Analysis: NZ’s Robertson Needs to Talk to RBNZ’s Fin Stability Arm, Not MonPol

By Sophia Rodrigues

New Zealand Finance Minister Grant Robertson is right to be worried about the effect of rising house prices on his government’s aim to reduce inequality and poverty, but the solution to his worry is not in the hands of the Reserve Bank’s monetary policy arm.

So, asking Governor Adrian Orr to take into consideration house prices when formulating monetary policy is akin to asking to shut an important transmission channel of monetary policy and one that would compromise the central bank’s overall price stability and employment objectives.

Earlier Tuesday, Robertson wrote a letter to Orr expressing concern about the recent rapid escalation in housing prices, and forecasts that price gains would continue. This is affecting the government’s ability to meet economic objectives and also presents a financial stability risk to the economy, particularly when monetary policy returns to more normal settings, he said.

Robertson proposed a change in Section 2b of the current remit to include house prices in the line that says the RBNZ should, “seek to avoid unnecessary instability in output, interest rates, the exchange rate, and house prices.”

Robertson also said he would welcome any alternative proposals with regard to the RBNZ’s monetary or financial policy.

In a prompt reply, Orr said, “I can assure you that the MPC, in making its decisions, gives consideration to the potential impact of monetary policy on asset prices, including house prices. These are important transmission channels that affect employment and inflation.”

“Housing market related prices are also included in the Consumer Price Index, for example rents, rates, construction costs, and housing transaction costs.”

What Orr meant is that house prices is important for monetary policy and is being considered but in the current situation it is different to what Robertson is proposing

Orr made his point by clearly stating the link between house prices and inflation.  Effectively it means, rising house prices is important because it feeds into consumer price index.

In the current environment, house prices is an important channel through which monetary policy is working. If the RBNZ gives consideration to house prices in its deliberations in the way Robertson wants, it would means monetary policy would have to prematurely tighten, or not eased further.

This would be contrary to what the MPC thinks is needed to progress to the economy’s goals and in the worst case, it would even lead to rise in jobless rate.

“In the current environment, higher interest rates are not the best policy instrument to mitigate these (higher house prices) risks. Higher interest rates now would make loans less affordable and reduce economic activity. This would add to uncertainty for households and firms,” the RBNZ said in the November Monetary Policy Statement.

“We would likely see higher unemployment, as well as higher credit impairments in the financial system,” it added.

To be clear, this does not mean the RBNZ is ignoring the implication of strong house price growth. Indeed, the RBNZ has acknowledged the risk but given the state of local and global economy, the RBNZ thinks the best way to deal with this is by reducing risky bank lending to households.

In short, in a world where central banks are well short of their mandates, monetary policy needs to remain easy for longer to help the economy move towards full employment and inflation goals. And that means dealing with financial stability risks by relying on macro-prudential tools. It is already proven that macro-prudential tools are directly effective in reducing risky lending in the system, and in turn helps in moderating house price growth.

That is exactly the path the RBNZ is taking. On the day of the November monetary policy announcement, the RBNZ said it will begin consulting about reinstating loan-to-value mortgage restrictions and aims to impose it from March 1, 2021.

It is interesting to note that in the RBNZ’s baseline scenario, house prices are projected to rise by 9.6% y/y in Q4 of this year, and close to 8% in each of the next two quarters before slowing to 4%, and further to 3% by the end of 2022, and accelerating again towards 5% by the end of 2023.

Other things being equal, such a pace of house price gains would be required to get inflation to 2% by the second half of 2023.