Housing and Monetarism

The Reserve Bank cannot deliver affordable housing by itself. Its actions have to be coordinated with the government's. Unfortunately the monetarist framework of the Reserve Bank Act obscures this.

The tensions between the Reserve Bank and the Government over housing policy go back to the mistaken economic thinking in the 1989 Reserve Bank Act. Monetarism ruled and it is that underlying monetarist approach which is creating the tensions.

I have no quarrel with the governance provisions which gave the Reserve Bank independence in the operating of its monetary policies. Many commentators, imbued with the tradition of the centralised governing of New Zealand, do. They forget the time when Prime Minister Muldoon used to ring the Governor secretly telling him what had to do. The Prime Minister can still do that, but to have the force of law it has to be done by a letter tabled in parliament so that any direction is transparent. So while the operating of monetary policy is today the preserve of the Reserve Bank, the Government still directs its goal.

I chose not to make submissions to the select committee considering the bill: parliament was not listening to critics of Rogernomics. However I checked that the proposed legislation did not rule out what in my, and others’, opinion is the primary function of a central bank – to maintain order in money markets. Fortunately there was a clause which allowed the Reserve Bank to take action, in tandem with the Treasury, to settle the New Zealand money markets as they went into turmoil during the Global Financial Crisis. Other central banks did too, implementing policies which are difficult to justify in a monetarist framework.

My objection to the Act was the requirement that the Reserve Bank be responsible for price stability. This has (at least) three implicit assumptions.

First, it assumed the notion of price stability can be rigorously defined. In fact an economy has numerous prices, many of which do not move together. Currently house prices are on quite a different trajectory to that of the majority of consumer prices. I’ll come back to that, but share prices, land prices and the exchange rate all move differently too (as does do tradeable prices from non-tradeable prices).

Second, there is the assumption that monetary policy can target effectively any chosen price index. The fact of the matter is that throughout the world central banks, including the RBNZ, have been unable to prevent the current world disinflation – falling or excessively low increases in prices. Monetary policy has only some effect and it is heavy handed or slow or even ineffective.

Third, the Reserve Bank Act assumes that effective monetary policy can be run independently of fiscal and other government economic policies. We shall see it cannot.

(I read the official papers which backgrounded the Act. Not one addressed these issues. The papers simply took the monetarist approach which assumed that its underlying economics was not problematic. The lacuna is reinforced in the recently published history of the Reserve Bank which also ignores the issues.)

The relevance to the current situation is that, first, the RBNZ is, rightly, concerned with (at least) two kinds of price inflation – consumer prices and housing prices (which threaten the long-term sustainability of the economy). Second, it can use monetary policy to target one or the other but not both, so it has been hunting around for ad hoc instruments (like loan-to-value ratios) to target the other. Third, its interventions are going to be ineffective unless they are supported by other policy settings which are the direct responsibility of the government. These include contributing to increasing the supply of housing, say by building more itself; reducing the demand by an effective capital gains tax and easing back migration.

Altogether this means that the RBNZ cannot adequately restrain house prices as long as it is also concerned with consumer prices. If it were directed to primarily target housing prices, its impact would be high interest rates, a brutal deflation and a long time to be effective, especially if the government did not play its part.

For reasons which partly reflect a monetarist ideology and partly because any effective decision is politically uncomfortable, this government is unwilling to play. The Reserve Bank Act becomes a nice little excuse for it doing hardly anything except facilitating the private supplyside, thereby avoiding uncomfortable policies (in the short term).

Meanwhile, that epitome of politeness, the Governor of the Reserve Bank, has indicated that the government has to take more responsibility for the unsatisfactory state of the housing market. Hence the tension between the Governor's and the Prime Minister's pronouncements.

Just to be clear, there is nothing in this column’s analysis which would upset an orthodox economist. Monetarism is not nearly as popular among them as it is among do-nothing politicians and pop-commentators.