In the wake of Thursday’s Monetary Policy Statement there has been a round of further comment on house prices and the risks around the housing market. In fairness to the Reserve Bank, it wasn’t a focus of their document, and comments from the Governor and Deputy Governor seem to have been made in response to questions, at the press conference and at the Finance and Expenditure Committee.
I had been a little sceptical of the strength of the nationwide housing market, and pressures are clearly still concentrated in Auckland and, to a lesser extent, nearby cities. But, equally, the overall level of activity appears to have picked up. Here is my favourite timely chart, of per capita mortgage approvals.
Earlier in the year. mortgage approvals were running no faster than they were last year. In the last couple of months the pace has clearly picked up. That shouldn’t be surprising, as the interest rate increases last year have gradually been reversed, but it is worth bearing in mind not only that the rate of approvals is still below the decade average, but it is barely two-thirds the rate in the peak years of this series, 2005 and 2006. And the mortgage approvals series does not go back far enough to capture 2003, the year when national house prices rose 23 per cent. There is no nationwide house price boom.
Housing market activity has clearly picked up. As it should have. I don’t think I’ve seen any commentator make the (perhaps too obvious) point that cuts to official interest rates work by a combination of lowering the exchange rate, and encouraging more interest-sensitive expenditure. In part, that is about bringing forward some spending from tomorrow to today. But it is also about boosting the prices of long-lived fixed assets, which (in part) encourages people to build instead of buy. If house prices hadn’t risen to some extent – relative to some unobserved counterfactual – in response to lower interest rates. there would probably be reason for concern. Real long-term interest rates have fallen by around 50 basis point since this time last year (15 year inflation indexed bond).
But, of course, this brings us back to the question of what is a fixed asset. Houses are long-lived assets, but – in principle – a new house can be built quite quickly. And lower interest rates actually reduce the cost of new building a bit (finance costs are non-trivial). Land is in fixed supply, but unregulated land isn’t particularly valuable or expensive. Good dairy land goes at perhaps $50000 per hectare. Lower expected long-term interest rates should raise the unregulated market price of land – at these low interest rates, a 50 basis point change in long-term real interest rates might make quite a large difference, all else equal. The unregulated price of land is a small component in the cost of a suburban house+land. But the unregulated price isn’t what we observe. Instead, what has driven land (and thus house+land) prices sky high is the interaction of two policies – high levels of inward immigration, mostly under direct government controls, in conjunction with tight land use restrictions. The combination has been disastrous in Auckland. Non-resident purchases probably haven’t helped either. With much looser land use restrictions, house+land prices would be much less sensitive to demand pressures (whether from population or interest rates) than they are now.
The Reserve Bank talks of the Auckland market being in “dangerous” territory, but mostly that seems to be slightly inflammatory rhetoric more than the fruit of hard analysis. Yes, house price to income ratios are higher than in most cities around the world. And yes, that is a social and political scandal. But it is largely the outcome of real forces – not underlying economic ones, but mostly government policy-controlled ones. They also aren’t, by contrast, the result of some speculative frenzied lending binge (unlike many of the boom-bust markets in the US last decade). Of course, many property purchases need credit, but credit growth remains pretty subdued, and housing market activity (per capita) remains well below previous peaks. And the Reserve Bank has pointed to no evidence of a material deterioration in credit standards. If that sort of deterioration is going on, it is surely incumbent on the Reserve Bank to illustrate the evidence (as, say, Waynes Byres recently surveyed the Australian evidence). Moreover, banks operate on a nationwide basis, and as the Governor observed the other day, the “problem” is largely an Auckland one. That suggests looking at Auckland-specific causes – and the interaction of immigration policy and land use restriction policy is the most obvious one.
The Deputy Governor was quoted the other day as telling MPs that “it’s always very difficult to pick the top of any asset price cycle”. Indeed, and nor is it the job of officials to do so. But it is also very difficult to know what the equilibrium price of an asset is, especially when the market for that asset is so heavily distorted by policy interventions, in this case policy-driven population growth running head on into land use restrictions. Auckland prices are very high, scandalously so, but there is nothing that guarantees – or even offers a high degree of certainty – that real house prices will settle any lower over the longer-term. I hope they do, and I’m sure most of those currently shut out of the Auckland market do, but this is not just (or even primarily) a market process. The same goes for Sydney, or London, or Vancouver, or San Francisco. All the Reserve Bank should be doing is monitoring lending standards, and – most importantly – ensuring that banks have ample capital to cope with things going badly wrong. They’ve done the second part of that job, and on their own numbers they (and the banks themselves) have done it well. Beyond that, if they can add in-depth and considered research that sheds light on the housing issues that might be welcome – although the research resources might be better spent on getting monetary policy right – but beyond that the housing market just isn’t their job.
Just briefly, I noticed a soft interview with the Governor in today’s Herald. It is a platform for the Governor to advance his (remarkably upbeat) case, rather than an occasion when the journalist posed any searching questions. Some of it is just misleading, or straight out wrong. New Zealand’s economic performance in the last few years has been mediocre at best – better, certainly, than many of the euro area countries, but generally underwhelming – poor by historical standards, and no better than, say, the United States which was at the epicentre of the financial crisis. There has been no per capita real income growth at all in the last 18 months, and real per capita GDP is not much higher than it was in 2007. That isn’t (mostly) the Bank’s doing, but it isn’t a good performance either. Oh, and the unemployment rate – had I mentioned that before – has hardly come down since the severe recession of 2008/09.
The Governor attempts to rebut some (currently straw man) critics.
Wheeler is keen to make the point that the bank is anything but robotic with its primary focus on inflation.
Critics, particularly on the political left, have called for the bank to broaden its outlook.
“Some people say … we don’t care about growth. But I think every central bank thinks quite deeply about how the economy is going, what’s happening to demand, to investment, to unemployment.”
Perhaps, but right at the moment – and for the last five years – a rather more “robotic” focus on actual inflation might have produced better outcomes than we’ve seen. The Governor seems totally unbothered about his persistent inflation errors, or about the increase in the already high unemployment rate. As I noted the other day, at present there are no nasty trade-offs between real activity and inflation. Easier monetary policy would be likely to lower the exchange rate – something the Governor calls for at every opportunity – to boost economic activity, lower unemployment, and – not incidentally – get inflation averaging somewhat closer to the 2 per cent target midpoint that he agreed three years ago to deliver.
And finally an advisory. There won’t be many posts here in the next few days, and none for several weeks from next Thursday. We are taking the kids off to see museums and art galleries (and a few other things) in the United States, and to reintroduce two of them to the land of their birth. Despite a suggestion from one reader, I won’t be blogging about the lead up to the presidential primaries, fascinating as those races always are, or anything at all. I’ve been quite taken aback by the level of interest in this blog, and have really appreciated the many typically thoughtful comments and questions. I’ve also written much more than I had ever expected, or intended to (and especially more than I intended to about the Reserve Bank), but it has been fun. As for the future, I have quite a large pile of topics I haven’t yet got to write about – in some cases ones that were on the pile on 2 April when I left the Reserve Bank – so I expect I’ll be back writing here once the rest of the family is back to school and work on 13 October.