Rwanda and every Muslim in Serbia would be dead.

Progressives everywhere ought to welcome international controls on appalling behaviour by "sovereigns" - a useful crutch for the world's kleptocratic tyrants to lean on - as they have since (at least) the founding of the League of Nations in the wake of another fine exercise of national sovereignties, the Great War.

What "sovereigns" are demonstrating when they resist principles-based restraints - when, for example, neither China nor the US will participate in the International Criminal Court - is that they prefer the option of unprincipled behaviour. When countries sign up to the likes of the ICC, or to the ISDS provisions in the TPP, they're saying the opposite: we'll play fair, and we don't mind being judged on it. That's exactly where New Zealand should be.

No appeal? Good

I've been catching up with stuff that's happened over the summer holidays, and I have to say I was quite encouraged when I found out that Chorus has decided not to appeal against the Commerce Commission's decisions on copper broadband pricing and on backdating the regulated price.

Chorus's statement on January 28 said that "the Chorus Board has elected not to appeal the decision, despite disagreeing with some key elements such as the lack of backdating. While we are aware that some investors feel there may be merit in further testing aspects of the determination in court, it is the strong view of the Board and Management that the best long-term value for our shareholders and customers will be achieved through the industry focussing on bringing New Zealand better broadband".

Well said. Even if there is also something of a Mexican standoff going on - "we won't appeal against some aspects of the decisions if everyone else holds off, too" (my words, not theirs) - the general idea is bang on the button. There has been a deal of opportunistic regulatory and litigatory rent-seeking in the telco, and other, sectors over the years, and it is good to see someone turning their back on it and getting on with running the whelk stall.

More companies could usefully realise the true extent to which regulation and litigation are a distraction from their core lines of business. The direct costs of management and board time, and of lawyers and economic experts, are only a fraction of the true cost of diversion of focus from longer-term performance. In my experience, across various governance roles, that item on the agenda about the regulator or the court case takes on an entirely disproportionate importance. The corporate ego gets overinvested in winning: business strategy and longer-term performance are the inevitable losers.

Chorus may well have come to another correct conclusion that others could learn from: if you play the regulatory game too hard for too long, it will bite you (as I've argued before). We might eventually have had sector-specific regulation in any event, but there's little doubt that Telecom (as was), and various parties in the electricity business, pulled their current sectoral regulatory regimes onto their own heads through their bloodyminded intransigence.

I'm perfectly happy to accept that focussing on the business was the primary motivation for Chorus flagging away any appeals.  But if in the background Chorus also reasoned that pushing their luck on backdating - they might have scooped a pot of some $140 million - on top of a halfway decent outcome on the price, would have been a bad strategic move, given that the whole regime of telco regulation is currently under review, then they made a good call.

A New Take on Competiton

There are tons of people out there who have great ideas for new startups. However, most of them never actually act on them. Obviously, there are many different reasons for this. For some it may be because they lack the time, others do not want to take any risks, and some possible entrepreneurs are discouraged because there is already another company in the market that does a similar thing. 

At the end of the day, these are all valid excuses. But that is all they are. Excuses. If you really want to start your own business, you will have to face all the issues mentioned above. You will find hardly any entrepreneurs who feel like they have time to spare, or who did not have to take any risks. And most importantly, you will never find any entrepreneurs who will tell you they don't have competition. And you know what, that is a good thing. 

Just think about the very basic things you do with your company. Maybe you are selling a certain product. Fair enough. But why do people buy your product? It's pretty simple. They buy it because it satisfies a need. So at the end of the day you are not only offering a product, but more importantly you are offering a way to satisfy needs. This is a critical change of perspective. 

If you look at your business from this perspective, you will soon realize that you are not only competing with companies that offer the same product, but with a whole bunch of other companies that offer seemingly different products as well. For instance, if you are selling ice cream on a hot and sunny day, you might think that you are mainly competing with other ice cream sellers. But that's not quite right. In fact, you are also competing with the kid next door who sells lemonade. 

Most people buy ice cream because they feel like they need a sweet refreshement. Both ice cream and lemonade could potentially satisfy this need. So if your potential customers chose to buy lemonade, they are probably not going to buy ice cream from you anymore. Because you know, that too much of that sweet stuff is unhealthy, right?

This thought can be pursued even further. If your potential customers have access to a swimming pool they have other means to cool themselves down and get a refreshing experience, so they might not even feel like eating ice cream anymore. So even products from a whole other industry might compete with your products. 

Now, this may appear rather intimidating if you are thinking about starting your own business. Why even bother if there are so many competitors? It's simple: because competition proves that there is a need. If there is nobody who satisfies the same needs that you are targeting with your product, in most cases there is no need for it either. Literally. This is important to keep in mind. Even if you are the first one who comes up with a new product, there are probably others that target the same needs. 

Of course that does not mean your idea is not new or innovative. It actually means that you might be on to something. If your product is able to satisfy the same needs better than the existing products (from other companies or industries) then you have a chance to be successful. You "just" have to be better. In fact, this is how most disruptive innovations start. 

Just keep that in mind next time you talk to a potential investor. They will always ask about your competition. Whatever you do, don't tell them you don't have competition. Talk about the needs you are targeting, how you are targeting them and why that's better than what is being done at the moment. There is no such thing as no competition.

In a nutshell

Companies are selling products and services. More importantly however, they are selling ways to satisfy needs. This is a critical change of perspective. If you look at your business from this point of view, you will soon realize that you are not only competing with firms that offer the same product, but with a whole bunch of other companies that offer different products but target the same needs. Even if you are the first one who comes up with a new product, there are probably other competitors that satisfy the same needs. So at the end of the day competition is a good thing because it proves that there is a need for what you do.

Did we ask the right question?

Normally I'd take time out early on, to explain some of the telco/regulation jargon, but as I suspect virtually everyone likely to read this post already knows what UCLL, UBA, WACC and TSLRIC are, I'm going to plunge right in.

Unless there is some diehard with a large legal budget to burn, last month's final decision by the Commerce Commission setting the wholesale price of copper-based broadband at $41.19 brings the curtain down on a long, complex and contentious process.

I'm not going to spend much time revisiting the details of the Commission's decision, other than to note that in an exercise like this one, with so many moving parts, there is inevitably going to be room for even reasonable people to disagree.  In their place, I might well have gone a different way on aspects of WACC, for example, or taken a different position on the challenge of digging trenches through New Zealand's allegedly idiosyncratic topography, but so what: overall it was a reasoned, careful piece of work.

The end result looks to have ended up in the right area, and I say “area” advisedly: there is no single “true” point-estimate answer to these sorts of questions. You only have to glance at Figure X1 of the decision, for example, to see how second thoughts on various component bits can have significant impacts on the final price. I was comforted in particular, as I thought it was a realistic result, by the Commission's calculation (in paras X34-5) that its price on a “like for like” basis came out lower, at $31.60, than the entry-level UFB price of $37.50. And no, I don't want comments from conspiracy nutters who think the Commission was steering its decision to within cooee of the UFB price.

But let's step back from the specifics and consider some broader picture issues.

For me, the big one was the task the Commission was constrained to do. By law, it had to set a forward-looking TSLRIC price, and it did. But that task answers the question, “what would be the cost to use a shiny new whizzbang broadband network rolled out efficiently today”, not the question, “is Chorus ripping off my broadband provider, and, at one remove, me?”. Or as the Commission summarised it

E109 … our task is to set a price according to TSLRIC which we and submitters agree is best set relative to the forward-looking efficient costs of the hypothetical efficient operator, rather than the past costs of the regulated entity.

E110 Putting that another way, we do not consider that concepts such as “windfall gains” or “windfall losses” are particularly relevant. A price determined according to TSLRIC does not attempt to regulate the incumbent’s revenues such that it earns a normal return on its actual investments. Rather, it attempts to set a forward-looking price based on modern technology and irrespective of the incumbent’s past investment decisions.

The Commission is completely correct in saying that its hands were tied, and that any financial impact on Chorus was beside the point. And I know that TSLRIC is a good price to use if (for example) your main issue of interest is whether retail broadband providers (or others) are given a fair go at getting into the wholesale broadband business for themselves. And that's an important point if you believe that consumers are best served in the long run by competing suppliers deploying a choice of infrastructures.

But I'm still not convinced that the Commission was asked the right question in the first place. There was a good consumer case for an alternative approach, the one the Commission described in the extract quoted above as an “attempt to regulate the incumbent’s revenues such that it earns a normal return on its actual investments”, and which is standard in many regulatory proceedings.

Consumers, for example, are wearing the cost of a hypothetical brand new network. It's as if the government had decided to regulate the price of cars, and as part of the exercise decreed that only the latest new models in the showroom would be made available. Many of us, however, would prefer to get our cars from Honest John's Japanese import yard. Instead, we're being asked to pay the depreciation costs of a brand new car, and we've lost the option of paying a lower price for an already depreciated second-hand one.

So yes, I'm still concerned that the inherent design of the regulatory regime had the capacity to deliver windfall gains to Chorus (at consumers' expense) or windfall losses (at Chorus's expense). The whizzbang modern technology element probably counts against Chorus if it is still using some earlier generation gear, as does the efficiently deployed element, if it is still carrying inefficiencies from its dominant incumbent Telecom days. But the depreciation aspect is a clear bonus for Chorus: the price is based on a brand new network, with its deployer entitled to a reasonable rate of return on the whole amount invested. Chorus, on the other hand, has already recovered some proportion of its investment, through depreciation, and should only receive a reasonable rate of return on the funds still invested. To that extent Honest John is being paid the new car price.

There's another aspect that also leaves me wondering if the TSLRIC question was the right one to ask.

Earlier, the Commission had provisionally set the broadband price on an international benchmarking basis. It's an approach which I hope survives the current review of telco regulation, as I remain convinced that it can in many circumstances provide a decent enough approximation of what the New Zealand price ought to be. But it didn't work on this occasion: the Commission was (again) constrained, and could look only at the overseas prices in countries that also costed broadband on a TSLRIC basis. And the answer to that quest was – Sweden.

Understandably, various parties weren't happy that New Zealand prices were going to be set on the basis of an overseas sample of one, we moved smartly into the final pricing process that concluded last month, and the initial benchmarking exercise became moot. But it still leaves a big question unanswered: how come there are only two countries in the developed world that are setting broadband prices this way?

I know, there will be times when there are just a few enlightened countries ahead of the pack, and most everyone else is doing it wrong. I'm not sure, though, that this is one of those times. While we're in the mood to have a rethink of our telco regulation regime, why don't we ask ourselves if we can live with mainstream overseas practice – especially if the alternative is fractious, protracted, complicated, and expensive.

Most Popular Posts of 2015

The year 2015 is over and we have had a great time. To bring this blog's first full year to a close we have analyzed all the 65 posts and created an overview of the most popular posts of 2015, divided by categories. Check it out below:

Top 3 Infographics Posts:
1. Australian Economy At a Glance (5344 views)
2. German Economy At a Glance (2305 views)
3. 10 Principles of Economics You Should Know (1829 views)

Top 3 Economics  Posts: 
1. Limitations of GDP as an Indicator of Welfare (2479 views)
2. Positive Externalities vs. Negative Externalities (2243 views)
3. The Law Of Supply And Demand (1231 views)

Top 3 Business Posts:
1. How to Ruin Your Startup in 7 Simple Steps (1275 views)
2. Why Do Firms Need Growth (277 views)
3. What Type of Entrepreneur Are You? (216 views)

Top 3 Dictionary Posts:
1. Tax Incidence (39 views)
2. Gross Domestic Product (GDP) (26 views)
3. Adverse Selection (19 views)

In total we have counted 38'234 views up to this point. Thank you very much for all the support and positive feedback. We wish you all a happy new year and see you in 2016.