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Ryan Greenaway-McGrevy warns that low interest rates are not manna from heaven – they are a consequence of the economic climate and tell us something about where the economy is headed

Ryan Greenaway-McGrevy warns that low interest rates are not manna from heaven – they are a consequence of the economic climate and tell us something about where the economy is headed

By Ryan Greenaway-McGrevy*

The RBNZ is widely expected to cut the OCR on Thursday. And although it has erected many macroprudential barriers to try and stop them, I imagine many Kiwis will feel the urge to buy property, should the banks pass on the cut to borrowers.

Many will take the plunge, if they can.

But should they? Do we overreact to interest rate cuts?

Unlike some other countries in the world, here in New Zealand we cannot lock in an interest rate for the duration of a long-term mortgage (usually thirty years). This means that if you want the cheapest rates you will be renegotiating your mortgage with the bank every couple of years or so.

There is always the risk that interest rates will be higher when it comes time to renegotiate. That is a risk – and a substantial one if you are already forking over more than half of your after-tax pay check to the bank. I suspect that if interest rates climb back up to the historical averages seen in the 2000s, a lot of households will be put under financial strain, especially in Auckland. If you are paying sixty percent of your after-tax income to the bank at five percent interest, how much will you be paying if mortgage rates are back up to seven or eight percent five years from now?

On the other hand, perhaps low interest rates are here to stay for the foreseeable future. That is a distinct possibility. Inflation rates worldwide have remained stubbornly low, and many point to the deflationary effects of global overcapacity in production (see: China).

Deflation – or at least lower rates of inflation – matter if you are borrowing money. Deflationary pressures mean that the incomes that ultimately service a mortgage – be it your own or those of your tenants – are not going to be growing as fast as they have in the past.

Handing over massive mortgage repayments to the bank every month may appear palatable right now if you expect your income to grow over time. But these lower interest rates are reflective of those deflationary pressures – meaning that it would be wrong to expect incomes to grow all that much over the foreseeable future.

Inflation-adjusted (or real) interest rates are what matter over the long term. Prior to the economic reforms of the 1980s, the government gave cheap loans to many home buyers at rates of interest below the rate of inflation. That turned out to be a free lunch for those who could borrow, because inflation simply eroded their debt over time.

But the days of the free lunch are long-gone.

In this era of inflation-targeting and liberalised financial markets, real interest rates do not move around all that much. Nominal interest rates are low when expected inflation is low, and they are high when expected inflation is high.

There is, however, another possibility. Perhaps nominal interest rates are lower because real interest rates are permanently lower.

Economists Bob Gordon and Tyler Cowen tell us that the “average is over” – meaning that there are not many technological innovations left to be discovered that will generate the same amount of economic growth that we experienced last century. In such a world, the returns to investing in capital could be lower – and hence we may expect permanently lower real interest rates.

A world in which real interest rates are permanently lower is perhaps a much more frightening prospect – because lower real interest rates are part of a permanent reduction in economic growth.

Again, this should matter if you are borrowing money. If the rate of technological progress has slowed down, wages and salaries are not going to be growing as fast as they have in the past.

There are not many ways out for heavily-indebted households. Some breadwinners will earn those promotions and make it easier for the household to service its debt.  But not everyone can get promoted.

The only quick-fix that I can see would be for the government to abolish inflation targeting and unleash a tidal wave of inflation to shrink household debt. While that may rescue those who have borrowed beyond their means, it would come at a massive cost. The economic fallout of such a policy would be disastrous, to put it mildly, and would punish households that have chosen not to ride the exuberance of the property market.  Let’s hope it never comes to that.

Rock-bottom mortgage rates make it tempting to borrow huge sums of cash from the bank. But households should consider much more than the current level of interest rates when making that decision. Low interest rates are not manna from heaven – they are a consequence of the economic climate and tell us something about where the economy is headed. Take heed of all the information before taking the plunge.

*Ryan Greenaway-McGrevy is a senior lecturer in economics at the University of Auckland. Prior to that he was a research economist in the Office of the Chief Statistician at the Bureau of Economic Analysis (BEA) in Washington DC.

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There are a lot of points that are worth discussing but I'll limit this: we have maybe 15 years of low interest rates. If people have mortgages targeting to repay it within that 15 timeframe is a good idea. Even if it's not fully repaid future high interest rates don't mean much when there's hardly any mortgage left.

The problem I see at the moment is that 30 year mortgages are common and with people refinancing a lot are sticking to the 30 year time frame or resetting the clock to 30 years when they buy their next house. I see a lot of suffering that will happen when interest rates do come back to higher levels.

Before the humans could become immortal, debt has.
Wise words there, to pay off the mortgage quickly, taking advantage of the low rates and more saving capacity.

So I was talking with a guy the other day about mortgages, his theory is that he has life insurance therefore the mortgage is sorted when he dies. So he re mortgages every year and spends whatever the increase in value of his property (ie new car, holiday etc). My mind boggles! Is this the new reality? Am I missing something? Is this the new age sense of entitlement on steroids? This is a middle aged guy with a family and a very well paying job.

What??? I think we're on the point of identifying a tiny flaw in this plan.

Wife should kill him ASAP before it goes any further. Make it look like an accident.

haha, I know a rich lister that started doing this with property in his twenties and now he is in the >100 million bracket. For some it has been reality for the past twenty years.

Trouble is, if debt cant keep growing courtesy of flatlining wages, energy companies go bust. Then what.

In the past debts would be written off. We seem to be in a strange environment where debts are being perceived as risk free with interest rates to match the false perception. In the past bad debts would disappear and people would start again, it'll likely happen to energy companies that go bust. A simple rebalancing.

I wouldn't focus on energy companies as there are others in manufacturing that would collapse first, then that would have a follow on effect on energy companies.

I mention energy companies because they are the basis of the economy.
I should probably rephrase it to .. what happens when energy companies can't raise further debt .. because unless they are actively spending(borrowing) gazillions on exploration constantly, a full blown energy crisis is heading our way. If energy supply falls, deflation has to follow. And unless they get paid enough for the end Oil through high commodity prices, they cant repay these loans... so end consumer debt growth is critical to whether commodity prices stay up high enough to keep energy companies in business.

ham n eggs,

Every post of yours that I have read goes on about the coming energy crisis/apocalypse. I am looking at a book as I write called "The End of Oil" by Paul Roberts written in 2004. Very persuasive,just wrong. The US fracking business is ramping up activity again and renewables are making big strides.
Again, I have in front of me, an article in the current issue of Catalyst, published by The Union of Concerned Scientists in the growing use of Solar energy in Texas. ERCOT(The Electricity Reliability Council of Texas) is forecasting that Solar is now cheap enough that no other type of power plant is likely to be built in the state.
Of course, oil is finite but as we have seen time and time again, we are nowhere near its demise and even in the US, the pace of change from fossil fuels to renewables is gathering pace. why the spending of trillions on military to keep an interest in the middle east? Why not just walk away and spend the military budget on renewable etc? Ponder that.

Sorry, but you are misinformed. Fracking is not ramping up, rig counts are falling big time. You might want to go to and read discussions - plenty of graphs there.
Re renewables ... again, its a facade, accounting for a pathetic 2.8% of worldwide energy use last year, despite billions in subsidy. And have you heard any discussion about electric trucks for freight? Or how are those solar planes going? Ships? No, because it simply isnt viable. The problem is trying to run a complex infrastructure on a massively reduced energy source .... when the economy is broke simply defies logic.

So people have been saying the last 8 or 9 years I guess.

Cheap money is the perfect time to buy appreciating assets. Auckland has a long way to go yet, just look to vancouver and other cities.

Its an irrefutable fact that falling interest rates have an inverse relationship to prices of real assets .

Here's my personal experience

When we had a mortgage , our home used to cost us $600 a week (at a 11% mortgage rate) on a mortgage under $300,000.

Now that same $600 per week can service a mortgage of $800,000 at 4%

What did everyone expect ?

That property prices would come down ?

Get real

I don't know where you get your mortgages from by an $800,000 mortgage is more like $900 week at 4% interest.

"Now that same $600 per week can service a mortgage of $800,000 at 4%"

And even with an annual income of $100,000 and....$100,000 can STILL only borrow $400,000 max according to KB calculator Boatman.

Property prices only go up due to two main reasons:

Continued access to greater credit for each new purchaser of a mortgage

Continued pyramid feeding by increasing number of cashed up migrants

You need to get real.

An annual income of $100k isn't much for a couple. That kiwibank calculator will let to borrow $600k on an income of $100k and a deposit of $150k. Just entered my details and it will let me borrow $1.017M. I'd hate to pay that mortgage

Your'e right, its not much for a "couple" .....unless you like a majority DO NOT earn $50,000 a year each Dave. That's the reality for most.

Actually full time median income was about $51k (in 2014) so if both are in fulltime work the combined income for most couples would be over $100k. The average salary for jobs advertised on seek is over $74k (there will some lower paying jobs not advertised on there though). There are a huge number of people that earn significantly more that that too. No one at my previous employer earned under $50k.

An annual income of $100k isn't much for a couple. That kiwibank calculator will let to borrow $600k on an income of $100k and a deposit of $150k. Just entered my details and it will let me borrow $1.017M. I'd hate to pay that mortgage.

@Justice , have you ever had a mortgage?

Because you have clearly never heard of Interest -only Mortgages , which are more common than you may realise

Never had a mortgage cause I came back from the UK after 7 years earning a 'real wage' in 2005 and bought outright. And yes, I do know IOL's are the last chance for the desperate who can't really afford.

Not that common boatman, only 29% of loan balances, and that includes revolving credit ( Would be nuts to keep owner occupied on IO, pay a lot more interest in the long run

I have the feeling that we are "using up our bullets"... and we are not in a gunfight..

I don't recall when , in the past, we lowered interest rates when the economy was doing ok...
Generally we raise them when the economy is "overheated" and lower them when we have a "shock" or a recession ..

The danger is that if we keep lowering interest rates we will have nothing left when we really do get into a gunfight..... ( recession or shock )...

Lower interest rates will simply entrench further, the current trends in the NZ economy... in my view.. ie. more borrowing

yeap, they are desperately turning economics on it's head to try and save a dead duck for mainly the benefit of the 1 to .1% at the top of the pyramid

"The only quick-fix that I can see would be for the government to abolish inflation targeting and unleash a tidal wave of inflation to shrink household debt. While that may rescue those who have borrowed beyond their means, it would come at a massive cost. The economic fallout of such a policy would be disastrous, to put it mildly, and would punish households that have chosen not to ride the exuberance of the property market. Let’s hope it never comes to that."

ohhh, Im afraid that is EXACTLY what they will do. Interest rates are going nowhere but down for a very very long time. Maybe even negative like they are trying overseas. When they eventually workout that they can't boost any 'real' economic growth other than continued debt binge feeding of property speculation then ....they will do exactly what you fear the most.

Curious as to how they can actually "unleash the tidal wave of inflation"?
Its not as if they are controlling inflation down accidentally at the moment, they cant get (reported) inflation to rise. Any debt amnesty has a loser on the opposite side of the equation ... esp pension funds. Helicopter money will just see debt retired and doesnt necessarily result in an uplift in demand...

How many 'fingers in the pie' does government have in things like the electricity or building sector alone?

Things like that ham n eggs

They can very quickly make the CPI go ballistic if they chose too. For now their focus is to keep the speculation frenzy going at least till after the election. Many are feeling rich with all their 'perceived' rocketing capital gains. That can't continue much longer unless they plan on bring in 100 thousand migrants per annum ?

Yes, but presumably that has a very deflationary effect on demand ... which would send producers of commodities broke.

you don't "need" electricity? You don't "need" petrol at all?

Is the increasing cost of housing stopping 'demand' at this point?

We just so happen to have a form of 'hyper inflation' right now! It just so happens to be a form not accounted for in the CPI. Hyper house price inflation is doing damage for the longterm

That doesn't really explain how debt is going to be inflated away though - because incomes are going nowhere without actual growth. And real growth needs resources and cheap to produce energy = something we are fast running out of.

It's being inflated away now. Most of the personal debt is in mortgage loans for housing which is being 'inflated away' now via the 'perception' of massive cg's. (meanwhile the dollar is being hammered in relation to its buying power in that sector) Except .....that it really isn't 'generationally', as the debt is just being past on at ever increasing personal cost to whomever is next or willing to submit to new debt levels on the idea that capital gain will be perpetual and nullify the interest they need to pay.

A game of musical chairs with debt.

The debts will never just vapourize away ever ...unless they try something like a debt jubilee which still has victims and many draw backs.

Some might say who needs a 'real income' when your debt can be inflated away to some other sucker paying off your mortgage directly or indirectly?

My point is ham n eggs, it's happening

Yes definitely musical chairs - The trouble system wide is that enriching a non majority through capital gains doesn't elevate commodity prices - because you need the incomes of the masses to prop up commodities. Commodity producers going broke is the real nasty to avoid ... ie It doesnt matter how rich Bill Gates gets, he wont save the dairy industry on his own...

@ Justice, with all respect. most of your comments are correct in an "ideal world" , the one we used to live in before 1980 , A lot of water has gone under the bridge since and a lot of technology, sociology, ideology and Economy has changed ... I think that the old rules do not apply in a low inflation low ( or zero) interest rate and very high dept environment for so long. That is why the whole world is struggling to find a solution for it ....
When it comes to musical chairs , it actually is the only way to adjust and live in the current market conditions, Interest rates are low as is Wage growth , so is most goods and services you buy - albeit other than building costs because of high demand and that is normal,
I don't think how theorising and explaining the cycles of dept and inflation can get rid of the real problem - which BTW is far too complicated that we can ever debate here.
Unfortunately, we all have to live this decade ( with all its flaws ) and stick to the huge Centrifugal Wheel to pass beyond it - the ones who don't will be thrown away and never catch up.
As so many of us here have said before, today is NOT 2000s, 1990s 1980s or 1970s its not even 2007 anymore ...

Especially with all these blasted investment schemes and seminars going on, I see something to do with Robert Kiyosaki of Rich Dad Poor Dad, fame, now. Now it really is every man and his dog jumping on the bandwagon, and I wonder if they wonder, where their clientele is going to come from if everyone is an investor. The whole thing needs re-working so that residential property investment becomes seriously unattractive in the existing housing market, and if NZ is to become a nation of renters, that terms similar to those in Germany are available.

Record profit again. Maybe we aren't reacting near enough?

Bernard is right maybe their Margins are not high enough..... record profits lol

"Your dreamworld is just about to end"

Interest rates low going lower= any one born 1947ish or five years eithier side the message is quite clear, time to cash out and or downgrade. I am in my forties and think that's what I should do as in 25 yrs I think the world will be very different place KiwiSaver to replace pension etc.....

Crazy to think RBNZ was the first developed countries to raise rates back in 2014.....

.... and now one of the last to apply stamp duty on investors or foreigners....

Not really crazy Joe, NZ has always been an economic experiment country, first to adopt 'inflation targeting, one of the first to introduce eft pos transactions.....they try these things on small populations first.

Test Kitchen of the Shadowy Cabals Running the World.

I feel like we should be doing more to screw up the results.

Yes it was great we got EFTPOS so early. Very slow to take up internet shopping and fibre broadband though.

Seems like the handbrake was pulled up after EFTPOS.

Would be nice to see NZ as the tech start-up hub of Australasia. There is a lack of government initiatives to encourage more investment in this area. UK have EIS whereby if you invest in a start-up you can claim 30% tax relief on your investment. If the business fails you can claim an additional 30%. You pay zero tax on any gains. So invest 1,000 and you can claim 300 off your tax return. Firms like make it easy to invest as you get the same terms as the lead investor.

Anyway back to property..

The other day my partner showed me a map of high-speed broadband access around the world, and apparently NZ is the only place in the southern hemisphere that has it, with Australia lagging behind. I didn't verify any of this and was only really pretending to pay attention, but seems to me that we could do more with this. NZ in general is using it to buy rather than sell. The people I know who have done really well targeting the world as their customer base are small-scale artisans doing hand-made products that sell out in 30 seconds because there are people in the USA waiting for an update at 3.00am and jumping on whatever's available the second it loads.

If NZ was slow to take up internet shopping (as customers) I'd suspect that was more to do with prohibitive exchange rates and restrictive shipping policies more than anything else. Where NZ has been slow to take advantage is as sellers and providers, which is where theoretically we should have an advantage, with our exchange rate against the currencies of the US, Canada, Australia and Europe/UK. Offer overseas consumers free or discounted shipping, and show them the price in US dollars or Euros and they'd jump on it for all kinds of things. But what few local companies and manufacturers remain are barely targeting NZ as online shoppers, let alone the world. For intangible goods, the barriers should be even lower.

I just applied to renovate one of my homes and was turned down. Now my tenants can continue to live in a cold house for another 2 years. Bummer for them and for any tradie that was going to do the job. The 40% rule completely stuffs up any renovating and improvements. NZ is worse off for this policy. Doesn't matter if interest rates are 2 percent, I can't get the money.

You may need to fund the repairs using money other than from a bank loan.
How is your supply of retained profits.
Or are you describing your Plan B.?

Plan B = Cold house for tenants...

I think you should dip into your own funds to meet your obligations to provide a minimum liveable standard for your tenants. It is not your tenants fault you won't do the necessary upgrade, nor that you cannot borrow. Nothing to do with them, all to do with you.

House is weather tight and has floor and roof insulation. What it does not have is double glazed windows and a heat pump. And with out credit I will not supply tenants with the same. Please understand I am using an analogy that with 40% LVR's any 'nice to haves' will and have stopped.

DC please don't get on the band wagon of evil landlord vs. victim tenant. I am a good landlord and do more than most.

I just wish to highlight a very real example of unintended consequences. Anyone who thought 40% LVR's will be good for tenants are dreaming.

Therein lies a simple way to get house price inflation under control. Put more and more obligations on landlords. Insulation, heating, minimum rent reviews etc. load them up to the point that owner occupied home ownership is the only economic way to own a property. Job done.

How could you allow them to rent the place in the first place of it was a cold house ?

Should have repaired it before allowing tenants in.

I guess that's the problem with no minimum standards. Nothing to do with the 40% policy.

How many others are like this, would you think.

The lender must have known the borrower had not the real money to operate the business being funded.
Black mark against the mortgage lender.
Especially as the asset they funded is foregoing of repairs and maintenance.

Mind you the lender may say, well funded the house purchase using a home loan, we never expected nor thought to review the borrower as a business man.....
Or, the mortgage broker based applications never said....

Agreed bad business renting out cold homes. I bet his home is warm :)

I disagree.... I was born in a cold house... (I remember mum placing containers to catch the leaks in the roof in a heavy storm)..
Most of the kids in our small town went to school barefoot, in a t shirt and shorts, in the middle of winter... . we played die hard bull rush at playtime...
We were, mostly, very robust and healthy..
It was only after I became an adult , that I realized we were poor back then.
As a Kid .... they were great yrs..

Ain't nothing wrong with a cold house... as long it is dry and clean.
Father in Law once lived in a tin shed for a yr..... He was a teacher in Taumaranui ... No running water. (Had to crack the ice on his basin of water , each morning, during winter)

As Chopper Read would say.... some people need to drink ...... "A can of harden the F**k up."

Say that to these sick children ...'-cost-arguments,-mps-told

If only it were that simple....

JP... do u really think that is the answer to kids being healthy..?? ( I do agree that damp is bad )..

My own life experience says different.... maybe my generation , as kids, were more robust..?? I don't know.

Sure other factors come into play ...

I think in NZ we assume its normal to have a cold damp house... however the rest of the developed world this isn't the case. Simple things like double glazed windows, central gas heating etc ... it is improving in NZ I guess with new minimum requirements for new builds.

number 8 wire housing

With the 40% rule you can expect a lot more cold houses...people cant get credit. No credit means no major repairs or 'nice to haves'. I have a stack of cash sitting in revolving credit, but I am not going to use it for a reno if I cant get a credit extension. Hence am being a prudent business person that does not want to dip into the cash safety net for a 'nice to have' heat pump etc

No credit means stuff stops getting done...

My tenants can always move out...I was planning to do an extension and modernize it, put in a heat pump...of course I was going to put the rent up a few hundred dollars a week...after it was done up. The house is over 100 years old.

What do you do.
The house is well past its design life (so it doesn't owe anyone anything).
Q. Has some histerical society slapped a note on it?

Clearly the bank doesn't want a bar of it.

I am using analogies when referring to a cold house, the house is fine otherwise no one would rent it. The point is I can't get credit to improve it.

So sell it to someone who can actually afford to own it/make it habitable

Plenty more foreign buyers out there .. time to hit them with stamp duty to help pay for some of the infrastructure costs the country will need to pay for and give NZ citizens and Permanent Residents a chance in the market.

Per Hoegarden article :

" Auckland house prices growing at rocket-like speed to jump up...... but compared with the domestic first-tier cities .....New Zealand real estate prices are still relatively "cheap"

Auckland median house price is now 992,000 New Zealand dollars according to the current exchange rate equivalent to 4.713 million. many places in the Auckland area can buy a Freehold detached villa while in Beijing or Shanghai only urban fringe to buy a three bedroom apartment in the heart of downtown or a small apartment with two bedrooms or a home apartment. "

What as they decrease interest rates this morning and the kiwi dollar starts tracking up over the next month.

These people running our economy are like bart simpson getting electrocuted constantly in a rat trap. Don't learn.

Needs more than .25 cut or else you may very well be right with your analogy. I feel it might be a .50 this time. Let's see, not long to go now.

Exactly as i predicted. Fail.

And, more fuel for house prices. Double wrecked the economy.

Well, now we know. Wheeler cuts the OCR by 0.25%, goes on about the need for the dollar to fall and what happens? It immediately rises by almost a cent against the US$. What a surprise!
The ANZ has already announced that it will pass only a small percentage of the cut onto borrowers and that will apply to all the other banks I imagine,so the cut will have achieved nothing. He needs to either stop cutting rates or else cut the OCR by say a full 1%. That might just pull our $ down a bit.

Ryan excellent article I enjoyed reading that.

The next wave of technology will likely reduce the number of jobs that exist as Artificial Intelligence & robots improve. It will be hard to service those 30-year mortgages without jobs.

Presumably there will be jobs tidying the robots' houses.

Days to the General Election: 22
See Party Policies here. Party Lists here.