While the Reserve Bank may have startled everyone by asking the government to take a fresh look at taxation on investment housing, the recent statement by the Deputy Governor indicates that we are inching towards a more holistic approach to macroeconomic policy.
The April 15 statement by Grant Spencer, Deputy Governor of the Reserve Bank and Head of Financial Stability, concluded ‘on the demand side, we consider that greater attention needs to be given to issues relating to the tax treatment of investor housing’. Not surprisingly it attracted widespread attention.
In the longer run, though, it represents a development in the macroeconomic debate which has been haunting economists. It begins the way the RBNZ ran in the Muldoon years.
Muldoon would ring the Governor and tell him what to do – frequently against the latter’s better judgement. The controls that Muldoon imposed on the monetary system may have had the required political impact in the short term but in the longer run they screwed the system so it could not give the support to the economy that a sound monetary system can and should.
As seems our way, the post-1984 regime went to the other – monetarist – extreme. There were informed contributions to the policy discussion, but the Rogernomes ignored them.
One change made by the Rogernomes, which most agree with, was that the Reserve Bank was given operational independence. The Act makes it clear though, that the government sets the objectives which the operations are to pursue. The settings are in the statute, they are elaborated into detail in the Policy Targets Agreement between the Minister of Finance and the Governor, and the Minister may direct the RBNZ. But secret phone calls are ruled out; any directions have to be written and tabled in Parliament so everyone knows. Such a framework for operational independence has proved popular and has been adopted overseas.
More controversial is the specific provision in the Act that the RBNZ is to pursue price stability. Such a pure objective has not been adopted everywhere else. My concern at the time was that the primary responsibility of a central bank is to maintain order in money markets. Fortunately the Act says that RBNZ is to ensure financial stability, which sets the context for the Deputy Governor's recent speech.
A speculative financial bubble, such as that which is happening in the Auckland housing market, can threaten financial stability. If the speculators used just their own money it would not matter much. However speculation relies on leverage – investing other people’s money, which usually involves financial institutions, so when the bubble pops the institutions’ stability may be compromised.
For obvious reasons, the Reserve Bank talks about this possibility in the abstract but let me give an illustration which probably wont happen but gives a feel of how the Auckland housing market might collapse.
Suppose the Chinese monetary system went into a financial contraction. Chinese investors in the Auckland housing market might well be forced to sell some of their housing investments in order to cover their financial pressures in Shanghai (say). Suddenly there would be less demand for Auckland housing and the market would falter. If the Chinese contraction was really severe there could be local distressed selling – that is, selling at low prices to get cash out of the market. (Spencer pointed out that increasingly rents for let houses are not covering the investors’ costs.) That would impact on New Zealand housing speculators and they would start distressed selling too. There could be considerable turbulence in the Auckland housing market which would impact on ordinary house-owners – say those who had to move houses.
If I read various RBNZ statements aright they seem to be concerned, although the situation is not immediately judged dangerous. They have issued cautions, while the Loan-to-Value-Ratio restrictions were designed to reduce the possibility of financial instability. Of course the trading banks themselves are aware of scenarios such as I described and maintain margins to cover the downturn. Given the imposition of the LVRs the RBNZ must be more cautious, perhaps because the trading banks can turn to it for help if there is too much turbulence.
So what can the RBNZ do? It is has tried public cautions but they failed a decade ago too. The LVRs seem to have had some success but that has been judged insufficient (and were politically unpopular, but that is rarely a consideration by an independent central bank). It could raise interest rates to squeeze the Auckland housing market but the required levels would probably have to be ruinous to ordinary house owners, to the rest of the country and to business investment. (Additionally it is using interest rates to regulate CPI inflation as required by the PTA. You cannot use the same policy instrument – the official cash rate (OCR) – for two objectives – consumer price stability and housing price stability when the price paths are dramatically diverging.)
What is interesting about Spencer’s statement is that the RBNZ was asking others (the government) to take initiatives. It does not have all the policy instruments it needs for the challenges it faces.
His statement evaluates supply-side measures (such as building more houses) and concludes that they would impact too slowly. So it turns to demand-side measures – especially a more aggressive tax regime on speculating financial investors – to discourage thier hypping the market.
This is some distance from the monetarism that underpinned the thinking behind the 1989 legislation.
First, you have to think of different sectors and localities. If you don’t, you can screw down the Auckland housing market only by screwing up the non-Auckland housing market and the business sector.
Second, you have to think of the demand-side of a market. The stance of the government and some of its advisers seems to have been that managing the supply-side is sufficient. It wont work fast enough.
Third, the Reserve Bank cannot succeed in its statutory tasks by itself (ruinous policies aside); it needs a whole-of-government approach.
Orthodoxy is steadily returning. Next stop the exchange rate?