A harder rock and a harder hard place

Bernard Hickey argues the Reserve Bank Act should give the bank the power to burst an asset price bubble. Your view?

13th Jun 13, 9:17am by Bernard Hickey

By Bernard Hickey

It's been described as the Reserve Bank's Catch 22. The bank has also been portrayed as between a rock and a hard place.

The Reserve Bank knows a housing price boom is threatening financial stability and eventually inflation stability, but it can do little about it with its current framework for targeting consumer price inflation at between 1-3% with its single tool of the Official Cash Rate.

Given that consumer price inflation is at the lower end of its target band and its forecast is for it to stay around the middle of that band out into the foreseeable future, it could look to cut the Official Cash Rate.

But it knows that would just throw petrol onto the fire in Auckland's housing market.

It could also choose to put up the Official Cash Rate to try to slow the housing boom, although that would clash with its existing Reserve Bank Act and Policy Targets Agreement, which essentially say it can only target inflation and can only monitor asset prices, not necessarily act to burst an asset bubble.

It also knows that an Official Cash Rate increase would just put more upward pressure on the New Zealand dollar.

So the bank is stuck. It can't act to burst an asset bubble, yet it can see it developing before its eyes.

The Reserve Bank's June Monetary Policy Statement shows the rock is harder and the hard place even harder. It forecast house price inflation could rise to as high as 14%. It acknowledged that may force interest rates about 1% higher by 2016 than would otherwise be the case.

This implies floating mortgage rates would rise as high as 8% from the current implied peak of around 7%.

This is at the heart of the debate about the Reserve Bank Act. Its inflation targeting mandate stops it from targeting asset bubbles. Low inflation and the associated low interest rates are helping to blow up the asset bubble.

The Reserve Bank can wave its hands from the sidelines about supply problems, which is all well and good.

But what it really needs to do to avoid a bubble is to put up the official cash rate and aggressively use its macro-prudential tools. That would focus politicians' minds on the need to build or at least create the conditions to build thousands more houses.

The Labour/Green/NZ First opposition want to change the Reserve Bank Act to give the bank more targets than just inflation. This will no doubt be a major topic of political debate ahead of the November 2014 election.

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15 Comments

by kin | 13th Jun 13, 9:55am 1371074158

Bernard, please beam yourself back from wherever you are....

No central Banks ever "burst" and "bubbles".

Infact in Central Bankers lexicon, there is no such thing as a "bubble".

alan Greenspan himself has said : 1. You cannot identify a Bubble (meaning there is no such thing)

2. Even if there was one, it is better to let it burst and then clean up the sh..t later.

Mr Wheeler has be whinging for ages about high house prices but he never seems to stop whinging and start doing...which means it is all a show. When the bubble pops he can safely say he has warned everybody but nobody listen....A bit like the Wolf Boy except he don't get eaten.

I remember in my "younger" days studying Economics 101, Central Bankers are supposed to be the most powerful dude in the Banking world. When they "say" (they don't command) the Bankers ask "how high?"...

To say that Wheeler has no options is total crap....He has no choices because he choose none...

by Brendon | 13th Jun 13, 6:22pm 1371104524

And how did Greenspan approach to monetary policy work out?

by steven | 13th Jun 13, 9:01pm 1371114078

Oh about as badly as it could I reckon.

regards

by Plan B | 13th Jun 13, 10:14am 1371075271

The Reserve Bank is not there to control the price we pay for Chinese assembled flat screen TVs and the like. Nor are they there to control the weather and thus control the price we pay for locally grown cabbages.

The job of the Reserev Bank is to maintanin the value of our dollars. Not what our dollar is worth vs the Yen or Sterling or USD.

The Reserve Bank seems to make pronouncements on all of these things. When Chinese Assembly reduced the price of manufactured goods all over the world they told us that they had inflation under control! Amazing.

They played tricks with the measurements and continually redefine what it is tha they are measuring so that they look good and that there masters look good.

Yet fundamentally since the Reserve Bank Act and old Don Brash we have sat there while the value of our dollars has gone down and down.

The disconnect between reality and what they talk about is now so large that there comments are meaningless, except for people trading currency who do so almost instantaneously.

If ther Reserve Bank had to actually be the vehicle by which we maintain the actual value of our own currency then they might be of some use. Splitting House pricing off of TV prices is barking mad.

Inflation is a measure of our currency not of the price of imported TVs

No one is prepared to say that our dollar has halved in value over the past few years- easily 2001- 2006 our dollars halved.

House prices nationwide doubled in that time- or the value of our dollars halved.

The idea that the Reserve Bank tamed Inflation is laughable,

by Stephen Hulme | 13th Jun 13, 10:21am 1371075661

House prices nationwide doubled in that time- or the value of our dollars halved.

The idea that the Reserve Bank tamed Inflation is laughable,

A stream of Governors are acutely aware of your observation and demand a salary to offset the diminished buying power - how else to account for the NZD 600,000.00 of past and probably present salary tribute taxpayers underwrite.

by starfish1 | 13th Jun 13, 11:35am 1371080102

I suspect rates will rise quicker than anticipated possibly Jan 2014 rather than forecasted April 2014 given that inflation numbers may start to show through higher than anticipated with a weaker Kiwi dollar, plus continuing house price appreciation to the end of the year and a steady economy.

by steven | 13th Jun 13, 8:59pm 1371113965

I think you are completely and utterly wrong. Principly because of push and pull inflation (let alone anything else going on). Historically we have had pull inflation, ie printing put money in ppls pockets, they spent it and with inadequate manufacturing capacity, prises rise. This isnt the case today, suppliers who can push up rises will, sure but NZers have no more money, so if some parts of their budget sees greater cost they have to cut back elsewhere, the result is no inflation overall, and with no pay increases, not for years.

Sure the dollar will drop, I agree, again that means imports rise in price, say petrol, so it goes up, but if you have no more money you have to buy less of something(s) else like food, which then has to drop in price.

Steady economy implies that out present un-emplyment rate has dropped, that isnt showing much sign of a long term trend of improvement....in fact just about nil. So to suggest a quicker than anticipated return of inflation would first have to be heralded by a big drop in un-employment jst where are the jobs to come from is all I can say.

regards

by Ms de Meanour | 13th Jun 13, 1:14pm 1371086076

Indeed; surely the basic Econ101 approach of ceasing to prevent the supply side from responding to price signals is worth at least a try before you fall back on the incredibly dangerous step of assigning ever greater controls and powers away from democratic accountability and towards an unelected body of technocrats?

by iconoclast | 13th Jun 13, 12:51pm 1371084716

Bernard Hickey:

The difficulty you are faced with in your article is this:-

In arguing that the RBNZ has the tools to solve the problem, your hypothesis makes assumptions.

The first is that property price pressures are domestic.

The tools the RBNZ has are only useful in a domestic context.

The elements driving property prices in auckland are manifold. No one single element is the causation.

It would be really interesting if you prepared a list of the elements that are driving property prices in Auckland. Select the top 5 drivers in terms of their effect or importance. Then assemble the list in descending order of importance. Then compare that list to what the RBNZ can do.

Would be most interested in your views

by MortgageBelt | 13th Jun 13, 6:57pm 1371106649

With the general NZ economy so fragile, interest rates are not going to rise for a long time.

by steven | 13th Jun 13, 8:45pm 1371113155

While I agree that NZ's and indeed just about every economy of any other country and hence the world economy is fragile, lets not rule out dogma/mistake/stupidity. So its quite possible that at some stage the NZRB will raise the OCR to frighten the housing market, maybe right into a heart attack and a collapse...but they may not have to worry about it as,

Meanwhile there are signs that cheap money thrown into emerging markets to make a profit as that was one of the few least bubbles is now being withdrawn. That spells bad times IMHO for those economies. Either its because those speculators now think the gains have finished and are cashing up, or because they see risk....in either case that exit could prove a self-fullfilling recession in those countries.

OZ looks to be also taking a caning and by extension, us.

Anyone who thinks china is healthy and is going to keep on powering the world is I think in need of new glasses......

The Eu is already in recession and apart from Germany all the EU looks ropey...I mean Holland's property market looks lossy...France ikky, italy, oh dear.

Meanwhile in the USA many of the states themselves seem very poorly. The GOP seems determined to drive the country into recession and aim to blame it and everything else on Obama, I cant see this ending well....only worse or worser (a GOP Presidential win)

japan might yet utterly hari kari....abenomincs better work....

So a booming world economy that NZ's economy rides on the tales of just doesnt seem plausible and hence a rising OCR, nope....not one bit....So OCR north of 5%? cant see it, not even 4%....before the retreat begins...

regards

by bigblue | 14th Jun 13, 10:04am 1371161042

Steven - do you think the OCR is more likely to be cut at some point during 2013.

by steven | 13th Jun 13, 9:15pm 1371114958

BH, put up the OCR? and what about un-employment? and deflation in other sectors? Raising the OCR will impact these 2 badly....

I feel like it would be a pilot raising the nose of his plane knowing full well a stall is certian but gambling he can get out of the stall without going into a tail spin, which in turn means before he wacks the ground, which he cant see.

good luck with that....oh wait Im here to.

oh........

by Stephen L | 13th Jun 13, 9:16pm 1371115000

Mr Wheeler for the most part has tried to do the right things, it seems to me. It seems plausible that he actually is not all that impressed with the way Treasury is run; given some of their actions seem at cross purposes to his stated goals. (and given some different actual positions such as Key's "We really actually quite like a high exchange rate; and in any case there's nothing you can do about it", there seem philosophical differences as well.)

You can start the following chicken and egg process at any point in the chain.

High inward capital flows = high exchange rate=struggling trading industries=high current account deficit = loss of wealth= very low consumer inflation/deflation= very high major asset bubbles= very high private debt. Only one of these outcomes seems remotely positive, and in his statements, Mr Wheeler seems to agree.

The government, by borrowing large amounts offshore to fund its deficit worsens stage 1, and helps set the ball rolling, while also giving everyone else in the process a strong signal that they should go with that steam roller and not against.

So stopping that alone; and working with the Reserve Bank on then keeping the money supply appropriate to meet economic and inflation goals, would seem a good start.

by Matt Nolan | 14th Jun 13, 9:37am 1371159427

I think perhaps we need to be clearer about why we care about "the bubble". When it comes to looking at the RBNZ the concerns are only a subset of the general worries we might have as a society - I flesh out the idea a little bit here :P

http://www.tvhe.co.nz/2013/06/14/bubbles-remember-to-ask-about-the-mech…