Over at the Rates Blog Andrew Coleman has written a piece on fixed mortgage rates and the monetary policy transition mechanism.
His initial point is that the ability of the Reserve Bank to smooth economic activity has been constrained by the fact that so many New Zealander’s hand fixed rate mortgages, compared to Australia where the majority of mortgage holders were on floating rates.
While his point holds weight, given that New Zealand is a net debtor country and higher average interest rates imply that the “increase in income” associated with a fall in the OCR was smaller.
However, there are three comments I would need clarification on before deriding the effectiveness of NZ monetary easing.
- My impression was that the target of monetary policy was regarding relative prices. We want to make “additional” consumption more attractive now, and any “additional” savings less so. The fact that fixed mortgage rates are fixed doesn’t directly change this – a change in the OCR will be just as appropriate at the margin. The income loss is unfortunate, but is the result of the risk-return trade-off choice made by individuals.
- The net debt position implies that the negative income effect needs to be offset by a positive income impact somewhere else. As the long-term fixed rates were with banks (not international investors, who were generally borrowed off based on a shorter maturity) does this imply that bank profitability is increasing? If so this would only be a negative income shock for us insofar as dividend payments would head over to Aussie right?
- It is more important to understand “why” NZ felt it was appropriate to fix itself to high mortgage rates to buy over-priced and overly large houses.
Moving past his initial point he does go on to cover the second issue nicely:
Since 1993, New Zealand 90 day interest rates have been at least one percent higher than five year interest rates some 37 percent of the time – and in the last five years a staggering 70 percent of the time. Other central banks seem fortunate enough to control inflation without needing to do this. Since 1993, Australian 90 day bank bill rates have been one percent higher than five year government bond rates only 5 percent of the time, and such a margin is scarcely ever seen in the United States.
It is unclear why such high short term rates have been necessary to counter inflation in New Zealand for such a long period of time, for inflation outcomes have not been noticeably different to those experienced in other developed countries. It is possible that inflation is easier to control in other countries because the tax systems are different, or because their economies have different wage-price dynamics.
Further research on these topics is urgently needed to better understand why New Zealanders face some of the highest interest rates in the world.
That is the kicker. What are the structural imbalances in the economy that implied we required a relatively high OCR.