Why the Government Should Be Setting Expectations of the Reserve Bank

The row that raged last week over the Reserve Bank’s role in the housing market is an argument we must resolve – and quickly.

Since the Reserve Bank started reducing interest rates in May last year, house prices have jumped 25 per cent. Average house prices in Auckland hit $1 million in October and the median house price across New Zealand increased by 20 per cent, from $605,000 in October last year to $725,000.

Much of this has come about because the Reserve Bank has been pumping cash into our banking system to reduce interest rates and to stimulate economic activity.

This situation comes on the back of a housing shortage, due to excessive land use restrictions and an overly burdensome Resource Management Act.

But the question remains, where is this newly printed money going?

Since March, housing lending has increased by $8.7 billion, but business lending has fallen by $6.1 billion. There has been no new funding at all to support agriculture and horticulture and very little provided to property developers to build new houses and increase our housing stocks.

In effect, all we’ve done is funded the buying and selling of existing houses contributing to a rising property market, when we should have been trying to target funding at those areas that will improve New Zealand’s productivity and grow our economy.

Unless something is done, house prices and the value of other assets will continue to rise as investors look for a higher yield than they can get for their deposits at their local bank.

That’s bad news for first-home buyers – it’ll be even harder for them to compete with investors – and ultimately raises the prospect of an asset price bubble pop when interest rates eventually rise again.

But the Reserve Bank doesn’t believe it has the mandate to address the rapid escalation in house (and asset) prices, unless it affects financial stability.

Last week I called for the Government to write a letter of expectation to the Reserve Bank to ensure its programmes to assist trading banks are targeted at the more productive parts of our economy, not the housing market.

Those calls have been met with some resistance, not least from the Prime Minister. But I think we are suffering from short-term memory loss here.

Last year, the Finance Minister led the charge to change the mandate of the Reserve Bank. A second component of “supporting maximum sustainable employment” was added to its original mandate of ensuring monetary policy is focused on targeting price stability. In other words, keeping price inflation in a band of 1-3 per cent over the medium term.

Given the Reserve Bank’s so-called independence this was, in effect, a political move by the then Government.

So to now suggest writing a letter of expectation would be “politicising” the role of the Reserve Bank to address the raging housing market seems a bit of a stretch.

Furthermore, there is an implication that politicians don’t have the right to do this - or shouldn’t. I disagree.

The Reserve Bank Act has a clause that specifically allows the Minister to direct the Bank to have regard for government policy.

Clearly, we should only use this clause very sparingly.

But right now there is a major disconnect going on - on the one hand, the Government is trying to stimulate the economy through its spending (fiscal) programmes and on the other, we have a Reserve Bank effectively stimulating a non-productive sector of the economy through its Quantitative Easing (monetary policy) programme.

These two fiscal and monetary programmes need to be in sync - they are not but they should be.