By Bernard Hickey
A chink of light broke through the clouds over New Zealand's economy this week.
The Reserve Bank seems finally to be talking seriously about adding a few extra weapons to its rather bare arsenal.
This week Deputy Governor Grant Spencer, who is widely seen as the likely successor to outgoing Governor Alan Bollard, revealed the bank is actively considering adopting so-called Macro-Prudential Policy tools to add to its main tool, which is the Official Cash Rate.
This has to be welcomed and, if adopted, could break a horrible Catch 22 that the New Zealand economy has been stuck in for much of the last decade.
New Zealanders' love for property investing funded with foreign borrowing helped fuel a consumption binge and economic boom from 2002 to 2007 that succeeded only in loading households up with debt and pushing up our interest rates and currency to levels that stunted growth in non-commodity exports.
The Catch 22 goes something like this:
1. A booming property market fueled inflation and economic growth.
2. This forced the Reserve Bank to push up the Official Cash Rate to keep inflation within its 1-3% target band.
3. This in turn pushed up the New Zealand dollar and reduced the competitiveness of exporters.
4. This reduced export employment and increased New Zealand's reliance on foreign borrowing to service its foreign debt.
5. The increased inflows of foreign funds and pushed the New Zealand dollar even higher.
6. Any attempt to cut interest rates simply fired up the property market, sucking in more foreign debt.
7. Rinse and repeat.
Breaking out of this cycle has seemed impossible.
Various short and long term solutions have been proposed. Governments from both sides of the spectrum have tried to increase domestic savings, which would reduce the reliance on foreign borrowing and, in theory, reduce interest rates in the long run. The National-led government's moves to make rental property investment less attractive by reducing the ability to claim depreciation on buildings was also one of the attempts to break this Catch 22.
The current strength of the New Zealand dollar despite weak commodity prices shows the Catch 22 is still operating with a vengeance. The Reserve Bank has been so frustrated by this that the outgoing Governor has even suggested in recent months he might cut the Official Cash Rate to tried to drag the currency lower. This has served only to increase the heat in the property market. Not much has changed since Dr Bollard was appointed in September 2002.
Labour and the Greens have tried to spark a debate in recent years about how to break this Catch 22, including suggestions for currency intervention, a capital gains tax and a dual or triple mandate to target employment and exports as well as inflation.
But until now both the Government and the Reserve Bank have been reluctant to break away from the current inflation-targeting regime with the use of the single tool of the Official Cash Rate.
In 2005 and 2006 the Reserve Bank and Treasury investigated Supplementary Stabilisation Instruments, including a mortgage interest levy, property tax changes and a loan to value ratio limit, but decided in the end to do nothing. In mid 2007 the Reserve Bank intervened to push the currency lower, but has been reluctant to do it again.
Now the Reserve Bank is again looking at tightening regulations for banks that would make it harder for them to lend heavily against property during booms. These suggested Macro-Prudential policy tools include loan to value ratio limits, a counter cyclical capital buffer for banks and changes to the Core Funding Ratio introduced after the Global Financial Crisis.
Let's hope this latest study goes a lot further than the one that petered out in 2005 and 2006.
Somehow New Zealand needs to break its economy policy Catch 22.
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A version of this story first appeared in The Herald on Sunday
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