By Alex Tarrant
“Brian, we don’t actually have a new-build housing market; we have a housing market.”
We all sat there thinking it through for a bit while Steven Joyce carried on.
…helpful when people do decide to build a new house when moving from an existing one…Reserve Bank macro-pru exemptions for those who build leaning in the right direction…
“…we do have a housing market and if you get a lower level of housing activity – buying and selling of houses – less demand will lower the housing supply response.”
“It’s just simple economics.”
Housing demand and supply.
What better place to talk it through with the Finance Minister than the Reserve Bank museum, right after the OECD’s chief economist had called on the government to give the central bank power to limit debt-to-income ratios (DTIs).
As always, Joyce was naturally cautious on that front.
“There’s no free lunch in economics.”
That was regarding the housing market dip following the Reserve Bank’s introduction of speed limits on loan-to-value ratios.
“Demand management tools can also soften supply responses. I think we’re seeing that a little bit at the moment.”
Yes, the Reserve Bank is trying to manage the demand side of the housing market. But we must be careful not to soften the supply side so much that the Bank is effectively chasing its tail in a downward spiral.
Planning regulations are the primary cause for Auckland’s housing supply issues, Joyce said. Improvements are being made, and we’ve seen a supply response.
We just don’t want to choke that off by reducing demand so much that supply stops coming on-stream.
“That’s the constant battle for the Bank and for the government in that space.”
Can we read that to mean he’s not a fan of adding DTIs to the RBNZ’s macro-prudential tool kit?
“No, I just think we’ve got to look closely at it, because you’ve got that balance of demand and supply to think about. I think, in the meantime, the fact that the Unitary Plan in Auckland is now in place, it does allow a lot more residential construction activity around the city.”
It may well be simple economics. But aren’t officials talking about exemptions for new-builds? Aren’t policy settings trying to encourage new-builds? How could tools affecting current housing have a perverse effect on the supply side for new housing?
This is where Joyce’s comments at the start of this column appeared in the piece.
Brian Fallow’s follow up question required a bit of thinking through too – but it was spot on.
Isn’t there a distinction between the demand and supply for housing, and the supply and demand sides of the housing market?
“Well they’re all linked,” was the response.
A personal anecdote: “Take, for example where I live in Albany. Some big apartment plans there. Where it gets to the key sharp point where somebody’s proposing to build 500 or 1,000 apartments, and how many they can sell off the plans…that determines whether it’s bankable and whether the apartment complex goes ahead or not.
“If the demand side measures are too restrictive then you just won’t have that development going ahead, because the banks won’t fund it. We’ve seen a little bit of that in Auckland," Joyce said.
“Overall, you’ve got…this tricky balance, of demand versus supply. And it’s just something that we’ve got to constantly to be aware of. I think it is important though, that the Reserve Bank does its job, and the banks do their job [with credit standards], and they don’t get too far out on a limb, because nobody wants a sudden sharp fall in the housing market.”
There’s a bit of a paradox, then. We want to reduce demand, while boosting supply. We want developers to keep building, even as they’re seeing lower potential for getting current prices further down the track.
A few notes on that:
Demand might be ‘coming off’. But remember, that’s at current prices. Demand curves slope downwards. There will be more demand at lower prices. High price, low quantity; low price, high quantity.
There’s a problem though. Supply curves slope upwards. Supply tends to fall at lower prices. High price, high quantity; Low price, low quantity.
Generally, rising demand puts upward pressure on prices, which leads to a supply response. That supply response then puts downward pressure on prices and we head back towards equilibrium.
Joyce’s point is that the opposite also holds – falling demand means a negative supply response.
What to do then?
We know there’s more demand down there below the current equilibrium price. The problem is how do we get the supply curve to match that?
It’s simple economics.
Reduce your costs of production. Alter where that equilibrium settles.
Find ways to allow prices to fall while keeping supply constant or even boosting the incentive to supply a greater number of units. Allow for economies of scale. Build smaller units of output. Have government intervene in the market.
Sounds like an answer, doesn’t it?
Keen readers will notice a roadblock though. The bit about allowing prices to fall, or finding a lower equilibrium. None of our main political parties want to entertain that (although the Greens were a bit less opposed than others). Existing home owners tend to vote.
It's not simple politics.
Unless we go with the other answer, which is to try and boost demand at the current price. Give more people the ability to buy houses as the market sits now. Improve their incomes.
How about tax cuts to improve take-home pay, lifting those consumers shut out of the market now above that threshold of income required to purchase a house?
In other words, reduce the tax base to boost the housing market.
Then supply will respond too, won’t it? That’ll stop all that extra demand from contributing to prices rising too much – a supply response should eventually bring the market back to equilibrium.
Sure. But just remember, this will require much more time to reduce New Zealand’s house price to income ratio from the highest in the world to a level we're not all complaining about all the time.
A better way: How about a bit of both?
Ah, no. Sorry - that still requires prices to fall.
Simple economics. Not simple politics.