The Reserve Bank is dismissing "monetary policy orthodoxy" too quickly and taking "an educated guess" that its speed limits on high LVR lending will work, according to BNZ's head of research Stephen Toplis.
The comments from Toplis in his weekly "Economy Watch" follow on from criticism he levelled at the central bank last week.
Then he termed the, at that stage, proposed RBNZ limits on high loan to value lending as the biggest central bank experiment seen here in decades.
This week, of course, RBNZ Governor Graeme Wheeler announced that from October 1 banks would be restricted to making no more than 10% of their new loans to customers borrowing in excess of 80% of the value of the property they are acquiring. See here for articles on LVRs.
Toplis said the RBNZ had "moved into the realms of experimentation" with its "macro-prudential prescription".
"The Bank accepts that it is in broadly uncharted territory," he said.
New for NZ
He quoted the RBNZ statement that:"The macro-prudential policy approach is new for New Zealand, and experience in the use of these policy instruments and the data required to support them are currently limited. This makes the quantification of costs and benefits difficult".
"Again," Toplis said, "the clear message here is that the Bank is taking an educated guess that what it is proposing will work".
"...What continues to worry us is the Reserve Bank’s reluctance to utilise orthodox monetary policy to cure the 'problems' that the economy faces. If the Bank really does believe that house price inflation is getting out of control the accepted wisdom is that rising interest rates will be most effective at limiting it."
Toplis made the following points:
- We are fully supportive of the central bank doing what it can to ensure the integrity of the New Zealand banking system is protected;
- We are comfortable that the recently announced LVR restrictions will help, in this regard;
- We do believe that excessive house price inflation is unwelcome;
- We do think that house prices are “overvalued” relative to standard metrics;
- And we do think that the LVR restrictions will have a negative impact on house price inflation;
- Moreover, we do accept that an overvalued housing market will tend to go hand-in-hand with an “overvalued” exchange rate so reducing the pressure on housing inflation will, all other things being equal, result in a lower currency.
However:
- We still believe that monetary policy orthodoxy is being dismissed too quickly;
- The central bank is tending to use spurious analysis to support its stance;
- There are many inconsistencies in the central bank’s diatribe.
Toplis said he understood the reluctance of the RBNZ to raise interest rates given the strength of the New Zealand dollar and current low inflation.
"...But this is a tried and true way of attacking the problem.
"Is the housing market overheating because the banks are supplying too much credit or is it because the cost of money is simply too low?
If it is the latter then 85% of home borrowers and nearly every other borrower in the economy will not be adversely affected by the LVR announcement. In fact, they will face lower interest rates than would otherwise have been the case."
Toplis said he remained "bothered" that the Reserve Bank continued to promulgate the view that New Zealand was vulnerable to a housing correction based on what happened in such places as the United States, the UK, Ireland and Spain.
"One would have to first correct for such things as the prevalence of low-doc loans to predominantly low-income people, the impact of adjustable rate mortgages, the fact that LVR’s in some cases were well above 100%, the excessive growth of finance sectors, different refinancing obligations and, most importantly, the role of excess supply of housing before making such comparison."
Toplis said you would be hard pressed to conclude that New Zealand house prices were currently under threat from excess supply.
He said BNZ economists restated their premise that they are not opposed to LVR restriction per se.
"...But we are worried lest an experimental macro prudential tool becomes seen as a replacement for orthodox monetary policy."
39 Comments
Why is every economist scared of chage? They all seem to say we should stick with 'orthordoxy' as it must be right. What we have now is an evolution of something else that went before. We can't just do nothing for ever and hope it all gets better.
Toplis said he understood the reluctance of the RBNZ to raise interest rates given the strength of the New Zealand dollar and current low inflation.
"...But this is a tried and true way of attacking the problem.
Really? Tried - yes. True and works???????
You've got no basis for the statement that "every economist is scared of change". That's like saying that "doctors are scared of change" if one of them were to object to a proposal to hit a cancer victim with an unproven new treatment when they hadn't even tried chemotherapy.
Having said which, the fact that RBNZ's action is an experiment is not in itself a bad thing. All policymaking is experimental; one can never be sure exactly what the impacts will be. What's important, but not often done, is to make sure that you treat it as such - ie, state your hypothesis (what you expect the policy to achieve), observe the results in order to evaluate whether your hypothesis was correct, draw conclusions (including being ready to acknowledge that your hypothesis has been disproven), note the learning points and adjust the approach accordingly.
RBNZ fall at the first hurdle of this righteous path, by not being clear exactly what they do and don't expect to achieve. That's typical of politicians, who have a vested interest in not being clear and therefore allowing everybody in the short term to believe that their particular concern will be addressed, and making it difficult in the long term to call the policy a failure. But it's disappointing in technocrats.
Ms de M; The RBNZ's multiple concerns seem clear enough:
1) High house prices threaten bank stability.
2) High House prices threaten long term inflation.
3) Over valued exchange rate affects current account, trading industries, employment and a whole range of things.
Their LVR approach might reasonably affect all three; and it would seem has had an almost instant effect on the exchange rate- the particular metric that gets me most exciteable.
Lifting the OCR would likely (although not certainly) affect 1 and 2 positively, but materially worsen 3. In fact the capital flows chasing yield may well worsen 1 and 2 as well- the OCR seems no longer fit for purpose it seems to me, and certainly not on its own.
I do listen to the various commercial bank economists, but in this case their argument is so obviously self serving as to be easily enough discounted.
Sorry! Here it is the old-fashioned way
http://www.tvhe.co.nz/2013/08/13/lvrs-are-coming-lets-think-about-the-causes-underlying-this/
Thanks, Our good friend Matt Nolan. Am willing to concede from reading things that the RBNZ has not apparently been clear in its reasons or intentions for the LVR move, and so I have put my own interpretations on them.
I have a view that just possibly the RBNZ sees (as I do) NZ's main economic issue not being housing prices at all, but being its current account, driven by an overvalued exchange rate, driven by an excess of property and farm chasing foreign investment- whether as direct asset sales or in debt through the banks. But fixing that issue is not the RBNZ's remit, so they have to find excuses and tools to do so; and they cannot be totally clear about fixing something they are not supposed to address.
Could be wrong, but I actually hope I'm right, and willing to credit Mr Wheeler if I am.
I have said this before the Reserve Bank should stop playing silly games and raise interest rates. Toplis is right. The bank should stick to orthodoxy to retain creditability.
Furthermore given the $NZD is likely to come under significant selling pressure given the situation in Aus and China.
I have said this before the Reserve Bank should stop playing silly games and raise interest rates. Toplis is right. The bank should stick to orthodoxy to retain creditability.
Furthermore given the $NZD is likely to come under significant selling pressure given the situation in Aus and China.
Central Bankers all over the world are having to learn the hard way, that an OCR is rendered impotent as a macroeconomic management tool, by a house price bubble caused by inelastic "supply".
Graeme Wheeler and colleagues are to be commended for being up to date with the most recent analyses of these effects - not to mention that Don Brash might have been the first ever central banker in the world, way back in the 1990's, to have these effects analysed. The result was a report by Owen McShane that should have made himself and Brash famous.
But the leading institutions of economic research are slowly coming around to the reality. Consider this from a 2010 OECD Report:
".......Another concern is about the ability of monetary policy to thwart the development of a housing bubble without causing widespread damage to the rest of the economy. In a house price boom, prices increase strongly – often at double digit rates – and expectations of future prices are similarly upbeat. Under these conditions, large policy rate hikes would be necessary to cool housing markets. High interest rates would crowd out sound and socially useful investments......"
I liken this dilemma to that of a cancer victim, with central bankers as a surgeon with inadequate treatment options. The bubble is a cancer. Its growth is bad for the vital organs - the tradables sector. The only treatment is chemotherapy - the OCR. A strong enough dose to kill the cancer, will kill the patient too.
Attending to the fiscal and prudential and regulatory aspects of a bubble in land prices, is like using "surgery" instead of chemo.
The orthodoxy has been part of the problem. Alan Greenspan has been blamed for causing the bubble in the USA, when in fact he was absolutely correct that it was a localised phenomenon that did not affect the entire USA. In fact it affected a minority of cities. Elasticity of supply of housing is the significant variable.
It is also a significant red herring to claim that oversupply is necessary for bubbles to burst. They will crash further if oversupplied, but undersupply is the cause of price volatility. And bubble mania can do the rest - up and down. The UK is a chronically under-supplied market that has been one of the world's most volatile historically.
The fact that some markets have managed to engineer both price inflation and oversupply, is a legacy of the length of the supply chain due to regulations. It is short run supply elasticity that stopped most of the USA's cities from having any price bubble at all.
Some bubbles involved "10 year plans" for supply of land, which was all developed and hit the market in, say, 2 years flat. The "10 years supply" of land was bidded up crazily in price before anyone even started to build anything.
This does not mean that supply should be restricted even further, although the Irish, bless their hearts, have drawn this conclusion.
It does mean that if there is a democratic consensus that cities growth must be constrained, other instruments are necessary to ensure that land prices do not get out of hand. I favour compulsory acquistion, including for redevelopments at higher intensity in existing urban areas. Otherwise the owners of sites favoured by "the plans" capture monopoly gains and nowhere near as many people and businesses end up relocated as the planners wished (eg onto rail routes) because the prices are too high.
In fact, just as gold can be traded indefinitely between speculators without any of it ever being sold for any actual use, land and real estate in a rationed market can change hands indefinitely between speculators without even being put to its most efficient use. The UK's cities are infamous for empty sites "worth millions". And "the planners" point to these as evidence that "there is no undersupply".
Portland is infamous for under-utilised sites and massive subsidies being paid to developers and land vendors to make anything happen. Which of course just worsens the psychology of the participants and the likelihood of corruption.
You highlight the importance of being able to assess whether this experiment works. See remarks above about the implications of policy as experiment.
Even if it does "work", that does not mean that one should always in future use this tool. The fact that it "works" in one particular set of circumstances does not mean that it always will. One needs to be as clear as possible in understanding why it worked.
Contrariwise, even if it doesn't, that does not mean that one should never use this tool. The fact that it doesn't "work" in one particular set of circumstances does not mean that it never will. One needs to be as clear as possible in understanding why it didn't work.
The RBNZ seems to think the interest rate affects the NZD directly. It's the increase in borrowing (government + households + business) that pushes the NZD up (ie borrow USD and buy NZD with it).
The mistake the RBNZ make is waiting until there is momentum in house prices before putting up interest rates. Therefore they are always behind and their interest rate rises are ineffective.
But that is the carry trade. Yes I know it's oversimplified. My point is the the change in debt drives the NZD, not the interest rate as such. Yes, I know it's probably a derivative (in the mathematical sense) of the change in debt, perhaps the rate of change in debt, or even the rate of acceleration of debt. Steve Keene is the chap who seems to understand this, not these woolly bank-centric economist/bankers or regulator/bank promoters.
The banking system has a fundamentally fraudulent core as it is currently formulated and the RBNZ does it's best to keep the system going (and is therefore complicit in the fraud).
That which the banks borrow offshore is swapped for NZD, not sold for NZD, hence there is no specific pressure to buy the NZD/USD currency pair from that quarter. An old RBA document confirms what our Aussie banks' parents do in Australia - they do the same here.
Ah, yes, well my grasp of the details of banking is pretty thin. The general idea I was following was that debt, and the change in debt, or maybe the rate of change in debt etc, was the driving force behind the currency. By letting momentum develop the RBNZ attract the speculative effects that push the momentum as far as it can go. If they reverted to their best guess at a normal rate as soon as possible as Rodney Dickens has suggested then much misallocation of our limited capital might be averted. The RBNZ are reluctant to do this cos it ends the party before we all get drunk.
Stephen,
I understand the banks hedge their foreign exposure such that they are not exposed to drops in the local currency, but given from your linked paper
According to the latest available data for 2009, banks’ main foreign currency exposure was through foreign debt liabilities which, when netted against foreign currency debt assets, amounted to a net foreign currency debt position of $339 billion, up from $186 billion in 2005 (Table B1).1. The value of derivatives held against this on-balance sheet debt position in order to hedge the foreign currency risk increased to $414 billion in 2009, leaving an open long position on foreign currency debt of $75 billion. there was a lift in foreign debt of $153 billion in 4 years in Australia. Has there not been in net terms a purchase of A$153 billion in that time? Someone somewhere is holding the risk that the AUD would drop. My issue is with the absolute scale of the increase- 82% in 4 years; which will be proportionate here. All good for the Aussie banks; not so good for our economy. Apart from the interest costs going offshore, the effect on the exchange rate has to be material.Its worse than "The banking system has a as it is currently formulated." The entire economy is based on a "fundamentally fraudulent core", that of infinite growth, with infinite cheap and abundant energy underpining it.
Yes the RB is doing its best to keep the system going because otherwise with no banking system we dont eat and it goes to pot very quickly.
Im always scratching my head that somehow the right wingers just dont see a severe economic depression as possible from the actions they repeatedly spout as solutions. Its like a zombie, no matter how often these ideas are shown to be false and without basis they get right back up and keep stumbling along some minutes later....
Maybe the right wingers are well stocked up on zombie ammo and are impatient to use it...
regards
Why does everyone refer to controlling lvr as being unorthodox? This is old school and is one of two ways to shore up a banks bank sheet. The other is to be well capitalised. Economists seem to think that because we have had rampant house price inflation you can ignore these. I say do so at your peril. I give wheeler a big plug for doing something proactive.
Scarfie - your comment is confusing the jargon and this is where many people get confused. You cannot look at the Capital only component without looking at equity, earnings and a whole plethora of other accounting terminology to get the full picture. You can have a business that is well capitalised and highly leveraged and earnings can support the cost of that capital. Business works out the return on equity and the return on capital, the nett asset position, total funds employed etc.
Maybe interest.co.nz should run some accounting articles to help educate people.
I think you may be confusing the two concepts. Shareholder funds or capital goes first. More capital equals less leverage, equals less roi, equals safer bank. If a bank has a high concentration of high lvr lending this implies it is riskier than its counterparts which should equate to it being required to hold more capital. This risk should also result in shareholders demanding a higher roi. And conversely the interest rate charged on this riskier lend should be above its competitors.
A good article on the UK housing market through the financial crisis and how
government intervention is skewing the market further away from first home buyers
http://www.theguardian.com/books/2013/aug/18/default-line-extract-faisa…
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