A couple of good articles on monetary policy reform

Here are a couple of good articles on the monetary policy debate.  First from Australia (and this fine blog with more discussion here and here):

Meanwhile, the central bank’s primary focus on inflation recognizes that monetary policy needs to be based on a single instrument and policy objective. Pursuing multiple objectives with multiple instruments, as Labour now suggests, is a recipe for incoherent policy and poor economic performance such as New Zealand experienced before its path-breaking reforms of the 1980s.

And then there is BK Drinkwater, who has gone full hog discussing monetary policy issues with the Standard here and here.

I didn’t take Marty G’s post—or Cunliffe’s—seriously, because for all the storm and stress about “hot money” coming from overseas, there’s a certain obliviousness to the fact that for debt to happen, for mortgages to happen, for credit to happen, someone has to borrow in addition to there being someone willing to lend. Why ignore half of supply & demand?

This is THE point that is CONSTANTLY being ignored.  Never have I seen so many smart people ignore a demand curve for so long

Update:  I should point out that Westpac is also making the point on demand, good on you guys 😉 .  I don’t actually receive weekly updates from any of the other banks, if any of them are saying it as well could someone tell me in the comments and I’ll link.

Good work everyone.  Hopefully someone is listening …

  • What you and BK seem completely oblivious to is the idea that the demand is the excessive interest rate rather than the excessive demand for housing credit. The supply of carry trade cash is meeting a price set artificially too high. That floods the New Zealand market with credit. Being only human the bankers keep letting the money out the door to make their sales targets and the bubble fuels itself. Change the NZ Treasury risk free rate to a global risk free rate of 0.5% (or match the US fed rate consistently) and force the banks capital adequacy ratio’s to genuinely reflect the asset inflation bubble risk they are taking on. Then see what happens to supply & demand. You are happy to focus on “consumer” inflation but blithely ignore house price inflation which is exactly the same thing over a longer time frame.

    The world just went through a massive credit bust related to excessive housing credit but you seem blind to the same issue in New Zealand. There is a hugely distortionary effect on New Zealand’s economy.

  • @Phil Sage (sagenz)

    “What you and BK seem completely oblivious to is the idea that the demand is the excessive interest rate rather than the excessive demand for housing credit”

    When credit comes into the country it has to go somewhere. According to the data New Zealand has excessively invested in the housing stock (in terms of the value we spent rather than the quantity – another interesting issue in itself) so it is the prime candidate for the imbalance.

    Money doesn’t flow in, drive up the exchange rate, and then just sit in a field somewhere – it only comes in when someone borrows it. There HAS to be a demand for the capital.

    Now, as the domestic interest rate goes up, demand for capital falls. I have a post on the carry trade going up at 1pm – it will discuss all this in more detail.

  • @Phil Sage (sagenz)

    “The world just went through a massive credit bust related to excessive housing credit but you seem blind to the same issue in New Zealand. There is a hugely distortionary effect on New Zealand’s economy.”

    Which implies that there is an issue regarding the housing market – not monetary policy. Again monetary policy is about the “general price level”, not relative prices. If the relative price of global housing has been excessive, and if this has leveraged imbalances, then we should be trying to understand the issues driving these imbalances.

    New Zealand monetary policy, which is focused on targeting medium term general price growth, is not part of the issue here. And as a result, any talk about destroying the Reserve Bank Act to fix a problem it didn’t cause is a little strange.

  • “Which implies that there is an issue regarding the housing market ”

    Agreed. Asset price inflation! which is no different to quality of life from consumer goods inflation, you still get less bang for your buck.

    “New Zealand monetary policy, which is focused on targeting medium term general price growth, is not part of the issue here.”

    You have a learned definition of inflation. I have a functional definition which includes consumer goods and houses. What is the practical difference on consumption between an ever increasing house price and ever increasing price of cars, clothes & food. They all reduce the real value of disposable income.

    “Money doesn’t flow in, drive up the exchange rate, and then just sit in a field somewhere”

    The holding pen before the money is let into the field is the Treasury risk free rate. New Zealand monetary policy is a VERY big part of the issue.

    “Now, as the domestic interest rate goes up, demand for capital falls.”

    That is classic economics. You are operating in a world of behavioural economics. The increasing value of houses draws in more people who are prepared to pay higher prices in interest and housing because they believe they will make a housing “profit” that others have made and they can too. Classic bubble however.

    US housing prices were driven by Congress loosening credit controls in the 90’s to promote ninja loans and the Fannie Mae implicit government guarantee. UK prices were driven by bankers at the top end and huge flows of equity into London looking for a home followed by behavioural economics. I generalise grossly on that but look at German and French house prices. They went nowhere.

  • @Phil Sage (sagenz)

    “Agreed. Asset price inflation! which is no different to quality of life from consumer goods inflation, you still get less bang for your buck.”

    The implied rental component of housing is in the CPI, as a result the “consumption part” is in there. Any asset price component is missing because it isn’t “inflation” – it might represent a structural issue in the housing market but it doesn’t represent monetary inflation.

    “The holding pen before the money is let into the field is the Treasury risk free rate. New Zealand monetary policy is a VERY big part of the issue.”

    Someone still needs to borrow at the interest rate.

    “That is classic economics. You are operating in a world of behavioural economics. The increasing value of houses draws in more people who are prepared to pay higher prices in interest and housing because they believe they will make a housing “profit” that others have made and they can too.”

    Shift vs movement. House prices have risen and because of expectations credit demand has risen – this is a shift in demand for credit and has nothing to do with the interest rate. In this environment not increasing the OCR would have led to an even greater “housing bubble”.

    This shift is a structural issue with given global housing markets and the global availability of credit – it has nothing to do with domestic monetary policy, which is what a change to the RBA tackles.

  • We will have to agree to disagree about whether rental represents consumption and the asset price component not being inflation. There is a loose correlation between rentals and house prices.

    I have been making the point that the price of money is not the only driver. Damping the housing bubble would only come from a change in capital adequacy ratios. You are correct that someone still needs to borrow at the rate but if they see a 10% gain then paying 7% with no real credit control seems like a reasonable exchange for your average property investor.

    We will again have to disagree about how much of New Zealand’s economic problems relate to residential housing bias in capital adequacy and an overvalued exchange rate from poor monetary policy evidenced by too high a price paid for money internationally.

    nice crossing swords again, off for a sleep now. 🙂

  • @Phil Sage (sagenz)

    Hi Phil. Have a good sleep, but I’m not sure if we disagree as much as you feel – our policy conclusions are simply the main difference.

    In the long-run the house price should represent its consumption value – which should be equal to the sum of rental payments (as rent is the payment for housing consumption). The fact that the correlation is only weak implies that there are other factors driving house prices – these structural issues may be (and in our current situation are) detrimental to the economy and society.

    The changing of capital adequacy ratios is not a monetary policy issue – it is a prudential policy issue. It has nothing to do with the central mandate of the bank (to keep growth in the general price level restrained). However, it is an issue we need to look at.

    “We will again have to disagree about how much of New Zealand’s economic problems relate to residential housing bias”

    But we agree here. I simply lay the blame at external monetary policy (not our Banks) and tax/housing policy in New Zealand.

    “an overvalued exchange rate from poor monetary policy”

    It is not clear our exchange rate is overvalued, remember our terms of trade (the ratio of how much we receive for stuff against how much we pay) is historically elevated and the US is printing the hell out of money. In these terms it seems that we could justify an even higher exchange rate!

    The idea that monetary policy is holding our dollar too high is not robust, there are too many other factors.

    Catch you later.

  • steve

    great post, and great response to cunliffe’s post too.

  • Miguel Sanchez

    Phil Sage (sagenz)
    That is classic economics. You are operating in a world of behavioural economics. The increasing value of houses draws in more people who are prepared to pay higher prices in interest and housing because they believe they will make a housing “profit” that others have made and they can too. Classic bubble however.

    The question is whether higher interest rates make people borrow more or less – according to some of the drivel that’s been written lately the answer is “more”, when the sensible answer is “less”. It doesn’t matter whether this is against a background of a ‘bubble’, where people buy houses on the expectation of capital gains. At the extreme, get mortgage rates above the expected rate of capital gain, and not even behavioural economics will predict an increase in borrowing demand.