By Rodney Dickens
The Reserve Bank (RB) is exaggerating the threats from the housing boom it created to justify expanding its realm of influence beyond what is good for New Zealanders.
The RB and Minister of Finance have announced the plans for more interventions by the RB in the housing market. This is supposedly in the pursuit of “tackling financial stability risks”. However, as was pointed out by ex-RB senior economists, the RB’s initial housing market interventions were based on substandard analysis that overstated the threats. I back their assessment and judgement well ahead of that of the self-aggrandising RB.
The RB has single-handedly driven a housing boom by cutting the OCR excessively and being too slow to reverse the cuts. Instead of doing the obvious and reversing the excessive cuts quickly, the RB is using the boom in house prices it created to justify adding to the dubiously justified interventions. A bit like the RB drawing links between itself and Tāne-mahuta the Māori god of forests and birds, it is trying to make its role unnecessarily grandiose.
The RB is showing signs of being power crazy and the Minister of Finance doesn’t appear to have the quality advice or knowledge to see the dangers of a central bank that justifies decisions on substandard research and has such a poor understanding of the drivers of the housing and labour markets it cannot make quality OCR decisions.
The RB’s incompetence in assessing the outlooks for house prices and the labour market is so alarming it will be a fluke if it makes quality OCR decisions.
How can the RB be trusted to make quality decisions about the OCR when it has a poor understanding of pivotal drivers of economic-inflation outcomes like the housing and labour markets?! The top right chart shows the RB’s unemployment rate forecasts from the last four Monetary Policy Statements. Even in May it predicted the unemployment rate would not fall this year (green line), but it has tumbled.
Criticising the RB in retrospect is easy, but there was information available before the RB produced the forecasts that said the outcomes would be much different to what the RB predicted. The second right chart shows what a useful leading indicator of the unemployment rate was already predicting before the RB finalised the May forecasts. The third right chart shows what the same indicator now predicts for the unemployment rate. I doubt the RB will predict a further large fall in unemployment in the forecasts it releases on 18 August.
The unemployment rate is a useful indicator of the balance of bargaining power between employers and employees. At 4%, it is, in my assessment, below the level consistent with the RB’s inflation target. But it takes a while for an overly tight labour market to filter through to higher wage and core CPI inflation as is covered in the economic reports. It is clear most firms are finding it harder than before Covid-19 arrived to attract and retain staff.
It is similar with the RB’s house price forecasts and this needs to be viewed in the context of the RB itself acknowledging that the housing market plays a big part in economic cycles.
In the November 2020 MPS the RB predicted minor near-term upside in house price inflation followed by a fall back to below average in 2022 (next chart). At the time the RB was finalising these forecasts there was already information available pointing to a much higher outlook for house price inflation.
The chart below shows the REINZ information that was available prior to the forecasts in the chart above being finalised. House sales had surged to above the pre-Covid-19 level, pointing to much higher near-term house price inflation. In addition, the fall in interest rates pointed to further upside for the number of house sales over the next four months (2nd chart below). Add a super low stock of property for sale – top right chart – and it was clear that the housing demand-supply balance was supercharged.
The chart below shows the number of house sales reported by REINZ relative to the number of for-sale listings on www.realestate.co.nz available to the RB when it prepared the house price inflation forecasts in the adjacent chart. The number of sales largely reflects demand, while listings measure supply. The same story emerges when sales are compared to the median number of days properties were taking to sell (2nd chart below that again shows the info available prior to the November 2020 MPS).
It does not take rocket science to forecast the near-term outlooks for the unemployment rate and house price inflation, just sound analysis of the drivers and use of the most useful leading indicators. Equally it does not take hindsight to expose the low quality of the RB’s forecasts for critical bits of the economy. If the RB had a robust approach to forecasting (and making OCR decisions) that included taking account of the most up-to-date, relevant indicators it would not have produced the hugely inaccurate forecasts it did in November (and more generally).
How can it make such incompetent forecasts? Based on what I saw in my time at the RB I know why. The forecasts just vindicate the RB’s preconceptions. The RB has an arduous formal process for preparing the forecasts but along the way they get amended to fit the preconceptions of the overseers (overlords). The RB indulges in a rigorous process that is flawed to the extent it would be funny if it wasn’t for the damage the resulting OCR decisions can have.
You cannot rely on the bank economists to warn you when the RB is making a huge mistake because they are no better.
You don’t have to think back long to remember the bank economists predicted falling house prices, a negative OCR and protracted low interest rates. An example is ANZ’s November 2020 forecasts for the OCR that was supposed to stay at 0.25% until at least September 2022 while the unemployment rate was not supposed to fall to as low as the 4% reported for the 2021 June quarter even by December 2022. I have highlighted the forecasts by ANZ’s economists because they were the worst when it came to predicting falling house prices.
Despite holding somewhat different views at times, the bank economists have in general been as bad as the RB in the inaccuracy of key forecasts especially since the advent of Covid-19, but even before then. The chart below shows what the economists of the four major banks were on average forecasting for the NZ average house price in May 2020, August 2020, October 2020, January 2021, April 2021 and most recently. In October 2020, for example, house sales reported by REINZ had been above average for four months. Despite this fact, the bank economists on average predicted a near-term fall for the national average house price (light blue line).
The problem is the bank economists’ forecasts are not backed by quality analysis of the drivers nor by an assessment of the demand-supply balance that is critical to near-term price behaviour. The problem runs so deep their house price forecast should be ignored, but there are rare exceptions. The problems with their latest forecasts are covered in the August Housing Prospects report.
The bank economists have been equally wrong with unemployment rate forecasts for the same reasons: lack of quality analysis of the drivers and insufficient use of the proven leading indicators.
The Reserve Bank’s excessive OCR cuts in response to Covid-19 will have a range of undesirable consequences in addition to creating a “wellbeing disaster”.
You know something is seriously wrong when the former chief economist and Chairman of the Board of the Reserve Bank criticise its OCR decisions for creating a “wellbeing disaster”. Arthur Grimes is now a prominent academic economist who I’ve known since university days.
I tend to be non-conventional by choice because the traditional approach to forecasting used by the bank economists is flawed. Arthur is mainstream in a good way. When someone like Arthur is publicly critical of the RB you should take notice.
The RB’s overly stimulatory response to Covid-19 will have other undesirable outcomes as covered in my regular economic, housing and building reports.
This article is here with permission.