In early December, the Reserve Bank published a Bulletin article, “House price collapses: policy responses and lessons learned”. The article wasn’t by a Reserve Bank staffer – it was written by a contractor (ex Treasury and IMF) – but Bulletin articles speak for the Bank itself, they aren’t disclaimed as just the views of the author. Given the subject matter, I’m sure this one would have had a lot of internal scrutiny. Or perhaps I’ll rephrase, it certainly should have had a lot of scrutiny, but the substance of the article raises considerable doubt as to whether anyone senior thought hard about what they were publishing in the Reserve Bank’s name.
I’ve only just got round to reading the article and was frankly a bit stunned at how weak it was. Perhaps that helps explain why it appears to have had no material media coverage at all.
The article begins with the claim that
This article considers several episodes of house price collapses around the globe over the past 30 years
In fact, it looks at none of these in any depth, and readers would have to know quite a bit about what was going on in each of these countries to be able to evaluate much of the story-telling and policy lessons the author presents.
Too much of the Reserve Bank’s writing about house prices tends to present substantial house price falls as exogenous, almost random, events: a country just happened to get unlucky. But house prices booms – or busts – don’t take place in a vacuum. They are the result of a set of circumstances, choices and policies.
And none of the Reserve Bank’s writings on housing markets ever takes any account of the information on the experiences of countries which didn’t experience nasty housing busts. Partly as a result they tend to treat (or suggest that we should treat) all house price booms as the same. And yet, for example, New Zealand, Australia, the UK and Norway all had big credit and housing booms in the years leading up to 2008 but – unlike the US or Ireland – didn’t see a housing bust. What do we learn from that difference? The Reserve Bank seems totally uninterested. Their approach seems to be, if the bust hasn’t already happened it is only a matter of time, but 2018 is a decade on from 2008.
One particular policy difference they often seek to ignore is the choice between fixed and floating exchange rates. When you fix your exchange rate to that of another country, your interest rates are largely set by conditions in the other country. If economic conditions in your country and the other country are consistently similar that might work out just fine. If not, then you can have a tiger by the tail. Ireland, for example, in the 00s probably needed something nearer New Zealand interest rates, but chose a currency regime that gave it interest rates appropriate to France/Germany. Perhaps not surprisingly, things went badly wrong.
In the Bulletin article, the Bank presents a chart showing “house price falls in [10 OECD] selected crisis episodes” (surprisingly, not including Ireland). But of those, eight were examples of fixed exchange rate countries (in several cases, the associated crisis led the country concerned to move to a floating exchange rate). The same goes for all the Asian countries the author mentions in the context of the 1990s Asian financial crisis. There can be advantages to fixing the exchange rate, but the ability to cope with idiosyncratic national shocks in not one of them. And yet in the ten lessons the author draws in the article, there is no hint of the advantages of a floating exchange rate, in limiting the probability of a build-up of risk, and then in managing any busts that do arise. It is a huge omission. As a reminder, New Zealand, Australia, Norway, the UK, and Canada – the latter a country that has never had a systemic financial crisis – were all floating exchange rate countries during the 2000s boom and the subsequent recession/recovery period.
The author also hardly seems to recognise that even if house prices fall, house prices may not be the main event. Even the Reserve Bank has previously, perhaps somewhat reluctantly, acknowledged the Norges Bank observation that housing loan losses have only rarely played a major role in systemic financial crises. But there is no hint of that in this article. Thus, in the severe post-liberalisation crises in the Nordics in the late 1980s and early 1990s, house prices certainly went up a lot and fell back a lot too, but most accounts suggest that those developments were pretty marginal relative to the boom and bust in commercial property, in particular development lending. The same story seems to have been true for Ireland in the crisis there a decade ago. Housing also wasn’t the main event in Iceland – a floating exchange rate country not mentioned here that did have a crisis. Even of the two floating exchange rate countries the article mentions – Japan and the United States – only in the United States could housing lending, and the housing market, be considered anything like the main event (and the US experience may not generalise given the very heavy role the state has historically played in the US housing finance market).
(And as I’ve noted here before, even the US experience needs rather more critical reflection than it often receives: the path of the US economy in the decade since 2007 wasn’t much different to that of, say, New Zealand and New Zealand experienced no housing bust at all.)
Some of the other omissions from the article are also notable. The author seems quite uneasy, perhaps even disapproving, about low global interest rates (without ever mentioning that inflation has remained persistently low), but there is no hint in the entire article that neutral interest rates may have been falling, or that global trend productivity growth may have been weak (weakening before the 2008/09 crisis showed up). Thus, where economic activity is now – 10 years on – may have little or nothing to do with the specifics of housing market adjustments a decade ago. And although he highlights the limits of conventional monetary policy in many countries (interest rates around or just below zero), again he doesn’t draw any lessons about the possible need for policymakers to give themselves more room to cope with future downturns (by, for example, easing or removing the technological/legislative constraints that give rise to the near-zero lower bound in the first place.)
It is also remarkable that in an article on housing market collapses, there is only one mention of the possible role of land use restrictions in giving rise to sharp increases in house prices in the first place. And then it is a rather misguided bureaucrats’ response: because supply may eventually catch up with demand the public need wise officials to encourage them to think long-term. Perhaps the officials and politicians might be better off concentrating their energies on doing less harm in the first place – whether fixing exchange rates in ways that give rise to large scale misallocation of resources, or avoiding land use restrictions that mean demand pressures substantially translate in higher land and house prices.
But in all the lessons the Bank (and the author) draw in the article, not one seems to be about the limitations of policy and of regulators. There are typical references to short-termism in markets – although your typical Lehmans employee had more personal financial incentive (deferred remuneration tied up in shares that couldn’t be sold) to see the firm survive for the following five years – than a typical central bank regulator does, but none about incentives as they face regulators and politicians (including that in extreme booms, an “insanity” can take hold almost everywhere, and even if there were a very cautious regulatory body, the head of such a body would struggle to be reappointed).
And nor is there any sense, anywhere in the article, as to when cautionary advice might, and might not, look sensible. Alan Greenspan worried aloud about irrational exuberance years before the NASDAQ/tech bust – someone heading his concerns then and staying out of the market subsequently would probably have ended up worse off than otherwise. Much the same surely goes for housing. In New Zealand, central bankers have been anguishing about house prices for decades. Even if at some point in the next decade, New Zealand house prices fall 50 per cent and stay down – the combination being exceedingly unlikely, based on historical experience of floating exchange rate countries, unless there is full scale land use deregulation – that might not be much encouragement to someone who responded to Reserve Bank concerns 20 years ago. (Oh, and repeated Reserve Bank stress tests suggest that even in a severe adverse economic shock of the sort that might trigger such a fall, our banks would come through in pretty good shape.)
The article concludes “housing market crashes are costly”. Perhaps, but even that seems far too much of a reduced-form conclusion. The misallocations of real resources that are associated with housing and credit booms are likely to be costly: misallocations generally are, and often it is the initial misallocation (rather than the inevitable sorting out process) that is the problem. To me, it looks like an argument for avoiding policy choices that give rise to major misallocations (and all the associated spending) in the first place: be it fixed exchange rates (Nordics or Ireland), land use restrictions (New Zealand and other countries), or state-guided preferential lending (as in the United States). Of the three classes, perhaps land use restrictions are most distortionary longer-term, and yet least prone to financial crises and corrections, since there are no market forces which eventually compel an adjustment.
It was a disappointing article on an important topic, sadly all too much in the spirit of a lot (but not all) of the Reserve Bank’s pronouncements on housing in recent years.
On housing, in late November, the Minister of Housing Phil Twyford commissioned an independent report on the New Zealand housing situation. According to the Minister
“This report will provide an authoritative picture of the state of housing in New Zealand today, drawing on the best data available.
The report was to be done before Christmas and it is now 15 January. Surely it is about time for it to be released?