….on unrelated matters.
One of the objections sometimes raised to my advocacy of a deeply negative OCR is along the lines of “it will only lift asset prices”, with the implication – and sometimes directly stated – that that is what has happened in the last decade or so, even as policy rates in most of the advanced world fell from materially positive numbers to somewhere near zero. In 2007, policy rates in the US and the UK had been over 5 per cent, in the euro-area 4 per cent, and in New Zealand and Australia higher than all those rates. Only Japan was then in the extreme low interest rate club.
The asset price that tends to attract most attention in New Zealand is house prices (really house+ land). The Bank for International Settlements maintain a nice quarterly database of real house prices for a large group of advanced and emerging economies.
Here is what has happened to real house prices for the largest advanced economies, and for the advanced economies as a whole, over the 12 years from the end of 2007 to the end of last year.
Very little change at all.
The aggregate advanced economy measure only starts in December 2007, and for quite a lot of countries the data starts getting thin for earlier periods. But for the UK, the euro-area, and the US, I had a look at the previous decade – over which period policy interest rates hadn’t changed much at all (ups and downs of course during the period) – and in each case real house prices increases were much more rapid in that period than in the more recent (extremely low interest rate) one. The US had experienced a 53 per cent increase in house prices – and they had already fallen back from peak by the end of 2007 – and the euro-area a 40 per cent increase. In Japan – very low interest rates throughout – real house prices had fallen substantially over the 1997 to 2007 period.
Of course, within these aggregates for the last decade or so there is a lot of cross-country variation. We all know real house prices in New Zealand and Australia have risen a lot. In some other countries, they’ve fallen a lot. But even in New Zealand, Australia and Canada, the rate of increase has been less in the last (low interest rate) 12 years than it was in the previous decade.
That shouldn’t really be a surprise. After all, in principle, houses are reproducible assets (some labour, some timber, some concrete, some fittings) and in few countries is very much of land built on. Moreover, interest rates aren’t where they’ve been as the result of some toss of a coin, or a draw from a random number generator; they reflect underlying changes in savings/investment imbalances, which central banks adjust policy rates to more or less reflect.
When a wide range of countries have had fairly similar interest rate experiences (and inflation outcomes; the check on whether monetary policy is out of step), and yet have had very different house price experiences, it probably suggests that some non-interest rate factors have been at work. Of course, in some cases, that might just mean working off past crises – although if you want to cite the US there (a) recall that by the end of 2007 real house prices had already fallen by 15 per cent from peak, and (b) that in the boom years nationwide real house prices in the US never rose as much as they did in, for example, Australia and New Zealand.
A more plausible story is that some combination and land-use restrictions and population pressures continue to explain a lot about differential house prices performance in the years since 2007. In New Zealand and Australia, for example, we have had tight planning restrictions and rapid population growth. I don’t know much about planning rules in central and eastern Europe, but there isn’t much population growth (deliberate understatement here) in countries with strong economic growth such as Bulgaria, Romania, Slovenia, Slovakia and the Baltics. It isn’t a simple one-for-one story, but taken across the advanced economies as a whole it just doesn’t look as though low interest rates are a credible part of the house price story – house prices, in aggregate, not having done much at all.
Of course, had central banks completely ignored the market signals re savings/investment pressures and simply held policy rates up then no doubt house prices would have been lower. Then again, we’d also have had persistent deflation and (more importantly) unemployment rates that stayed much higher for longer and more persistent losses of output.
On a completely different topic, I found myself yesterday on an email exchange with some fiscal hawks, very worried about the future level of public debt.
I’ve noted previously that on the Treasury budget numbers our ratio of net debt to GDP in 2023/24 would still be sufficiently modest by international standards that if we had had that high a debt ratio last year, we’d still have been (narrowly) in the less-indebted half of the OECD.
Another way of looking at things is to take the government at their word and assume that by the end of the forecast period the Budget is more or less back to balance, such that the nominal level of debt stabilises at the level forecast for the end of 2023/24.
If that were to happen that what happens to the debt ratio depends on how much growth in nominal GDP the economy manages in the years ahead. If we assume that the terms of trade is stable (or that the only safe prediction is that we don’t know, so assume no change), then there are three components to the rate of growth of nominal GDP. As an illustrative experiment I jotted down a range of possible average outcomes for each.
| Average annual growth | ||||
| Low | High | Average | ||
| Population | 0 | 1 | 0.5 | |
| Productivity | 0 | 1.5 | 0.75 | |
| Inflation | 1 | 2 | 1.5 | |
| 2.75 | ||||
So I’d assume growth in nominal GDP averaging 2.75 per cent over the decades beyond 2024. Of course, there will be booms and recessions in that time, but this is just an average. And then I’ve taken two alternative scenarios – one in which nominal GDP growth averages 2.25 per cent, and one in which it averages 3.25 per cent. Those aren’t extremes, and one could envisage even higher or lower numbers.
But this is what a net debt chart looks like out to 2064.
Even on the worst of these scenarios this (exaggerated, because it excludes NZSF assets) net debt measure is back to 30 per cent of GDP by 2050. That doesn’t seem too bad to me for a one in a hundred year shock (as the government likes to claim) or – less pardonably – a one in 160 year shock as the Reserve Bank Governor was talking up the other day.
Of course, fiscal hawks will say, “but what if another really nasty shocks happens in the meantime?”. Well, of course we would have to face that if it comes – and it could – but, as I noted, our net debt at peak is not high by pre-crisis international standards, and isn’t even high by our own longer-term historical standards.
Governments might choose to lower the debt faster, although if real servicing costs remain low it is difficult to see why one would, since faster consolidation involves either higher taxes than otherwise (with real deadweight costs) or less spending than otherwise (and while each bit of spending has its own antagonists, there is a case to be made for most of it). There is precisely no evidence that anything important would suffer if our net public debt took a trajectory something like the central scenario in that graph.
(Of course, it is a purely illustrative scenario, and the composition of nominal GDP growth does matter to the budgetary implications – eg faster population growth means more infrastructure demand, faster inflation might mean some unanticipated inflation tax, faster productivity is more like pure gain – but there is no reason to suppose that if governments can get back to balance (as they repeatedly have now for decades) that we will need anything much beyond that. Getting back to balance will require discipline and focus – and a strong credible recovery would help – but since most of the fiscal measures to date have been avowedly temporary, doing so should not be beyond our political system, whichever group of parties happens to be governing by then.
croaking cassandra 
A parent came to collect their child from a playdate, and commented that low mortgage rates were motivating them to add another room onto their home… it’s great to hear that at least someone is having their animal spirits juiced up!
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A good news story…
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Economic predictions out past 10-15 years are pointless given rapid advancements in machine learning and vision systems. The industrial/social and economic disruption of status quo that wide-spread replacement of human workers in progressively more intricate roles renders all our base assumptions of economic continuity null and void. And the impacts could be vastly better or worse than business as usual predictions would have it, no-one knows, so it just isn’t useful to think about timelines beyond ~20 years when considering the big social, economic, environmental or demographic problems of the world. To further muddy the waters the near certain development of super-intelligent AI in next 50 years that isn’t subject to the same socio-evolutionary pressures that humans inherently are (forcing most humans to be empathic, cooperative and significantly altruistic) makes our survival prospects rather bleak.
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I’m sceptical of the value of forecasts at much shorter horizons that even that. These are purely illustrative scenarios.
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I am in the weird position (for me) of being more hawkish on debt than some fiscal conservatives!
Partly comparisons between a small country far away from the rest of the world, and other small countries, say Sweden or Finland, are not like for like. I was struck by how difficult it was for New Zealand to borrow during the GFC even though NZ/Australian banking system had none of the bad debts seen in other countries. No matter how low the objective risk, we will always be perceived as riskier because few of the people making lending decisions know much about us.
Partly, there is a ratchet effect. Thomas Schelling talks about “salience” and how, when making decisions under uncertainty, non-rational but easily identified points can be important for achieving benign outcomes. This is a formal version of “slippery slope” arguments. The point is that even though there is little objective difference in risk taken in a debt of, say, 20% of GDP and no debt, the salience of no debt makes that a more effective policy objective than 20%.
Finally, even a small debt still takes resources. From memory, even in 2019, finance costs for NZ were three times greater than the total child protection budget. I appreciate that eliminating net debt will not remove all government finance costs, but it is worth remembering that debt has opportunity costs even when the debt itself is not macro-economically significant.
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Thanks Tony. Yes, I find an odd inversion too!
Re 2008/09 the NZ govt never had the slightest difficulty borrowing, and on the other hand banks everywhere had great difficulties funding rhemselvrs in wholesale markets. It is fair to note that our negative NIIP position means our credit rating might be downgraded a bit sooner than a similarly indebted small country with a positive NIIP position, but the effect is likely to be small, esp when the current account deficits are much smaller than they used to be.
On your final point, yes there are debt service costs, but at present the NZ govt could issue 20 year indexed bonds at a real yield of very close to zero, so (as per the post) one does have to weigh up small servicing costs vs the costs (economic or social) of higher tax or lower other spending.
I suppose the other thing that leaves me more comfortable about the projection is that large pool of NZSF assets. In the measure that includes them, our 1 in 100 year health shock sees debt peak at about 38% of GDP, at a time when real financing costs are trivial.
All the said, I perhaps to revert to form I like a focal point of (true) net debt near zero, so if there were opportunistic fiscal gains that took us there sooner than 30-40 years, I certainly wouldn’t say no.
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I don’t have an issue with government debt when it is balancing shocks or inter generational assets. However, I look at the broad government expenditure and am dismayed at what our earnings are spent on. The focus on redistribution seems to ignore that if the pie was bigger we could afford a lot more.
I look at soon to be economic earners and contributors and your graph of the expected debt position and I am slightly dismayed. Having grown up through price freezes, carless days and the reforms post 1984, I had hoped that we had learnt something. Maybe we really are doomed to repeat our mistakes.
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Congratulations Michael, I see you had some comments in the sobering The Australian essay Flightless Economy to Land With a Thud.
Available (not paywalled) on Bob Jones’ site.
https://nopunchespulled.com/2020/05/29/foreign-objectivity/#more-1393
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Just to put a little realism up against the distortions of the article above, here is an extract from Simon Wilson’s NZ Herald article today on new Nat leader Muller
His main message now is that National has the better team to lead the economic recovery and rebuild. What nonsense. In its last nine years in government, National failed to plan for almost anything, and especially for the risk factors staring it in the face: poverty, population growth and climate change.
It ran down the public service, most obviously in health, where it spent less, as a proportion of GDP, every year from 2010. In Auckland, it allowed both housing and transport to become deeply dysfunctional. It simply did not know how to look ahead. National is a case study in not good economic management.
As others have noted, in times of major economic crisis – like the Great Depression of the 1930s and after World War II – it’s the centre-left that has proved itself able to rebuild economies and societies. When the centre-right has a go – after the 1987 crash, say – they’ve made things worse. Here and around the world. Sorry, but it is what it is.
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To be clear, I had no contact with Creighton – he just picked some lines from the blog.
I reckon our govt has done poorly this year but have no confidence National would be any better. I don’t buy the “centre left does things better” – as so often so much depends on the the times and key individuals.
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It’s not helpful or meaningful to make assumptions on the basis of the ideological leanings of the parties 39.
Look at the Labour led coalition’s dismal track record on it’s key planks:
Child poverty worse than when they came in – fail.
Kiwibuild/housing shortage – fail
Gazillion trees not planted and Shane’s nephs still on the couch – fail
Climate still the same – fail.
The childish Jacinda cult is cover for some serious shortcomings on the front bench; seriously, Kelvin Diversity Davis at number two? There are obvious and genuine concerns around the competence of the current lot. Having to drag up Fraser, as if he’s got any relevance, looks pretty desperate.
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39: It [National] ran down the public service, most obviously in health, where it spent less, as a proportion of GDP, every year from 2010.
That is misleading and dishonest, what does proportion of GDP have to do with it since it’s only a reflection of good GDP growth following the GFC; a reflection of National’s competent handing of the crisis?
This is the actual health spend under National:
Nominal spending increased 44% from 2008 to 2017
Real spending increased 23% from 2008 to 2017
Real per capita spending increased 10% from 2008 to 2017
In what parallel universe does that equate to “running down the health service”?
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Somehow your later comment has disappeared. I just wanted to note that I was surprised to see Savage and Kirk on your list. From my perspective, whatever Kirk might have been we’ll never know – having died just a few months into the huge econ challenge. And Savage, altho a Labour icon (almost literally) presided over a govt that led us into severe economic crisis. Re recovery from the Depression, I would rate Coates higher.
I rate Fraser fairly high, esp re the war. For most other 20th C PMs/MOFs most – left and right – seem at best “good in parts”. ANd on the economic side, we’ve now spent 70, perhaps 100, years in relative econ decline, and no govt has done what is needed to reverse that – despite some courageous reforms mosly by Douglas, despite (now) 30 years of macro stability, and so on.
Having said all that, my comment about times/personalities was really more about the wider world (prob mainly the Anglo bits).
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I couldn’t access the Simon Wilson Herald article, I don’t have a subscription.
If the quoted passage is a reflection of the standard of one of their senior journalists; if you’re not prepared to pay for the privilege of being blatantly propagandised, cancel your subscription and tell them why.
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Michael, any thoughts on why the RBNZ is continuing to pay 0.25% interest on the reserve deposits it holds for the banks (which presumably are surging on the back of QE). Like the RBNZ, the RBA has a policy rate of 0.25% but it is only paying 0.1% on reserve balances. And, given the surge QE-related deposits over there, banks are keen to lend to anyone who will offer them more than 0.1%. Hence money market rates in Australia are around 0.12% for terms out to twelve months. In contrast, due to the RBNZ paying 0.25% here, understandably our banks don’t want to lend at anything lower than that.
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There is no good macroeconomic justification for keeping the deposit rate at 25bps, rather than either the 10bps the RBA pays or indeed zero.
I presume the RB’s defence/explanation would be that they made the solemn pledge on 16 March not to lower the OCR any further for a year, and that to move to 10bps or zero would breach that, and undermine the value of future promises.
Since the initial promise was rash and without full information, it should simply be set aside, but I guess the argument internally would be that if they were going to set it aside at any point they’d want a lot more bang for buck than just 10bps – which then just brings them back to the curious claims the “operational readiness” issues prevent them going negative.
My summary, in the large it is a crazy stance, but on their own terms it (not moving off 25bps) makes a certain amount of sense.
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