Author: Michael Reddell

What has been happening to private rents?

Michael Reddell Housing

I don’t usually look at Sunday’s Herald but I was filling in time in an airport yesterday and noticed an article on private residential rents, drawing on MBIE’s tenancy bond database.  I don’t think I had previously realised that the data were easily available, at both a TLA and regional level.

One of the striking aspects of the house price boom has been the way rents have lagged well behind house prices.  House price to rent ratios have increased substantially.  Of course, in many ways that should be no surprise.  After all, real interest rates have fallen very substantially over the last 25 years or so  (having risen sharply over the previous decade).  Even in New Zealand – with the highest real interest rates in the advanced world –  real interest rates are lower than at any time in modern history (the heavily regulated period of the 1970s and early 1980s excepted).  Falling rental yields might reasonably have been expected, and that is what we have seen.

The MBIE data go back to the start of 1993. Since then, consumer prices (the CPI) have risen by around 60 per cent.   Average private rents on this measure have risen by about 150 per cent in that period.  The QV measure of house prices has risen by just over 300 per cent in that time.

Perhaps what is most striking, and something the Herald article didn’t bring out, is how similar Auckland’s experience has been to that of much of the rest of the country.    Since the start of 1991, Auckland rents, on this measure, have risen by 158 per cent.  Those in Gisborne –  the median regional council – have risen by 130 per cent.  Auckland rents have risen faster than those in most of the country, but they just don’t stand out the way that the increases in Auckland house prices do.

rents since 93

And if we restrict the analysis simply to the period since, say, 2007, the picture is not materially different.

And what of incomes?  Nominal GDP per capita increased by 144 per cent from 1992q4 to 2015q2.  Even in Auckland, rents have not increased much relative to (national) average per capita GDP.  Purchasing a house might have become “unaffordable” for many, but accommodation doesn’t appear to have.

And that conclusion is reinforced when one recognises that these MBIE data do not purport to be like for like measures.  The average house today is larger than the average house in 1993.  The average house is better appointed now than in 1993 (more likely to have double-glazing, heat pumps, or central heating).  And as the home ownership rate has dropped in the intervening years, it is likely that the median rental property in 2015 is further up the 2015 spectrum of New Zealand houses than the median rental property in 1993 would have been along the spectrum of New Zealand houses in 1993.

In the CPI, Statistics New Zealand attempts to adjust for the quality and compositional issues.  However, they only appear to report, in Infoshare, rental prices since 1999.  And even that series, which includes both public rentals and private rentals, is made harder to read by the abandonment of market-related rents for state houses in 2000/01.  But since 2001 (ie after the levels adjustment from the policy change), the CPI rentals component has risen by 37 per cent (very similar to the change in the CPI over that period), whereas the MBIE private rents series has risen by 87 per cent.  Per capita nominal incomes have risen by 71 per cent over that same period.    Even over the period of the biggest house price boom in modern history, a constant-quality house looks to have become more affordable to rent, not less.  And, of course, that is what one would normally expect.  Stable long-term ratios of house prices to incomes, for example, tend to reflect the fact that as incomes rise, the size and quality of houses tends to increase.

Of course, if land use restrictions –  in conjunction with policy-driven population pressures –  had not driven urban land (and house) prices sky high, we might perhaps have expected to see real rents falling.    All else equal –  which it never is –  sustained lower real interest rate lower the real cost of providing rental accommodation services.  But the fact that Auckland rents have not increased enormously relative to those in the rest of the country tends to reinforce the idea that it is not so much an issue of an extreme shortage of accommodation in Auckland, as of the regulatory restrictions on land use.  Such restrictions, which “bite” more in Auckland because of the population pressures, offer returns to landlords through actual/expected capital gains.

And for anyone interested in the rental increases at the TLA level, here is that chart.  (To deal with a few missing observations at the start of the period, this chart uses the percentage increases from the first 12 months of the series  to the most recent 12 months).

rents since 93 by TLA

Converging on the US: trends in government spending

Michael Reddell Fiscal policy

I was dipping into the latest update of the OECD Outlook database, and landed on the tables for government current spending and revenue as a share of GDP.

Spending first. I’ve shown here the shares for the US, New Zealand, and for a median of the OECD countries for which the OECD has data all the way back to 1970. Unfortunately, the New Zealand data aren’t available before 1986 – which was probably about the time government spending as a share of GDP peaked here.

gen govt disbursements.png

What I found interesting was how general government spending as a share of GDP in New Zealand has converged with that of the United States. Back in 1970, the United States was only just below the median for the other member countries for which there is data all the way back.  Now, both New Zealand and the United States are well below the median (whether for this sample, or for the whole OECD – for which group the median is now 42.6 per cent). The role of the US government in its economy may, in effect, be even larger than that in New Zealand, since there are so many “tax expenditures” in their system. Mandated private spending, such as that under Obamacare, would also add to the effective US total.

Of course, our government accounts are close to balanced, and those of the United States are not. When we look at current government receipts we are about half way between the US and the OECD median.

gen govt receipts.png

What about changes over the last few years? For all the talk of austerity, in only two OECD countries – Hungary and Poland – is current government spending as a share of GDP lower this year than it was in 2007, the last pre-recessionary year. In New Zealand, for example, general government spending this year is estimated to be almost a full percentage point of GDP higher than it was in 2007. At the other end of the chart, 11 of these 29 countries have government current spending five percentage points or more higher than it was in 2007. Check out Finland – an increase that almost defies belief over such a short period, at least outside wartime.

spending 07 to 15.png

And what of taxes? The median country is estimated to have seen almost no change in the government revenue share of GDP since 2007. New Zealand is among the countries with the largest reductions, but then we were running surpluses prior to the recession. Greece has, quite remarkably, managed a very large increase in the revenue share of a falling GDP.

receipts 07 to 15.png

Most of the countries with large increases in the government spending shares are still estimated to have material negative output gaps. In principle, an eventual recovery might help shrink the relative size of government. But, for most, it is not remotely clear where the sustained recovery is going to come from, and when.

On which note, for a bit of gloomy weekend reading, I suggest Ambrose Evans-Pritchard’s piece on Finland. The tragedy of the euro, compounding what would in any case have been a difficult economic adjustment.

Housing: what would the market do?

Michael Reddell Housing

My post last week about the Wellington City Council’s consultation meeting, on its proposals to amend the district plan to allow more medium-density housing in Island Bay, attracted some attention and a range of interesting and thoughtful comments.  Readers seem to have taken from the post what they wanted (those opposed to more density focused on the critical comments about the Council’s case, those in favour on the critical comments on the residents and the planner mentality that dominates the Council).   Perhaps that reflects my own ambivalence.  In general, I favour allowing greater flexibility to property owners, but I don’t think we  would see much pressure for the sorts of development that concerns many residents, at least beyond the immediate fringes of the central city (Thorndon, Mt Victoria, Kelburn etc) if councils did not continually and actively resist the expansion of the physical footprint of cities.

It perhaps also reflected the fact that I’m not overly affected personally.  We are probably 12 minutes walk from the “town centre”, not the rather arbitrarily-chosen 5 or 10 that the Council focused on.  If a slightly largely population increased the chances of the convenient neighbourhood supermarket surviving into the years of my dotage, so much the better.   And it would be almost impossible for any conceivable development to materially impair either our sun or our views.

However, there is no point pretending that the sentiments of residents are just illegitimate or misguided.  Or that what happens elsewhere in their neighbourhood cannot impinge on their wellbeing. Nor do I favour riding roughshod over the concerns –  in fact, on a city or countrywide basis it is just not going to happen.  As I’ve pointed out previously, I’m not aware of any examples anywhere where tight land use restrictions, once put in place, have been substantially unwound.

Perhaps as importantly, the  private marketplace itself has mechanisms to deal with the sort of issues and concerns that drive the vocal residents of Island Bay or Khandallah, at least in respect of new developments.

As the Productivity Commission’s recent land supply report noted

Restrictive covenants in new subdivisions are a very common feature of property developments in New Zealand.  The mayor of one fast-growing New Zealand city told the Commission that all subdivisions in their area were subject to detailed covenants.

And according to one source I looked at, around 55 million Americans now live in “homeowner association” complexes –  some mix of apartment blocks and suburban developments/gated communities etc.    These arrangements  presumably exist because they meet a demand, and hence enable developments to occur more profitably than otherwise.  They add value to the people’s homes.    They are not just a legacy of centuries gone by, but have become much much more popular in the last few decades (at a time when local authority planning restrictions have also become more onerous).

I’m no expert in these sorts of arrangements.  As the Commission notes, in some cases they just last until all the homes in a particular development have been built (ie they govern what is first put on the section, and nothing subsequent to that), but many others are permanent.  The rules are often very detailed –  the example the Commission cites particularly caught my eye when it specified the details of the size and construction of the letterbox.  The focus is clearly intended to be on collective action provisions that limit the possibility that some future action of a neighbour might impair the value of my property.

I wouldn’t want to live in such a tightly restricted subdivision myself.  As one succinct summary put it, they aren’t the place for people who don’t like being told what to do.

The Productivity Commission seemed rather ambivalent about these covenants.  They had three “findings” and one “recommendation”.  One was arguably just a factual statement

Covenants established in new subdivisions are increasingly common and impose detailed restrictions on purchasers.

although that could easily have been reworded to include the phrase “provide considerable protections, and impose detailed restrictions on, purchasers”.  That is, after all, what contracts do in all areas of life.

The Commission finds that

regulatory controls on covenants should reflect both the costs and benefits of covenants

which is fair enough perhaps, but fails to recognise that these are already a market solution to a revealed demand.  Market contracts might reasonably be assumed to have internalised the costs and benefits already.  The case for regulation isn’t really made.

The Commission also notes that

Covenants reduce the flexibility of land use now and in the future, and increase the cost of constructing dwellings.

Of course, the first part of the sentence is true, but really the point of these voluntary contracts.  Voluntary contracts exist to enhance welfare.  Flexibility is not an unalloyed good.  The second point is unsupported in the report –  all it seems to amount to is that buyer and sellers have voluntarily agreed that, as a condition of buying in that development, they will not use certain lower end building materials. Why is that a public policy issue?  It does not detract from the ability of other people to build using those materials and technologies.  And each covenanted development presumably has to survive the market test, in competition with other covenanted developments, and standalone dwellings (new or existing).

Consistent with the uneasiness that pervades the discussion, the Commission then recommends (page 118) that

The Ministries of Justice and of Business, Innovation, and Employment should review the legislative provisions governing covenants with a view to:

  • reducing the proportion of landowners required to agree to covenant changes from all to a super-majority; and
  • introducing a statutory sunset period on restrictive covenants of 25-30 years.
I don’t have a particular problem with super-majorities (they are not uncommon in other collective action areas, eg bondholders dealing with distressed debtor).  But, equally, nothing stops such contracts developing voluntarily, and it isn’t clear what the Commission sees the problem as being.  Nor is it clear how the Commission would minimise the risk of abuses of minorities.  Perhaps, at minimum, any super-majority would have to be prepared to offer to purchase the property of an aggrieved minority at a price which reflected the assessed benefit of the changed provisions to the majority.
More egregious is the suggestion of mandatory sunset clauses, effectively banning private property owners from voluntary collective action solutions for more than, say, 25 or 30 years (and as property will trade on the basis of expected future use, even the value of a 25 year covenant will start to decay pretty quickly after, say, 15 years or so).  Again, what is the public policy interest that should override the freedom of homeowners to enter voluntarily into contracts?   The Commission cites one jurisdiction in which the term of covenants is statutorily limited (Ontario, at 40 years), and one example (Massachusetts) where after 30 years covenants can be renewed for 20 years at a time.  But it appears that the rest of the 55 million Americans living in such developments are free to establish permanent covenants, which can generally only be dissolved by unanimous agreement.

The Productivity Commission is uneasy about these increasingly widespread private contracts.  But I wonder if we shouldn’t think about moving in the opposite direction.  Why not facilitate covenants of a sort in existing neighbourhoods?  Is there any obvious reason why, say 1000 households in Island Bay or Khandallah should not be able to  mutually agree that only, say, the current planning rules will apply to their sections in perpetuity, with perhaps a 75 per cent majority required to change those rules in future?  I can’t think of one.  I guess one can argue that the developers, and purchasers, in 1890 should have envisaged these issues and established the covenants then.  But, actually, the then borough had only 600 rateable properties, and if they have given the matter any thought the residents might reasonably have assumed they had effective control through the ballot box.    When Councils pick off one suburb at a time –  as opposed, say, to amending the district plan to allow more medium-density housing everywhere in the city –  effective control through the ballot box is much attenuated.  Which suburb has the “misfortune” (from the aggrieved residents’ perspective) to be chosen for medium-density housing, is no longer a matter of collective agreement among affected residents, but of who can lobby the most effectively and  shift the issue onto some other suburb.  That isn’t the market at work.

I’m not sure what the current legal position is.  Perhaps local property owners could already put in place such restrictive covenants now, with the consent of every one of those involved?    But why not consider amending the relevant legislation to provide for a standard set of rules that a group of homeowners could voluntarily adopt, by say, a 90 per cent initial majority of those in the area concerned?    That would empower homeowners (you would presumably vote for change when the increased value of your land, under rules allowing more intensification outweighs the risks of loss of sun, views or the “changing character of the neighbourhood”).  And it would remove the arbitrariness that exists in the current law.  I’m not suggesting giving legal force to an ability to force your number to mow his or her lawns, or get rid of the gaudy letterbox, but it would enable communities to “protect” themselves (mutually agreeing to entrench existing planning laws for their own properties)  –  or to remove those protections themselves to take advantage of new opportunities –  at a level that existing planning legislation often attempts to do, until it doesn’t (ie until some distant planner or councillor suddenly decides it is time for change).

Perhaps the grand houses that once filled The Terrace might once have been subject to such covenants.  Such houses are probably not the best used of that land today.  Owners would be free to recognise that opportunity, but to do so collectively.

Half of me thinks this is a second-best suggestion, but so widespread are such covenants in private developments here and abroad that I’m not even sure that is true.

Of course, the quid pro quo for such an amendment –  which would, at the margin, probably slow any process of intensification of a particular neighbourhood that might otherwise take place –  would have to be legislative provisions that removed the  ability of councils to restrict the physical expansion of cities and towns.  If, say, all land was automatically zoned residential (in addition to any other approved uses it might have)  and, as a default, was able to be built on to a height of two storeys, there would be ample scope for population pressures –  themselves largely now the consequence of policy choices – to be met with new building on new sites.

From voters’ perspectives, such a bundle of changes look as though it ticks most boxes.  It allows much more new peripheral development more cheaply than occurs now [1].  That, in turn, would remove some of the artificial pressure for intensification  –  arising from councils directly, and from the market because councils restrict the physical expansion of cities.  And, at the same time, it recognises a right for local communities, at a much lower level than whole cities (or even whole wards), to collectively make decisions about the nature of future potential land use changes for their properties.  Since such contracts are increasingly widespread in new developments here and abroad, they seem to reflect real pressures that have real economic value to citizens as property owners.

There is no real, or necessary, tension between keeping housing affordable and allowing property owners to act collectively, in response to opportunities (costs and benefits) to make decisions as to how their land is able to be used.

[1] And, yes, pricing the infrastructure and transport connection issues still has to be resolved.

Weak expectations and accountability

Michael Reddell Current New Zealand data, Uncategorized

The Reserve Bank released the results of its Survey of Expectations yesterday afternoon  – aggregated responses from 60 or so relatively informed participants.  For some reason, this quarter they have separated the release of the survey of household inflation expectations, which is now apparently not due until next week.

After the release of the previous results in August I wrote a post that provided a fairly downbeat assessment of the information in the two surveys, a little in contrast to the commentaries I saw at the time from market economists.

I’m a participant in the survey, and had actually revised many of my responses up a little from those I provided in August.  But my reading of the results suggests that the respondents as a group are about as downbeat as they were in August.  In particular, there is little sign of any sustained pick-up in inflation expected over the next year, despite the repeated Reserve Bank rhetoric.

This isn’t going to be a long post, but just a few highlights:

First, respondents expect the economy to do no more than limp along, beneath capacity, for the next two years.  The unemployment rate is expected to stay at or above 6 per cent throughout, and GDP growth of 2.2 per cent and 2.4 per cent is expected in next two years.  Those would be fine growth rates for Japan, with a slightly falling population, but New Zealand’s population growth was estimated at 1.9 per cent in the year to June 2015.   There doesn’t look to be much per capita growth envisaged by respondents, even with the lagged effects of monetary policy easing, unless respondents are expecting quite a sharp reduction in the net migration inflow.

Second, inflation expectations remain very subdued. Fortunately for the Reserve Bank, two-year ahead expectations have done no more than reverse last quarter’s slight bounce, and are still at 1.85 per cent.  But one year ahead expectations are only 1.5 per cent, and expectations for the second six months of the one year period (beyond the immediate “noise” of oil price fluctuations) are no higher than those for the first half.  In the whole period since the recession started in 2008 only once have those second six month expectations been materially lower than they are now,     Respondents still appear to loosely believe that the Reserve Bank is aiming for 2 per cent, but they aren’t seeing any signs that suggest the Reserve Bank will get it there soon.  Since the various core inflation measures are 1.5 per cent at most, at best they seem to envisage a continuing undershoot.

inflation expecs

Third, respondents don’t appear to expect much more of an OCR cut.  Even a year ahead, respondents expect the 90 day bill rate to be 2.79 per cent, probably not even consistent with a full expectation of the OCR being cut to 2.5 per cent.

However, the survey also asks respondents about their expectations for monetary conditions, both currently and a quarter ahead and a year ahead.  Each respondent can decide for themselves what counts for assessing monetary conditions –  the exchange rate, the OCR, equity prices, retail lending rates, LVR restrictions, or whatever.  Since the survey began in 1987 there have only been two quarters when respondents thought conditions were easier than they are now.  But typically when respondents think conditions are easier than neutral they don’t expect that state to last for long –  looking a year ahead they typically expect things to tighten.  For the last year or so that hasn’t been the case.  The extent of the extra easing isn’t large, but the fact that is expected at all in unusual.  It is not a sign of confidence that the Reserve Bank has yet got on top of things.   Expectations a year ahead are for looser conditions than they’ve expected at any time since this question was first asked in 1999.

expected mon con.png

The OCR is still 25 basis points higher than it was at the start of last year (as are the floating retail rates the Bank reports).  Over that period, inflation expectations (at least measured by this survey) have fallen by about half a percentage point.  Inflation expectations implied by the spread between indexed and conventional government bonds appear to have fallen a bit further (to only around 1.3 to 1.4 per cent).  So real short-term interest rates are at least 75 basis points higher than they were at the start of last year.  Why? For what?

Since that time, we’ve seen little or income growth, little real per capita GDP growth, the unemployment rate stop falling and start climbing, and inflation continue (on a core basis) to be well below the 2 per cent target midpoint (focal point) that the Governor explicitly signed up to only three years ago.

As I noted in my post yesterday about Stan Fischer’s speech, effective accountability in any area of life isn’t just about talk: it  has to imply that there is potential for adverse consequences for the independent decision-makers themselves. As in any area of life, a single mistake is usually not a safe signal of anything much.  But established patterns of error must raise more serious questions if the much-vaunted accountability is to have any real meaning.   This is looking quite like a repeated pattern of errors, compounded by a reluctance to acknowledge errors or to learn from past mistakes.

Stan Fischer on central bank independence

Michael Reddell Central banks

Stan Fischer is one of the global elite of macroeconomic policy. Born in what is now Zambia, he has spent most of his adult life in the United States. He was Chief Economist of the World Bank, First Deputy Managing Director of the IMF, Governor of the (central) Bank of Israel, and is now Vice Chairman of the Board of Governors of the Federal Reserve.   He spent several years making a great deal of money at Citigroup in one of those door-opening roles senior officials and politicians often gravitate to.  Fortunately for his reputation, the next big job came up before Citi ran into its latest crisis over 2008/09.

In his time as an academic, Fischer, together with Guy Debelle, came up with the nice delineation between “instrument independence” and “goal independence” in analysing monetary policy arrangements.  In practice, the distinction is never as clean as all that, but one can think of our Reserve Bank having “instrument independence” in monetary policy (it can set the OCR wherever it likes from day to day) but as having relatively little “goal independence”.  The Minister of Finance takes the lead in setting the policy targets and although the Governor is a party to the PTA, the PTA has to be agreed before the Governor is formally appointed.  The Minister does not need to appoint someone who will not agree with his proposed policy targets. And, in principle, the Minister can have the Governor dismissed if the Minister is satisfied that “the performance of the Governor in ensuring that the Bank achieves the policy targets …has been inadequate”.

In many other modern central banks, there is no counterpart to the Policy Targets Agreement, and the statutory objectives for monetary policy are written sufficiently loosely that the central bank has a fairly high degree of goal independence too.   The Federal Reserve  –  where key policymakers rarely even quote the relevant section of the Federal Reserve Act[1] –  is a good example of the latter.

Stan Fischer gave a speech on central bank independence a couple of weeks ago, in which he discussed independence in respect of both monetary policy and (some aspects of) financial stability and regulatory policy.   I thought it was a slightly disappointing, rather complacent, speech.

Part of the context presumably is the simmering discontent with the Fed.  The 2016 Presidential race is getting underway and demand for changes to the Federal Reserve  legislation governing the Fed are being heard –  something that used to be common in New Zealand, but rarely seen elsewhere.

Two issues in particular have prompted legislative initiatives in the United States. One is to limit the Federal Reserve’s operational flexibility in response to financial crises, and the second is the ‘audit the Fed” movement.   I wanted to focus on the audit side.

At present, although the Federal Reserve is subject to regular financial audits, it is exempt from GAO reviews of “deliberations, decisions or actions on monetary policy matters”.   The purpose of the exemption is, supposedly, to protect the day-to-day operational independence of the Federal Reserve  –  the fear, in the words of a Wall St Journal piece, is “that aggressive members of Congress unhappy with a Fed interest-rate decision could dispatch the GAO repeatedly to investigate, essentially using the GAO as a way to pressure the Fed to change its policies.”

I don’t find this resistance overly persuasive.  After all, as Fischer points out, there is lots of external scrutiny and debate around the actions of the Federal Reserve.  Members of the FOMC need to have the fortitude and integrity to make the decisions they think are needed, in accordance with the law, regardless of the weight of external pressure.  If they can’t take the heat, there is always the option of finding another job.  It isn’t clear to me why GAO inquiries, no matter who prompts them, represent a more serious threat.  Either Congress can or can’t overrule the FOMC on specific decisions.  It can’t now, and wouldn’t be able to under any of the legislative initiatives that are around.  Anything else is scrutiny and steps towards effective accountability.

A similar fight is going on in the UK at present, where the Bank of England is fighting back (successfully it appears) against government plans to allow the National Audit Office to undertake value-for-money audits of Bank of England activities (the Court –  the equivalent of our Board –  will be able to block such audits).

Consider, by contrast, the situation in New Zealand.  Not only is the Reserve Bank Board paid to scrutinise and hold to account the Governor, in respect of all his responsibilities (including, quite explicitly, monetary policy), but in New Zealand the Auditor General is (in the Reserve Bank’s own words) “able to commission quite extensive investigations into the activities of the Bank”

And then there is section 167 of the Reserve Bank Act, which explicitly provides the Minister of Finance with powers to commission a performance audit of any or all aspects of the Bank’s responsibilities under the Reserve Bank Act [but not, it appears, those under the other Acts the Reserve Bank is responsible for?]

167 Performance audit

  • (1) The Minister may, from time to time, appoint 1 or more persons (whether as individuals or as members from time to time of any firm or firms) to carry out an assessment of the performance by the Bank of its functions and of the exercise by the Bank of its powers under this Act.

    (2) As soon as practicable after completing an assessment the person appointed shall submit a report to the Minister setting out the results of that assessment.

    (3) The report stands referred, by virtue of this section, to the House of Representatives.

    (4) A person appointed to conduct an assessment under this section, for the purpose of conducting that assessment,—

    • (a) shall have full access to all books and documents that are the property of or that are under the control of any person relating to the Bank or its affairs:

    • (b) may require any director, officer or employee of the Bank or any other person to answer any question relating to the Bank or its affairs:

    • (c) may, by notice in writing to any person, require that person to deliver any books or documents relating to the Bank or its affairs in the possession or under the control of that person and may take copies of them or extracts from them.

    (5) Nothing in subsection (4) limits or affects section 105.

    (6) The fees of the person appointed to carry out an assessment under this section shall be paid out of the funds of the Bank.

 

Of course, the section 167 powers have not been used in the 26 years since the Act was passed (although Lars Svensson’s inquiry into New Zealand monetary policy, commissioned by Michael Cullen, might be seen in that light)

And yet the best argument that Fischer can put up in response is that if such further audit or review powers were established

“the Fed would be subjected to the very sort of political pressure from which experience suggests central banks should be independent. Instead, a modern governance framework calls for the political system to give the central bank a mandate along with the operational freedom to pursue that mandate, supported by transparency and accountability”

Central banks are very keen to conflate the ideas of transparency and accountability – the Reserve Bank did it recently in their Bulletin on monetary policy accountability – but apply the parallel to an employee. Effective accountabiity for an employee rests on the simple fact that, after all the discussion and debate, if the employee does not work to the required standard he or she can be dismissed.

Members of the Federal Reserve Board cannot be removed from office for their policy choices, no matter how bad they might be. That is not uncommon for central bankers internationally, but it severely compromises the meaning of accountability. Central bankers don’t face re-election either. Reappointment is certainly one opportunity for effective discipline, but in principle members of the Federal Reserve Board of Governors are appointed for 14 year terms.

If Fischer is serious about maintaining a distinction between instrument independence and goal independence in the United States it is not clear why he would not support a move more towards a New Zealand system, where policymakers can be removed if they make bad policy. But if that can’t be practically be done – and perhaps it can’t in a US system, and perhaps it isn’t a practical option even here – it is far from clear why he (and his colleagues would continue to push back against measures that would provide for more official scrutiny of the choices and actions of the Federal Reserve. It is all very well to say that markets, the media, and think tanks scrutinise the Fed, but statutory provisions bring with them statutory powers, including access to relevant papers and information. I’m not suggesting that the Rand Paul “audit the Fed” bill has things precisely right,   But as Vincent Reinhart, a former very senior Fed monetary policy official, has argued, what possible threat could a twice-yearly “GAO audit of monetary policy:, a week before the Fed’s own semi-annual monetary policy report to Congress”, be?

Of course, one could reasonably counter “what good would it do”? But that is surely a matter for Congress, as the people’s representative, not for those who are being reviewed. Central banks are given very great power and it is up to us, as citizens, to find ways to effectively hold them to account. That has to include the ability to put pressure on them, even if the day to day decisions are finally theirs.

The New Zealand model has not worked particularly well in that regard – the Board is just too close to the Governor, and Parliament’s Finance and Expenditure Committee has too few resources and incentives. But equally, one can hardly say that the powers that do exist – which go well beyond those in the US – have threatened the operational independence of the Reserve Bank, on monetary policy or any of its other functions.

But surely the practical problem for citizens is the difficulty of securing effective accountability. There is plenty of debate about what central banks do – at least in the US – but accountability is more than debate, and has to include the ability to make a practical difference.

There is a price for operational independence. If legislatures do not think that those wielding the operationally independent powers are doing so appropriately, on  average over time, and yet cannot effectively hold decision-makers to account for their choices, operational independence itself will come under threat.  In a sense, that is what the Warren-Vitter legislative initiative (which the Fed is also fighting) seeks to do in the United States, in further restricting the Fed’s freedom of action in a crisis.   As I’ve noted previously, the US authorities (Treasury and the Fed) already have far less operational autonomy in a crisis that the New Zealand authorities do. In some respects, the New Zealand powers are disconcertingly wide –  the Public Finance Act appears to allow the Minister of Finance to bankrupt New Zealand with no parliamentary vote, and the Reserve Bank also has uncomfortably unconstrained powers in these areas. I suspect that something between the two models provides a better balance, but at least we have formal powers to review, and potentially dismiss, the Governor if he acts unwisely or inconsistently with his statutory mandate.  The US system has no such power.    If anything, it looks to me as though the Fed –  were it operating consistently with the goal vs operational independence model –  should be embracing as many reviews, and as much official scrutiny, as possible.

But perhaps that is the problem with global elites, in macro policy or other areas.  They often don’t really believe in effective accountability to citiznes, or in their potential for making mistakes.  They believe, too readily, in the rightness of their own judgements.  Institutional design has to operate with the limits of human knowledge and incentives. Humans –  even very able ones – and human institutions make mistakes.  And yet in the whole of Fischer’s speech, the words “error”, “mistake” and “misjudgement” don’t appear once.  Good models for governing powerful institutions have to built, and refined, starting from the proposition that people like Stanley Fischer, Ben Bernanke , and even Graeme Wheeler, will actually make mistakes.

[1] “The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”

Thinking about the euro and common currencies

Michael Reddell Euro area, Exchange rate regimes

There was interesting and stimulating piece by Matthew Klein the other day on the FT’s blog Alphaville headed “The euro was pointless”.  I’ve been a euro sceptic from way back, and am still counting the months until it dissolves.   A common currency should be an intrinsic part of common nationality, and if the latter isn’t going to happen neither, generally, should the former.  The exception, where there might be some gains from a common currency, and no real costs, could be if countries’ economies were so similar that they faced the same shocks and the same stresses.

That said, I’m not persuaded that Europe’s current plight can be attributed largely to the creation of the euro.  After all, the whole region is at or near the lower bound for nominal short-term interest rates.  If each of the countries had their own currencies, perhaps some would be doing a little better than they are, but on average interest rates couldn’t be lower, and there is no reason to think that, on average, the real exchange rate would be lower.  The zero bound looks as though it binds more tightly in countries/regions with little or no population growth than in others.

But what caught my eye was when Klein got into his stride with a discussion of  “the most natural currency union never to exist: Australia and New Zealand”.

I presume he is unaware that for the first 89 years of its modern existence, New Zealand to all intents and purposes did enjoy a currency union with Australia.  To the extent that one can even think of a NZ/Aus exchange rate until 1929 (or NZ/UK or Aus/UK ones) they were each 1.  After 1914 it was no longer a matter of law, but the private sector still found it worthwhile to manage the exchange rates to retain parity.  (Of course, prior to 1901, “Australia” was a geographical expression only –  a continent made of up of several different self-governing colonies).  There was no banking union or fiscal union (but a great deal of debt), although labour flowed pretty freely between the two countries in response to differences in economic performance.  In those days, of course, both countries traded primarily with the United Kingdom, and trade between them was not overly important.  Some of the shocks –  see the Australian financial crisis of the 1890s –  were nastily asymmetric.

(Here is a link to an earlier post on the longer-term developments in the NZD/AUD exchange rate.)

What about now?  We largely share the same banks, but not the same banking system (having different currencies and different regulators).  Australia is New Zealand’s largest trading partner, but it is by no means a dominant partner (and some of the trade is simply commodity exports –  oil notably –  where it really doesn’t matter if the product is shipped to Australia, or to, say, Singapore or Japan.)  Foreign investment flows are substantial, although in terms of Australian foreign investment in New Zealand the largest single component is the banks.

Klein argues that we do just fine with separate currencies, but I suspect he undersells the possible costs and benefits in the economic case for a common currency.   If the NZD/AUD is typically one of the least variable of New Zealand’s exchange rates, it is much much more variable than the exchange rate between, say, the Netherlands or Germany.  In just the last three years, the monthly average NZD/AUD exchange rate has fluctuated between 79c and 98c –  a difference of around 25 per cent.  Commodity exporters in the two countries have to live with that sort of variability (and more) in world markets for those products, but in the rest of tradables sectors most of the pricing variability comes through the nominal exchange rate.  Economists haven’t been very successful in identifying the empirical magnitudes of the costs of exchange rate variability, and Klein usefully reminds us of the cases of Hungary and the Czech Republic which, even with floating exchange rate, have become highly integrated with Germany (gross exports to Germany in excess of 20 per cent of each country’s GDP, compared with well under 10 per cent of New Zealand’s GDP in exports to Australia).

Nonetheless, it doesn’t seem plausible that the degree of variability in the NZD/AUD exchange rate is not reducing the amount of trade between the two countries to some extent.  Much of the integration of Hungary and the Czech Republic with Germany is, as he points about, about large scale FDI by the highly capital intensive (and highly internationalised) German car industry –  a scale of manufacturing that neither New Zealand or Australia has.  Fluctuations in the exchange rate can be managed within the balance sheets of the car companies themselves (and for them, FDI is often a way of managing the variability of exchange rates).  But that is not an option for smaller producers.  Typical Australia firms considering supplying New Zealand, and vice versa, have to manage themselves the still-substantial fluctuations in the exchange rate, in a way that small firms in the Netherlands don’t face in dealing with Germany, or those in the South Island don’t facing in dealing with the North Island.  Physical distance is still a barrier that is not going away, but it is hard to believe that the exchange rate is not also an obstacle to growing that foreign trade.  The overall effect on potential GDP might be small, but it must be bigger for New Zealand than for Australia, and….after our performance in the last few decades, every little would help.

But the other side of the picture is interest rates.  As Klein notes, we have had similar inflation rates (actually Australia’s have been a bit higher, reflecting the higher inflation target) but real interest rates in New Zealand have been persistently higher than those in Australia.  There have been brief exceptions, but consider the current (not unrepresentative) situation: Australia’s policy interest rate is 2 per cent, and its inflation target is 2.5 per cent, while our OCR is 2.75 per cent against an inflation target of 2 per cent.  Putting an Australian interest rate on the New Zealand economy in the last 20 years would have been a recipe for rather more rapid credit growth, a bigger boom, higher inflation, and a more serious risk of a nasty economic and financial adjustment somewhere down the track..  That is, after all, pretty much what happened in Ireland and Spain, where a German (or Franco-German) interest rate was put on economies that typically needed rather higher interest rates.

It is why, unless we are signing up to a full political union with Australia, I’d be pretty reluctant to think that a common currency was a reasonable proposition, even though such an arrangement might boost real trade.  Perhaps it would be different if we’d seen a couple of decades in which New Zealand’s real interest rates had persistently averaged very close to those in Australia..  And even then, there would still be that nagging “are you sure about what you are getting yourself into”.

After all, one could easily look at France, Germany, Austria, and the Netherlands and think that a common currency and single policy interest rate worked fine there.  Real exchange rates had been pretty stable for decades (in contrast to, say, NZ/Australia or NZ/UK real exchange rates).

core RER

nz rer

But notwithstanding that, or perhaps even because of it, the unemployment rates in New Zealand and Australia have tracked materially more closely over the last 20 years or so (data for all countries only exists since 1993) than the unemployment rates of France, Austria, or the Netherlands have tracked with that of Germany.  If stabilisation is a concern –  and it is usually does count for rather a lot in modern macro and modern politics –  it isn’t obvious that the euro has necessarily been a great economic choice even for this core group of countries.  In principle, microeconomic policy can deal with these difference, but somehow New Zealand’s and Australia’s arrangement look practically better –  not optimal necessarily (few things are) but not too bad as things are.

differences in U

Then again, if your countries are merging, and becoming a single state none of that may matter.  But there has never seemed much public appetite for that in Europe, and perhaps even less now than there was six months ago.

The nation as a club?

Michael Reddell Immigration

In a moment of weakness a while ago I agreed to participate in a Goethe Institute and New Zealand Initiative panel discussion. “The Sharing Game” later this month.  Here is a link to event for anyone in Wellington who would like to come along.

The topic is written in a perhaps rather Germanic style

Sharing and exchange are basic human cultural practices. They play as big a role in poor countries as in affluent societies. But when do we share – and with whom? What social and cultural developments emerge from the various forms and manifestations of sharing and exchange in times of immigration from cultures that are foreign to ours? How is New Zealand’s face changing through an ever increasing influx from immigrants – rich and poor? Is a bicultural society a utopia?

But I take it as a discussion and debate around diversity and its implications for New Zealand.   I presume I was invited as someone who has been a bit sceptical about the economic benefits to New Zealand of our large-scale immigration programmes.  Since most of those arguments were independent of who the migrants were –  they would apply if the migrants were all from the Home Counties –  the diversity issues are not ones that I have previously focused on very systematically or for very long.

But in thinking about the topic, and reflecting on the importance of openness to new ideas in the historical success of nations, I’ve also been wondering what a nation state means today.  What, for example, if anything does it mean to be “a New Zealander”, (is it just citizenship of this legal entity)?  Are there things that unite us, and how does an immigration programme like ours affect that over time?    Is the decline of religion – itself once an expression of a society’s shared understandings – relevant to the answer?   Quite how is the distinctive position of Maori in New Zealand affected?

This post is an advertisement rather than one offering any answers.  But as I was reflecting on the issue this afternoon and reading around the (unpersuasive to me) open borders literature I stumbled on this stimulating blog post by the Canadian (but British immigrant to Canada) economist Nick Rowe on whether we should best think of the nation as a club.

Don’t think of a country as an area of land. Think of a country as a club, to which a group of people belong. Nomadic tribes were not attached to any particular area of land. Settled agriculture on scarce land is a recent and contingent fact.

Clubs provide club goods to their members. Club goods are (at least partly) non-rival and (at least partly) excludable. Mutual defence is the most obvious club good that countries provide their members, but they often provide others too.

Membership of a club brings with it both rights and obligations. Membership of a club is itself a good. It’s an asset that provides a future flow of benefits (and costs). Membership of a successful club, that non-members want to join, is a very valuable good. Should that very valuable good be priced at zero?

Open borders is not about free trade in land or labour. It’s not about physical geography. Open borders is a proposal that membership of a club be a non-excludable good, and must therefore be priced at zero. Anyone can become a member of any club, without the club being required to give its consent. Countries may not charge non-members a one-time enrolment fee (or cherry-pick applicants) to become a member. Anyone who applies for membership must be granted membership, and pay exactly the same annual schedule of dues (taxes) as existing members to benefit from using the club goods.

Rowe uses the image to build a possible case for an entry fee for migrants, perhaps a substantial one. But it is also prompts a thought around whether there is a sense in which the club has, or needs to have, some meaningful common identity or sense of purpose (the basis for the provision of public goods).  I’m not sure, but as Rowe he notes later in the comments (as much worth reading, in many cases, as the post itself).

My thoughts themselves are not at all clear on the migration question. I just think that the Open Borders people are missing some important stuff. They think of open borders as something like free trade (they say in labour, but I would say in land). But countries are a lot more than just land. Even thinking of countries as clubs seems to me to be leaving out a lot of what is important. Countries are also homes, and extended families. We are born into one, and changing countries is a big deal, both for the migrant and for the hosts (if there are a lot of migrants).

I’m a migrant myself. My views have changed over the years. I have become more small-c conservative. I don’t like too much change, and I can respect others who don’t like too much change either. Countries, and communities, and social institutions, don’t just create themselves overnight.

I find it an interesting perspective to reflect on, and to wonder about the implications of.  I’m suspect the other panellists will be more optimistic than I am, but I wonder if any will lean strongly towards an open borders approach for New Zealand?

Medium-density housing in suburban Wellington

Michael Reddell Housing

Partly in the cause of research, and partly because I have a bit more time these days, last night I went to my first ever Wellington City Council public consultative meeting.  The Council is keen to promote more medium-density housing in Island Bay (and several other suburbs).  To their credit, they have gone beyond the formal requirements of the RMA and are undertaking an informal community consultation, with information delivered to every household, very early in a process that they hope will eventually lead to a change in the district plan. I think I recall seeing a comment in the recent Productivity Commission report commending this WCC initiative.

The meeting wasn’t an edifying experience, but then I’m not sure that was a surprise.

It doesn’t help that the Council doesn’t have a great reputation in Island Bay at present, despite (or perhaps even because of ) the Mayor being a local resident.  There has been a sense of them ignoring community opinion –  the seawall, severely damaged in a storm almost 2.5 years ago, still not repaired, and a hugely acrimonious debate over a rather expensive new cycle-way which can’t pass any conceivable cost-benefit test.   All that makes for a degree of cynicism –  vocally expressed last night – about the genuineness of any consultative process.  (And all that is before one considers the folly and hubris of an organisation that wants to put tens of millions of dollars into an uneconomic airport runway extension. )

There is also a degree of hostility to the local Special Housing Area. I don’t fully understand that hostility.  The moribund buildings of a former Catholic school (closed by the church 35 years ago) are less than a couple of hundred metres from our place, and I have long looked forward to them being replaced with houses or apartments[1].   Island Bay is a popular place to live, and this private land is not currently being used at all.  If someone is keen, at last, to develop it, it might be small step towards keeping housing only moderately unaffordable.

But that is all by way of background to the medium-density housing consultation, which continues to puzzle me.  Question 1 on the WCC consultation form says “Where should medium-density housing development happen in your suburb?”, which on the one hand presumes that people agree that such development should happen at all, and on the other leaves me scratching my head thinking “well, surely on any site where someone finds it worthwhile to do so”.   And then “what standards of design should the medium-density housing meet?”, and I’m thinking “whatever works best for developers and willing buyers”.   But I’m pretty sure I was the only person in the room last night thinking anything remotely along those lines.  Not that I would be any more sympathetic if it was, but Island Bay is not some olde worlde place with uniform Edwardian architecture.  It is a pleasant mix of the old and new, where the number of dwellings per square kilometre has increased enormously in the 37 years since I first came here (through some mix of infill, new streets further up hills, and medium-density developments on several larger existing sites).

Instead, it was a case of the regulatory state run rampant (from both the supply and demand side).  The Council staff had a Powerpoint presentation which started well –  headed “Housing Supply and Choice”- but it was pretty much downhill from there.  Instead of a focus on facilitating landowner rights, consumer choice, and competition, the whole thing flow from a central planner’s identification that Island Bay is one of those places with a strong “town centre” and hence a candidate to promote medium-density dwelling.  I was trying to work out why Island Bay is identified and not, say Seatoun –  similar public transport, similar vintage houses –  and I can only conclude that it is because the latter lacks a supermarket, an anchor of the “town centre”.  It puzzles me what happens to the Council’s logic if the(small by modern standards) supermarket were to close –  or if the Council were, for once, to do a hard-headed cost-benefit analysis and close the small local library.    The local identities who have run a stationery and children’s bookshop for the last 40 years are just about to retire, and the chances of that business continuing can’t be strong.

But part of the consultation is about preparing a “plan to guide development in Island Bay town centre”.  The so-called “town centre” is perhaps 15 private shops, in a higgledy-piggledy variety of styles, several of which are threatened by the Council/government earthquake-strengthening requirements.  But why do we need bureaucrats “planning” a “town centre” to “ensure coherency across different developments and help contribute to a more attractive and vibrant centre”?    At the meeting, the bureaucrats talked of checking to ensure that “we have located the town centre in  the right place” –  to which one response might be that the market already resolved that one more than 100 years ago.  Sometimes I think I must be missing something important, but then I think it is just bureaucrats and local politicians run amok.

And the Council draws on some demographic projections for the next thirty years to argue that they need to facilitate housing for older people who will want to downsize but stay in the neighbourhood.  Quite possibly there will be such a demand –  I expect to be one of the older people, although I don’t intend going anywhere  – but when you rely on such projections, and especially when you can’t even adequately explain how they are done, you are on a hiding to nothing.  Council staff drew a lot of fire for those numbers.  Much of it was quite ill-informed, but it was hard to have much sympathy.  Inevitably, holes appear the moment you prod, ever so gently, a projection of that sort. Choice and flexibility etc should be the watchword not “we wise bureaucrats have identified this specific need 25 years hence and want to change the law now to meet it”.

And then Council staff talk of undertaking a “character assessment of the suburb”, and burble on about wanting to “make sure that all new development is high quality, the design and appearance fits in with the surrounding environment, and it can stand the test of time”.    Just like the IMF the other day, the Council is keen on only “high quality” housing, but why is that something for them to decide, rather than willing buyers and sellers?

And so it goes on.  Bureaucrats talk of a desire to “decrease private motor vehicle use” and “encourage more walking”  (and hence medium-density housing might be encouraged five minutes walk from the town centre but not seven).  What happened to facilitating choice I wondered?  Oh, and fixated on accommodating possible demands from old people, the chief planner present commented that the Council wanted to encourage medium density housing in which the core living facilities were on the ground floor.  It gets tedious to say it, but isn’t there a market test in these matters?  Dwellings that meet market demand will sell better than those that don’t.  And aren’t maximum site coverage rules one of those things that work against single storey dwellings?

So the Council staff were bad, but they met their match in the residents.  There was a strongly negative reaction to the notion that anyone outside Island Bay should have any say on the proposed changes – forcing staff to downplay the very suggestion.  There was a great deal of concern about protecting people’s house prices (up), but no apparent sense that allowing land to be used more intensively would, all else equal, make it more valuable not less.  There was concern about what sort of socially-undesirable people might move into these new dwellings (and this is one of the more left wing suburbs around), and so many demands for controls and restrictions that –  briefly – the Council staff were forced to defend the ideas of choice and private property rights.  One person was appalled at the idea of three storey dwellings – this is a suburb surrounded by, and partly built on, high hills. And not a mention from the floor – although it was hard to get a word in – of the idea that people should be able to use their own land as they liked, or of the attractions of helping keep places only moderately-unaffordable so that perhaps one day our children might be able to buy here.

Council officers were reduced to plaintive observations that “the city is growing and people have to live somewhere” (downtown high rises appeared to be the response from the floor), which I might have sympathised with were it not for the historical evidence that as cities get richer they tend to get less dense not more dense –  something the planners are no doubt oblivious to, and perhaps disapproving of.  Harder to encourage walking I suppose, as if technological change had not given us options.  The invention of the tram helped open up places like Island Bay in the first place –  otherwise it was a bit far to walk to work.

I recently criticised the Productivity Commission for the bits of its land supply report that appeared to endorse the way some (most?) Councils were setting out to promote compact urban forms (rather than to facilitate choice and respond to individual preferences).  I came away from last night confirmed in that view.  I’m all for allowing more intensive development, not just in individual suburbs but across Wellington (and all other areas for that matter).  But the pressures to do so, and the sorts of vocal clashes I witnessed last night, arise largely because Councils are reluctant to see the physical size of the city grow.  Wellington might not have much flat land –  although most people probably don’t live on flat land in Wellington anyway –  but any time I fly in or out of the place I’m reminded that it is not short of land.   Regulatory restrictions –  and perhaps at the margin the rating system –  combine to make it optimal for developers to release land only slowly, and that helps keep the price of all urban land high.  For landowners in existing suburbs part of the appeal of more intensive housing (eg infill on existing rules) is realising the value that regulatory restrictions had artificially added to land prices.  If a section on our main (flat) street, The Parade, is worth $500000 or more, subdivision and more intensive development must be attractive.  If it were worth $150000 –  which it might well be if  new building opportunities were readily available on the periphery (or in greater Wellington’s case, most actually between Wellington on the one hand and Porirua and Lower Hutt on the other)), more people would probably prefer to keep a decent-sized backyard or front lawn.  I’d probably still favour allowing more intensive development, but I don’t think we’d see much of it, especially this far from the centre of town.  Space appears to be a normal good.

As it is, the confrontations will go on.  I don’t like to predict how our one will end, but whatever the outcome the process is a pretty unedifying, and unnecessary, one.

[1] There is a beautiful chapel in the buildings, and I would be sorry to see it go. But I’d also be reluctant to see my rates used to save it, especially if doing so compromised the development opportunities of the site.

Are land taxes the answer to house prices?

Michael Reddell Housing, Taxation

I’ve been pondering a post on land taxes for some time, but was prompted to jot something down today by a couple of recent pieces, including in today’s Herald  by two lecturers in politics at AUT, Nicholas Smith and Zbigniew Dumienski.  Sub-editors present their arguments under the headline “Land tax best fit for housing crisis”, and the authors’ own conclusion is only a little more nuanced.

Given the multiple problems stemming from Auckland’s housing crisis, an LVT stands out as the best-rounded of the policy options on the table. Not only would it address house price inflation, it could also result in a more efficient use of land, mitigate urban sprawl, lower the burden on the natural environment and reduce the risk of real estate bubbles; all without undermining the foundations of economic growth.

I’m not a land tax expert, but I’m no longer so convinced.

Which doesn’t mean that I’m inherently unsympathetic to the argument for a land tax. In fact, I once wrote a Treasury paper on overall economic policy direction, that ended up on Bill English’s desk, and which was, with hindsight, rather too readily enthusiastic about a land tax.

In principle, taxing things that are in fixed supply has some theoretical and practical appeal.  Collection is pretty easy –  every piece of land has an identifiable owner.  And  whereas if one taxes business profits (say) heavily there will be less investment taking place,  taxing land won’t make much difference to how much land there is  (it will make some difference because the value of land is partly about work done to it (drainage etc).

And, of course, as the authors point out we’ve had a land tax previously –  it finally disappeared in the early 1990s, by when it apparently applied mainly to land under urban business districts.  And we still have, in effect, some partial land taxes: in some areas, local authority rates are levied on the basis of land values, and in many places (especially Auckland) even the capital value rating system have come a lot closer to a land tax as the land share of a typical “house + land” has climbed sharply.  And OECD data show the New Zealand property taxes, as a share of GDP, are already a bit above the OECD average.

property taxes

Had we put a land tax on in 1840, and kept it in place ever since, I’m not sure I’d be arguing for abolition now.  But the historical track record of the tax we had was not that good.  Apart from anything else, the rules kept changing (and changing), with the base being progressively whittled down.  Smith and Dumienski note that “it was arguably an important factor contributing to New Zealand’s once-famed egalitarian character”.  I’d be keen to see the evidence for that claim.   New Zealand economic historians, at least those I’ve read, don’t seem to have seen the land tax in quite those terms.

Any material change in the tax system involves significant redistributive consequences (or big compensation packages).    No doubt there isn’t much public sympathy for “land bankers” in and around our cities (and since these people are mainly profiting from other regulatory distortions, I wouldn’t have much sympathy either).  But what, say, about the sheep farmer, in an area where values haven’t been much affected by dairy conversion opportunities?

I’m also not quite sure what sort of tax rate the advocates of a land tax have in mind.  People often glibly talk (and I have in the past) of a 1 per cent annual land tax as if this is a pretty small amount.    But real risk-free returns are not what they were.  New Zealand has probably the highest real interest rates among advanced economies and a long-term real interest rate here (20 year inflation indexed bond) is still just under 2.5 per cent.  The comparable US yield when I checked this morning was 1.1 per cent, and that is now quite a common sort of rate internationally.  People (especially central bankers) keep talking about interest rates “normalising”, but real interest rates have been trending down now for decades, and no one really knows with any confidence whether the process has ended, let alone whether it will be materially reversed.   In this climate, a land tax of anywhere 1 per cent would seem quite incredibly burdensome (in a way that it might not have seemed in New Zealand in the 1990s when real risk-free interest rates were touching 6 per cent).  Even if one could make a theoretical case for such an onerous tax, the political economy suggests that it could not be sustained (and would not be expected to be sustained).

Perhaps we could have a rather lower rate of land tax?  Perhaps a half or a quarter of a per cent land tax could be politically sustained?  But then one is left asking whether it is really all worth it.  Bearing in mind that urban land is already taxed, would it make that much difference to the cost of urban land –  the issue Smith and Dumienski are driving at  – or allow a material gain in economic efficiency from shifting away from more distortionary taxes (eg lowering our high taxes on capital income)?   After all, most people now agree that the real issues around urban land prices are not ultimately the tax system, but the regulatory restrictions on land use that central and local governments facilitate.  To some small extent, those restrictions seem endogenous to land prices –  ie when land prices get sky high (or least rise rapidly) there is pressure to ease the land use restrictions. If so, perhaps a land tax would just allow Councils to keep tighter restrictions in place for longer, undermining any possible efficiency gains from a land tax.

But let’s get back, in conclusion, to the Smith/Dumienski list of benefits.  They argue that a land tax would

  • address house price inflation,
  • result in a more efficient use of land,
  • mitigate urban sprawl,
  • lower the burden on the natural environment and
  • reduce the risk of real estate bubbles;

All without undermining the foundations of economic growth.

What’s not to like?  Well, first, in principle a land tax should lower the value of land (ie a one-off shift in the price). But it is not obvious that it will have much impact on either house price cycles, or trend pressures resulting from, say, the interaction of population pressures and land use restrictions.    Perhaps the authors have in mind some more sophisticated land tax that would  effectively be  a capital gains tax, but they don’t suggest so in their article. And as we know, real world capital gains taxes don’t appear to have done much to improve the functioning of housing and urban land markets

Would it result in a more efficient use of land?  I suppose that depends on one’s model, but I’d have thought that taxing an asset will result in a more intensive use of that asset, with no necessary presumption that the more intensive use is more efficient.  Of course, it might be less inefficient than the alternative possible taxes, but that is a different issue surely?

Relatedly, if land (across the country, not just in cities) is used more intensively, why is there a “lower burden on the natural environment”?  Land in its natural state poses no such burden, but if (say) farmers need to use marginal land more intensively, to maximise profit subject to a land tax, I’m not sure why this is an environmental gain.

And I simply don’t see the argument made that to “mitigate urban sprawl” is an appropriate public policy objective.  As is well known, urban areas in New Zealand make up a very small proportion of New Zealand’s total land area, and I’d have thought that revealed preference (reflected in prices) suggested that the most valuable use of land on the fringes of cities was typically for housing, rather than for agriculture.  “Sprawl” is just the pejorative term for “space” –  most people seem to want some (and historically as cities get richer they have gotten less dense) much though the planners might disapprove of their preferences.

To repeat, I’m not in principle opposed to a land tax, but I’m:

  • sceptical that it could be imposed, in an efficient way, on an enduring basis
  • sceptical that it would allow much effective tax system rebalancing
  • and doubtful that, on the scale at which it could be imposed, it would really make much sustained difference to urban land prices, and trends in them over time.

There is no great secret to why New Zealand urban land prices are high. It is largely down to the impact of the central and local government regulatory restrictions on land use.  Far better to tackle those at source, and give freedom back to landowners.  Competitive market processes could then be expected to produce affordable houses, as they have in much of the United States (which doesn’t mean Mt Eden prices will ever be the same as Invercargill ones).    Of course, one can reasonably argue that such reforms themselves might not prove durable, and if reform were totally “open slather” that would probably be true, but whether or not we have a land tax is simply not at the heart of the urban land price issues.

I’d welcome comments and thoughts on this issue, and if (for example) Andrew Coleman, at Otago, felt inclined to add one of his occasional, typically very insightful, comments drawing on his own past work (eg here) in the area I’d be very interested to read it.

Some FSR omissions

Michael Reddell Uncategorized

Sometimes you read a document, particularly one that has interesting material in it, and react (positively and negatively) to what is in front of you.  It is harder to spot what isn’t there.

After my earlier post I went out, and as I walked the streets it struck me that I didn’t think I had seen any mention of credit standards in the Financial Stability Review.  I got home and checked.  Searching the whole document, none of these terms appeared:

“credit standards”

“lending standards”

“credit policies”

“lending polices”

In fairness, there was a brief mention of the difference between how much banks would lend thirty years ago ( in the 1980s when banks were really only just moving into housing lending) and now, but I don’t think that really fills the bill.

At one level that wasn’t too surprising –  I’ve highlighted previously how their Head of Financial Stability (and Deputy Governor) had managed to give a whole speech on housing and housing finance risks without mentioning bank lending standards.  But it was pretty disappointing nonetheless.  Bad loans collapse banks and financial systems.  Sometimes macroeconomic circumstances turn out quite differently than anyone could have expected and even what were objectively pretty good classes of loans can get into trouble.  But, mostly, the really bad losses arise from a climate in which lending standards have been pushed progressively lower and laxer.   Very aggressive lending on Irish property development springs to mind, and the policy-driven deterioration in US mortgage standards.

But if it is the sort of omission we have come to expect from the Reserve Bank, that doesn’t make it any more acceptable.  Surely we should expect our bank supervisors to have a good feel for trends in bank lending standards, and to be able to adduce evidence to support their view?  APRA manages to, so why not our Reserve Bank.  So far, they have given us no evidence of, say, a sustained deterioration, beyond the point of prudence, in the lending standards of our banks over, say, the last decade, or even just the last couple of years (the latter being the period in which they have adopted much more aggressive regulatory interventions).

Incidentally, I also checked and found that the phrases “credit to GDP” and “credit to GDP gap” did not appear –  even though I’m not aware of any systemic financial crisis which has not been preceded by a recent substantial increase in credit to GDP (increases 10 t0 15 years ago don’t count).  It was also a little surprising that the terms “exchange rate”, “real exchange rate” or “TWI” don’t seem to appear either, even though the thing that usually goes hand in hand with a sharp run-up in credit to GDP, in foreshadowing heightened risk of crisis, is a material appreciation in the real exchange rate.    In the period 2002 to 2007 we had both –  and the banks had much smaller (liquidity and capital) buffers –  and yet the banks still came through unscathed.

If the Bank can’t point to detailed prudential evidence (deteriorating lending standards) or adverse trends in the big macro indicators (rapidly rising debt etc), it is really difficult to be confident that their recent regulatory actions are necessary, and well-warranted bearing in the mind the costs to individuals and businesses, in promoting the soundness and the efficiency of New Zealand’s financial system.