A good follow-up

The New Zealand Institute of Economic Research has followed up on an idea I threw out here in August, suggesting that somebody ought to ask New Zealand businesses exactly what was bugging them when they reported low levels of business confidence (and thanks for the credit in the latest Quarterly Survey of Business Opinion, guys, it's appreciated).

Here are the answers to the special question the NZIER included this time round.

While it's good to know more precisely what's on businesses' minds, in the event it's not hugely surprising. Most people had suspected that businesses were not enormously enamoured of various current economic policies, and sure enough government policy topped the list. The tightness of labour markets (staff availability, wage pressures) and its impact on profitability, are also right up there, as is profitability more generally.

As NZIER said in the media release, "Profitability continued to worsen, reflecting intensifying cost pressures for many businesses. Businesses remained pessimistic about an improvement in profitability", and the overall results in the QSBO were downbeat. Looking just at the "own activity" results, which track GDP pretty well, "Firms’ own activity for the September quarter and expectations for the next quarter both fell, indicating a slowing in economic growth over the second half of 2018".

Hopefully the support from still very supportive fiscal and monetary policy will carry us through whatever slowdown occurs in coming months: in particular, the lower Kiwi dollar has tilted overall monetary conditions in businesses' favour, even as the RBNZ has stood pat on already low interest rates. And let's trust that the long-running  post-GFC global business expansion will not blow a gasket, despite the best efforts of American tomfoolery to derail it.

That's the upbeat take. But if there's one thing that would give you special pause for thought, it's "consumer confidence" turning up in the graph above as businesses' third most pressing worry. I didn't expect it to rate so highly, but looking at it now, I can see why it's there. I'd finger the petrol price as one big factor: here in Auckland the regional tax, the general rise in fuel excise, the high world price of oil, and the weaker Kiwi dollar have resulted in a litre of 91 costing $2.35 - $2.40, and households aren't in a great place to absorb a thumping great whack like that. I also suspect that housing wealth effects, again maybe more in Auckland than elsewhere, have stalled or even reversed.

So the state of consumer confidence is something I'll be watching a bit more closely. Hopefully rising wages in a tight labour market will alleviate some of the budget pressures from the petrol station forecourt, and the September QSBO result of no rise in employment likely reflected firms' inability to find scarce labour, rather than any cutback in hiring intentions, which remain positive. I certainly wouldn't want to see any job insecurity thrown into the already fragile household mix.

What's behind the slide in optimism?

The latest quarterly Westpac McDermott Miller survey of consumer confidence came out this morning, and much of it was pretty positive. But there was one chart in particular that I was keen to see, and it was that mysteriously saggy 'outlook in five years' time' one that's been puzzling me for a while. Here's the latest reading.

The odd thing is that, after a surge of relief  in late 2009 and early 2010 that the worst of the GFC had passed by, people in New Zealand have steadily turned less optimistic about New Zealand's future prospects, despite our recent strong business cycle.

And it's not an oddity of the Westpac McDermott Miller survey: exactly the same pattern shows up in the ANZ Roy Morgan consumer confidence survey.

So why this steady loss of optimism?

That latest bounce in the Westpac reading (and the smaller lift in the latest ANZ one) suggest part of what's going on: it looks as if both measures are picking up the recent improvement in dairy prices. As Westpac commented, "Despite picking up, the number of households expecting favourable economic conditions in five years’ time remains at some of the lowest levels we’ve seen in decades, with those in rural areas especially downbeat...Recently, we’ve seen global prices for dairy starting to
improve, and we’ll be watching to see if confidence in rural regions also starts to lift over the coming months".

International trading conditions are clearly one of the drivers of these measures: they can also be seen in that dip in the ANZ survey readings in mid 2015, which coincided with volatility in world financial markets when it seemed the global economy might be running out of oomph (people at the time were worried about China in particular). Evidently the people surveyed think that (some recent improvement in dairy prices excepted) the world economic outlook is not crash hot at the moment, which looks to be a realistic assessment: every recent major review of the world economy has found it is growing more slowly than usual - as shown for example in this indicator of the world economy from J P Morgan/Markit - and that the balance of risks is tilted to the downside.

There are also probably a couple of other things feeding into the downbeat mood. One is expensive house prices. As the ANZ commented, "Higher house prices aren’t a win for all. Confidence in the 25-34 year bracket (first home buyer heartland) continues to see-saw: as house price expectations rise, their confidence in current conditions falls and vice versa", and I wouldn't be the least bit surprised if very expensive housing isn't feeding into lower longer-term confidence as well.

I wondered if politics also had something to do with it, but neither the ANZ nor the Westpac surveys have questions obviously linked to political perceptions. So I turned to the separate Roy Morgan research which asks people, "Generally speaking, do you feel that things in NZ are heading in the right direction or would you say things are seriously heading in the wrong direction?".

There's a rough and ready fit: in the ANZ, Westpac and Roy Morgan graphs, there's been a rise over 2012-14 and slide over the past couple of years. People are still, on balance, happy with where the country is being taken, but not as happy as they were. What this says I'm not sure: perhaps people feel that somewhere over the next couple of elections, a safe pair of hands will be replaced by something less predictable? Or are they becoming progressively disenchanted with steady as you go and don't frighten the horses?

In sum, that slide in optimism, which seems at odds with the current strong state of the business cycle, can, I reckon, be unpicked - a realistically downbeat assessment of the world economy, a close concern with trends in commodity prices, angst over the dream of home ownership, and, for one still unclear reason or another, some modest loss of confidence in political direction.

In denial

The first edition of the new Household Labour Force Survey came out yesterday, and there have been some strange reactions.

At first I agreed with Grant Robertson, Labour's finance spokesman, when he said that it wasn't right that people looking for jobs solely over the Internet aren't being counted as unemployed. In today's world, that is indeed a daft approach, as I said at the time when Statistics NZ was running its (very useful) seminars around the country about the new-look HLFS. It's particularly odd, since this definition, which as Robertson correctly said has the effect of making unemployment look lower than it really is, came from the UN's International Labor Organization, which is emphatically not a labour-hostile institution with an agenda of concealing unemployment: it is, as its website says, "devoted to promoting social justice and internationally recognized human and labour rights".

But I was then surprised, and dismayed, to see Robertson casting aspersions on the motivation of Statistics NZ, which justifiably took exception. We don't need the quality of public discourse getting nudged further into the mud.

I was also surprised by commentators who took the line that, because the new survey contained methodological changes, we could not be sure that employment grew at all in the second quarter. At face value, the HLFS had shown a 58,000 rise in employment in the June quarter compared with March, but as Stats said (here) "part of this increase reflects improvements to the redeveloped HLFS alongside any real-world increase in employment this quarter".

It is technically angels-on-the-head-of-a-pin true that the HLFS doesn't tell us whether there was "any real-world increase in employment". But to try and make the case that there really wasn't any is complete cobblers. Absolute arsehats.

For one thing, Stats had earlier published the June quarter results from what used to be a separate Quarterly Employment Survey publication and is now part of an overall Labour Market Statistics release. It isn't on all fours with the HLFS one (for example it misses very small businesses, and agriculture) but it is another valid perspective on employment, and it showed that the number of full-time equivalent employees rose by either 0.3% (seasonally adjusted measure) or by 0.6% (the 'trend' measure) in the June quarter.

For another, every single business survey tells us that employment is growing. The latest employment components of the BNZ/BusinessNZ Performance of Manufacturing Index, the BNZ/BusinessNZ Performance of Services Index, and the ANZ's Business Outlook survey are all showing growth in employment. Here's the ANZ one.

So it's time to stop playing silly buggers with the data and to stop denying the undeniable: employment is growing. That's it.

The other interesting thing in the new HLFS was a new 'underutilisation' measure, which adds up the officially unemployed, the underemployed, those looking for work but not quite ready to take it up, and those not "actively" seeking work but who would like a paid job and are available (which includes those Internet-browsing people, who aren't being "active" enough, apparently, to fit the official definitions).

Measures like these are often politically abused - "Sure, the unemployment rate has gone down, but see, there's all these other people..." - but it's still an interesting concept, as this Stats publication (pdf) explains. And it's one where we can see (here) how we're travelling by international standards (give or take - it's the picture from last December, as not every country has up to date figures).

To be honest, I'd thought we would show to greater advantage than 'a bit better than the OECD average': cyclically, the economy has been doing well by international standards, so you wonder how (for example) the sluggish Japanese economy is to the left of us. Perhaps the answer is demographics: there may simply be very few warm bodies left unemployed in the relatively aged Japanese population, compared with our younger structure. It's less of a surprise, though, that our relatively flexible labour markets have produced better outcomes than the sclerotic institutional arrangements in France, Italy, Greece and Spain.

But we have one blot of our own (shown below) that badly needs fixing. I don't have any immediate answers, beyond the traditional liberal nostrum of more, and better, training and education. Hopefully others have more ideas: either way, this can't be allowed to go on.

Links to the HLFS presentations

Yesterday I wrote about Statistics NZ's day seminar on the Household Labour Force Survey. Here are links to the papers I mentioned.

Stats' Diane Ramsay on the history of the HLFS
MBIE's David Paterson on the changing nature of the labour market
AUT's Gail Pacheco on the impact of minimum wages
Waikato's Bill Cochrane on the gender pay gap
Stats' Sharon Snelgrove on updates to the HLFS

I've tested the links, and they work, but sharing links via Dropbox files is on the frontier of my technology skill set, so please let me know if there are any issues.

Happy birthday, dear survey...

It's not often a statistical survey has a birthday celebration, but yesterday Statistics NZ had a 30 year anniversary do at AUT to celebrate the Household Labour Force Survey (the HLFS) getting underway in 1986. Stats brought along copies of the very first HLFS data announcement: it had a well-written press statement that has stood the test of time pretty well, though the tables will take you back to the era of dot matrix printers and what looks like Lotus 1-2-3 output (children, ask your parents).

Diane Ramsay from Stats took us through the history of the HLFS. There could have been, should have been, an HLFS in 1979 - the Department of Labour and the then Statistics Department had done a feasibility study and recommended one - but the Muldoon government, with characteristic incompetence and contempt (my comment, not hers), decided it couldn't afford one. The Labour party, on the other hand, recognised that a proper measure of employment, unemployment, underemployment and participation is a fundamental piece of information in an open democracy, and got the HLFS going in 1986.

And so here we are today, with the HLFS pretty much as it was day one. It's one of the biggies for the financial markets, right up there with GDP and the CPI, but as the various presenters showed, the long set of consistent data has also been enormously useful over that time to investigate all sorts of social and economic issues. Dave Paterson from MBIE, for example, explored a number of trends over that time - notably the large rise in the labour market participation rate of women, how the various business cycles had different regional impacts, and what the forecast demographic profile of the workforce looks like and its implications for aggregate economic growth and productivity.

AUT's Gail Pacheco - a fellow Warriors tragic - summarised her research papers (written with various colleagues) on the impact of changes in the minimum wage. This is one of the red-hot economic policy topics in the US (and elsewhere) at the moment, and to be honest I wasn't aware that there was equivalent research in New Zealand. Turns out, Gail said, that by international standards we have a relatively high minimum wage relative to the median income, so our results happen to be especially relevant to people overseas thinking of whacking up their minimum wage (like this month's US$15/hour moves in New York and California). If you're interested in the topic, best read Gail's output properly rather than rely on my takeaway, but in one study where she focussed on employment effects where the minimum wage was a binding constraint, she found negative effects on teenagers and minorities, which is what I would have expected.

Gail and Waikato's Bill Cochrane used the HLFS, and an occasional supplement run alongside it, the Survey of Working Life, to look at the gender pay gap. It has been narrowing, but it's still there, and even after throwing a battery of control variables at it to allow for different occupational distributions and everything else that might be a plausible explanation, there's still a 10% gap left unexplained. Is that big or small? Well, as Bill said (and I'd endorse as the father of a working daughter), why don't you leave 10% of your income at the door when you leave, and see if it feels small to you.  The Herald's social issues editor, Simon Collins, had the gumption to come along to the day, and you can find his coverage here.

The other news was that, after 30 years. the HLFS is getting a bit of a remake and a refresh, though not so as to cause any major inconsistencies and series breaks - there'll be an element of 'backcasting' if needed to put the old data on all fours with the new. Fuller details here. As Sharon Snelgrove of Stats explained, some of the changes reflect different ways of doing things today (looking for jobs over the internet, for example, rather than in the job ads in the newspapers), and some are aiming at new data (such as union membership, or being part of a collective bargaining agreement). When people respond that they'd like more hours of work, they'll now be asked, "how many?", so we can get a volume measure of underemployment.

Three technical details I found interesting.

One, the HLFS rotates out one-eighth of the survey panel every quarter. The same rotation process appears to have caused real issues for the Aussies and the volatility of their monthly employment data, so I asked the Stats folks if ours were likely to go off the rails. The answer was, it's hard to know, as there's quite a lot of volatility in the employment data anyway, and it's not that easy to figure out how much might be due to some non-representative oddity of the new one-eighth intake. But their rough-and-ready feel was, no.

Two, immigrants have recently been one of the big components of growth in the labour force: do we know anything about their employment experience? Short answer, no, not in the short-term anyway: the HLFS is designed to exclude anyone who has been been in New Zealand for less than a year.

And three, I was reminded - well, got into a bit of an argy-bargy about it, really - about the very tight definition of unemployment. To be unemployed in an HLFS sense (which in turn is a definition set by the International Labour Organisation)

A person must be actively seeking work and available to work in the reference week to be classified as unemployed. ’Actively seeking work’ means an individual must use job search methods other than looking at job advertisements – for example, contacting a potential employer or employment agency. Previously, responses that specified using the internet to seek work were captured in an ‘other’ category and consequently classified as ‘active seeking’

My beef is that if I were an unemployed economist, and keen to get a job, I might very well turn to Seek or whatever, enter 'economist' in the keyword box, read the options, and flag them away if there's no fit. That, for me, has all the look and feel of an unemployed person actively looking for work. But not for the HLFS (nor other ILO-compliant surveys). I won't feature in the unemployment stats, though I will be in what is called 'the potential labour force', which makes up one part of the 'underutilised' labour force (the unemployed, the underemployed, and the potential labour force).

So my reaction is that I think I won't be quite so hung up on the headline unemployment rate in the future, and I'll pay a bit more attention to the underutilisation rate, as will Stats itself: "As part of the new outputs released from the June 2016 quarter, Statistics NZ will include the underutilisation rate as a key statistic".

Well done to all involved - Stats really does go the extra mile to connect with its users.

A peek behind the veil of ignorance

Last week's post about a paper that documented the remarkable level of economic ignorance amongst New Zealand's business managers seems to have hit the spot, going by page views and comments.

Comments have been somewhere on a spectrum between head-shaking bafflement and outright incredulity, with a soupçon of "how can people this ignorant stay in business?". And, mostly, I'm somewhere in that range myself.

But one commenter pointed me to something that shows managers' beliefs in a modestly less awful light. It's an earlier paper by largely the same people, 'How do firms form their expectations: new survey evidence', an NBER working paper from April of this year. The abstract is here, but the whole thing will cost you US$5 unless you 're in academia or the media or a developing economy: us common or garden bloggers have to pay up, and I did. Oh, and the NBER is funny about copyright, so here it is - © 2015 by Olivier Coibion, Yuriy Gorodnichenko, and Saten Kumar.

What this paper found is that managers may be terrible at estimating the current or likely rate of consumer inflation - no better than the populace at large, which seems rather strange for people at the business coalface - but they are rather better at knowing what producer prices are doing in their industry. Here's the graph that shows it.

The left-hand panel A shows the distribution of managers' estimates of various recent macroeconomic data - the inflation rate in their own industry, inflation overall, GDP growth, and the unemployment rate. Negative values mean that the managers' estimates are too high relative to the real number.

Managers aren't too bad at getting their own sector's inflation rate right: on average, in fact, they're bang on, though there's still quite a big dispersion around the right answer. They're reasonably good at the unemployment rate (they have it a little higher than it really is), but not so hot at GDP growth (they have it about 1.5% - 2.0% higher than reality, from eyeballing the graph). And as my previous post said, they're really bad at the CPI inflation rate, being well off the mark on average and with estimates all over the shop.

The authors show that you can explain the managers' ignorance of the true rate of inflation in terms of 'rational inattention' - life's too short to be on top of everything, and if it's not important to you, you don't bother. Equally they show that managers who think inflation is important for their business do a better job of tracking it, and as we've seen in the graph above, managers stay on top of their industry's inflation pretty well, given that they've got both the incentive and the opportunity. And the paper's authors also show that if you give managers some additional information on actual and forecast data, they improve their estimates. Managers, in sum, aren't the complete ignoramuses you might have imagined when (for example) you see their level of ignorance about the basics of what the Reserve Bank does.

But it all still leaves that basic question: why do so many managers think inflation isn't important to them, and hence or otherwise get it so wrong?

There'a clue in the right-hand Panel B. It takes the (badly overestimated) inflation estimates in the left-hand panel, and breaks them out by the sector of respondent. You can see that there's a decent proportion of people in manufacturing and trade who have an accurate idea of inflation (though even then there's a tail of people with shots that are too high). But there isn't even a semblance of getting within cooee of the right answer for the average managers in professional and financial services firms, or in construction and transport businesses.

So here's my interpretation, not the authors' (though there are also bits of the paper that point the same way, such as the bit that shows managers in businesses with more competition pay more attention to inflation). That sectoral breakdown in Panel B is pretty much along tradables/non-tradables lines. Managers in tradables sectors have to be reasonably okay at getting inflation right, as there are enough competitors (domestic and overseas) who will eat their lunch if they're systematically bad at it. And managers in non-tradables sectors don't have to be, because there aren't.

I've thought it before, and I'm thinking it again: there are a lot of businesses in non-tradables sectors who can coast on a cost-plus mentality, and I doubt if we're going to make much inroads on our national productivity issues until stronger competitive pressures are brought to bear on them.

Extraordinary ignorance

We got a remarkable insight recently into something very odd indeed in New Zealand, and it came from a rather unlikely source, the latest Brookings Papers on Economic Activity conference.

One of the papers presented was 'Inflation targeting does not anchor inflation expectations: Evidence from firms in New Zealand', a paper with four co-authors, one being AUT's Saten Kumar. You can read the abstract and media release, or the whole paper: even if you don't often read more academic papers, this one's worth it. It's pretty easy to follow - indeed, the authors have a rather non-academic flair for making their points crisply and colourfully.

The main focus of the paper is whether inflation expectations are 'anchored': roughly, do people clearly believe that inflation will stay reliably low? They look at five possible ways of assessing it: for example, do expectations vary very widely across the population rather than most people being in the same sort of place? Do expectations jump all over the place from one time period to the next? And so on.

On all five criteria, they find that the business managers they polled did not have settled inflationary expectations. As the abstract puts it

Managers of these firms display little anchoring of inflation expectations, despite twenty-five years of inflation targeting by the Reserve Bank of New Zealand, a fact which we document along a number of dimensions. Managers are unaware of the identities of central bankers as well as central banks’ objectives, and are generally poorly informed about recent inflation dynamics. Their forecasts of future inflation reflect high levels of uncertainty and are extremely dispersed as well as volatile at both short and long-run horizons. Similar results can be found in the U.S. using currently available surveys.

This leads into all sorts of serious cogitation about the efficacy of monetary policy, the need for central banks to communicate better, and how people form their inflation expectations, and if you're a monetary policy tragic you'll love it.

But it also says something pretty damning about the level of ignorance among New Zealand's business community. I'll pass quickly over the facts that only 31% of managers could identify the main objective of the Reserve Bank, and that only 30% could name its governor (even when, in both cases, they were given prompt sheets of the possible answers), and concentrate on this one. Here's a table (clipped from table 7 of the paper) of responses to the question, what inflation rate do you think the RBNZ is trying to achieve? Column 1 shows the possible answers, column 2 shows the percentage of managers who opted for each possible answer, and column 3 shows what they thought actual inflation would be over the following year.

As the authors summarised it, "Of the respondents, only 12% correctly responded 2%, although an additional 25% said either 1% or 3%, the bottom and top of the target range of the RBNZ. But 15% said the RBNZ’s target inflation rate was 5%, 36% said the target was more than 5%, with 5% of respondents saying that the RBNZ’s target inflation rate was 10% or more". Just over half (50.9%) thought that inflation was going to be at least 5%. It turned out to be 0.8% (year to December '14).

Now, I know that there will be a lot of managers doing a perfectly acceptable job of getting the widgets made and out the door, with or without knowing what the rate of inflation is or exactly what the Reserve Bank is trying to do. I'd suggest, particularly if they come anywhere near the strategic planning end of the business, that they're nowhere near as effective as they might be, but there's surely a valid role for heads down, bums up, and get the salads packed and despatched.

And I know that those of us who are into macroeconomics can sometimes forget that others aren't as familiar with the jargon and the details, and that you can actually have a life without delving into the national accounts or the CPI. People get caught up in their own preoccupations, but we don't all need to know the niceties of the LBW rule.

And I know that other countries can be just as bad: the paper documents a similar pattern in the US, though that's little comfort. Not many of us would like to be found on a par with what's happening in twilight Trump-or-Cruz America.

Apologetics apart, though, let's face it: this is a staggering level of ignorance. It makes you ask, among many other things, what on earth the secondary schools can have been teaching in their economics classes over the last twenty years. It leaves you thinking that one of the reasons for our well-documented issues with productivity might well be ill-equipped management. And it makes you wonder about the level of understanding voters have brought into the polling booths: as I've written before, every general election has brought proposals for changing our monetary policy regime, ranging from the potentially promising to total nonsense. How likely is it we'll get a good outcome when people have only the foggiest idea of the current arrangements?

A statistical addendum The first, and often the only, rule when you find extraordinary data like these, is that the data are wrong. They've been mismeasured, someone didn't clean the test tubes, there's an error in the spreadsheet. And I can't quite shake the doubt in this case that there might be a self-selection bias in the survey the researchers carried out. When they first sent the questionnaires out, they got a 20% response - a pretty good outcome. But what if the more clued-in managers opened the envelope and said, "Jeez, I've done enough of these, I'll pass", and the less clued-in ones said, "Wow, no-one's asked for my opinion before"? And if that happened, the potential self-selection bias probably became more acute as an issue in later waves of the survey, since the researchers only went back to people who responded to the first wave. There's a risk that the surveys could have progressively zeroed in on the most clueless. Whether it happened, or what difference it might have made, I can't tell, and it might be completely off the mark, so I'll take the data at face value. Overseas evidence of the same ignorance is rather suggestive that this paper is broadly right anyway.

I'm not there! Are you?

Bryce Edwards' Twitter feed pointed me towards an interesting new piece of research from the Lifestyles Research Group at the University of Otago - 'Change, Challenge and Choice: A New Zealand Consumer Lifestyles Study'. It's an interesting insight into our collective beliefs and behaviours, and rings true, sometimes almost archetypically: I was amused to see that one of the statements New Zealanders most disagree with is "I keep my wardrobe up to date with fashion".

This is the sixth instalment of what is now becoming a pretty impressive longitudinal survey (dating back to 1979). The guts of it is a derivation of seven different consumer segments, based on cluster analysis of quite a large survey sample (2,036) and a large number of questions (almost 600). Here is the key result: there's more detail on each segment in the full paper.

The cluster analysis fits the data pretty well, and no doubt marketers, and others, will be thinking up cunning plans to pitch to the different segments.

I've got only one, eentsy issue with it: I don't seem to fit any of the boxes...what about you?

Great expectations

The latest monthly business opinion survey from National Australia Bank had this interesting item.

The interesting bit, for me, was that top right hand box: the high "hurdle" rates of return that businesses typically require new investment projects to meet. There is a big puzzle here: the hurdle rates are well above the weighted average cost of capital (WACC) that finance theorists, and regulators, say should be adequate for companies to earn. The sectoral distribution of the hurdle rates makes more sense, and looks to be broadly in line with back-of-an-envelope guesstimates of the relative riskiness of the different sectors, but the levels of the hurdles looks remarkably large.

Turns out that this isn't peculiar to the sample of companies the NAB surveyed: it seems to be well nigh universal. In the latest issue of the Reserve Bank of Australia Bulletin, there's an article, 'Firms' Investment Decisions and Interest Rates', which confirms NAB's findings for Australia...

...and which also summarises international research that found exactly the same thing overseas. For example

Studies of firms overseas have found that they also use hurdle rates that are above their cost of capital. Jagannathan, Meier and Tarhan (2011) surveyed firms in the United States in 2003 and found that a typical firm used a hurdle rate several percentage points above its WACC. Brunzell, Liljeblom and Vaihekoski (2013) found a similar result for Nordic firms. Similarly, firms in other countries also appear to use hurdle rates that are not sensitive to the cost of capital

I think we can safely assume that New Zealand businesses are in the same boat (anyone aware of specific research on topic?)

We don't know exactly (or even approximately) why this happens. I've always thought that part of the explanation was a principal-agent problem: the CFO is bombarded with potential projects from ambitious executives with self-aggrandising projects, and needs some device that might help sort out the viable from the vanity (though a high hurdle rate will also have the downside of encouraging hitting fours and sixes at the expense of lower-risk steady accumulation of runs). But I'm also rather attracted to two other possible explanations canvassed in the RBA article: this one...

the level of the hurdle rate may be greater than the WACC if the potential investment has greater non-diversifiable risk than the overall operations of the firm

...and this one

managers might value the option to defer an investment until its expected net present value is greater. In the absence of more sophisticated analysis, using a hurdle rate in excess of the WACC may be a reasonable approach to account for this option value of waiting (McDonald 2000)

If I were still a regulator - and particularly a regulator looking at a sequence of projects rather than a company's overall rate of return -  I think I'd be somewhat perturbed about these results. For good reason, more enlightened regulators tend to err a little on the side of generosity when it comes to regulated WACCs, since for dynamic efficiency it is far better to slightly overcompensate than undercompensate. But when you see the prevalence of these high hurdle rates, well in excess of WACC, you wonder if there's something that the standard regulator's WACC calculation is missing.

What's happening in the telco sector

Earlier this week the Commerce Commission came out with its latest Annual Telecommunications Monitoring Report (pdf), and very interesting reading it was, too (as was last year's, as I commented here). In passing, it's daft that the Commission is obliged to report on the state of competition in the telco markets, while it is not allowed to publish proactive reports on the state of competition in the rest of the economy. If you're interested in the whole 'who can report on the state of competition' and 'market studies' issue, I'll be talking about it at this year's New Zealand Association of Economists annual conference - full programme here.

Back to the report. Lot of things to like by way of positive developments in the sector, though there is still quite a flavour of the deadweight legacy cost of the copper network, and the Commission's likely reduction of the copper price next month will be a positive move. In particular among the positives, consumers are mostly getting better value for mobile services: as the two graphs below show, mobile bundles are competitive by international standards, and prices have been falling.

But there are some oddities even on the mobile side. When you see the table and graph below you have to ask, why the very expensive prices by international standards for slugs of mobile data, and why aren't they falling, too?

I don't have any good rationale for this and neither does the Commission: on static prices, it comments (p33) that "This suggests there is a lack of demand for and/or competition to supply mobile broadband data when it is not part a bundle of mobile phone services, particularly when it is a relatively large amount of data". Don't know about lack of demand - you'd think there are plenty of people running around these days with lots of uses for their tablet-style devices - and you'd think mobile companies would compete harder for this upmarket business. Odd.

Apart from the prices, usage, revenue and investment sort of stuff, the report has heaps of other interesting stuff. For example, did you know this (below) about the percentage of our students who are taking computer science courses?

There was one pair of graphs which I had some difficulty with. I'd like to believe this one, which shows we're right at the head of the international pack for the proportion of businesses selling over the internet...

...but I can't square it with this one...

...which says that only 11% of small businesses make sales over the net. If (conservatively) you say 80% of all businesses are small businesses, you can't get to the national 47-48% figure of the first graph.

Never mind: this is still an excellent resource. As well as all the obvious stuff, it's also got a very useful chronology of events in the sector over the period January 2014 to March 2015: if, like me, you have to go away and look up things like the sequence of draft copper loop pricing decisions, it's all there in one convenient spot. 

How's the other property market doing?

The latest global commercial property survey from the Royal Institution of Chartered Surveyors in the UK came out recently, and it said some interesting things about our commercial property market - the market that gets trampled in the reef fish rush to cover the residential property market. You can download the latest, March, report for yourself from the RICS site (head for the 'Knowledge' section), though there's a (free) registration process to get at it.

Here's the most dramatic result.

When you combine the demand from tenants with the demand from investors, we have the strongest commercial property market in the world right now. It's become fashionable to mock our 'rock star' status, and it's true we're probably past the peak growth rate of the current business cycle, but every now and then it's worth noting that by international standards we're still doing pretty well. For example - and I'm not knocking Australia, we need its economy to be a strong export market for us - you can clearly see what the current sub-par rate of growth in Oz has been doing to tenant demand there.

Another reaction might be that we're doing rather too well for financial stability comfort, especially as overexuberant commercial property markets tend to be near the front of the queue in financial crises. Here's another RICS chart.

It doesn't look to me that rent and capital gains expectations in our property market have got out of hand. They're fairly strong, but we're in the middle of the better performing pack, rather than at an extreme. That said, as the RICS commentary noted, "more respondents in the majority of markets now believe that commercial property in their locality can be categorised as either expensive or very expensive rather than cheap", a consequence of the global hunt for residual pockets of yield in a world of ultra-low interest rates on bank deposits and bonds.

An alternative way of getting to the same conclusion, that our commercial property market is on the expensive side but not at silly levels, is to compare the dividend yield on our listed property securities to those overseas. The yield on the FTSE EPRA/NAREIT Global Real Estate Index (which you can find here) is currently 3.27%: our yields haven't fallen so low. A representative selection: Kiwi Property 5.25%, Precinct Properties 5.92%, Property For Industry 5.77%.

I really like these RICS reports (I know, I've said it before). We don't have a lot of other info on what can be one of the more important moving parts in the cycle: they fill a real gap:

Policymaking when you don't know where you are

Last week the Reserve Bank published the latest in its Analytical Note series, 'The Reserve Bank’s method of estimating “potential output”' (pdf here). If you're into macroeconomics in general or monetary policy in particular, you probably don't need your hand held about what potential output, and the output gap, are, but in case it's passed you by, the Note explains that

Potential output can be thought of as the level of activity that the economy can sustain without causing inflation to rise or fall, all else equal (for example, assuming no shock, such as big changes in oil prices). By implication, the difference between actual and potential output (the output gap) indicates the extent of excess demand, and therefore the direction and magnitude of this source of inflation pressure

This latest Note, like its predecessors, is a useful resource: I could see undergraduate economics courses using it, and maybe  the more with-it secondary school classes (yes, there are some equations, but they're no biggie). There's also a one-page 'non-technical summary' at the front, so if you're the proverbial intelligent lay person that's for you.

The Note has two graphs which I thought were interesting. The first is a straightforward graph of where the output gap has been, where it is currently, and where the Bank thinks it's headed over the next year or two. The implication would be that the Bank needs to be watchful about potential inflationary pressures down the track, though (a) how it would tighten policy without causing the Kiwi $ to head into the stratosphere isn't obvious and (b) it's possible that inflation, for some reason we don't yet fully appreciate, isn't picking up the way it used to when economies run hot (it's a major policy conundrum in the US at the moment)..

This second one, for me, was highly thought-provoking. It shows what the output gap in early 2012 was estimated to be at the time, and how that estimate later changed as revised GDP data came to hand. Originally, the economy was thought to be running well below capacity; as more complete data came available, it became apparent that the extent of spare capacity was nowhere near as large, and even that the economy might have been running on the hot side, a bit above capacity; and on the latest data we're back to an assessment that it was running slightly on the slow side. As it happens, no harm was done - policy in early 2012 was kept at its supportive post-earthquake level, which turned out to be an okay stance to have taken - but you can see the potential for policy mistakes.

What are some of the other implications?

I'd be more charitable when assessing the performance of central bank Governors. There are plenty of trigger-happy people out there with a Gotcha! mentality: the reality is that monetary policymakers are likely doing their best in an environment of very considerable uncertainty about where are are now, let alone where we are heading next. Ditto Finance Ministers, who face exactly the same issue of assessing where we are in the economic cycle.

The uncertainty also suggests (everything else being equal) that policy is better adjusted gradually rather than in big dollops. Somewhere around the internet in the past few days I saw the analogy of driving in the dark beside a cliff: if you're not sure where you are, it's probably best to drive slowly until you get a better idea. Even if you do become easy game for the Gotcha! brigade, who will be saying you've got "behind the curve".

You'd clearly want to be careful about how much reliance you place on measures like the output gap, and you'd want to be supplementing it with all the other evidence you can garner about how hot or cold the economy seems to be (which is why the RBNZ has all those meetings with companies and organisations in between its policy decisions). It's also why I think business opinion surveys and their ilk are so valuable.

And then there's that problem of the 'true' (or 'least untrue') data only becoming evident years after it's any good for cyclical policymaking (though the data will still be fine for many less time-dependent uses). I'd like to think this will become less of an issue, in particular as we become more adept at using 'administrative' data (things like GST returns, or spending at the supermarket checkouts, that are being collected for non-statistical reasons of their own). That's the way Stats is headed, and they're right: it's likely to be cheaper,  more accurate - and faster.

Fancy a spendup?

I really like Bill McBride's Calculated Risk blog, a great guide to what's happening to the US economy. Apart from the obvious coverage of the major macro stats, he's also got the gift of presenting the data well - I blogged before about his really impressive graph of the US labour market, and judging by the pageviews lots of others thought it was pretty neat, too - as well as the knack of finding data series that are somewhat off the beaten track but provide interesting insights into what's happening in America.

Here's his latest find, the Restaurant Performance Index produced by the National Restaurant Association and originally published here (where you can see the methodology of the thing). Bill calls it a "minor indicator", and he's right in the sense that it doesn't move markets or get much headline coverage in the business media, but that said, for me this is one of the best summary indicators of the US economy I've seen in ages.

You can see the GFC 'Great Recession', you can see the prolonged period from 2010-12 where double dips, treble dips and jobless recoveries were all in play, and then you see the more recent strong rise (particularly in 2014) where the US economy finally pulls free and starts to grow more strongly on a sustained basis. The Restaurant Performance Index is very closely aligned indeed with turning points in the overall economy, partly (as Bill notes) because it tracks largely discretionary spending decisions, which you'd expect (and you'd be right) would be highly sensitive to the economic cycle.

All of this got me wondering whether the monthly data Stats collects on electronic card transactions (latest example here) couldn't be turned into a roughly equivalent indicator for New Zealand,. One of the card series is electronic card spending on 'hospitality', which includes "accommodation, bars, cafés and restaurants, and takeaway retailing", which again is heavily discretionary and hopefully cyclically sensitive. It's unlikely to be as good a tracker as the American restaurant index, which is built up from a detailed industry survey, but it might show something interesting.

So I downloaded the series (it starts in October 2002 and at time of writing runs to November '14 - you can access it yourself on Stats' Infoshare, it's in the 'Economic Indicators' bit), ran a simple regression to eliminate the long term time trend, and looked at the residuals as a percentage of each month's hospitality spending. What you get is a graph that shows when spending on 'hospitality' is unusually strong or unusually weak, and it looks like this.

It's not too bad. There are oddities: I'm not sure why there's that cyclical weakness in 2003-05, which may be an artefact of how I've calculated the indicator (by construction there will be similar numbers of 'overs' and 'unders' whereas in real life expansion and contractions aren't the same length). But it catches the GFC and post-GFC weakness, and in particular it shows the strength of the current upswing. As far as the consumer is concerned, this is the best time for a bit of a spendup in the past dozen years.

The economy's still in good shape

Treasury's latest Monthly Economic Indicators came out today. Here's a selection of some of the bits I found interesting.

First, the current growth cycle is still in good shape. The NZIER's survey measure of firms' trading activity in September suggests the economy was still growing at about a 3% rate. As I've said before, I love these survey measures: they're quick, relatively cheap, and usually have dependable relationships with the big macroeconomic statistics.

Looking ahead, prospects are still pretty upbeat, too. In the chart below I've shown firms' hiring intentions, but I could as easily have picked firms' expected trading activity or firms' expected investment. It's all good.

You might well feel that we've had a bit of a blow to our export incomes given the degree of attention that's been given to lower world dairy prices, and while that's true to a degree, as the chart below shows it's not the whole story. For one thing, dairy products aren't the only things we sell: overall export prices have been hanging in there. And for another, import prices have been falling (and may well fall quite a bit further, if world oil prices keep sliding), so our overall purchasing power - our terms of trade, what we can buy with our export income - has actually been rising sharply.

And finally there's that unexpectedly low inflation rate that we've been having. As the chart below shows, there's generally been a fairly close link between various survey measures of firms' price setting and overall inflation, but over the last eighteen months or so actual inflation has come out lower than the surveys would have led you to believe. Some people have been climbing into the Reserve Bank for overestimating the likely inflation rate: well, don't be too quick to rush to judgement. On the traditional relationships, they were making a sensible call.

Why the relationship appears to have broken down, at least for now, is a big question, and one I'll probably come back to, but we are not alone. In many places around the developed world, inflation is turning out to be lower than central banks were steering for, as the chart below, from this article in the Economist, shows: look where the dark brown marker lies relative to the bright blue one (or to the white range between blue markers). Another reason not to get too into finger-pointing at our RB: there's evidently something happening at a global level here that's blindsided a whole bevy of central banks (or whatever the collective noun for central banks might be).

Why can't you get a 30 year fixed rate mortgage?

I was re-reading Charles Wheelan's excellent Naked Economics: Undressing the Dismal Science - one of the best books I know for explaining to non-specialists what economics is all about, as well as being a good reminder to those in the trade that you can actually write professionally about economics in accessible and entertaining English - when I came across this (on p232, in the chapter on the Federal Reserve and monetary policy):

Massive inflation distorts the economy massively...Fixed-rate loans become impossible...Even today, it is not possible to get a thirty-year fixed mortgage in much of Latin America because of fears that inflation will come roaring back.

And then I thought, hang on a sec, you can't get thirty-year fixed rate mortgages in New Zealand either. Nor twenty, nor ten: five years fixed looks to be as far as it goes, as you can see (for example) in the mortgage rates quoted at Good Returns. And it's not just mortgages that are relatively short term: our government bond market stops at 10 years, when many other countries' go for far longer.

Here's a table I collated (from the useful data on government bonds at Investing.com) showing the longest conventional (i.e. fixed coupon, not inflation-indexed) government bond in most of the usual comparator suspects.

No doubt about it - we're right down the short end with a maximum bond maturity of 10 years. So what's going on? Why can't someone in New Zealand do what people can routinely do in the US - get a 30 year fixed rate mortgage (current rate 4.5%), or buy a 30 year Treasury bond (current yield 3.6%)? Or if 30 years sounds a bit outlandish, a 15 year fixed rate mortgage (it costs 3.5%)? Do we have some kind of fear of resurgent inflation that is preventing the development of markets in long duration assets and liabilities?

Interestingly, we do have a long-maturity market in one kind of government bond. In recent years the government has issued 12-year, 13-year and 17-year inflation-indexed bonds, where the capital value gets adjusted for movements in the CPI. They've been quite popular, with an issued face value of $9.75 billion, and in recent bond tenders they've been bid for pretty solidly.

But that kind of makes the same point again - we're only prepared to buy long-dated assets with explicit inflation protection. We don't look at all happy to incur, or offer, longer term uninsured interest rate risk, though it's perfectly common behaviour elsewhere. At least one side, and maybe both sides, of really long-term borrowing or lending transactions don't look prepared to strike a deal in New Zealand. Why is that? Is it, as Wheelan noted about Latin America, a subliminal fear of Muldoon-style inflation returning?

Among financial market professionals, there doesn't seem to be much of a concern. The AON Hewitt survey of economists asks for their expectations of inflation seven years out (shown below), which is the longest forecast of inflation that I'm aware of: the numbers in bold are the latest reading, the italics the previous survey's. It gives the All Clear. But it's a very small sample of insiders, and it's the general public's perceptions that matter more.

We do have some evidence that the citizenry as a whole aren't as relaxed. The Reserve Bank tracks households' expectations of inflation, and in the chart below I've shown what people believe inflation to be, what it actually is, and households' expectations of inflation one year ahead and five years ahead (the furthest looking measure, surveyed since December '08). I've used the median measure from the survey results.

This may be typical of households everywhere, and not just in New Zealand, but even so it's kind of disquieting. As a summary, households generally believe inflation is higher than it actually is (a perceived 2.9% over the period, versus the actual 2.3%), and they expect it to be higher in a year's time (by 0.5% on average, with an expected 3.4%). And the five year inflation rate says much the same thing - on average people expect the long-term inflation rate to be 3.5%. Both the one year and five year forecasts are above the top of RBNZ's inflation target band. Even if you knock off 0.6% as some kind of inherent subjective over-reading of what inflation has been, you still get to the point where people apparently believe inflation is always going to be very close to the top of the RBNZ's target band. And this after over a decade of generally successful inflation targetting.

I'm not too sure where all this leads to in its implications for monetary policy or the development of the capital markets, other than to the obvious and well-known conclusion that inflation-fighting credibility takes forever to accumulate, but can die overnight. I do wonder, though, about our short electoral cycle: every three years, we get one political group or other threatening to change the inflation targetting regime. Baldrick couldn't have improved on it as a Cunning Plan to undermine stable inflationary expectations.

Wrong answers to an interesting question

It's not the best known of surveys, but every quarter the Reserve Bank carries out a survey of expectations across a reasonably broad cross-section of respondents (mostly financial sector types, including me, making 35 of the latest respondent group of 72, but also 19 from business, 8 from agriculture, 3 from labour groups and 7 miscellaneous). So it's a useful complement to the economists-only consensus forecasts compiled by the NZIER.

You can see the RB's latest results here. The Bank's main interest is, as you'd expect, the behaviour of inflation expectations, which are tracking as shown in the graph below. It also collects views on GDP growth and unemployment (the cycle is getting ever stronger), earnings growth (modest), bill and bond yields (expected to rise), and the NZ$/US$ and NZ$/A$ exchange rates (no great change expected).

There is one small flaw in the survey, however. The Bank asks people for their perceptions of the stance of monetary policy on a scale from very loose to very tight, and turns the answers into an index number: the latest result is shown below. As you can see, people are answering that monetary conditions are remarkably easy.

But they're not, of course, and if you've come across this survey before and took this graph at face value, you'd have been misled. As I said a wee while back, overall monetary conditions reflect the combined impact of both interest rates and the exchange rate (and arguably other factors too, such as ease of access to credit or equity). If you go back over the past few years and graph the Monetary Conditions Index, which takes both interest rates and the exchange rate into account, against the RB survey measure of what monetary conditions feel like, you get the result below (I've estimated the Mar '14 MCI at current bank bill and TWI levels).

The reality, in short, is that overall monetary conditions, far from being unusually easy (as assessed by the survey) are in fact heading for levels that are quite stringent by historical standards (going by the MCI).

What's happening, unfortunately, is that respondents are actually supplying their estimate of whether interest rates are unusually low or unusually high.

Maybe the RB is able to make some other use of the answers, but they're not good answers to the question the Bank was actually asking.

The ANZ's latest Business Outlook

I was waxing lyrical yesterday about the great utility of the longer-running business opinion surveys to anyone   interested in getting an up to date feel for what's happening in the economy and what lies around the corner in coming months.

As it happens the ANZ's latest Business Outlook survey (for May) came out as I was writing, and it was essentially good news all round. Some of the (seasonally adjusted) measures dropped a little compared to April, but that doesn't matter - the overarching picture is a good one, as you can see for yourself if you follow the link. Firms' expectations for their own activity levels - the key indicator - were high across all the sectors of the economy; firms are planning on investing (farmers were especially on building up the livestock herds) and on hiring; and profitability is good. Exporting is okay rather than brilliant - understandable, given the high Kiwi dollar, the so-so state of the Australian economy, and the weakness of the Eurozone - and inflation is under control. Firms aren't planning on big jack-ups too their own prices, and they aren't expecting inflation elsewhere in the economy, either.

That said, businesses also believe that, while there isn't much of an inflation issue, the Reserve Bank's next move will be to raise interest rates, and they're very likely right. It's probably not going to be a big move, though. The financial futures market, which essentially makes forecasts of where the 90 day bank bill rate is going to go, expects the 90 day rate (2.64% at the moment) to be just over 3% in a year's time, which would be consistent with one, maybe two, 0.25% increases in the Bank's official cash rate over the next year.

Data you should notice

One of the odd things about media coverage of economic developments is that some releases get lots of coverage, while others go largely unreported.

As a financial journalist in a previous life, I can understand how this happens: you develop some contacts at a particular institution - at one point when I lived in Tokyo I was the world expert on the Japanese syndicated loan market (I appreciate this is not anyone's life ambition) because I knew who to ask about the latest deals - so you invest some effort into understanding the data that originators produce, and you get comfortable with them. If they seem to have a good feel for what's going in their neck of the woods, you tend to stick with them, and you don't pay much mind to alternative data sources.

All that said, it's a little bit odd that the Reserve Bank's surveys of private sector expectations get such little coverage. It's not the fault of the comms folk at the RB: they're diligent, and personable. But for whatever reason, the RB's survey doesn't get much airtime.

And that's a pity. The survey is, to be sure, mostly aimed at things the Reserve Bank, more than anyone else, would most like to know, and it's not tailored for mass consumption. From the RB's perspective, they are especially interested in inflation expectations, and in people's perception of whether monetary policy is a stimulus or a brake on the economy. On the latter point, you might think that there couldn't be a great deal of debate on the stance of policy - either the Reserve Bank is aiming to boost activity, or it's aiming to slow things down, and by and large the Bank tells you where it is at - but at the end of the day, what some policy authority intends may not match up at all well with what its target constituency is actually experiencing. And as we'll see in a moment, its target constituency has mixed views.

So here (given that I'd bet a dollar or two the mainstream media haven't covered it) is what the latest Reserve Bank survey is telling us.

You can see it for yourself here, but before we go there I should disclose upfront that I'm one of the respondents to this survey. In passing, this might be a bit presumptuous, and the Reserve Bank might have its own reasons for the people it asks, but the number of people the Bank consults is getting a bit on the thin side. In this latest survey. they sent out 117 questionnaires, and got 71 responses back. That's not awful, but it's not fully covering the waterfront, either. If you think your view is as good as anyone else's, why don't you have a word with the RB about participating? Get in touch with Mike Hannah, their PR guy. Tell him I sent you. When he's finished laughing, he might still add you to the survey panel.

Where was I? Oh yes - the latest survey results. Four things.

One, we don't have a generalised inflation problem. Whether you look at the immediate inflation outlook, or 1 or 2 years ahead, the answer comes out the same. People expect inflation to fall, and to be well within the RB's 1-3% inflation target.

Two, and despite the benign inflation outlook, people expect monetary policy to become a bit tighter. That could be for lots of reasons. Many people might reckon (rightly) that we needed lower interest rates in the wake of the Canterbury earthquakes - the RB was quite explicit at the time about providing support to the economy, as an insurance policy, to help us through the impact - but equally, now that it's obvious that the economy is on an upswing, that insurance policy is no longer needed. It's possible, too, that respondents to the survey have some sympathy with the Bank's concerns about frothy housing markets.

Three, people have differing views about the current orientation of monetary policy. Before I tell you what the survey says, what's your own perception of the stance of monetary policy - easy? middle of the road?  tough? If you found that an easy question to answer, that's fine, but you may be missing something:  the respondents to the latest survey didn't find it an easy question to answer at all. They were all over the place: just over a quarter of them thought monetary policy was tight, 15% thought it was neutral, 60% (give or take) thought it was easy.

What's going on here? We have one of the most transparent monetary policy regimes in the world. The Bank goes to great lengths to tell us, upfront (rather than well after the event), what it's doing, and why. How can there be this range of views about its stance?

The short answer is that respondents are actually weighing up both interest rates (which are very low) and the exchange rate (which is very high). How that combination impacts you is an entirely empirical matter, and if you're an exporter (for example) you could well, and honestly, report that, taken in the round, monetary conditions are making life difficult for you. All the more reason, by the way, for paying more attention to indices of monetary policy that include both interest rates and exchange rates, and arguably other measures too (for example, the availability of credit,and  the feasibility of raising equity on the share market). Have a look at my April 23 post about the Monetary Conditions Index, which makes the same sort of points. On that overall monetary conditions basis, by the way, you'd have said that monetary policy was relatively restrictive, despite low interest rates.

Four, and despite incessant hand-wringing reports in the media to the contrary, the survey respondents believe the economy's in a growth phase. There wasn't a single respondent who expected a fall in GDP in either the March or June quarters; no respondent expected a fall in GDP in either the year to March '14 or the year to March '15; and the consensus view was that GDP would grow by 2.5% in the year to next March, and by 2.8% in the year to March '15.

Expectations can of course prove off the mark, but wherever you look - and the latest BNZ/Business New Zealand performance indices for manufacturing and services, published in the last few days, are as good a place to look as any - the New Zealand economy is on an upswing.