Rising house prices do not make New Zealanders better off

I didn’t really read the housing section of last week’s Reserve Bank MPS – housing isn’t their responsibility and their analysis of it has rarely been up to much, often lurching unpredictably from one story to another. And their new material on house prices in each MPS only stems from the Remit change Grant Robertson foisted on them early in the year, knowing it would make no substantive difference to anything, but designed to look as though the government cared.

So it was only when the Herald’s Thomas Coughlan tweeted this chart yesterday that I noticed it.

RB house prices

The chart is prefaced with this text

The MPC sets monetary policy to achieve its inflation and employment objectives in the Remit. It considers the outlook for the housing market because house prices can influence broader economic activity, employment, and consumer price inflation (figure A5).

So we are presumably supposed to take this as the best professional view of the seven members of the Monetary Policy Committee. After all, it isn’t a throwaway line from a single member in an ill-considered press conference or interview comment. There is a bunch of different channels identified (and no obvious space constraints – they could easily have added more if they thought others were important), and nothing of substance gets into a Monetary Policy Statement without a fair degree of senior management scrutiny and review.

There are so many problems with this graphic it is difficult to know where to start. But perhaps first with the clear impression a casual reader would take away from this that the seven Robertson-appointed members of the MPC think that higher house prices are “a good thing”. After all, for most of the last decade inflation undershot the Bank’s target (unemployment lingered disconcertingly high for a disconcerting period of time too). More would have been better on both counts. Perhaps a charitable reader might wonder if the MPC really only had some short-term effects in view, but there is nothing in the substance of the chart or its title to suggest that.

And then there is the problem of the left-hand box: they start from “house prices” and “housing market activity” but these things never occur in a vacuum (as, for example, they would no doubt – and rightly – point out if they were talking about any other price (say, the exchange rate). Most often, surges in house prices (at least in New Zealand) have been associated in time with surges in economic activity driven by a range of different (policy and non-policy) factors.

But perhaps the biggest problem is with the claim – almost explicit in the top box of the second column – that higher house prices leave New Zealanders as a whole (remember, this is a whole-economy macroeconomic agency) better off. They don’t.

That they don’t, in principle, is easy enough to see. Everyone in the country needs a roof over his or her head. If I need a roof over my head for the rest of my life, ownership of one house meets my housing consumption needs. What matters is the shelter services the house priovides not the notional value the house might be sold at. Whether my house is valued today as $0.5m (roughly what I paid for it years ago), $1.75m (roughly what an e-valuer site tells me it is worth today) or $3.5m makes not the slightest difference to me. I still want to consume the bundle of services (location, size, sun etc) that this particular house provides.

Now, I might feel differently if I had a large mortgage: after all, negative equity gives the bank the right to foreclose (which can be both expensive and inconvenient), and even if the bank didn’t foreclose (mostly they don’t) it might also make it impossible for me to buy a similar house elsewhere if job opportunities suggested a move.

But this is where one needs to step back and think about the population as a whole. To a first approximation, for every apparent winner from higher (national) house prices there is a loser and for most – perhaps especially middle-aged owner occupiers – it makes no difference at all. There is no more economywide purchasing power created. And real gains that accrue to some people are offset by real losses to others. Owners of rental properties really are better off when real house prices go up. After all, they don’t own houses to live in them, but mostly for the profit they expect to make and the future consumption opportunities for themselves and their families. They can realise their gains and move on, or simply borrow against them.

But on the other hand, there are a lot of people made materially worse off by higher house prices – the people who don’t own a house now who either want to buy one in future or who are, and expect to, keep on renting. Consider someone just graduating from university who, a few decades ago, might have expected to buy a house after a couple of years working. But with real house prices in New Zealand as they are now not only does the deposit requirement push back any feasible purchase date, but the total amount of the lifetime income of the young graduate will have to devote to house purchase costs is so much greater. (Of course, real interest rates are lower than they were decades ago but recall that in the Bank’s scenario we are just thinking about house prices.) Earnings that are (eventually) used for the acquisition of a house can’t be used for other things. Earnings saved now to accumulate a deposit are not spent.

The story isn’t so different for long-term renters since in the medium-term (the adjustment isn’t instantaneous) if house prices are higher one can expect rents to be higher (than otherwise). In latter day New Zealand that has taken the form of rents holding up, or rising a bit, even as real interest rates have fallen a lot, which would otherwise have been expected to lower rents. Earnings spent (and expected to be spent) on rents can’t be spent on other things.

What (mostly) happens when house prices rise is that purchasing power is redistributed – usually towards those who have (houses) and away from those who have not (houses). Of course, it is further muddled by things like the Accommodation Supplement which shifts some of the losses onto the Crown……but that only means that taxes will be higher than otherwise in future. There is no net new purchasing power for society as a whole. (Were one inclined to an inequality story one might note that wealthier people tend to have lower marginal propensities to consume than poorer people.)

Are there possible caveats to this in-principle story? The story I used to tell was that, in principle, we might be better off from higher house prices if we all sold our houses to foreigners (at over the odds prices) and rented for the rest of our lives. But it was a story to illustrate the absurdity (and marginal relevance) of the point, and that was before the current government made such foreign house-buying illegal.

I’ve told you an in-principle story. The Bank likes to claim that the data don’t back this sort of story, And it is certainly true that there will often be a correlation between increases in house prices and increases in consumer spending. But that is mostly because – as I noted earlier – in the real world something triggers house price increases, and that something is often strong lift in economic activity and employment (in turn with triggers behind those developments). When the economy is running hot – and especially when land supply is restricted – buoyant demand, buoyant employment, rising wage inflation, increased turnover of the housing stock, and surges in house inflation are often happening at the same time. And in recessions vice versa. It isn’t easy to unpick chains of causation in the data.

Since higher house prices do not add to the lifetime purchasing power of New Zealanders as a whole, the Bank’s wealth effect story has to rest largely on some sort of view that households are systematically fooled by the house price changes. It is possible I suppose, at least the first time prices surge, but it doesn’t seem very likely. It isn’t as if surges in house prices – nominal and/or real have been uncommon in modern New Zealand.

The Bank also sometimes likes to highlight a story (it is there in that graphic) that even if the population doesn’t feel any wealthier, rising house prices might also boost consumption – at least bring it forward, without boosting lifetime consumption – by easing collateral constraints. In principle, a bank would lend even more to me secured on the value of my house than they might have done a couple of years ago. But again my ability to borrow a bit more has to be set against the reduced ability to borrow of the young graduate who now has to save even more in a deposit to get on the (residential mortgage) borrowing ladder at all. Sadly, in today’s bizarrely distorted housing market, we often find parents with freehold or lightly-indebted houses gifting or lending money to children, net effect on consumption probably roughly zero. With real house prices surging to fresh highs each cycle for decades now, it doesn’t seem that likely that many people are very collateral constrained.

For years I’ve been running a commonsense test over the Bank’s claims. This chart is of New Zealand real house prices

house prices aug 21

This series ends in December last year, so as of now we can probably think of real New Zealand house prices being four times what they were in December 1990 (I chose the starting point because that quarter was just prior to the 1991 recession getting underway, but you can see that real house prices hadn’t moved much for several years).

These are huge increases in real house prices, some of the very largest (for a whole country) seen anywhere over a comparable period (notably a period in which productivity growth was underwhelming). Were there to be much to the Reserve Bank’s wealth effects story (or its collateral constraints story) at the whole economy level mightn’t one have expected to see consumption as a share of national income rising, savings as a share of national income falling?

Of course there is all sorts of other stuff going on, but this is a really big – unprecedented in New Zealand – change in real (and nominal) house prices. But here is consumption as a share of national disposable income, back to the late 80s, just before house prices began to surge. The data are for March years.

consumption and NDI

The orange line is private sector (households and non-profits) consumption, while the blue line adds in public (government) consumption spending.

Of course, there are cycles in the series. There are two peaks, during the two big recessions (1991/92 and 2008/09): consumption tends (quite rationally) to be smoother than income. There is quite a dip in the early-mid 2000s, which can readily be shown to line up with the really big surpluses the government was running at the time – the country was earning a lot of income, but the Crown was temporarily sitting on a disproportionate share of that income.

And what of the house price booms. There were three during the period in the data (so not including the last year) – the few years running up to 1996, the period from 2003 to 2007 (particularly the early part of that period), and the period from about 2013 to about 2016. There is nothing in the consumption/savings data over those periods that would surprise someone who didn’t know about the house price surges.

And across the period as a whole, at best consumption has been flat as a share of income over 30 years of unprecedented house price increases. Looked at in the right light perhaps it has even been trending down a bit (private consumption as a share of income was as low in the March 2020 year as it was 16-17 years early when not only was the Crown running huge surpluses but real house prices were much lower.

I’m not suggesting any of this is definitive but when there is (a) no reason to think that New Zealanders as a whole are any wealthier when real house prices rise, and (b) no sign over decades in the macroeconomic data of the sort of effect the Bank likes to talk up, it might be safer to conclude that the effect just isn’t there to any meaningful macroeconomically significant effect.

Of course, as noted earlier there are all sorts of short-term correlations, typically resulting from common third factors at work, but the story the Bank seemed to be trying to tell in that graphic was neither representative of the economy as a whole, nor helpful.

The line I’ve run in this post is not new. In fact, 10 years ago now the Reserve Bank itself published an article in its then Bulletin discussing many of the same issues, and suggesting very similar sorts of conclusions (with, of course, 10 years less data). I was one of the authors of the article but – as was the norm – Bulletin articles carried the imprimatur of the Bank, and were not just disclaimed as the views of the authors.

Perspectives on New Zealand immigration policy

Several years ago the Law and Economics Association hosted an event in Wellington in which the New Zealand Initiative’s Eric Crampton and I each told our stories about New Zealand immigration policy. My account is here, and a link to the talk I gave is here.

A few months ago a couple of Victoria University of Wellington academics responsible for a Masters class (in a programme I didn’t even know existed (Masters in Philosophy, Politics and Economics)) invited us to do something similar for their class. We did that today.

My text (a bit fuller than what I actually used) is here (if Eric chooses to link to his slides on his blog I will include a link) (UPDATE: link here). My focus was solely on the economic dimensions of immigration policy, and in particular on the implications for economywide productivity (as the best proxy for whether large-scale policy-led non-citizen immigration has been beneficial for New Zealanders). My focus was primarily on the long-term programme, and entirely on the situation in normal times (ie I was not addressing the current Covid mess, which reflects poorly on the government but has no necessary connection to the appropriate medium-term approach).

My approach tends to start from a series of stylised facts about New Zealand’s economics performance in recent decades. This was the list I used this time.

But first, the gist of my story, which starts from a set of stylised facts about our economy.  Most of them are not in contention, even if the meaning and implications are debated:

  • New Zealand’s productivity growth has continued to languish, and even after the reforms of the 80s and early 90s (including a return to large-scale immigration) there has been no narrowing of the gaps. We’ve fallen further behind Australia, and increasingly behind central and eastern European OECD countries.  It would now take a two-thirds lift in the level of productivity to catch the OECD leading bunch,
  • Foreign trade as a share of GDP has stagnated, and this century has gone backwards. This in the new great age of globalisation,
  • New Zealand’s exports have remained overwhelmingly reliant on natural resources (whether agriculture, tourism or whatever).
  • Consistent with this, the rapid growth areas in our economy have been the non-tradable, not internationally competitive, sectors,
  • Also consistent with this, our real exchange rate has remained high, even as productivity has declined relative to other countries over decades,
  • Even as real interest rates have fallen, they have remained persistently higher than those in other advanced economies,
  • Business investment as a share of GDP has been weak (OECD lower quartile),
  • Indications are, globally, that if anything distance has become more important not less, with high value economic activity increasingly clustered in big cities near the major markets of the world,
  • Unlike what we see in the US and Europe, GDP per capita in by far our biggest city isn’t much better than that for the country as whole – if anything the gap has been narrowing.
  • Over the last few decades, no country has aimed to bring more migrants (% of population) than New Zealand did – although Canada and Australia have come close to matching us, and Israel too.   
  • OECD data show the NZ migrants also have the highest average skills levels (but still a bit behind natives) of migrants to any OECD countries.

Not one of the expected economywide benefits of a large-scale immigration promotion policy has shown up. Not one.   And we aren’t five years into this experiment, by 25 to 30.

I stepped through my standard arguments for why large scale immigration here may have been damaging to our medium-term economic performance. I noted that of the handful of OECD countries that have tried anything on the scale of New Zealand’s experiment (Canada and Australia and – in a slightly different context – Israel) none stands out as a productivity leader, and yet very little of the literature on the economics of immigration looks specifically at this group of countries. What isn’t always appreciated is that New Zealand has much more experience of large scale immigration and emigration (the latter, of nationals) than almost any other country – the sustained outflow of natives has been a thing since at least the mid 1970s, while our governments have actively promoted large-scale non-citizen immigration for all but about 15 years since World War Two.

When we’ve considered the economic performance over recent decades of the active immigration-promoting countries, and the countries experiencing outflows of their own people, the ball should really be in the court of the pro-immigration economists to show us, concretely, where and how large-scale immigration is lifting the productivity and incomes of the natives.   That is particularly so in New Zealand, given the disadvantages we can enumerate in advance – distance and continued natural resource reliance – and the signal implicit in the decades-long outflow of natives.

I talked about a number of other problems, and (in particular) gaps, in the existing literature before ending with this conclusion.

There might be all sorts of reasons for favouring high immigration – better ethnic restaurants[1], defence, a liking of big cities, or trains. If your country has prospered greatly, you might be happy to share the gains widely.  But the economic case for large scale immigration, as a way of boosting the productivity outcomes for natives in already advanced economies[2], looks thin at best.  Not many countries have run the experiment in modern times, notwithstanding the models that are claimed to support such an approach.  New Zealand has been at the forefront – actively promoting large scale immigration for all but 15 years since World War Two.  Unfortunately, New Zealand has had the worst relative economic performance of any advanced economy over those decades – we haven’t just come back to the pack, but now languish well down the rankings, have led the GDP per capita tables just 100 years ago (when abundant land, small population, and asymmetrically favourable technology shocks combined in our favour).

As I review the experience of advanced countries, if one wanted to take a punt on policy promoting large scale immigration (and few have) the best places to try look to be countries:

  • Close to the centres of global economic activity (whether Europe, North America, or East Asia),
  • Having experienced an asymmetric productivity shock – whether from the market or other policy reforms – favouring longer-term economic prospects in your country,
  • With economies with substantial reliance primarily on sophisticated manufactured products and high-tech services,
  • With their own people coming back home

And it looks like a highly risky strategy if your country is

  • Very far from anywhere,
  • Heavily dependent on (fixed) natural resources,
  • And has seen little sign of asymmetric favourable productivity shocks for your industries in a quite a long time,
  • Somewhere your own people have been leaving in large numbers

These look to be quite general insights.  And yet few if any of the countries that have three or four of the first characteristics have gone in heavily for policy-led immigration (perhaps Ireland or the UK might have been the closest- but UK immigration per capita was also about a third of New Zealand’s (per capita), and the UK is no productivity star).   Of the countries that went heavily for policy-led immigration, even Canada and Israel each meet only one of the three criteria – and neither can readily show the economic gains from large-scale migration. Australia and New Zealand meet none.

As for New Zealand, we can (sadly) tick all four items in that second class of conditions.  This was – and is – perhaps the least propitious advanced economy on earth to experiment with a large-scale immigration strategy.  And yet we did. If it was perhaps defensible in 1946, and optimistic in 1990, persisting now it just stubbornly wrongheaded, defying experience and evidence.    It isn’t quite as wrongheaded as a strategy to promote mass migration – however able the people – to Kerguelen, the Chathams or the Falklands, but not far short of it.  Australia has coped better with its experiment only because they were able to bring to market lots of natural resources previously lying idle.

It isn’t that people are any different here – locals or migrants.  And water still flows downhill.   But the opportunities just aren’t very good at all.  It is an old line but no less true for that: a definition of insanity is doing the same thing again and again and expecting a different result.  We’ve tried this one far too many times for our own good.

[1] I recall Eric Crampton once suggesting an Ethiopian quota

[2] The contrast, say, to the economic gains New Zealand Maori may have received from 19th C immigration.

Colonial constructs

A couple of weeks ago the Sunday Star Times had a full page article – in a Money supplement, self-described as offering “Intelligent Money News, Tips and Insight – by Jade Kake headed Debt as we know it is a colonial construct (the online version runs under the title “Maori have colonisers to blame for concept of individual debt”.) The column ends even more starkly: “Debt is a colonial construct”, observing that “the implications of which continue to be felt in the colonies”.

As it happens, Ms Kake herself could probably be described – without animus – as something of a “colonial construct”. When I looked her up it turned out she was Australian (born, bred, and educated), of parents who themselves had been born in New Zealand and the Netherlands respectively. Lots to celebrate there one might have thought, and certainly it would have been inconceivable – impossible really – prior to, say, 1769. These islands and the descendants of their first settlers had been almost entirely cut off from the rest of the world- whether people-to-people movements, trade or technologies. And one of those missing “technologies” was credit – or debt.

There doesn’t seem to be any real debate about that. Ms Kake states it herself, and when I looked up some books on the pre-contact Maori economy they all made more or less the same point. There was some gift-exchange elements, but nothing at all resembling credit/debt as it had been known for some time – rather a long time in some places – in much of the rest of the world. A few years ago there was a book by the American sociologist David Graeber called Debt: The First 5000 Years. and I’ve written here about debt jubilees from thousands of years ago But that innovation, and evolution, had completely passed this part of the world by. Consistent with the absence of so many technologies and trade here, material living standards were very low.

“Colonial” is one those ill-defined words. Sometimes it means lots of permanent settlers from abroad, and sometimes just a period of control and government by a foreign power. In New Zealand, of course, it involved both, although the control by the foreign power was very short-lived. But, as people sometimes point out, even if these islands had never fallen to any foreign power, or if there had been little or no foreign settlement, many of the technologies would still have found their way here. Credit/debt is surely one of those sets of technologies. And that is a good thing.

Ms Kake is, of course, less sure (to put it mildly). But even she doesn’t really seem able to make up her mind. On the one hand she laments the arrival of the first bank in New Zealand (an ANZ forerunner) – but interestingly doesn’t mention our first very early quasi central bank, the Colonial Bank of Issue – but by the end of her column she is lamenting what she sees as evidence that it can be a bit harder to get credit if you are “visibly Maori”. If the latter is true it is, of course, unfortunate, but then we are left thinking that really credit/debt isn’t so bad after all. It depends – on what is used for, the reasons it is taken on, the conditions applied etc etc. Hitler’s regime borrowed in World War Two, but so did our side to defeat him. But when private parties take on debt, and do so not under duress, it is generally enabling and empowering.

Could one envisage a modern technologically-advanced world without debt? One could (and I briefly did here, in a debate a couple of decades ago with a visiting monetary reformer), but they’ve tended to go hand in hand. And no doubt Ms Kake would tar arms-length equity investment – also unknown here in centuries gone by – as another “colonial construct”. One might – as I do – wish there was much less household debt (because governments fixed the land supply regulatory disaster and got house/land prices a long way down), without having any particular qualms at all about young couples being able to borrow to buy a first house (rather than, say, generally wait until they were 50+ to buy a house outright). Much the same goes for business credit. Credit/debt is a sophisticated device enabling risk-taking, enabling smoothing of consumption, and so on. Financial development tends to go hand in hand with more intensive economic development and much higher material standards of living – not necessarily causally, although there are probably causal aspects (long-distance trade tends to rely on credit, on trust).

It is simply silly to say the debt is a “colonial construct” – it was simply one of the many things (institutions, cultures, technologies) that residents of these islands got access to when these remote islands finally opened, so late, to the wider world. There was – and is – nothing particular British – or even Dutch or northern European – about debt, technology itself transferred to, refined in etc, those parts of the world from elsewhere well before anyone settled here.

There has been a bit of debate over the weekend about the legacy of colonisation in New Zealand, prompted by some remarks by National’s education spokesman suggesting that in his view colonisation had, “on balance” been beneficial for Maori. One might debate aspects of his framing, and I don’t want to launch into an extensive debate here (a couple of pieces of mine that might be relevant are here and here). But, equally, the state of economic development and material living standards tend to speak for themselves about at least some aspects of such a question.

There is a big academic literature on the influence on imperial government, colonial settlement etc on the level of (say) real GDP per capita of different countries, and I’m not going to attempt to summarise it here. My own take is that the effects of imperial rule are not that large, but those associated with colonial settlement often have been. British settlers to (say) New Zealand and Australia in the 19th century brought with them many of the aspects – legal systems, culture, education or whatever – that had then made Britain the country with the most advanced economy and highest incomes.

Here is the IMF’s estimates of real GDP per capita this year for a variety of Pacific countries.

IMF real GDP

All of these lands were governed for a time in the 19th or 20th centuries by countries from outside. Two had large scale settlement – complete with the attendant, often embodied, “institutions” broadly defined – from places that were among the very richest and most productive on earth. It shouldn’t really be a surprise that the inhabitants of those two countries now – and not just the descendants of the settlers but the descendants of the earlier inhabitants (categories now often quite mixed) – have by far the highest material living standards of any of the countries in this region (all of which had previously been largely cut-off from the technologies of the rest of the world). Of the other countries on the chart it probably isn’t a coincidence that Palau and Fiji had the largest degree of settlement of peoples from outside the region. (As far as I can see the French territories – French Polynesia and New Caledonia – would come between Palau and New Zealand on the chart, but their stories are complicated by the ongoing ties to – and subsidies from – France.)

My best guess is that if, somehow, these islands had not been settled by outsiders but had simply been governed from outside for 100 years or so – as with most of these other Pacific states – real GDP per capita here might be similar to that in Samoa. They have computers, they have phones, they have credit. But they do not have an advanced economy offering high material living standards for their people (many of whom prefer to migrate to New Zealand). There might be reasons to debate this view, but even if these islands somehow generated per capita incomes twice those of Samoa they’d still be very low by advanced country (or modern New Zealand/Australia) standards.

Material living standards aren’t everything by any means. But they do seem to count for quite a lot.

Lacking in serious analysis, not well-grounded in law

Yesterday was the Reserve Bank’s six-monthly Financial Stability Report. It might these days almost be almost better labelled the “Make the financial system ever less efficient report”, and with little real challenge or scrutiny from the assembled media.

With the Governor off sick it was left to the Deputy Governor Geoff Bascand to front the press conference. He seemed ill-at-ease and a bit uncomfortable in the spotlight – surprising in one who has held senior positions for so long – and often offered answers that were longwinded without actually saying much.

One of the questions he was asked on several occasions was about the reforms announced last week, and whether they reduced or increased the powers of the Minister of Finance and/or the Bank when it came to imposing direct controls on lending. Bascand never once answered the questions directly, delivering lines about how the new law would provide “greater clarity” but in what he said, and in what he didn’t say, he more or less confirmed the interpretation I ran in a post last week that the de facto powers of the Minister will be reduced – since the Minister will have no say on which tools the Bank can use, whereas under the ad hoc convention of the last decade the macroprudential Memorandum of Understanding between the Bank and the Minister governed that. Under the planned new legislation the Minister will be able to stop the Bank putting in place controls on broad classes of lending (eg residential mortgages) but at least under this government that will be an empty power, since the government is already content with the Bank having LVR restrictions, and the Bank will be free to apply any other controls it likes, whenever it likes. You might think that is a good thing. The Bank probably does. But it hands over much too much power to an unelected unaccountable Board.

But what I really wanted to focus on in this post was the area the Bank itself (and much of the media coverage) focused on: housing. 

You would barely get the idea from any of the material that the Bank has no responsibility for housing at all.  Its financial regulatory powers over banks have to be exercised to promote the maintenance of a sound and efficient the financial system.   And that is pretty much it.     The government is in the process of reforming the law to downplay the efficiency dimension, but (a) the law today is as it is, and (b) even under their new law the focus is supposed to be on the soundness of the financial system.   A couple of months ago, as is his right, the Minister of Finance issued a direction to the Bank requiring them to “have regard to” this government policy:

But this direction alters neither the statutory purposes the Bank must exercise its powers for, nor alters the Bank’s statutory powers.   The Governor promised that the Bank would explain quite what import this section 68b direction actually had, but it appears that that would have been embarrassing or awkward, because no such explanation is offered or attempted in the FSR.  In fact, they both misrepresent the substance of the direction, and then do more than suggest that it “aligns well with the Reserve Bank’s objective to promote the maintenance of a sound and efficient financial system”.   But bear in mind that not even the Cabinet paper that discussed this direction (and the equally empty change to the monetary policy Remit) envisaged much effect on anything much.

So we are simply left with those twin goals of maintaining a sound and efficient financial system.    But amid all their talk of housing financing restrictions, old, new, and foreshadowed, there is barely a mention of the efficiency of the financial system.   Which is probably just as well (for them) as there is no conceivable way that there most recent restrictions, described here, do anything but seriously impede the efficiency of the financial system.

The Bank hasn’t even attempted to make an efficiency case for almost completely banning any loans to residential rental property providers in excess of 60 per cent of the value of the property (all the while allowing much easier access to credit for owner-occupiers). If there are any real differences in the riskiness of such loans, not already factored into pricing and capital requirements, they are small relative to these differences in rules. So what we have isn’t a set of rules that is about either soundness (which capital requirements already manage) or efficiency – in a banking system that has proved itself robust over many years – but purely political interventions, resting on no sound statutory foundations, to attempt to skew the playing field in the housing market, consistent with Labour Party wishes and political preferences. Thanks to the Reserve Bank the market in houses will function less well, and the market in housing finance will be much less efficient and effective (and that without even addressing the “new homes” carve-outs, which again are all about politics and not at all about risk – new developments tend to be riskier – or efficiency).

Now, on a good day there are still some shreds of economic rationality and logic buried somewhere in the Bank. Deep in the FSR we find this good paragraph

I especially liked that slightly desperate footnote “see it isn’t only us”.

Now the Reserve Bank can’t fix any of that stuff – it is all about central and and local government failure – but they are nonetheless quite happy to operate beyond their legitimate sphere and powers to feed a government narrative and paper over symptoms. providing aid and comfort to the government doing little to get to the heart of the issue (the government that disavows any suggestion that perhaps house/land prices should fall). But that’s Orr for you.

Now perhaps you are thinking “but isn’t the financial system imperilled by these higher house/land prices?” Well, the Bank itself doesn’t think so and in the rest of the report they are at pains to stress how resilient the system is, how sound the banks are – even while being just about to resume their never-well-justified drive to push further up capital ratios that are, in effect, already among the very highest in the world. At the press conference, the Bank was at pains to note that the system could cope quite well with even a large fall in house prices. The Deputy Governor rightly highlighted that if prices fell recent borrowers might be in a difficult position, especially if for some reason the unemployment rate was to rise a lot at the same time but…….that simply isn’t a financial system soundness issue.

Much of the discussion in the document and in the press conference etc was about what fresh horrors – housing finance interventions – the Reserve Bank might be cooking up, in league with the government. Unsurprisingly perhaps – since they’ve wanted this tool for years – their preference seems to a debt to income limit (or a series of them, perhaps further impairing the efficiency of the system by picking favourites). Even the Bank seems to recognise that LVR limits are already so tight, especially on residential rental providers, that it might be embarrassingly inconsistent with their mandate to go further, and (sensibly) they don’t seem at all keen on banning interest-only mortgages. It is all a bit hypothetical at present – since as they note the latest LVR controls only came into effect last week – but there is no stopping a bureaucrat with an agenda (Bascand used to be regarded as a fairly pro-market economist), so we heard lots of talk about what they’d be prepared to do “if needed”. There were no criteria outlined for what might warrant further interventions, let alone criteria grounded in the Bank’s act. It really was handwaving stuff, of the sort we might once have been familiar with under people like Walter Nash or the later Muldoon.

You will note that the Minister’s direction referred to the government’s desire to support “more sustainable house prices”. The Bank has picked up that line and has clearly been toying with how to give it substance – but appeared to have made little or not progress, one of their staff even suggesting it was a new phrase and there wasn’t much research around about it. All the FSR itself says is this

FSR 21 2

And that’s it. And it didn’t seem to have taken them far. Bascand claimed to be optimistic that in time the Bank would be in a position to opine regularly on whether house/land prices were above, below, or close to sustainable levels, but he offered no real hint of what he thought sustainability might mean in this context, let alone attempting to tie it back to the Bank’s actual role, around the soundness of the system. For now – clearly keen not to get out of step with his political masters – he couldn’t even bring himself to suggest that lower house prices would be a good thing, although for some reason he did claim (on RNZ this morning) that a gradual fall would be better than a sharp one (offering no clue on why the death from a thousand cuts might be preferable, and for whom).

And, from the few hints he offered, his concept of sustainability seemed idiosyncratic to say the least. Apparently if the population was trending up it was okay for house prices to rise and stay up – quite why was never stated (and he ran this population line several times). We heard a lot about interest rates, but no real suggestion as to why low long-term global neutral interest rates supposedly mean higher house prices (they don’t seem to in much of the US, places where it is easy to bring land into development). It was just a muddle. I guess he couldn’t bring himself to say that no sustained fall in house/land prices was likely unless/until the government sorted out the regulatory dysfunction around land use, nor could he easily own up to the fact that if such laws seemed set to remain problematic then, with well-capitalised banks, what was any of this to do with the Reserve Bank.

It really was all over the place, not well-grounded in any of the Bank’s statutory roles, and yet…….these are the people the government wants to hand more discretionary power to, to further mess up access to finance. It was all too characteristic of the pervasive decline in the quality of policymakers (political and official) and policy advisory institutions in this country.

The sprawling burble continued with questions about whether banks should lend more to things other than housing – one veteran journalist apparently being exercised that a large private bank had freely made choices that meant 69 per cent of its loan were for houses. Instead of simply pushing back and noting that how banks ran their businesses and which borrowers they lend to, for what purposes, was really a matter for them and their shareholders – subject, of course, to overall Reserve Bank capital requirements – we got handwringing about New Zealand savings choices etc etc, none of which – even if there were any analytical foundation to it – has anything to do with the Bank. (He did, in fairness, note that there wasn’t much sign of strong business credit demand.) But I guess once you start down the path of the highly regulatory and intrusive state, it is hard to get free of the tar baby – in fact, bureaucratic life then selects for the sort of people who relish this stuff.

On a quite different topic, there was a box in the FSR on what was described as “Maori access to capital”. The Bank has apparently decided that, with no evidence whatever that there are distinctive Maori issues around either monetary policy or financial stability, to spend scarce public resources promoting this sort of stuff. Again, it is all highly non-analytical – no sense, for example, of why these ill-identified so-called Maori issues (in the ambit of the Bank’s functions) might be different than those of (say) ethnic Indians or Chinese, Catholics or atheists, left-handers, ethnic Samoans, women, men or whoever. It is all just a political whim, pursuing the personal ideological agendas of the Governor and at least some of his senior management (one of his offsiders has an extraordinarily political speech out this morning).

Anyway, we are told that

This work aims to use the Te Ao Māori strategy to incorporate a long-term, intergenerational view of wellbeing into the Reserve Bank’s core functions. It will also inform the Reserve Bank’s financial inclusion work and the allocative efficiency elements of its monetary policy and financial stability mandates. The Reserve Bank is treating this work as a high priority within its strategic work programme.

So with no serious problem identification, no serious grounding in the Bank’s statutory functions (which incidentally have no “intergenerational” character at all) all this is – in the Governor’s view – a high priority use of scarce public resources.

One can’t help feel that the Bank’s core functions might be in need of any spare resources they happen to have.

Holding senior officials to high standards

I’ve been bothered for some time by how lightly the Director-General of Health, Ashley Bloomfield, was excused over his lapse of judgement in accepting hospitality from New Zealand Cricket at a time when preferential access to the Covid vaccine for the New Zealand cricket team was a matter of some concern to New Zealand Cricket, and when Bloomfield himself exercises considerable clout in such matters (having both formal statutory powers assigned to him ex officio, but also being (one of) the Covid minister’s chief advisers). It wasn’t even as if this was a single lapse, since Bloomfield acknowledged that he had last year several times accepted tickets to rugby games, and yet the Rugby Union had been negotiating with the government re the ability to host foreign teams in New Zealand.

New Zealand has tended to pride itself over many years about the incorruptibility of public life. Unfortunately, we have seen too many cases over the last few decades that suggest this is more folk myth than reality, although clearly there are many places worse than us. But “many places worse than us” is simply not an acceptable standard; rather it expresses a degree of complacency that allows standards to keep slipping a little more each time, with excuses being made (“not really that big a deal”), especially for those who happen to be in favour at the time. But those sorts of cases, those sorts of people, are precisely where a fuss should be made, where mistakes or rule breaches should not be treated lightly. Integrity – and perceived integrity and incorruptibility – really matter at the top, and if there is one set of accommodations for those at the top, and another (more demanding) standard for those at the bottom it simply feeds cynicism about the political system and about our society.

What I worry about was captured quite well in a recent article in the Financial Times headed “British politics is morphing from delusion into sleaze”. Britain used to be highly regarded on this score too, but (sadly) no longer. Things seems worse there than here, but “many places worse than us” isn’t the standard we should tolerate.

I really don’t understand the near-deification of Ashley Bloomfield in some circles. Perhaps it is because I have not watched a single one of those 1pm press conferences. The man is a highly-paid very powerful senior public servant who, in the course of his stewardship at the Ministry of Health. seems to have done some things well and quite a few things not that well. But my indifference to the “cult of St Ashley” is really neither here nor there. A senior public servant could have, so to speak, walked on water, and it would still have been a staggering misjudgement to have been accepting hospitality from an organisation that wanted to lobby him/her. Even more so, when it was not just a single lapse.

When the story first broke, I lodged OIA requests with both the Ministry of Health and the Public Service Commission (former SSC) asking for copies of their policies on acceptance of gifts and hospitality. The Ministry of Health responded quite quickly and I wrote about their response in a thread of Twitter. Rather than go through all the material again, here is a copy of the thread I posted.

bloomfield 4

bloomfield 5

bloomfield 6

Good policy, simply ignored by the chief executive (Bloomfield). It wasn’t as if this was the sort of decision he’d had to make under extreme pressure or on the spur of the moment. If he wasn’t aware of his own agency’s policy – which would be pretty extraordinary – no doubt he has not just an EA but a whole office, any one of whom could have been asked to check the policy and get back to Bloomfield. He could have checked with his senior colleagues whether taking this hospitality was likely to pass the smell test. If he was still in doubt, he could have checked with his employer, Peter Hughes, the Public Service Commissioner. It appears he did none of this things, until after the story broke. From someone who has huge powers vested in them, it is not just a lapse of propriety but a stunning lack of judgement. If this is how things we come to hear about are dealt with, how much confidence can we have re other matters the Director-General is responsible for.

One hears suggestions that, Bloomfield having eventually realised it hadn’t been appropriate, all was made good by the fact that Bloomfield wrote a cheque for the equivalent of the cost of the tickets and donated it to the City Mission or some other worthy charity. In fact, that is almost pure distraction, since the money was never the main issue – on his salary he’d not have had any problems going to the cricket or rugby at his own expense if he’d wanted it (as many thousands of others did). Writing a small cheque simply doesn’t adequately deal with the inappropriate behaviour in the first place – any more than it likely would have were it to have been someone well down the public sector food chain.

Anyway, that was the Ministry of Health response. Yesterday, the Public Service Commission finally responded to my request. They provided me with the PSC’s own policies, for their staff and management, and a link to the guidance the PSC provides to public sector chief executives on such matters. I thought they were both pretty good documents.

The guidance to chief executives (of whom Bloomfield is one) is most relevant. This from the first page was just the sort of thing one would hope to see.

hughes 1

And this was pretty good to.

hughes 2

Did Bloomfield never read it?

And, slightly off topic, I was quite impressed with the austerity of this section of the guidance.

hughes 3

In some respects, the PSC’s own policies for their staff – not binding on Bloomfield – are even better.

hughes 4

hughes 5

Good stuff. The SSC policy even extends to immediate family.

hughes 6

Stringent rules, and aptly so.

So the Ministry of Health has stringent policies, the SSC has stringent policies, and the SSC guidance to chief executives is also stringent. Not one of those sets of policies should have led any employee – no matter how junior, or senior – to think that accepting sporting hospitality from entities trying to influence (“persuade, convince, explain”) the public servant would be anything close to appropriate. Such offers should have been declined immediately and repeatedly. And not necessarily because Bloomfield’s advice or decisions would have been influenced by hospitality – though as he is human too, who (including himself) can really know – but because it is simply a dreadful look, that corrodes reasonable public expectations around the integrity of the public service, all the more so in this time of Covid when the state has been wielding more extensive than usual powers, and then (somewhat inevitably) exercising discretion around exceptions to the rules.

But what actually happened? We might deduce from Bloomfield’s later comments that the Public Service Commissioner had told him his conduct in these matters had not been acceptable. But we are left to guess even at that. Perhaps defenders of Bloomfield might cite personal privacy, but when you are a very high official and you overstep the bounds in public, any rebuke also needs to be clearly visible to the public. Otherwise, we might reasonably think one of the public sector elite was looking after another of that same elite, perhaps even playing politics.

Because the political “leadership” was far worse. We – the public can’t do anything about Peter Hughes or Bloomfield – but we rely on the politicians we elect to demand high standards from the public service. And what happened in this case? Both the Prime Minister and the Covid minister did little more than laugh off these breaches, suggesting that no one begrudged Bloomfield an afternoon at the cricket after all his work. Pure distraction, pure minimisation, when the issue was never about him having a Sunday afternoon off at the cricket, but about who hosted him, and what interests his host had in influencing him.

I don’t think accepting one invitation to a sports event should be a firing offence – even for someone as powerful and prominent as the Director-General of Health. Repeat offences, as we saw in this case, do raise the ante somewhat, because they create doubts about the man’s judgement, and even about a possible sense of entitlement. David Clark lost his position as Minister of Health for offences that, in the scheme of things, were less serious, albeit embarrassing to the government.

But we should have been able to expect the Public Service Commissioner, the Prime Minister, and the Covid minister (for that matter the Minister of Health) to all have made it crystal clear, in public, that Bloomfield’s behaviour represented a serious and repeated lapse of judgement, a breach of the clear standards expected of MoH staff and public service chief executives, and that any repetition of this sort of lapse would be utterly unacceptable.

Or are the rules only for (a) show, and (b) little people?

Messing around with housing

And so yesterday we got the long-awaited government package in response to the latest surge in house prices. As a reminder, it is just the latest surge in the more than trebling in real New Zealand house prices over the last 30 years.

BIS real house prices

We know it wasn’t really a serious policy designed to fix the housing market, not just because it didn’t even address the core issue (land use regulation etc) but because the Prime Minister still can’t bring herself to say that she would like to see lower house prices – not even just reversing the rise of the last few months – and the Treasury’s Regulatory Impact Statement is headed “Tax measures to moderate house-price growth”. Add to that I’ve seen reported that Treasury expects the extension of the so-called “brightline test” to boost government revenue, when a package that actually did something about fixing the market would see that specific revenue line almost evaporate for many years to come.

There is a lot that is odd about yesterday’s announcement, including the Treasury claim (in the RIS they published) that they opposed the deductibility rule change because they hadn’t had time to properly analyse it. Even if this was a last minute idea dreamed up by someone in the Beehive – and Richard Harman’s newsletter this morning suggests not, that the idea had been under consideration at least since November – what does it say about the loss of accumulated expertise in The Treasury that they could not offer robust analysis at short notice on almost any of the myriad possible housing tax changes that have been proposed and analysed at various times over the last 20 years? Surely (a) this is core capability (especially in a New Zealand with longrunning housing policy dysfunction), and (b) the analysis involved would have been qualitatively similar to whatever advice and analysis Treasury provided on ring-fencing rental income losses only a couple of years ago?

There are two tax components to the package; the extension of the brightline test to 10 years, and the removal of the deductibility of interest expenses for residential rental landlords. The latter is the more significant measure, but I’ll come back to that.

The only good case, ever, for the brightline test was what the name implied. Using time rather than intent (hard to prove) to determine which sales of investment property were subject to tax was easier, clear and simple. If, instead, you want to tax investment asset appreciation more generally, you’d introduce a capital gains tax. Such a tax would capture all investment assets (not just a particular class the government of the day doesn’t like), and it would provide for loss-offsetting arrangements. A proper CGT is somewhat akin to the government becoming an equity partner in your assets; ups and downs (although not generally in a fully symmetrical way). You might or might not agree with a CGT, but (a) no serious person/government ever thought one was the answer to house prices (and if any did experience should have long since disillusioned them), and (b) there is no sign in New Zealand house prices (and unsurprisingly) that the initial introduction of the brightline test, or its more recent extension, made any material difference to New Zealand house prices. So there is little reason to suppose this change will either (contrary to Treasury who claim to believe it will make a difference even in the “medium term”, albeit perhaps not the long term). It will, of course, change some transactional behaviour, reinforcing a lock-in effect for some investors (and thus reducing the efficiency of the housing market), but that is a different matter than any sustained impact on prices.

One aspect of the brightline test extension I haven’t seen referred to – and is not mentioned at all in the RIS – is the interaction with inflation. Over a 10 year horizon – let alone the 20 years Treasury favoured – a significant chunk of any house price increases will be general CPI inflation (if the Reserve Bank met its target the CPI would rise by 22 per cent over 10 years). There is little serious case anywhere for taxing general inflationary gains (as distinct from increases in real asset prices/values), and the issue is reinforced by the increases in the maximum marginal tax rate to 39 per cent. Suppose the government’s policies finally got on top of growth in real house prices and the only increase in house prices was from general CPI inflation. Someone selling just before the 10 years would be paying 8.5 per cent of the value of their asset in tax even though they had had no increase in real purchasing power at all. That would be a straight confiscatory tax, even more so at the horizons Treasury favoured (where it is harder to avoid by delaying sale). And yet Treasury regards a longer brightline test horizon, with full nominal gains taxed at a higher rate as both fairer and more efficient! A capital gains tax should tax either real gains or, much less desirably, tax nominal gains at a reduced rate. For the scapegoated sector we now have nominal gains taxed at a high (and rising) rate.

What of the deductibility policy? This is, as announced, a simply bizarre policy, not helped by the egregious spin – really bordering on lies – from the government suggesting that the ability to deduct interest from gross income in calculating the owner’s tax liability is a “loophole”. It is simply standard practice, a deduction open to any business. Except, very soon, operators of residential rental businesses. In many firms, in a wide variety of sectors, interest is a cost of doing business.

I can think of three bases on which a policy change around deductibility might have made sense. There is a decent argument that, for tax purposes, no interest paid should be deductible and no interest earned should be assessible. But that would involve universal application. There was an argument that some (from memory including Don Brash) used to advance that with no tax on capital gains, perhaps interest on investment property should not be deductible. But extending the brightline test to 10 years substantially undermines that argument for houses…..leaving it more potent for other assets (eg farm land) to which deductibility has not been limited. And that argument that I find most appealing – and which from memory the Reserve Bank used to favour – was that some proportion of interest deductions were really just inflation compensation, and didn’t really amount to a real expense (just maintaining the real value of capital). But that would argue for a symmetrical treatment of interest income and interest outgoings, and for a comprehensive approach, not just one picking on a current government scapegoat. Had the government been serious about rigorous reform that improved, not worsened, the tax system they could have foreshadowed that sort of change. At present, with interest rates so low, it probably would have reduced by about half the extent of interest that could be deducted.

(The “loophole” argument appears to be based on the fact that owner-occupiers cannot deduct interest. It should barely need saying that owner-occupiers are also not assessed for tax on the imputed rental value of living in their home – nor, of course, (generally) are they subject to the “brightline test”. Whenever there have been serious suggestions of taxing imputed rentals it has been recognised that interest deductibility would need to be introduced as part of any such mix. )

There seems to be a range of views around about what impact the deductibility change will have, especially on house prices. Westpac appears to mark out one end of the range, suggesting in a bulletin yesterday that house prices could settle 10 per cent lower over the longer-term with the potential for “much greater effects” in the shorter-term.

As they note, the Westpac economics team – their chief economist is currently on secondment to The Treasury – have long been advocating a model of house prices in New Zealand that emphasises the power of tax policy and tax policy changes to affect house prices. I’ve long been sceptical of that sort of story (and to refresh my memory dug out notes I’d written on the specific role of tax while at both the Reserve Bank and the Treasury). A paper with a very similar approach to the Westpac one was published as a Reserve Bank discussion paper some years ago, and it has a useful table (page 14) looking at the way in which various variables, including tax ones, affect the price various classes of potential purchasers (leveraged, unleveraged, investors, owner-occupiers) will be willing to pay for a house.

I’m no more convinced this time that tax (or regulatory) changes will have a large effect on prices (and a 10 per cent longer-term effect is quite large) than on previous occasions. One might expect some difference in what type of entity owns the property, but even then it is as well to be cautious. Just a couple of years ago, the ability to offset rental losses against other income was removed, and I’ve seen little in the way of analysis or argument suggesting that had very much effect at all, in prospect or in realisation. But if we go back further, there was little sign that the increase in the maximum marginal tax rate in 2000, foreshadowed with certainty for at least a year, gave a big boost to house prices (as the model predicts, because interest deduction is more valuable) or that the reversal of that increase a decade later cut house prices. The arbitrary removal in 2005 of the ability to deduct depreciation – on houses (as distinct from land) – didn’t seem to have a discernible sustained effect. The PIE regime, which worked against individual landlords, had little obvious effect. And going back further there is even less sign of such effects as decades earlier maximum marginal tax rates rose to 66 per cent, and then fell again, when inflation raised nominal interest rates (increasing the value of the interest deduction) or when ring-fencing was abolished in the early 80s and reinstated in the early 1990s. I’m also sceptical because we can see the huge divergence in house price outcomes in US cities, with fairly similar tax codes and banking practices across them, in ways that point to land use restrictions – and the long-run supply price of new houses – as the more important explanatory factor.

Perhaps this time will be different (although, almost inevitably, we will struggle to know, trying to unpick all the competing influences. Presumably some holders of investment properties will take the opportunity to sell now. Quite probably yesterday’s changes will help bring forward the temporary pause, or perhaps even pullback, that was always likely before too long (with no population growth, much tighter LVRs, perhaps a (irrational) ban on interest-only lending, perhaps even some lift in term mortgage rates etc). We’ve seen such pauses before and will no doubt see them again. But the supply/land issues have not been tackled.

It is worth noting that under the sort of model Westpac (and the Reserve Bank, see above) used, the purchaser willing to pay the highest price for a house was………..not the highly-leveraged investor but the unleveraged owner-occupier. That was so back in 2008 (when the RB analysis was done), reflecting the fact the imputed rental income is not taxed (and such purchasers have no interest payments). The difference is greater now – even prior to yesterday’s announcement – because owner-occupiers don’t have to worry about the brightline tax, while any investor – even if iniitally intending to hold for more than five years, rationally has to factor in a probability of seeling earlier.

Perhaps a little surprisingly (my notes record that it was so to me) is that the group next most willing to pay is the unleveraged investors. They do pay tax on their rental income, but – like the owner-occupiers – they have to think about the opportunity cost of their money, which has to be invested somewhere. Deposit rates are typically a lot lower than mortgage rates, and one will pay a price to avoid being stuck in deposits. Heavily-geared landlords (and remember, they can now borrow only 60 per cent from banks) come in only third. Of course, there may be times when highly-leveraged landlords are key marginal players – quite plausibly the last few months, especially when dealing with a temporary lifting of financial repression targeted at such people – but it wasn’t the general case, even pre-brightline.

One of the uncertainties, of course, is to what extent rents rise in the wake of this change. There is a lot of headline coverage of that, but the honest answer is that we don’t really know (although, again, the nature of the effect should be similar to that for ringfencing, albeit potentially on a larger scale). I’m a little sceptical as to how large the effect will be – notwithstanding the buffering the Accommodation Supplement provides – because if leveraged landlords were able to recoup all/most of their increased costs, that would leave excess expected returns on offer for unleveraged landlords (who are not directly affected by the loss of deductibility). Owner-occupation certainly hasn’t got easer – relative to six months ago LVR controls are back and prices/deposit requirements are higher (or even on Westpac’s take no lower) so I’d expect the biggest difference to be a shift over time from more heavily leveraged landlords to less-leveraged or unleveraged landlords, perhaps with a relatively modest (sustained) rise in rents.

This is, of course, then a policy that skews opportunities away from those needing debt finance (it explicitly no longer treats debt and equity similarly, previously one of the strengths of the NZ tax system) and they tend to be….the new entrants and more-marginal players. In favour of old money, institutional investors etc – who have pools of money that need investing. Now if you are a central banker you might think less leverage was “a good thing” (although that is what capital requirements are for) but it isn’t obvious that is so more generally, given the rigged land market. As Adrian Orr used to say – back when we were analysing housing options at the Bank 15 years ago – many of the leveraged investors are people like (his example) firemen, with a modest salary and using leverage – where it is available with good collateral – to get into an investment property, doing maintenance etc on their days off, getting a foot on the ladder (and some “forced savings” too). It was like that for a long time, whether or not real house prices were rising strongly.

Officials and ministers – especially Labour ministers – really don’t seem to like those sorts of people, and the sort of housing supply that results. Over a couple of decades now policy seems to have been set increasingly in ways that will have the effect of driving these small, initially quite leveraged, players from the housing field. In some cases that has seemed deliberate – including from some who really think home ownership isn’t something people should reasonably aspire to, and that long-term renting is some sort of Germanic ideal – in others just a side effect, but the direction is pretty clear: they favour institutional savings, not individual, and institutional (or large scale) rental providers not individual ones. And so the policy system – which 30 years ago treated these groups neutrally – no longer does. PIEs are taxed less heavily than individuals. Increased regulatory burdens (as ever) favour large players not small. Taxes based on realisations favour large unleveraged players, since they are less likely to be forced to sell, and have future gains to carry forward losses against). And now this egregious new distortion favouring equity over debt in rental housing. I don’t have any problem with institutional and corporate providers of rentals, but it should be an outcome of choice , enterprise, opportunity etc, not regulatory and tax distortions secured in their favour. Worse still, of course, is that if this latest package really does impair the availability of private rentals it will just strengthen the argument on the left that the state should be a much larger rental provider. There is a role for state rental dwellings, for a very small minority of troubled people, but in a functioning land and housing market there would simply be no market failure justifying such an intervention.

And a functioning land market – where there is aggressive competition among land providers/owners and genuine choice for potential purchasers between options on the periphery and options at greater density – is how unimproved outer-urban land prices should once again be somewhere near the price at the best alterative use (mostly farming presumably), not driven higher by artificial regulatorily-supported interventions. But such a market is what the government seems utterly uninterested in providing. The alternative – increasingly messy interventionist version of the status quo – appeals to the Greens and the statists, but it shouldn’t appeal to New Zealanders who care about their children becoming self-sufficient and able to meet the simple aspiration – readily achievable in a land-abundant country – of being able to purchase a basic house in their 20s.

Sadly, whatever was going to happen to house prices over the next three to five years anyway, it is hard to think that after some initial disruption, yesterday’s package will make very much sustained difference to prices at all. But I guess it will buy some political time and ease the headlines; today’s substitute for serious courageous leadership. Fixing the land market (and indexing the tax system) is still an option for some real leader, some day. If only.

Free up the land

I suggested on Twitter yesterday that the Green Party’s new housing policy – as articulated on BusinessDesk here by Julie Anne Genter – was absolutely right about the urgency of the issue (actually reform has been overdue for the best part of 30 years) and the need for boldness, but quite wrong about proposed policy responses, which seemed to tackle symptoms while failing to get to the heart of the matter. BusinessDesk invited me to submit a piece offering my solutions. That column came out this afternoon, and is here (not behind the paywall).

Since people tend not to click on links, and I haven’t given the copyright to BusinessDesk who published it a couple of hours ago, I’ve set out my full text below.

Bear in mind that I had only 800 words. That meant I had no chance to do anything much more than set out the key points of my own proposal – even then briefly – and in particular could not defend claims like “Banks aren’t the problem, and the tax system isn’t the problem either.   Nor are those popular scapegoats, “landlords” and “speculators” “, or elaborate on a whole variety of points, and qualifications, that a fuller treatment of the issue would warrant. I’ve dealt with many/most of those points here over the years, often at length, but might take the opportunity next week to do a further post, with commentary on each paragraph elaborating (or where necessary qualifying) various points and arguments.

In a way, my bottom line is in the second to last paragraph. With structurally record low real and nominal interest rates, houses and housing (two different things) really should be cheaper than ever in real terms. That they aren’t is the choice – active and passive – of successive waves of central and local government politicians. The current wave is currently responsible, and sadly they – especially the Prime Minister, who has the most say (and an absolute majority) – show no serious interest in the sort of better, much cheaper, outcomes – sustained over the longer-term – that are quite possible.

Free up the land

Real house prices have more than trebled in the last 30 years.  The most recent surge is just the latest in a series that result directly from the choices of successive central and local governments.   And what choices mattered most?   Land use restrictions, in a country with so much land that our urban areas cover only 1 per cent of it.    When people talk about real house prices having skyrocketed, mostly what they really mean is that the price of the land under the house has gone crazy.

Unfortunately, all indications are that the sorts of the things the government and the Reserve Bank  are considering will just paper over a few more of the cracks and not address the real issues.  Banks aren’t the problem, and the tax system isn’t the problem either.   Nor are those popular scapegoats, “landlords” and “speculators”.

One way of seeing this is to look at the United States, where the regions all have much the same banking and tax systems, but often quite different land-use regulatory regimes.   Some big growing cities there are among the most expensive places on earth – like Auckland and Wellington – while others have price to income ratios that are low and haven’t changed much over several decades.  They also tend to be the places with the highest rates of owner-occupied housing.

 So, what urgent steps should the government be taking?

First, legislate now to establish a presumptive right for any landowner to build as many single or two storey dwellings on any land they own, anywhere.    Aggressive competition among landowners on the fringes of our cities and towns, scared that they will miss out and that development will happen elsewhere, is what would underpin much lower urban land (and house) prices.

Second, empower groups of existing landowners in built-up areas (perhaps at a block or individual part of a suburb level) to determine – by super-majority vote (perhaps 75 per cent) – how much, if any, additional density they want to permit on their land.  Vote for greater density and they can capture any gains from land made more valuable as a result (which might not be large outside central city areas if new land can easily be brought into development). If not, respect those groups of landowners’ preferences.  

Third, the Prime Minister needs make it a personal priority – featuring prominently in all her communications – that house and urban land prices should fall very substantially and stay down. Serious reforms happen, and are followed through on, when Prime Ministers believe in them and commit their skills and political capital to making them happen.  We can’t have any more of senior political figures (both sides of politics) feeding a narrative that house prices should always trend up.  They shouldn’t. 

Asset markets trade on expectations, and no smart purchaser one is going to be keen to pay ever higher prices today when there is a serious chance, by actual reform now and evident political commitment, that the asset will be much cheaper a year from now.   

Fourth, as too many ordinary families – just wanting a place to call their own – have been caught in this government-facilitated mess, establish a partial compensation scheme for owner-occupiers (only) who have bought in the last decade and who sell in the next decade.  It won’t be cheap, but neither are the economic and social costs of the mess governments have got us into, that among other things has young people convinced that what should be a normal aspiration – buying a first house in your 20s – is now some unattainable aspiration, reserved for the offspring of the rich.  Stabilising prices now and hoping low inflation does the job over decades is no adequate substitute for proper reform.  Our young people deserve much better.

Real interest rates having been falling for decades, and are now at lows not seen persistently in a very long time, if ever.  If we had functioning markets in land and housing, that should mean houses and housing that are cheaper, in real terms, than ever.  It takes time (and a lot of money) to develop subdivisions, it takes time to build houses, and the interest costs of doing so are lower than ever.  Rents are the cost of using a long-lived asset for a period of time, and the alternative investments (bonds, term deposits) now yield less than ever. And yet because governments make land artificially scarce, house/land prices continue to push ever higher, and rents themselves are unconscionably – utterly unnecessarily – high.    

Reform should be about getting housing/land markets functional again, partly compensating some of the losers, and making housing once again something that young people don’t need to worry much about, all without messing up access to finance.  It is about fixing injustice now, and rooting out the systematic disadvantage, working against the young and the poor, that governments themselves created.

Not really

Late on Friday afternoon I saw a tweet from Stuff politics and economics journalist Thomas Coughlan linking to a new and substantive article he’d written under the headline “Reserve Bank repeatedly warned Government money printing would lead to house price inflation”. Several other journalists who’ve each had a bee in their bonnet about the Reserve Bank’s asset purchase programme weighed in in support. None of them is too keen on Grant Robertson, and so it was presented as if they’d found evidence that the Minister of Finance had spent the year ignoring things that were not only totally predictable, but of which he had been advised by his officials. The Bank knew (we are told), as did The Treasury, but Robertson fiddled while Rome burned. Or so the story goes.

Now I yield to no one in my distaste for this government’s 3.5 years of appalling indifference to the unnatural disaster that is New Zealand house prices. But on a first glance the Stuff story didn’t seem very plausible – even noting that Coughlan was drawing on papers he seems to have obtained from The Treasury (and which, to his credit, he provided links to). However, it was Friday afternoon and my appetite for chasing these things down isn’t what it once was. So it wasn’t until yesterday that I read carefully the article, and the official papers Coughlan cited.

Coughlan links to three official papers. The first of these is a joint paper from the Reserve Bank and The Treasury dated 29 January 2020 addressed to the Minister of Finance on “Institutional Arrangements for Unconventional Monetary Policy”. I’d be surprised if the Minister paid much attention to it at all, for several reasons:

  • it was more than 20 pages long,
  • it was signed out by two fairly junior people (one on each side of the street), and
  • all it asked was for the Minister to agree that officials keep working on the issues (not the substance of so-called unconventional monetary policy, but “institutional arrangements” for something officials explicitly say is a low probability event any time in the following two years).   The intention at the time was a report back by the end of July.

But even if the Minister had read, marked, and inwardly digested the full report, what else would he have found?

Coughlan notes that the report says that “as these tools have never been used in New Zealand before, the magnitude of the macroeconomic stabilisation benefits is highly uncertain”.  Well, indeed.  But what of it?  In fact, at least one of the tools on the list has never been used anywhere, so it is hardly surprising no one could be confident what effect it might have.   It is the sort of boilerplate statement that, in a report of this sort, any reader will quickly pass over.

Then we learn that “although UMP tools entail many of the same trade-offs as conventional monetary policy, the scale of the tradeoffs can be larger with UMP.  The trade-offs include fiscal risks, financial stability risks, distributional impacts, and the impact on financial market functioning”.  Not that the operative word is “can”, and the list of “tradeoffs” is still very generic.  However, officials refer to a Figure A.  In this table the orange-coloured items are “the more significant trade-offs”, and this box (below) is about the class of tools labelled “Large scale asset purchases, including domestic government bonds, foreign currency or foreign government bonds, and corporate bonds.


Note that

  • there is no mention of house prices at all
  • the observation is about what “may” happen, not what will happen
  • a reasonable reader might reasonably suppose that officials were talking mainly about bidding up the price of assets the central bank was purchasing in such operations –  the most obvious “more directly” effect, since conventional monetary policy doesn’t work by buying assets outright but by setting an overnight deposit rate.

And that is about it in the body of a 20+ page document.  There is, however, an Annex about specific possible tools.  Do Ministers read Annexes at the end of 20 page documents?  Not often is my guess, especially when all this is about hypotheticals (so officials were telling the Minister), and when the paper is about institutional arrangements not details of tools.    But had he got that far here is what the Minister would have learned from his officials about asset purchase programmes.

Not only is there is no reference to house prices at all, but officials explicitly tell the Minister that in a New Zealand context a lower exchange rate is likely to be the main transmission channel.

So that was the 29 January paper. One might reasonably criticise both officials and the Minister for the lack of urgency by then (Wuhan was in lockdown, the Ministry of Health had deemed the coronavirus a serious issue, and the NZ government was days away from stopping arrivals from China…….oh, and the Bank/Treasury had had 10 years to prepare for a crisis in which the OCR hit zero) but one could hardly say Grant Robertson was now fixed with knowledge that if monetary policy was eased in the next downturn house prices would go crazy. No one was proposing the Reserve Bank buy houses, and house prices weren’t even mentioned.

The next document Coughlan cites is a short aide memoire from The Treasury dated 9 March 2020, prompted by the speech the Governor was to give the next day on unconventional monetary policy. It is titled “Update on work on institutional arrangements for unconventional monetary policy”. There is no analytical substance in the note at all (nor would one expect there to be). It does note that the risks of needing unconventional tools at some point had increased due to Covid-19, but there was no sense of urgency, and officials simply noted that they were bringing forward the report-back date for some bits of the institutional arrangements work to the end of May. I count that as pretty damning – this was, after all, only a week before the MPC (with the Secretary to the Treasury sitting on it) finally confronted reality and cut the OCR sharply, and instituted a floor (OCR at 25 basis points) that not even Treasury seems to have envisaged, but none of this has anything to do with house prices, distributional effects, or the like.

The third paper is dated 16 March and is an aide memoire from The Treasury on large scale asset purchases, the MPC having announced that morning that the LSAP would be next cab off the rank if the Bank considered more policy support was needed (note that the Minister’s own Covid-response package was to be announced on 17 March). Unsurprisingly perhaps, there isn’t anything new in this note either. House prices, for example, are not mentioned at all. There is something similar to the bit from the January paper about how the portfolio rebalancing channel might “push up the price of a range of assets, helping to flatten yield curves” – a phrasing that clearly has in mind simply bidding up long-term bond prices – and a repeat of the point that the exchange rate effect might be particularly strong in New Zealand. (At this point, Treasury still doesn’t seem to have envisaged that the government would be issuing so many new bonds that total private holdings might not drop much, if at all.)

And a little later there is the repeat of the distribution line: “LSAPs have many of the same distributional impacts as conventional monetary policy, but can raise asset prices more directly than conventional monetary policy, creating wealth inequality. However, they can also mitigate inequality by supporting employment.”. One might challenge some of the Treasury’s economics, but there is no reason in any of this to think (or for the Minister to think) that they were referring to anything other than the direct effects on prices of assets the Bank itself might purchase. And no one was suggesting houses for that list.

And that is it. That is the set of documents Coughlan claims show that the Minister of Finance was repeatedly warned that asset purchases would send house prices further into the stratosphere. It seems like very slim pickings to me.

Of course, we don’t know what the Secretary to the Treasury and the Governor may have said to the Minister in their private conversations with him. But we do know quite a lot about the Bank was saying in public.

For example, there was that long speech (19 pages) that the Governor delivered on 10 March – when he was also doing everything possible to play down any sense that monetary policy might need to do anything soon. It was sold as some sort of framework for thinking about monetary policy issues and options when the OCR had got to, or very near, zero.

The Governor tells us about a BIS assessment of other countries’ asset purchase programmes

and something of the Bank’s own thinking (emphasis added)

and then something that looks a bit more directly relevant

But note that (a) here he refers to both low global interest rates and unconventional monetary policy, not just the latter, and (b) Figure 5 actually shows that house prices (and share prices) in New Zealand had increased more in New Zealand over the last decade than in advanced countries as a group (many of which had used asset purchase programmes).

The very next paragraph reads as follows

Not exactly some sort of smoking gun, and certainly no sense that the Bank thought that launching an LSAP early in a severe downturn would send house prices further into the stratosphere.

In fact, the Governor helpfully included this chart showing how the Bank thought the transmission mechanism would work

It is quite a complicated chart but note that (a) there is no channel to house prices that is different from the way they thought normal monetary policy works (ie through lower interest rates) and (b) the only separate channel they highlight in regard to an LSAP tool is the exchange rate.

On the final page of his long speech the Governor wraps up this way (again, emphasis added)

The Governor had his bases covered with a long list of issues, but note that even that final warning is (a) not specific to an LSAP tool, (b) never – as with the rest of the speech – mentions house prices, and (c) seems to be talking about prolonged period effects, not those in the first few months after an intervention.

Quite possibly the Minister of Finance didn’t read this speech either, but had he done so he’d still not have been fixed with the sort of knowledge, and implied guilt, Coughlan claims.

One could go on. One could look back to the Bank’s significant Bulletin article in 2018 on monetary policy options. It was a careful survey of some of the issues and overseas experience, but on skimming through it again I didn’t see references to house prices. Or the Governor’s substantial Newsroom interview in late 2019 – the one in which he expressed a distinct preference for a negative OCR over LSAP-type tools – where there was also no reference to house prices.

Or, since Coughlan claims the Minister was fixed with knowledge and that the Bank had clearly advised him, we could look at the Bank’s own Monetary Policy Statements last year. In May, for example. when it was still early days, but when the LSAP had been deployed and the OCR been cut, the Bank’s baseline scenario was that house prices would fall by 9 per cent over the rest of 2020. In August, several months on, they noted that “accommodative monetary policy is supporting household spending by limiting house price declines”. They weren’t telling the Minister of Finance the LSAP would cause house prices to explode because…..that wasn’t their view, and at most they thought all their interventions were limiting house price falls (as one would expect – see transmission mechanism chart above – with conventional stabilisation monetary policy).

One could go on. There are other telling quotes from the Governor and other senior officials – although of course never from external MPC members who exist, if at all, in some sort of purdah – and the actions of the Bank (eg suspending LVR restrictions) or the rolling out of stress test guesstimates based on falling house prices.

There is simply nothing in the paper trail to suggest that the Bank (in particular, but probably Treasury too) was vigorously highlighting to the Minister of Finance that if they were let loose with the LSAP tool house prices would starting rocketing upwards again. They just weren’t. (And for what it is worth, the Bank’s survey of expectations – mostly of economists – through last year consistently had house price inflation expectations at or below the expectations that existed at the start of last year.)

Now it is of course true that house prices have gone crazy again (yesterday a real estate agent put a brochure in our letterbox telling us of this little Island Bay house – 112 square metres of house, 259 square metres of section, no view – that just sold for $1.4 million). In a better world – more knowledge, more good analysis – our officials and economists would have anticipated such an outcome. But they (well, we) didn’t. Speaking only for myself, I expected that as in most recessions we would see a fall in house prices that wouldn’t last that long, or be that deep, but might take a few years to reverse. After all, in typical recessions (a) interest rates fall, often more than they did in 2020), (b) bank lending standards often tighten (as the survey suggested they did last year), and in this downturn the net inflow of migrants was also likely to be disrupted.

There are people – on both the left (including the journalists I mentioned earlier) and on the right – who want ascribe a lot of the blame (the different than normal outcome) to the LSAP. There is much use of the loose, and not very accurate, term “money printing”. In this lecture late last year I told my story on why I’m convinced that what is little more than a large scale asset swap (two very similar assets, differing only by maturity date) is not having much macro effect at all. And I echo the Reserve Bank’s own repeated view that to the extent the LSAP works it does so by lowering interest rates, and the fall in interest rates in not unduly large, or larger than the Bank’s own published forecasts repeatedly suggested was needed for macro-stabilisation purposes.

I’m not that confident of my own story, but for now it would emphasise macroeconomic forecasting errors. To date, and for reasons that still aren’t clear, the economic rebound has been much sharper than any forecaster – but notably the RB and the Treasury – expected. Perhaps that will last, or perhaps not, but for as long as it does, in an environment where governments keep land artificially scarce, people are more likely to be willing to bid house prices to even more outlandish levels than would have seem plausible when the Bank and Treasury were advising the Minister in the first half of last year of the likelihood that the Covid downturn would be quite deep and quite enduring.

(Of course, adding further distortions to the once-functional market for housing finance, pursuing political agendas more than hardheaded assessments of risk as with the RB’s new LVR controls announced today, can dampen some of those house price pressures for a time. But the solution to the house price debacle still lies where it always did, with the central and local governments that continue to make land for development artificially scarce in a land-abundant country. Blaming the Reserve Bank, blaming the banks, blaming the tax system, or blaming anything else is really just distraction.)

Not doing their core job

This isn’t going to be one of my usual lengthy post-MPS posts. I really just wanted to make one point about the disconnect yesterday between the words and the actions of the Governor and the MPC.

There were more than a few good words and phrases from the Governor, and even a few in the document itself. There was, for example, the reiteration of the MPC’s so-called “least regrets” framework, under which for now they say they’d rather run the risk of inflation being a bit high than run the risk that they (continue to) undershoot the target the government has laid down for them. And there was the Governor’s response to Stuff’s Thomas Coughlan about whether the Bank’s new mandate – the employment bits – had made any difference to monetary policy decisionmaking this year: he said not, since both unemployment and inflation indicators/outlooks had pointed to the need for much easier monetary policy, even highlighting the risks of inflation expectations settling below target. On Radio New Zealand this morning, Orr even allowed himself to say yes when asked if monetary policy would do “whatever it takes” to lean against a cyclical economic slump.

All of which sounded great. It was pretty much standard inflation-targeting cyclical stabilisation stuff, especially when overlaid on a background of the last decade when – as the Governor put it – central banks hadn’t demonstrated such a good track record in getting inflation back up to the target (recall that in our case in particular that target is set by elected governments, and that set by the current government is much the same as that of their predecessors.

But what do the MPC’s forecasts show? Recall that these published forecasts include all the expected effects of the monetary policy stance announced yesterday (although perhaps not the proposed new LVR controls), including the new Funding for Lending scheme (which, as the Governor noted, the Bank thinks market pricing for retail deposits has already anticipated).

Here are their CPI projections.

RB forecasts CPI

Inflation does not get back above 1 per cent – the very bottom of the target range – for two more years, at which point it will have been more than 2.5 years since the Covid-related severe downturn got underway. It is three years from now until inflation is forecast to get back to 2 per cent.

What about the unemployment rate, still probably the best indicator of excess capacity (at least in a forward-looking context)? They expect that the unemployment rate will keep rising and will be still 6.3 per cent by the end of next year. And at the end of 2023 – more than 3 years away – they still think the unemployment rate will be 5.2 per cent, barely lower than the current 5.3 per cent. Their output gap estimates for the year to March 2022 are slightly larger (negative) than their – inevitably wildly imprecise – estimate for the latest quarter.

And then there are inflation expectations. In a distinct step forward yesterday there was quite a bit of discussion of inflation expectations in yesterday’s MPS, including in the minutes of the MPC meeting. At least some members must be getting quite worried, even if staff gallantly try to play down the issue by refusing to engage with direct estimates of breakeven inflation from the government (indexed and conventional) bond market.

They included this chart in the document

RB inflation expecs nov 2020

On this measure – which deliberately excludes all market-based measures – inflation expectations are below target for the next several years and well below the target midpoint. The longer those low expectations persist the harder it will be for monetary policy to do its job. (Note that the latest of the RB’s own expectations surveys still has medium-term inflation expectations well below target, even though respondents now believe the OCR will be taken negative next year, and presumably included that expectation in their in responses about inflation too.)

And yet what did they do in response to this outlook? Nothing. Simply nothing. And in the process pushed the exchange rate – usually a key adjustment mechanism in New Zealand downturns – even further above the level it was, whether yesterday morning or at the start of the year.

There is simply no sign that they take their own rhetoric seriously. There is no sign of a central bank acting as if it really believes it would be better to run the risk of a temporary overshoot of the inflation target. There is no sign of a central bank that acts as if it thinks cyclical unemployment is a scourge that should be countered aggressively, at least while the inflation outlook allows it. And there is no sign of a central bank acting as if it takes the slump in inflation expectations as something it needs to take seriously.

Instead they are content with rhetoric (sometimes quite good rhetoric) and handwaving, and throwing around big dollops of money in ways that make little useful difference (and whatever good effects the Bank thinks those tools are having are already baked into the forecasts). Oh, and of course no serious accountability either: it is now 19 months into the new MPC and not one of the external members – the ones who don’t work directly for the Governor – has given a speech or a serious interview.

Oh, and remaining wedded to that bizarre commitment made in March – before the severity of the crisis was apparent to them – not to touch the OCR for a year, come what may.

(Of course, some readers may want to defend the RB on the basis that they – readers – don’t believe a negative OCR could help. There is an argument to that effect – I’m among those who resolutely disagree – but the point here is that it is not an argument the Bank itself is relying on. They claim monetary policy is still capable of doing useful and important stabilising stuff….and yet won’t even cut the OCR to zero, let alone negative, despite (a) such weak foerecasts, and (b) averring that a lower OCR would do good stuff.)

Bleak passivity

Reading last week’s statement from the not-very-transparent, not-very-accountable, Reserve Bank Monetary Policy Committee I was struck by both the bleakness of the statement and the do-little-or-nothing passivity of the monetary policymakers.

I guess you could argue it wasn’t much different than the previous month’s statement – which wouldn’t be much consolation, since that statement itself was pretty downbeat – but the relentlessness struck me. There was almost nothing positive in the commentary, even six months on from when the Committee belatedly recognised the Covid economic risks and started adjusting policy. The risks, both globally and domestically, are deemed to be to the downside – which seems right to me – and this around a base scenario in which the “the Committee expects a rise in unemployment and an increase in firm closures”. There is, again rightly, an emphasis on the susbstantial uncertainty firms and households face, again here and abroad, as the future course of the virus is really little more than anyone’s guess. We are told – in, I think, materially stronger words than they’ve used before – that “monetary policy will need to provide significant economic support for a long time to come to meet the inflation and employment remit”.

And yet what did they actually do? Nothing.

Seven months on from when they should have been first easing monetary policy, we still have an OCR that is only 75 basis points lower than it was at the start of the year. The Committee continues to cling to their bizarre March pledge – made in a climate of extreme uncertainty – not to change he OCR for a year, a pledge that has/had no solid economic foundations to it. They would prefer people to believe that in some sense they “can’t” move, but all it takes to know that is simply false is a look across the Tasman to Australia where, with a higher inflation target, and higher inflation expectations, short-term wholesale interest rates are 20 basis points lower than those here. Even if you buy the Bank’s claim that the OCR can’t be taken negative yet, there is no obstacle at all to them cutting the OCR to zero now. It should have been done months ago. It should be done now – their own outlook (all that downside talk) tells you as much. (20-25 basis points is, of course, not that much, and not a macro game-changer in and of itself, but in an all-hands-to-the-pump scenario, every little helps – and it would be a third more OCR easing than we’ve had to date.)

And, of course, the claim that the OCR can’t be taken negative now should itself be taken with a considerable pinch of salt. If true, it should of course lead to serious questions of the Bank’s competence and basic preparedness, which don’t yet seem to have been asked (although the Board’s Annual Report must be due out in the next few days, so perhaps…..unlikely as it is …..there will some sign of holding management to account). But it was never very convincing. For a start, had the Reserve Bank simply taken the OCR negative a few months ago it would have (a) rewarded the institutions that had read the – all too visible – international signs and got ready, and (b) encouraged the others to adapt very quickly. Even if the argument was partially defensible in February/March, it is now September….they’ve had months to get it right, and (on the MPC’s own reckoning) the economy could have done with more stimulus over that period. More generally still, a significant part of the way monetary policy works in an open economy is through (a) signalling and (b) the exchange rate: had the MPC moved aggressively months ago, or even now – not next March/April – it would likely have generated a lower exchange rate, supporting the New Zealand economy, and underpinned inflation expectations.

(As a reminder, the exchange rate has barely changed from where it was at the end of last year, real (1 and 2 year fixed) mortgage rates seem to be down perhaps 20-30 basis points since the end of last year, and the inflation expectations – whether survey measures or market measures – seem to be down about 50-60 basis points. Oh, and in case people hadn’t noticed, the unemployment rate has risen and the MPC expects it to rise further. Their August inflation projections – including all that fiscal policy – was also well below target. It is hard to imagine in any other circumstances a central bank doing nothing.)

Now defenders of the Reserve Bank will, of course, point out that the MPC is talking up some sort of “Funding for lending” scheme that it now says “would be ready before the end of this calendar year” (while also noting that “the design of the programme would be agreed and published ahead of deployment” – but there is only one more scheduled MPC meeting before the end of the year). The idea of this scheme is to lend to banks directly at a rate close to the (unnecessarily high) OCR, with the aim to “lower the financial system’s funding costs, and therefore borrowing costs for firms and households, and support the availability of credit to the economy”.

I don’t greatly like these sorts of schemes – although the details, which apparently won’t be consulted on, may matter. By contrast to the OCR, which is an instrument that works pervasively and unconditionally, FFL-type schemes are often available to some market participants but not others (undermining a core principle of efficient policy design, around competitive neutrality), and are often tied to some officials’ preferences around increases in lending to the private sector, whether or not such lending makes much sense in the prevailing economic climate (hint: in an environment of extreme uncertainty, of the sort the MPC talks of, not many firms are going to be voluntarily taking on much debt, and banks would generally be rightly cautious – even if not with the added uncertainty about the Bank’s new capital requirements next year). And an FFL is no substitute for an OCR adjustment when it comes to influencing the exchange rate, typically a really important part of the New Zealand transmission mechanism.

But here’s the thing. They’ve had a scheme like this in Australia since March. Term deposits rates in Australia have for a long time been closer to wholesale rates than has been the case in New Zealand, but – on checking this morning – are still materially higher than Australian wholesale rates. And although our Reserve Bank has been talking up an FFL scheme for some time now there is no hint in the schedule of retail rates banks are offering that, for example, 3-6 months are holding up but that longer-term rates (relevant to the period when an FFL will be deployed) have fallen away sharply, or at all. Big banks seem to be offering much the same rates for six month retail term deposits as they are for 1 to 5 year term deposits, just as they were at the start of this year. It just isn’t obvious that a realistic FFL is likely to make much difference to retail rates – and actual term rates suggest banks rather share that perception. It would be good to be wrong on this – all the evidence and the MPC comments suggest the economy needs the additional support – but nothing at present suggests it is likely.

Meanwhile, of course, months and months into this severe recession, there is no sign that the MPC or the Bank is doing anything about removing the real effective floor on the OCR (at perhaps -0.5 or -0.75), that results from the official provisions – regulatory interventions – that mean deposits are convertible to cash at par in unlimited quantities, with cash paying a zero interest rate. We have interminable debates and commentary on what macro difference a small further cut to the OCR – to just slightly negative – might make, but nothing on making feasible and useful the sort of deeply negative interest rates the economy might actually need. It is a cavalier indifference to the state of the economy and the plight of the unemployed – and to the health of the public finances – that seems to be shared by most central banks – which makes it no more excusable. One can, reasonably, haggle about whether threshold effects mean that,say, a -0.25% OCR would make much difference – although (a) the ECB seems persuaded, and (b) retail deposit rates in NZ would still be well above zero in such an environment. There should be much less room for doubt about the gains from a deeply negative OCR, including for the exchange rate and inflation expectations.

Of course, those on the left are often keen on fiscal policy substituting for monetary policy – especially while they are in power and get to choose the goodies being handed out – but that isn’t a path to an efficient allocation of resources, a wise evaluation of investment options (what do politicians have on the line?) and does nothing at all for promoting the health and growth of the tradables sector of the New Zealand economy. Whatever the merits of something like the wage subsidy scheme initially, fiscal policy initiatives seem to have become over recent months increasingly dependent on who you know, who is in favour, which project rings political bells, and not on a pervasive, fairly neutral, support framework in which politicians aren’t using your resources and mine to pick winners (unlikely to be so in actuality), rewards favourites and so on. Monetary policy operates much better as a countercyclical stabilisation tool for many reasons, if only central bankers would use it aggressively, or their political masters simply insist they do. It is fit for purpose, and respects the proposition that private firms and households are generally better at spending wisely than governments, in a way that handouts to Green schools, Pacific churches, this or that council, or whatever do not.