Jim Anderton’s Progressive party has some interesting ideas for reform of the monetary system:

Monetary Policy
New Zealand has escaped the worst of the financial crisis in the global economy to date, but if we don’t take more control of our financial system there is no guarantee we will escape similar outcomes in the future.

The US crisis was caused by a housing bubble, which was in turn generated by a deregulated financial system and monetary policy that encouraged overseas borrowing. It’s better to take control of the financial system before a crisis than to spend hard-won public funds bailing people out after it.

The Reserve Bank Act needs to be changed so that we never end up needing the New Zealand equivalent of a giant bailout for the banking sector.  In the US, banks were able to keep lending well beyond prudent levels for the economy, and new financial instruments allowed debt to be repackaged so that risk was wrongly priced.  Likewise in New Zealand, the Reserve Bank only controls the price of lending. There are no reserve ratios that control the level of bank liquidity. When a debt bubble takes off, all our Reserve Bank can do is put up interest rates. But that attracts more overseas lending, which therefore continues to fuel the bubble – as happened in our housing market here for several years. It also overvalues our dollar and increases the deficit in our account with the world because it gets harder to export and easier to import.

New Zealand also had a problem with mispriced risk and an uncontrolled financial system. The failure of many of our finance companies shows that interest rates in the New Zealand economy were not well-matched to the odds that investors could lose their money. When anyone could start a finance company, the savings of many small investors were too easily destroyed. Even responsible finance companies were affected.

Changes Progressives would make to monetary policy:

Widen the criteria to which monetary policy is subject.
Monetary policy would not only control the price of borrowing money, but would also have regard to the balance of payments, the rate of foreign exchange, the stability of the housing market and employment.

Strengthen Reserve Bank controls on the financial system.
Ensure that the financial system runs a properly diversified loans portfolio and has systems in place to ensure large risks are spread. Ensure the financial system has sufficient equity capital available in relation to the level of risk undertaken.

Off-balance sheet transactions should be explicit in financial accounts.
Transactions such as the sale of derivatives that have allowed risk to be repackaged and resold have hidden the systems’ exposure to potential default. It is in the nature of contingent risks that they can’t be defined precisely, but they should be disclosed so that the financial system can adequately measure the soundness of the risk and adequacy of capital provisions.

Tax

• Support a progressive income tax scale.

At the moment that can be best achieved by pushing out the thresholds at which people move to higher tax rates, as fiscal conditions permit.

• Retain R&D tax credits.

Progressives were the first party to call for a reduction in the corporate tax rate. Due to fiscal conditions at the moment we would keep it at the present rate. But, because business tax is effectively a withholding tax, over time we support reducing it to the level of withholding taxes paid by international corporates invested here – and possibly further.

• Provisional tax is simply an expensive and unnecessary compliance cost and we would remove it.

• Publicly-owned assets

We won’t sell strategic assets – such as Kiwibank, Air New Zealand, Kiwirail, Landcorp or the energy SOEs.

• Increasing infrastructure investment

New Zealand’s economy needs faster infrastructure investment to help it through the slow down caused by global financial conditions.

Infrastructure spending stimulates the economy when it would otherwise be starved of capital.

An economic vicious circle works like this: Large numbers of potential home buyers, worried that they might lose their jobs and that house prices are falling, decide not to buy a new house. As a result of falling demand, house prices fall more steeply. Less building activity results in less money in circulation and people lose their jobs. The resulting slow down confirms the fears of those potential house buyers, and so even more people continue to hold off from buying. Meanwhile, investors such as retired people who had some savings put away in finance companies have watched more than two dozen finance companies fail. As one after another tipped over, they withdrew their cash and others kept their money out, making the squeeze on those companies worse still. As a result, the investment those companies provided in new property developments and other projects has disappeared. There is less capital available for investment, holding back the pace of our economy.

The Great Depression was caused by a cycle similar to this. Policy-makers at the time decided to wait for the market to respond. It didn’t, until Keynesian policy-makers proposed using government capital to kick start investment and activity.

Today, the government needs to increase investment in infrastructure like housing, rail, roads, power stations, water projects and broadband to stimulate the economy quickly.

The next issue for policy-makers is how to make those investments.

Progressives propose that new infrastructure investment over ‘business as usual’ should be made through a New Zealand Infrastructure Development Bank.

The bank would be capitalised with Crown debt, just as any infrastructure project is currently funded.

The bank would then transparently select infrastructure projects that fit general criteria (see below).

The bank would issue bonds up to an agreed limit. A bond is an interest-bearing investment that is backed by an underlying asset. So Mum and Dad investors would be able to buy infrastructure development bonds associated with particular projects. It would even be possible to make the bonds tradeable on the NZX.

So, for example, the bank might approve an investment in a new toll road. The project would be funded partly out of capital from Crown debt, and partly by issuing bonds to New Zealand investors at a set interest rate. The business case for the road would make plain how the road would repay the investment and interest.

At other times we might have said projects like these can be funded on their own merits if they are truly bankable. But the problem is that, in today’s environment, the economy is capital starved.

The whole point of bringing forward infrastructure investment is to get capital moving through the economy again as quickly as possible.

Providing some stability for investors will help retain confidence to keep investing.

Governance
The bank would be run by an independent board. This would ensure infrastructure investments were made on a sound economic basis, and it would maximise transparency and accountability for investment.

For example, when the government decides to invest in, say, a railway line – it is making a choice about the opportunity cost of not making that investment in a housing project.  A bank, run by an independent board would make the opportunity cost clearer.

Only a certain, specified quantity of capital would be available, just as it is to government; but the sum at stake would be clearer. Economists would debate how much to invest. The Reserve Bank would take a close interest in the level of stimulation.

A board arrangement would ensure that investment was made on transparent grounds, not on the most politically convenient grounds. For example, when the government began its development investment projects in the early eighties (known as Think Big), observers noted a coincidental overlap between the location of new projects and the location of marginal seats. (It was nicknamed the ‘marginal seat retention drilling programme’.)

A board is also accountable for decisions. If it backs a project, and the project fails, the board will be to blame.

The bank should be set up as a Crown entity, with ministerial responsibility to the minister of finance and the minister of economic development. It should have policy support from the Ministry of Economic Development.

So where does the money come from?
Crown debt; plus

• The issue of infrastructure bonds, project by project – and possibly longer term generic infrastructure bonds; plus
• Possible contributions to capital, project by project, by other interested parties. The bank might fund capital investment in some local authority or even private projects that have national benefit and would not otherwise get off the ground in current conditions.

What would it invest in?
The government would set investment criteria when it set up the bank. Investments would be made in the highest priority projects reaching the criteria.

The government would also require that, at first, preference was given to projects that are quick to get underway. As projects are completed and funding comes back, new projects could be commenced – a new electricity generator takes time to plan and get resource consents.

Priority criteria would include:

• Economic return

In a bank, projects have to pay for themselves. Demanding an economic return ensures projects have ongoing value to New Zealand. An economic return is necessary to attract bond investment from private capital.

An economic return also unlocks future capital – as the money is repaid, it can be used again for a new development.

Some government investment in infrastructure, like new school buildings, cannot generate an economic return. The case for building more schools stands on issues like the quality of schooling we want our kids to have, expert advice about population projections and more. These investments would continue to be made, as they are now, by the government on its own balance sheet. They would not be Investment Development Bank projects.

• Contribution to New Zealand’s development

There are a large number of infrastructure projects we know New Zealand needs: faster Internet with better coverage; a stronger rail backbone; more roads. These projects should be prioritised because of the spill-over advantages for the New Zealand economy. Faster broadband and better roads, for example, not only stimulate the economy as they are being constructed, but they help businesses work better and thus lift the overall productivity of our economy.

• Other criteria

The government might decide to promote projects that met criteria for improving quality of life. It would be likely to demand that new projects are sustainable. They would still need to achieve an economic return. A project like housing, for example, easily meets these criteria.

So why not just get on with these new projects anyway?
Some will be started almost immediately, whether there is a bank or not.

It doesn’t take long to set up an infrastructure development bank. But without the bank, the government will have a much harder job of attracting private capital to buy bonds. One priority for policy should be to get Mum and Dad investment moving again as quickly as possible.

Second, a bank provides better transparency into development, so that trade-offs and the quantum of capital being used to stimulate the economy is more easily judged and debated.

And third, a bank provides a revolving pool of capital, avoiding the potential for a stop-start, boom-and-bust response to recession.

Ownership – Who would own the projects funded?
It would depend on the project.

When the bank lends money to you to buy a house – it doesn’t take ownership.

The Infrastructure Development Bank might partner with local authorities and building companies to develop low income housing projects. Ownership would go to the ultimate buyer.

The bank might partner with a water company to build a new storage facility. The ownership might go to a local authority.

How much?
The question of how much to invest through an infrastructure development bank is not really a question about the bank – it’s a question about how much stimulus the government should apply to the New Zealand economy.

To make any difference it would need to start off with seeding capital in the billions. This would be raised by increasing Crown debt. But the Crown would no longer be increasing debt to pay for infrastructure projects and so the net position is the same.

More quality investment is likely to be made through a bank because standards of transparency  and accountability are higher. Therefore, the net impetus through the bank is higher.

In addition, the bank’s involvement will help to attract private capital which, in the current environment is highly unlikely to be attractive to long term development financing in sufficient quantities.