Land supply and the Productivity Commission

I’ve been a bit behind with my reading since I got back from holiday, but today was the first day of my son’s cricket season, and an opportunity for some concentrated reading on the sidelines.

The Productivity Commission released its final report Using land for housing last week.  It is a long report (400 pages or so), and I’ve only read so far the 35 page summary version, and the first few chapters of the body of the report.  From what I’ve read there are some useful specific findings and recommendations. But they come in a document that – as the Commission (with its rather Stakhanovite-sounding name) documents often do –  puts altogether too much faith in government –  the good intentions, knowledge, and capacity to execute of central government in particular.  It was enough to prompt me to pull The Road to Serfdom off the shelf when I got home, as a bit of a counter to the over-confidence.

I haven’t read the whole report, and may want to come back with some more detailed observations later, but I suppose my overarching impression was of a report that was largely lacking in a sense of a positive role for markets, for the price mechanism as a reconciling and coordinating device, or indeed for the value of individual preferences.    Markets work, and typically meet the needs of citizens when allowed to do so.  Government planners not so much.

In its defence, the Commission would no doubt observe that they were asked not to undertake a fundamental review of the Resource Management Act (or, no doubt, the other relevant pieces of legislation). But I don’t find that sort of response particularly persuasive.  The Commission shows no signs of unease with the concept of urban planning, and indeed seems to treat as wholly legitimate the choices of local councils to pursue particular visions of urban form (especially compact ones).  It is simply those pesky voters who stand in the way of councils realising their visions.  And perhaps worse, the ill-defined concept of “national interest” provides an overarching framework to the report.   It is certainly true that local authority powers all flow from central government –  ours is not a federal system –  but the Commission seems to provide no basis to believe that central government will consistently establish better policy than local government.  Is the track record any better?  I’m not convinced.   All sorts of governments –  here and abroad  –  have defined all sorts of questionable things as being in “the national interest”.  As I recall, it was an argument for the Clyde Dam.  In some senses, this report was reminiscent of a report some worthy body might have written 50 years ago on making import licensing and exchange control work better –  not entirely unworthy goals in their own right, but not really the point.

Part of this “national interest” story involves the Commission signing on all too easily to the idea that Auckland should get even bigger even faster than it already has.  They do cite a single recent journal article about some modelling work done on several cities in the US (none of which makes up even 10 per cent of the population of the United States).  Auckland, by contrast, already makes up a third of the total population of New Zealand, and since World War Two has grown faster than the largest cities in almost any other OECD country (Tel Aviv is an exception, and Israel’s economic performance has been about as bad as New Zealand’s).  Scandalous as Auckland house prices are, is it really credible that the failure of Auckland to have grown even faster is –  as the Commission strongly suggests –  one of the largest conceivable explanations for New Zealand’s long-term underperformance?

And in neither its general tone nor in its recommendations is the Commission a friend of property rights, even though the land supply issues arise in the first place because central and local governments have severely restricted the ability of landowners to do as they like with their land.  The Commission, for example, proposes legislation to time-limit covenants put in place between willing buyers and willing sellers in private residential developments.  To what end?  And, worse, they endorse the extension of compulsory acquisition powers to allow local authority Urban Development Authorities to take private land (at less than the value to the owner –  by definition) for housing purposes.  Again, wasn’t it central and local governments that created the problem in the first place?  And now they want to further undermine the security of people’s interest in their own land, to enable Councils to pursue “their visions”.  Even if such an approach were likely to prove helpful on the immediate issue (lowering urban land prices) in the short-term, how does the political economy of powerful urban development agencies look in the longer-run?  Is it likely to be a model of good governance?  Or is it more likely to be a channel through which vested interests (public and private) operate to benefit themselves, to the disadvantage of the public.  In general, the report’s sense of political economy seems rather naïve.  They are very taken with the idea that Councils operate at the behest of voters, who are disproportionately older and home-owning, but never really analyse alternative perspectives.  Home-owners, for example, typically have children, but there is little sense of an intergenerational perspective in what I have read so far.   And it has never been clear to me why the Commission thinks that middle-aged home-owners would have any problem with their Councils facilitating new housing developments on the fringes of cities provided that those developments covered the true marginal costs to the Council of such development.

Finally, I was interested in the Commission’s description of the overseas visits they had undertaken.  There were visits to Australia, and to the United Kingdom, but aren’t these the two countries with the most similar problems to those in New Zealand (at least as indicated by the Demographia price to income data)?  No doubt there are interesting insights to be found in Australia and the United Kingdom, but the evidence suggests they have not gotten round to actually solving the problems.   I was quite genuinely surprised that the Commission had not visited the United States and looked at the models that operate in many large and growing cities there, where house and land prices remain highly affordable (medians often under US$200000).  It all seems to reinforce a sense that the Commission sees New Zealand’s urban planning not just as an unfortunate and costly feature we might be stuck with for now, but as something positively useful and appropriate.  Doing so might be politically opportune in the short-term, but it is hard to see that it really deals with the longer-term issues in a durable and sustainable manner.

I may have cause to revise these comments when I’ve read the rest of the report, but based on the front window the Commission itself has put it up, I’m not optimistic of being able to do so.  And that is a shame.

Statistics NZ talking up the data again

A while ago, I noted the tendency apparent in Statistics New Zealand press releases to “accentuate the positive” (at least as staff seem to see it) in any data releases they were making.

In the last few years, Statistics New Zealand has taken to “spinning” its statistical releases.  I use the term advisedly.  I’m sure all the numbers are reported entirely accurately, but my issue is more with which numbers, and which comparisons, they choose to highlight.  Almost always, they seem to emphasise what staff (and management?) presumably regard as good news.  Is that quite the job of a national statistics agency?  Personally, I value good quality data, and technical explanations for apparent oddities –  and the assurance that SNZ has no agenda other than good quality data, adequately explained.  There are plenty of others out there (backbenchers in parliamentary questions?) to highlight the good, or not so good.

I was almost moved to comment yesterday when the business demography data were released, but had better things to do with my time.  But there was another, rather more egregious, example this morning, when the building consents release was headed up “Home building accelerates in the north”, even though the data were showing a second successive five per cent monthly seasonally adjusted fall for the country as a whole.   Of course, those falls came after the rather odd 20 per cent increase in the month of July.

I’m not sure why Statistics New Zealand seems to regard it as appropriate to spin their releases this way.  Having thought about it a little more, I wonder if the managers and deputy secretaries have KPIs for the amount of media coverage their releases get.  If so, there might be an incentive to run a strong story line in the release headline (or the SNZ text).  It could be downbeat stories as well as upbeat ones – either might help meet these media targets.  But downbeat stories prompted by SNZ headlines would be more likely to prompt complaints from ministers’ offices, and all public servants want as few of those as possible.

Is that the answer?  Perhaps not, but there must be something behind it.

And I’m not suggesting they should set out to accentuate the negative – again there are plenty of other people to do that.  But they are a statistics agency, whose integrity and impartiality we rely on.  Perhaps this is boring economist speak, but what would have been wrong with a heading this morning “September building consents data released”, and an opening sentence that read “the number of residential building consents fell in September for the second successive month, following a very large increase in July.  Consents in Auckland appear to be growing more rapidly than those in most of the rest of the country.”?

How about leaving the storytelling to journalists, politicians, economists….and even bloggers.

UPDATE: A glance at this month’s ABS releases suggests they mostly do these things better.

Treasury on investor finance restrictions

Back in August, I OIA’ed Treasury for copies of any material they had prepared on the Reserve Bank’s Auckland investor finance restrictions in the period following the release of the Bank’s consultative document on 3 June.   I had written earlier about the pro-actively released Treasury papers, which captured some of the earlier round of discussions Treasury had had with the Bank on this issue.  At that time, Treasury was unpersuaded by the Reserve Bank’s case, for a variety of reasons, and were rather grumpy about late notice, inadequate consultation with them etc.

But then I went away, and when I got back and worked through my inbox I didn’t notice that Treasury had (helpfully) replied to my request.  In fact, I only realised it earlier this week, when stories started appearing (Politik, MacroBusiness, NBR and the Herald and the Dominion-Post) based on the papers Treasury had released, and which are now available on their website.

There is a curious, rather defensive, tone to the letter I received from Treasury.  It looked as though senior management was now quite uncomfortable about the perceptions of a split between the Reserve Bank and Treasury, and so went out of their way to present a sense that everyone was on the same page…..really.

No doubt for this reason they included in the material they released a letter from Gabs Makhlouf to Graeme Wheeler.  It looks to be a stock letter, sent by the Secretary to every government department/agency head at the start of the new fiscal year.  There is nothing specific about the Treasury/Reserve Bank relationship in the letter  –  and it was notable mainly for the odd line “we want to create a New Zealand that is prosperous, sustainable and inclusive”.  I could object to “create” –  government departments have such power? –  but it was the “we” that struck me.  Surely we elect members of Parliament, from whom governments are formed, to determine policy, and set policy goals.  Mere government departments –  even The Treasury –  have an advisory and implementation role.

However, Treasury seem to have included the letter in the release to me so that they could draw attention to the final paragraph.

The Treasury will continue to provide an independent perspective, and aim to add value to agencies’ business in doing so. Our goal is to be collaborative and challenging at the same time, engaging in a constructive spirit, with a shared sense of ambition and focus on getting better outcomes for all New Zealanders.

No doubt.

But the other thing Treasury was really keen to get across –  it was explicitly included in the covering letter –  was a sense that everyone was really more or less on the same page, at least on the need for some sort of intervention.

Please note that overall, the Treasury supports the Reserve Bank’s view that recent developments in the Auckland housing market could potentially pose a threat to financial stability over the medium term.  Although there may not be signs that a systemic risk may crystallise imminently, there is cause for vigilance.  Given the consequences of doing too little too late, we support the case for intervention at this stage on financial stability grounds on the basis of the available data.

I noted those lines when I first opened the documents.  And then I was struck by how often they were repeated, word for word.  It appears in the Treasury’s submission on the Reserve Bank consultation document. It appears in the Treasury Report to the Minister that accompanied a copy of the submission.  And it appears even in an internal briefing note for the Secretary to the Treasury on the critical assessment of the Reserve Bank’s evidence base undertaken by Ian Harrison, and presented in the document A House of Cards

The paragraph is not elegantly written at all, and it would have been easy to revise the words slightly over time to improve the expression. But it has the feel of words that were haggled over, to get just enough qualifiers included, and then perhaps finally imposed from the top. No one dared deviate, even stylistically, lest it reopen all the old debates and scepticism.

After all, it does not say that the Treasury supports the Auckland investor finance restrictions coming into force this weekend (or the relaxation of the LVR limit in the rest of the country). Indeed, it does not say much at all.  It doesn’t say that recent developments in the Auckland housing market “do” pose a threat to financial stability, but simply that they “could potentially” do so, and even that is qualified by “over the medium term”.    Then follows the awkward sentence “although there may not be signs that a systemic risk may crystallise imminently” –  but not even Graeme Wheeler has suggested imminent crystallisation – “there is cause for vigilance”.  Well, yes, but then that is what taxpayers pay bank supervisors for –  we hope they are always “vigilant”.

But then they conclude rather oddly, “given the consequences of doing too little too late” they support “the case for intervention at this stage”, not unconditionally but “on the basis of the available data”.  I’m not sure at all what that final qualifier is supposed to mean, or how its hedges the Treasury position, but my interest is the first phrase in the sentence.  Surely that just makes the whole argument circular, and bases policy on a straw man? By definition, no one wants to have done “too little, too late”.    If the financial system is, in fact, going to collapse in a heap if we do nothing then they support doing something.  Most people –  although not everyone –  would.

But how do we know?  How, for example, do we deal with the many countries that have had rapid credit growth (unlike New Zealand at present) and house price inflation, but no subsequent systemic problems.  The Treasury lines just assumes an answer rather than demonstrating it, assumes that intervention can make a material sustained difference “over the medium term”, and does not even address the costs of intervention, or the consequences of being wrong.   It is a poor quality conclusion, that seems to rest on rather poor quality analysis.  It is, for example, exactly the sort of line that could have been run in 2005/06, on the back of the larger, and more pervasive (regions and asset classes), credit and asset boom.  And yet the banking system came through the subsequent severe recession almost totally unscathed

There are some useful comments in the papers, if not always that clearly expressed.  And Treasury seems to be torn.  For example, buried in their comments is the telling observation “there is little evidence that lending standards are declining, a crucial component for assessing systemic risk”.  If lending standards are not declining materially, history suggests there is almost no chance of  the sorts of credit losses that would trigger a systemic financial crisis.  Treasury and the Reserve Bank should be challenged to cite any exceptions they are aware of.  Treasury might have highlighted the point in their advice to the Minister.

Many of the stories around these papers have highlighted an apparent Treasury preference that if there is going to be a direct regulatory intervention it should be done using debt to income  limits rather than loan to value restrictions.  In principle, I think they are probably correct  – and that some of the comments in the Dominion-Post this morning are just wrong. But they lack the courage of their instincts –  after all if there is no sign of systemic risk “crystallising imminently”, why didn’t they push back more strongly against the rushed use of LVR limits again?  The Bank’s excuse in 2013 was that it didn’t have time, and something urgent had to be done. They were clearly wrong then, and it is now 2015.  Good policy takes time, and rushed interventions rarely end that well.

Curiously, even though Treasury are the guardians of regulatory quality in New Zealand, there is no reference at all in the comments to the “efficiency” dimension of the Reserve Bank’s statutory responsibilities.  Surely a challenge and review body should be more sharply posing questions around the balance between soundness and efficiency, and offering perspectives on how to think about policy proposals that might make some modest difference to soundness, but which certainly come at some cost to the efficiency of the financial system?   Treasury do note that the regime is already becoming much more complex than was envisaged when the Reserve Bank first lurched into direct controls in 2013, but pay no attention to disintermediation risks or the distributive consequences of the policy, simply rather lamely concluding that ‘this is new territory for both the RBNZ and the Treasury and we will need to work together to ensure we continue to develop our understanding of these policy settings.

The one aspect of the new policy that Treasury is slightly stronger on is pushing back against the relaxation of the LVR restriction outside Auckland   Here I’m not sure I really understand their argument –  something about the risk of inconsistent signals. I think they are wrong on that – the logic of the Reserve Bank’s position seem clear, in trying to target specific areas of exuberance.  There isn’t much sign of exuberance in Gisborne, or Invercargill, or Nelson, or Wellington or Christchurch.  I don’t agree with the controls, at all, and I think regionalisation of prudential policy is another dangerous step towards politicising the Reserve Bank (akin to discretionary regional fiscal policy), but Treasury have already accepted the case for an Auckland restriction, so they’ve already abandoned that line.

These documents highlight the ongoing tussle between the Reserve Bank and the Treasury over prudential policy (as distinct from its application to individual institutions).  In principle, I mostly side with Treasury.  The Reserve Bank has far too much independent power to set policy without the direct involvement of the Minister of Finance –  both the ability to vary banks’ conditions of registration, and the far-too-extensive scope the legislation seems to allow them to set conditions on.  In my view, policy in these areas should be set by the Minister of Finance, with advice from the operating agency (the Reserve Bank) and the Treasury.  The Reserve Bank’s operational independence in this area should be more narrowly restricted to matters relating to the implementation of policy and its application to individual institutions.

Institutional rivalry and tension is probably inevitable, and hardly unique to the relationship between our Treasury and our Reserve Bank.  It isn’t helped by both institutions being led by people who had come in, not just from outside the public sector, but from outside New Zealand altogether, or by the rather weak senior leadership team at Treasury.   But there is also something about the quality of what the Treasury brings to the table.  The Reserve Bank tends to foster a rather closed environment, resistant to questioning, challenge, or even comment.  That is true of monetary policy to some extent, but it is even more true of their regulatory roles.  Some of that is about the individuals involved but it has fairly consistently been backed by more senior management.  The Bank has tended to foster an attitude that it is better and smarter than those it deals with, than other government agencies, and than outside agencies more generally.  If such an attitude was ever warranted (and humility is always a virtue), it has certainly not been so for a long time.

But Treasury does not help itself in this area.  The people they have involved have often not been very impressive.  Sometimes they are able individuals, but with no background in the subject matter –  a common issue at Treasury, especially among managers.  Sure the Reserve Bank can be difficult to deal with, but your case is a lot stronger when what you are bringing to the table is incisive and thoughtful.  Even when the recipients are inclined to be dismissive anyway, it is easier to simple dismiss lightweight contributions than those with depth.  On the evidence of these papers, Treasury unfortunately still has some way to go.

A new wave of financial interventions and controls come into force this Sunday, as the Reserve Bank continues to undermine the efficiency of our financial system.  The case for the interventions has never convincingly been made by the Reserve Bank, and we have what feels like a knee-jerk policy intervention, that materially affect the lives and businesses of ordinary citizens, based on little more than the hunches of a Governor, who has already been shown to have got his monetary policy consistently wrong.  In the earlier papers, Treasury showed some sign of challenging the weaknesses of the proposal, but as time went on instead of standing their ground, they have pulled their punches.  And the remaining concerns are not argued in a clear and compelling manner.

If this is the best that our two premier macroeconomic and financial agencies can come up with we should be pretty worried about the quality of economic policymaking and advice in New Zealand.  Responsibility for that rests, in particular, with the individuals in charge of those institutions, and those paid to appoint them and hold them to account.

(But, I continue to note that Treasury applies the Official Information in a much more helpful, and within the spirit of the Act, way than the Reserve Bank.  I made this point in the Ombudsman’s survey –  which I would encourage anyone else who has made OIA requests to complete.)

China’s fertility rate in an Asian perspective

The media are full of stories of the Chinese government/party decision to abandon the evil one-child policy and replace it with a marginally less evil two-child policy.  It is interesting to see the change presented by the authorities as a response to an ageing population, and I’ve seen various commentaries over the last few years suggesting that this easing could make a difference to the economic prospects of China, even perhaps only over the shorter-term as some couples took advantage of the slightly less repressive regime.

As a rank outsider, I’ve been more than a little sceptical since I started paying attention a few years ago to birth rates in the rest of Asia, and especially in the wealthier bits of Asia, to which China has been making some progress in converging.  As far as I know, in none of these countries have there been direct attempts by governments to suppress, by regulation, the birth rates (indeed, Singapore has been actively trying to encourage a higher birth rate).

Here is the time series (from the World Bank database) for China, Japan, and the four other predominantly ethnic Chinese countries/territories (Taiwan, Singapore, Hong Kong and Macao).

tfr time series

And here, from the CIA Factbook are the countries/territories with the lowest total fertility rates in the world, plus China and Thailand.  (The levels are slightly different in the two different sources –  the CIA numbers are 2015 estimates –  but the broad picture is the same).

tfr

The countries with the greatest cultural similarity to China have the lowest fertility rates in the entire world –  only around one child per woman.  The other advanced Asian economies (Japan and Korea) are only a little higher, and one of the other emerging middle income Asian countries (Thailand) already has a TFR below that of China (although, on the other hand, Malaysia’s is higher).

Perhaps the policy change will materially boost China’s birth rate, but it would really stand out relative to the rest of advanced and emerging Asia if that were to happen.

Who speaks for the 35000 unnecessarily out of work?

The Labour Party’s finance spokesperson, Grant Robertson, yesterday took the opportunity of today’s OCR review to make another statement on monetary policy.  I was pretty critical of his previous effort, which seemed to involve trying to blame Bill English for Graeme Wheeler’s errors and misjudgements.

The latest statement is little more inspiring.  It was good to see him focus on the high and rising rate of unemployment, and to point out that inflation hasn’t been at the 2 per cent midpoint since that target was set three years ago.

But he wants to use this record as a basis for amending the Reserve Bank Act to “put employment up as a core objective“.  I presume he would really mean low unemployment, since the Reserve Bank would (reasonably) point out that employment growth and participation rates have done quite well over the last few years.  And unemployment is the measure of excess capacity in the labour market.

Robertson talks about a dilemma that the Governor apparently faces.  But there simply isn’t one.  Inflation (and more particularly core inflation measures) is well below where it should be, and unemployment is (rising and is) much higher than it needs to be (than any plausible NAIRU).  That is a classic case of a demand shortfall, and the standard prescription is looser monetary policy.  Lower interest rates and a lower exchange rate will tend to raise both activity and inflation, and lower unemployment.

There are times when monetary policy faces hard choices –  when keeping inflation near the target might involve measures that will temporarily raise unemployment.    Some of them are explicitly addressed in the Policy Targets Agreement (and have been ever since 1990), and others are captured in a more general way –  the PTA is quite clear, for example, that the focus of monetary policy is supposed to be on the medium-term trend in inflation, not the near-term wobbles.  And, for better or worse, for 15 years the PTA has explicitly enjoined the Bank to avoid unnecessary variability in output.

I’m not a diehard defender of the way the monetary policy bits of the Reserve Bank Act are worded, or even of inflation targeting itself.  There might even be some sensible ways of formulating section 8 of the Act to include references to unemployment.  But section 8 of the Reserve Bank Act has almost nothing to do with the combination (persistent low inflation and persistent high unemployment) that Robertson rightly worries about.   Rather those outcomes are about a persistent series of misjudgements by the Governor (and, apparently, most of his advisers).

I’ve pointed out previously that central banks in other countries have also been taken by surprise by the events of the last few years.   But most of them have reached the limits of conventional monetary policy.  Several – including the ECB and the Swedish Riksbank –  even started to tighten, only to have to fully reverse those tightenings.   But the Reserve Bank of New Zealand is the only advanced country central bank that has (a) never been constrained by the near-zero bound on nominal interest rates, and (b) has twice (repeat twice) started tightening only to have to reverse itself again.    Taken together with the outcomes (too-low inflation, and too-high unemployment) it is a pretty poor track record.  And the Bank –  the Governor, recalling that the system is one of personalised accountability – has not been seriously called to account for that failure.

Legal responsibility for calling the Governor to account rests with the Minister of Finance and the Reserve Bank’s Board.  As I’ve noted, the Board seems to see itself as champions and defenders of the Bank, rather than being there to provide serious scrutiny and challenge.  And it isn’t clear that the Minister does more than grumble privately, and occasionally make slightly cryptic public asides.

But where has the political Opposition been?  In both his last two statements, Robertson absolves the Governor of any responsibility –  in his view the problem is the mandate, or even the Minister, not the month to month choices the Governor has actually been making.

Perhaps it is easy to call for changes in the mandate. It isn’t going to happen any time soon..  It might be harder to actually have a go at the Governor.  And one shouldn’t do so lightly, but this is an episode of repeated failure, and a stubborn reluctance to acknowledge, or learn the lessons from, those failures.  Of course, lots of the great and good have agreed with the Governor’s stance –  as I’ve pointed out before the NZIER Shadow Board’s recommendation have tended to mirror what the Governor actually does.  But they have been wrong, not just once, but again and again.  And the Governor is the person who is paid to get it right more often than not.   Why isn’t Robertson taking more of a stand and saying so.

And what about the governance arrangements?  Robertson notes that the Act was passed in the 1980s and is ‘out of date and out of touch with changes in the global economy’.  But if he looks at central banking legislation around the world what he will really find is that it is the governance aspects of the Bank –  the single decision-maker –  that look odd.  As the Reserve Bank’s survey showed, there is a wide variety of ways of expressing the statutory objectives for monetary policy, but there has been no trend away from something like a medium-term focus on price stability.  Our Governor simply has too much power.  Treasury reports that the Minister likes the current model because it provides better accountability, but where is the evidence of the accountability in the failures of the last few years?  The Minister can’t be blamed for who was appointed as Governor –  he had to appoint someone the Board nominated –  but he and the Board can, and should, be blamed for how little effective accountability there has been.

The unemployment rate is currently 5.9 per cent (and expected to rise further).  A reasonable estimate of the NAIRU might be 4.5 per cent.  If so, that is about 35000 people who are unemployed now who might not be unemployed if the Governor had run monetary policy, within his current mandate, rather better.  Even if the NAIRU, is nearer 5 per cent, it is still more than 20000 people unnecessarily out of work.   Does he get out and meet any of these people?  If so, I wonder how he explains his failure, and excuses the way his choices have blighted the lives of these people?

I suspect the answer to my question is “no”.  In fact, I just had a quick look through the list of audiences the Governor has given on-the-record speeches to since he took office.   There are various official forums and conferences, but not one of the remaining nine speeches was to groups representing workers, beneficiaries, or the wider community.  Most are to top-end business audiences (the “Admiral’s Breakfast Club” in Auckland, the Institute of Directors, INFINZ, Chambers of Commerce etc), and speeches given by the Deputy Governors seem to be to equally select audiences.  Perhaps the Governor gets no invitations from other sorts of groups, although in my experience that is unlikely.  Perhaps he gives lots of off-the-record speeches to such groups, and just by coincidence it is only the on-the-record speeches that were to upper-end business groups?

I’m not suggesting that the Governor is exercising anything other than his best judgement in making OCR decisions.   And his business audiences would also typically have been better off if the Bank had not been persistently and unnecessarily holding back the recovery, but his choices typically hit hardest on those at the bottom.  And it isn’t apparent that he is even listening to their plight, simply taking comfort from the echo chamber of the elite.

Traditionally, one might have expected an Opposition Labour Party to be their loud and clear voice.  Robertson’s is currently anything but that.

Thinking about housing again

I gave a talk in Nelson last night on housing issues.  It was largely a rework of material I’ve used before (posted here and here) so I won’t post the text here.   I’m not sure the speech quite hit the mark for the audience, but as always when I put together a presentation I find that I learn something in the process, or  some things come together more clearly in my own mind.

By Auckland standards, Nelson-Tasman house prices aren’t that high.   In real terms, house prices are still lower than they were in 2007.   But a median house price of around $400000 against a median household income of not much over $60000 reminds us just how high price to income ratios are across most of New Zealand (my old home town of Kawerau remains an unattractive exception).  Most of the “problem” is in the land.

As I often do, I devoted a bit of time to explaining why I don’t think features of the tax system are a material part of the explanation for high New Zealand house prices, or for the cycles that we –  and other countries  – experience.  As a slight counterbalance, I took the opportunity to put in another plug for land-value rating by local authorities, a case also recently made by the Productivity Commission.  Most New Zealand local authorities now use capital value rating, which – relative to a land value base –  provides less of an incentive to bring vacant land into development.  In principle, and all else equal, greater use of land value rating should help to dampen urban land prices, and close the gap between rural and peripheral urban land prices.

But one of the audience, a highly-respected figure in Nelson, with decades of experience in the building industry and on the local council, pointed out to me that Nelson city had, some decades ago, moved to land value rating.    Urban land prices remain very high.  It isn’t obvious that land value rating has been very helpful in easing land supply pressures.  Then again, nothing operates in isolation.  Neighbouring Tasman District Council, where much of the (flat land and) population and housing growth has been, still operates a capital value rating system.  And an ever-growing District Plan, that now runs to 1000 pages in Nelson City, probably has not a little to do with the continuing high land prices, and the continued excessively costly houses, in that part of the country.

A variety of factors no doubt explain the shift to capital value rating, although one can’t help wondering if the pervasive biases of so many councils towards more intensive, rather than extensive, development isn’t part of the story.  Many councils really don’t seem to want more land developed, or they want it developed only at a pace that suits them.  It is probably unrealistic to think that councils would favour a move back towards land value rating when those same councils are the ones applying land use restrictions in the first place.  If councils were committed to making urban land affordable, they could quite readily do it now.    Instead, as the Productivity Commission put it –  seemingly approvingly –  in its report last week:

Many urban councils in New Zealand have a clear idea about how they want to develop in the future, and how they intend to meet a growing population demand for housing.  Many larger cities have chosen to pursue a compact urban form.  Yet some of our cities have difficulty in giving effect to this strategy”.

Sadly, the Productivity Commission seems to see councils, and the planning regime, as part of the solution rather than as a large part of the problem.

I hadn’t been thinking much about housing while I was on holiday, but a conversation with friends we were staying with, in their growing prosperous (2 per cent unemployment rate) Midwest small college city, had got me thinking. I’d asked about local house prices and they’d commented that their house was probably worth about US$175000 –  decent-sized section, four bedrooms, and five minutes walk from the local college.  And they observed that prices had been moving up, and local sentiment was that they were really quite expensive.  In exchange I offered them scare stories about Island Bay prices, and vague references to the scandalous Auckland prices.

I didn’t give it much more thought until I got home and started preparing last night’s talk.  That observation that US$175000 was quite expensive was still running round in my head, and so I printed out the latest Demographia tables.  I’ve often used Houston as an example of a large, fast-growing, city with very moderate house prices –  in fact, lower in real terms than they were 35 years ago.   But, actually, Houston prices aren’t at the low end of the range –  the median house price was about US$200000 there last year.  Astonishingly cheap, absolutely and relative to income, by New Zealand standards but not by US standards.   Detroit (inner city) is a byword for cheap, but among cities with over a million people (and remember that Auckland hasn’t that many more than a million), these places last year had median house prices in a range of US140-175K (and price to income ratios of around 3).

Cincinnati

Grand Rapids

Pittsburgh

St Louis

Atlanta

Indianapolis

Kansas City

Louisville

Columbus

Oklahoma City

Memphis

Tampa

And there are dozens of other similarly affordable smaller cities.  I haven’t checked each of them, but I suspect “densification” hasn’t been a big part of keeping housing affordable.

Of course, the US has places at the other end of the range as well –  places I’ve barely heard of as well as Los Angeles, Honolulu, San Diego, San Francisco, and so on.

What marks out one group from the other isn’t being a “global city”, or a growing city:  it is mostly the land-use restrictions.  As Demographia highlight,  there are no cities  with high house price to income ratios that have liberal land-use regimes.

demographia

Which brings me back to a speech given last month by Bill English on housing affordability.  I noticed it has even been getting some coverage abroad, and it certainly has some useful perspectives on some of the issues (although looking through my copy I noticed I’ve scrawled “dubious” in a surprising number of places).  I liked the idea that our Deputy Prime Minister was making the case that urban planning has become a net drag on the country, and especially on its poorer and more vulnerable people, for whom housing has become progressively less affordable.  I was surprised to learn that the government now subsidises 60 per cent of all rentals in New Zealand.  And as the Minister notes of the 3000 page Auckland Unitary Plan “no one person [ or, one might add, no committee or Council] could possibly understand all the trade-offs in that plan”, or the implications of those choices.

I did, however, splutter at the suggestion that planning was an externality that central government might have to deal with just like “other externalities, such as pollution”.  The Minister seems to conveniently forget that the powers local governments have all flow directly from central government legislation – the centrepiece of which, the Resource Management Act, was passed by a government in which he served as junior backbencher.  Individual members of central and local governments may have their hearts in the right place, but this is ultimately a problem of central government failure at least as much as of local government failure.

And there are few signs that the problems are going away.  But perhaps that shouldn’t surprise us.  As I’ve noted here previously, I’m not aware of any examples of places in advanced economies where tight land use restrictions once in place have ever sustainably been removed.  When I first made this observation, I made it pretty tentatively.  I’m not an expert in the details of urban planning or familiar with the hundreds of individual regimes in various countries.  I was half-expecting that someone would come back to me quite quickly pointing me to a compelling case study of successful liberalisation.  So far no one has.  And I haven’t heard the Minister of Finance or the Minister of Housing highlight such studies.  I haven’t seen the New Zealand Initiative do so, and I haven’t seen Demographia do so, even though they have every incentive to highlight such examples if they exist.  I still hope there are such case studies out there, but it looks increasingly unlikely.

Bad policies don’t last for ever, but they can carry on for a  very long time.  I highlighted last night that New Zealand once had the unique feature of a car market where second-hand cars held their value and (by repute at least) were at times worth more than new cars.  My maternal grandfather often liked to tell the story that he reckoned my father was keen on marrying my mother as much because she owned a car as anything else (she’d done an OE and had overseas funds).  The insanity of the import licensing and local assembly regime eventually came to end, but it took a very long time –  sixty years or more.  Is there any reason to be more optimistic that housing will once again be affordable in New Zealand any decade soon?  If house prices had been bid up simply on the back of reckless bank lending policies, then perhaps so. But that isn’t the New Zealand story. Ours is a story of microeconomic policies, implemented and maintained by successive central and local governments, with the clear and predictable effect of making housing, and the sort of housing people want, much less affordable than it needs to be.

Fallow: the case for a lower OCR is compelling

Brian Fallow’s weekly column in the Herald yesterday  was fairly pointed.

Some further easing in the official cash rate seems likely, Reserve Bank governor Graeme Wheeler reiterated last week.

Well, good.

Because the case for more easing is compelling.

I agree with him.  Whatever measure of inflation one uses –  headline, exclusion measures, filtered measures  –  inflation has been persistently below where the Governor agreed to keep it, and shows no sign of rising (much or for long) any time soon.  On the Reserve Bank’s own numbers, the output gap is still modestly negative, and the unemployment rate has risen and is above any sort of NAIRU estimate.

But that wasn’t my reason for writing.  Instead, Brian notes a few considerations, including those mentioned in the Governor’s recent speech,  that might hold the Governor back

Housing is the first.  The Governor appears to have reversed himself, and gone back to thinking that (Auckland) house prices should be a factor in setting monetary policy.  But the Minister of Finance mandated him to target the medium trend in consumer price inflation, and New Zealand’s measure of consumer price inflation does not  –  rightly in my view (and that of most others) –  include existing house  prices or land prices.   House price inflation in Auckland is certainly scandalous, but the responsibility for that outcome is directly attributable to the choices of elected central and local governments.  The Reserve Bank’s role should simply be –  and in statute is –  to ensure that banks are sufficiently resilient to cope if nominal house prices ever fall sharply.

The second issue related to investment.  The Governor had suggested that the Bank needed to ask “whether borrowing costs are constraining investment”.   It isn’t clear why the Governor regards that as a relevant consideration –  absent some wild investment excess (1987 perhaps?), more private sector investment is generally a good thing.   Brian Fallow suggests that investment is sufficiently strong that there is no issue on that score anyway.  I’m not sure I agree.  Excluding residential investment, investment as a share of GDP remains pretty subdued. Historically, business investment as a share of GDP has been surprisingly low  in New Zealand relative to that in other advanced countries, given our faster trend rate of population growth, and now investment is low even relative to that history.  And that despite the rapid rate of population growth in the last couple of years.

investment to gdp

Not that the government’s ambitious export growth target is any concern of the Reserve Bank’s, but it is difficult to see anything like the targeted transformation in export performance occurring with these sorts of investment rates.  Of course, the big issue there is likely to be the real exchange rate –  still sufficiently high that even the Governor seems to comment on it whenever he can.

I touched last week on how odd it is to think of holding back on cuts now to save ammunition in case things get really bad again.  But Brian comes back to this issue by another angle.

But we can’t forget that New Zealand remains abjectly reliant on importing the savings of foreigners. The risk premium they demand to keep on doing that puts a floor under banks’ funding costs and the interest rates borrowers see, regardless of how low the OCR might go.

Here I think he is wrong.  I’ve dealt previously with the question of whether foreign lenders typically demand a “risk premium” for lending to New Zealanders (in NZ dollars).  The evidence strongly suggests that they don’t – and haven’t.    But if they were particularly concerned about New Zealand risk, there are two ways to get compensated for that risk.  The first would be to seek a higher interest rate.  They couldn’t typically get it at the short end, since the Reserve Bank itself directly sets the OCR based on domestic conditions.  They might perhaps get it on longer-dated assets (bonds), but expectations of the future OCR typically play the most important role in influencing the level of longer-term interest rates.

A much more plausible place to see any risk premium, in a floating exchange rate country, would be in the level of the exchange rate –  in other words, a surprisingly weak exchange rate.  Nervous foreign investors would be reluctant to buy NZD instruments at the interest rate set on those assets by domestic economic conditions.  But they might be happier to do so if the exchange rate were lower.  A lower exchange rate today, all else equal, means more prospect of some appreciation (and extra returns) in future.  It is a bit like the share market –  if concerns about a company, or the whole market rise, investors get compensation for the additional risk through a lower share price.  The lower exchange rate, in turn, helps rebalance the economy and reduces, over time, perceptions of risk.

But in thirty years of a floating exchange rate, I can think of only a handful of occasions when New Zealand’s exchange rate has been surprisingly weak (relative to New Zealand cyclical fundamentals)  –  most obviously at the height of the global crisis in 2008/09.  Global risk aversion was then at its height, and the NZD was caught in the backwash.  It isn’t a remotely typical story, and there is no sign that it is relevant now.  As the Governor keeps noting, the exchange rate is still rather high.

A materially lower OCR would lower domestic borrowing rates, which would provide a little support to lift investment.  But even if it did nothing at all on the score, it would work by lowering the exchange rate, in turn boosting returns to actual and prospective exporters.  Yes, it would increase the cost of domestic consumption a little, but the trade-off would be a stronger recovery, more resilient against any new wave of adverse shocks, lower unemployment, and –  not at all incidentally –  measures of medium-term inflation which would be rather nearer the rate the Minister of Finance asked the Governor to achieve.

The Reserve Bank apparently agonised for a while in 2008/09 about this idea that a too-low OCR might somehow create troubles with foreign investors.    Given the pace of the fall in the exchange rate during the international crisis, and the novelty of such low interest rates, they were perhaps understandable questions then.   But I doubt it is a factor that weighs much in the Governor’s deliberations now.  We shouldn’t welcome foreign investor concerns or heightened perceptions of risk –  they are a real cost –  but if those concerns exist, we are likely to be much better off absorbing them in a depreciated exchange rate, than trying to lean against them with unnecessarily high interest rates.  The alternative (‘lean against”) approach has usually been damaging, or disastrous, wherever it has been tried (think of all too many emerging market crises).

In the end, I think Brian agrees.

Even so, rather than keeping powder dry, the better way of mitigating the effects of another negative shock from the rest of the world might be for the bank to impart as much momentum as it can to the economy before the headwinds turn gale force.

It isn’t always and everywhere good advice, but given our continuing anaemic economic performance, it seems like very good advice right now, whether or not the headwinds ever gain further strength.  The debate probably shouldn’t be around whether the OCR should be 2.75 or 2.5, but why it should not quickly be cut to something more like 1.75 per cent.