LVR limits revisited

The Reserve Bank was out the other day with some research on the impact on house prices of the successive waves of loan to value limit restrictions put in place from 2013 to 2016.     It was a rare Reserve Bank discussion paper –  pieces typically designed to end up in a journal publication –  to get some media attention.   That was, no doubt, because of the rather bold claims made in the non-technical summary to the paper

Overall, we estimate that the LVR policies reduced house price pressures by almost 50 percent. ,,,,, When it becomes binding, LVR policy can be very effective in curbing housing prices.

Since nationwide average house prices (QV index measure) increased by about 40 per cent over the four years from September 2013 (just prior to the first LVR restrictions coming into effect) to September 2017), you might reasonably suppose that the researchers were suggesting that, all else equal, LVR restrictions had lowered house prices by almost 40 per cent (in other words, without them house prices would have increased by around 80 per cent).  Of course, that isn’t what they are claiming at all.

The paper was written by several researchers in the Bank’s Economics Department (two of whom appear to have since moved on to other things), and carries the usual disclaimer of not necessarily representing the views of the Bank itself.  Nonetheless, on an issue as contentious as LVRs, it seems safe to assume that senior policy and communications people will have been all over the communications of the results.  Even if the Governor himself didn’t see it, or devote any time to it, it seems likely this paper carries the effective imprimatur of the Assistant Governor  (Head of Economics),  the Deputy Governor (Head of Financial Stability) and (at least in the bottom line messages) the Head of Communications too.

In the paper, the authors attempt to identify the impact of the various waves of LVR controls using (a) highly-disaggregated data on property sales, and (b) the fact that shortly after the first LVR restrictions were put in place, the Bank buckled to political and industry pressure and exempted lending for new builds from the controls (even though, generally, such lending is riskier than that on existing properties).  By looking at the relationship between prices of new and existing properties before and after the various adjustments to LVR limits, they hope to provide an estimate of the effect on existing house prices of the LVR controls.

Trying to identify the statistical effects of things like LVR controls is hard, but I’m a bit sceptical of this proposed new approach.  After all, if new and existing houses were fully substitutable a new regulatory intervention of this sort could be expected to affect prices of both more or less equally.  People who were more credit-constrained (by the restrictions) would switch to buying new houses, and those who less affected by the contros (eg cash buyers) would switch more to existing houses.

In practice, of course, the two aren’t fully substitutable, for various reasons (including that most new builds are occurring in different locations –  even in the same TLA – than most existing houses), but in the Reserve Bank research paper I didn’t see any discussion of the issue at all.  If there is no substitutability at all then the research approach looks as though it should be reasonable, but that seems unlikely too.

But I’m more interested in whether the reported results are anywhere near as impressive as the authors claim.

As a reminder, here is their chart of house price inflation developments, with the various LVR interventions marked.


And here is their summary table of those successive interventions.


And here is their summary table of the impact of these LVR adjustments on house prices, as estimated from their model.


My focus is on the last two lines of the table: the estimated percentage effect on the various different intervention on existing house prices in Auckland and the rest of New Zealand  (the three asterisks suggest that the results are highly statistically significant).

Take the initial LVR controls first (which had the added effect of being something out of the blue, shock effects of a tool never previously used in New Zealand).  Recall too that, at the time, the big concern was about Auckland house prices and associated financial stability risks.    On this particular set of model estimates, the effect on house prices outside Auckland –  where there wasn’t a particular problem –  was larger than the effect inside Auckland.  In both cases, the effect (2 to 3 per cent) isn’t much different to previous estimates, or (indeed) to the sorts of numbers that were being tossed around internally before the controls were imposed.  It was generally expected that the controls would have a temporarily disruptive effect, lowering house prices for a while, but the effects would wear off over the following few years. (There are some model estimates on page 9 of this paper the Bank published in 2013.)

And what about the second wave of controls (which tightened financing restrictions on investors in Auckland, and eased them for everyone outside Auckland)?  On these latest estimates, those restrictions had no discernible impact on prices in the Auckland market at all, even though they were avowedly put in place because of explicit gubernatorial concerns about investor property lending in Auckland.  On, on the other hand, the moderate easing in the rules outside Auckland was so potent that it full unwound the price effects of the first wave of controls.

And, finally, the third wave of controls.  These represented a substantial tightening in investor-finance restrictions (especially outside Auckland), and a reversal in the easing (in wave 2) of the owner-occupier financing restrictions outside Auckland.   And yet, even though the rule changes were materially larger for borrowers outside Auckland, there is no estimated effect on house prices outside Auckland at all (even though, in wave 2 the easing in owner-occupier restrictions, now reversed, was supposed to have had a large effect).  And although the Auckland rule changes are smaller those outside there is no estimated effect on Auckland prices at all.  These results aren’t very plausible and suggest that – even if the results are statistically significant –  the strategy they used to identify the effect on prices isn’t that good.

One could also note that if one added up the effects across the three columns (which isn’t kosher, but still…….) the total effect outside Auckland is basically zero (actually slightly positive).  Even in Auckland, the total is about 5 per cent.

One of the reasons why simply adding up the estimated effects isn’t kosher is because everyone has always recognised that LVR restrictions are unlikely to have long-term effects on house prices.  They disrupt established established financing patterns, and thus can dampen house prices a bit in the short-term, but the effects dissipate with time.

In fact, the Reserve Bank researchers illustrate exactly that point in this chart which (if I’m reading them correctly) relates to the first wave of LVR controls.


As the authors themselves observe

Figure 5 plots the point estimates with 95 percent confidence intervals. Overall, the effect of the first LVR policy on house prices occurs within the first three months and is relatively stable over a six-month period. Thereafter, the moderating effect declines somewhat (to around 1.5 percent after 12 months), perhaps owing in part to individuals having saved up the required deposit under the policy and a price differential having opened up between existing and newly built houses.

Any substantial effects on house prices don’t seem to last long.

To be fair to the Bank, and the former Governor, they never claimed house price effects would last for long.  The argument was that LVR restrictions reduced financial system risks by altering the composition of bank balance sheets.  That is another contentious claim, but it isn’t touched on in the current paper and so I won’t deal with it further here either.

So what led them to write (and their bosses to approve) the extravagant claim that LVR policies reduced house price pressures by almost 50 per cent?    It seems to be this

The moderating effect of LVR 3 was clearly seen in Auckland with a 2.7 percent reduction in house prices. This LVR 3 effect is both statistically and economically significant, as during the same period the average house price increased by 5.8 percent.

Overall, we estimate that the LVR policies reduced house price pressures by almost 50 percent.


  • as the table above shows, there was no estimated effect on all (from LVR3) outside Auckland,
  • even inside Auckland, and granting their estimates, 2.7 per cent is under a third of pre-LVR price increases during that specific period (the 5.8 per cent that happened anyway, plus the 2.7 per cent they claim to have reduced prices by).
  • as the chart aboves shows, on their own estimates, the dampening effects of LVR controls seem to dissipate relatively quickly (in that case half of the effect had unwound within 12 months).
  • the estimate seems to take no account of the ongoing house price inflation outside the arbitrarily chosen period they measure.

Contrary to their claims, LVR policy is not very effective in curbing house prices.  Indeed, its staunchest advocates never really claimed otherwise (for them it was mostly about financial stability), which does leave one wondering why today’s Reserve Bank management are publishing such overblown (and undersupported) claims to be made.  As I noted earlier, over a period when nationwide house prices rose by about 40 per cent, this latest model suggests no sustained impact at all on house prices outside Auckland –  despite significant interruptions to established financial structures and effective property rights –  and probably quite limited effects in Auckland too.

Overblown claims about what LVR controls can do for house prices (especially with no discussion at all of efficiency/distributional costs etc) risk distracting attention from the real regulatory failures that explains the dysfunctional housing market.  And they also detracting from the credibility of the Reserve Bank, whose legitimacy depends in part of being authoritative when it speaks.



A sadly diminished central bank

Under the Reserve Bank Act as it stands at present, before a Governor is formally appointed the Minister of Finance is required to reach agreement on a Policy Targets Agreement (on monetary policy) with that person.  It is a strange system –  again one no other country has chosen to follow in law.  A Governor-designate may, for example, not know a great deal about monetary policy before taking up the job.  And it also appears to give a great deal of policy-setting power to an unelected official, treating the Governor-designate as almost an equal with the elected Minister of Finance.   Since the Governor-designate will generally be ambitious for the role –  and as even potential Governors give some deference to, for example, electoral mandates – in fact the Minister of Finance has the greater say.

The system is shortly to be replaced.  Here is what the Minister of Finance had to say in his announcement on the Reserve Bank reforms in late March.

Currently, the PTA is an agreement between the Minister of Finance and the Governor. Looking forward, as the MPC will be collectively responsible for making monetary policy decisions, it would be inappropriate for the Governor to be the sole member of the MPC to agree the operational objectives for monetary policy. As a result, we are changing to a model where the Minister of Finance sets the operational objectives for monetary policy. These objectives will be set after nonbinding advice from the Reserve Bank and the Treasury (as the Minister’s advisor) is released publicly.

The approach the Government has agreed to for the setting of operational objectives going forward was recommended by the Independent Expert Advisory Panel. This approach imposes discipline on the decisions of the Minister, given the fact that the Minister’s decision will need to take account of publicly disclosed advice from the Reserve Bank and the Treasury. Further accountability measures, such as requiring the Minister to justify decisions before the House, will be considered in the detailed design of this policy proposal.

It is also intended that the setting of monetary policy objectives going forward will involve greater transparency and public input. Decisions on monetary policy objectives are important, and therefore public debate and understanding should be required.

There are still a few unanswered questions, details to be fleshed out, but that looks a largely sensible approach.  I especially welcome the emphasis on

a) the routine pro-active disclosure of official (Treasury and Reserve Bank) advice on the setting of the operational objectives for monetary policy, and

(b) greater ex ante transparency, public input, and public debate.   Setting the operational objectives for monetary policy is the key bit of policy around macroeconomic stabilisation, and is far too important to be done secretly by the Minister and a few internal advisers.  In almost other area of multi-year policy, proposed frameworks would be open for much more public consultation, scrutiny and debate.  I’ve written previously about the much more open approach adopted to the five-yearly refresh of monetary policy targets in Canada.

So, well done Minister.

But despite the admirable promises about the future, in the most recent PTA (that signed with Adrian Orr in late March, a day before he took office), the process seems to have borne no resemblance to what the Minister promises for the future.

There was no public consultation (indeed, the Treasury papers that have been released talk of some consultation with some market economists in 2016 –  under a different government with a different view on monetary policy and the Reserve Bank).

The Treasury advice to the Minister has been pro-actively released (I wrote about it here), but it was disturbingly thin in key areas (issues around the effective lower bound for nominal interest rates, and the next recession).

And what of the Reserve Bank?  One might expect that the Reserve Bank itself would have the greatest concentration of official expertise on monetary policy and related issues –  not just drafting issues, but the key economic issues, including some of those monetary management issues that are just over the horizon).  One certainly wouldn’t want only Reserve Bank perspectives taken into account –  after all, one key part of the PTA involves the Minister, acting in the public interest, disciplining and holding to account the Reserve Bank –  but it would be astonishing if they didn’t have useful perspectives to add.   Perspectives that really should be seen by both the Minister of Finance and by the Governor-designate.  The Minister’s statement about future arrangements would suggest that, at least in principle, he’d agree.

When the Policy Targets Agreement was released I noted that I had lodged an Official Information Act request for the Reserve Bank’s analysis and advice on PTA issues, but that I didn’t really expect much, because I expected to be obstructed and delayed.

There was a bit of delay, in that the Bank took almost the full 20 working days to respond when –  as will shortly be clear –  they could have (and by law should have) responded almost immediately.

This was what I asked for

Copies of any papers relating to the new Policy Targets Agreement signed earlier this week.  I am interested in any advice to the Minister or his office, and any advice provided to the then Governor-designate, as well as any substantive internal advice or analysis papers prepared or obtained in the period since the current government was formed.

and this was the response

The Reserve Bank didn’t provide advice about the Policy Targets Agreement (PTA) to Adrian Orr prior to his start as Governor, and advice to the Minister of Finance was provided by the Treasury rather than the Reserve Bank.

That is a categorical statement: no advice (written or oral) to the Minister of Finance, and no advice (written or oral) to the Governor-designate.

In a follow-up email exchange, I also clarified with them that there were no “substantive internal advice or analysis papers prepared or obtained in the period since the current government was formed” either.

And there was also nothing of this sort in the Briefing for the Incoming Minister released late last year either.

It is almost literally incredible –  ie impossible to believe.  Public servants of my acquaintance have suggested that the Bank might just be lying, but I don’t believe that.  Or perhaps I crafted my request too narrowly?  Perhaps they had done substantive analytical pieces before the election rather than after it, but given the differences in emphasis between the two main parties it doesn’t seem likely that one would really be a substitute for the other.  And they probably will have provided comments to Treasury on drafts of its advice to the Minister, but nothing in that advice is a distinctively Reserve Bank contribution.

It seems rather a sad commentary on what the organisation seems to have become over recent years.  There has been much talk about collective monetary policy decisionmaking –  and ministerial commitments to legislate –  and yet the new Governor apparently neither sought nor received any advice from his (new) senior colleagues on the drafting of the Policy Targets Agreement, the key macroeconomic stabilisation policy document.  The Reserve Bank has substantial experience with the conduct of monetary policy here,  substantial exposure to what is done in other countries, and a significant research capability funded by taxpayers (presumably, at least in part, to shed light on such issues).   The Minister of Finance says he wants future PTAs (or their equivalent) to benefit from (published) advice from both the Reserve Bank and the Treasury, and yet he sought –  or at least received –  none this time from the Reserve Bank.  And yet the Bank itself, if its OIA response is to be believed, had done no substantive analysis or internal advice on PTA issues in the months between the government  – with, for example, its new emphasis on employment – taking office and the signing of a new PTA.

It seems like some sad mix of abdication of responsibility, and the sidelining of the institution that is supposed to be centre of official professional expertise in the area.

It is a far cry from, for example, the approach taken fifteen years earlier.  In April 2002 Don Brash resigned as Governor, and Rod Carr was appointed to act, holding the fort until a new permanent appointment could be made.  That process in turn spanned a general election.  At the time, Reserve Bank senior management took the view that it would prudent and useful for us to invest quite heavily in preparing background papers which could assist the Minister of Finance, The Treasury, the Board, and whoever was being considered for appointment as Governor to (a) get to grips with the issue, and (b) see where our reading of the evidence and arguments had led us to.  The resulting 100 page document is here.    And that wasn’t the limit of our involvement.  We provided advice to Alan Bollard (before he took office) for his discussions with the Minister of Finance, and participated directly in at least one (I say “at least” because I attended one  myself) of his meetings with the Minister on detailed issues around the negotiation of the Policy Targets Agreement.   It wasn’t a climate in which Reserve Bank staff and management perspectives were necessarily overly welcome –  the Bank was to some extent seen as almost an ideological “enemy” (see, as one cause, Don Brash’s 2001 speech I wrote about recently) and there was a great deal of opposition in the Beehive to the idea of anyone internal getting the job as Governor.     But it didn’t stop the Bank preparing and supplying what was (to my mind) reasonably good quality analysis and advice.

As I’ve said previously, the Reserve Bank certainly shouldn’t have a monopoly on advice/analysis in this area –  and much of its analysis on various issues in recent years has been less good than it should –  but the apparent complete lack of any serious analysis or advice to the Minister or the Governor-designate reflects pretty poorly on all involved –  Minister, “acting Governor”, Governor-designate.   It tells of a sadly diminished central bank.