Matt Nolan

New Zealand’s bubble

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I know, I know, I’m very late to the party – while I was busily writing about factor shares and income inequality the big news in New Zealand was this discussion of how our housing market is a “bubble”!

A bunch of points have already been made about why the US to NZ comparison isn’t fair, our shortage of housing being key among them.  Shamubeel also did an excellent post last week noting how the framework for thinking about the issues wasn’t really there – and what was missing from each of the points raised.

However, there were a few things that didn’t get play that should have over the last couple of weeks.  As a result, and after conversations with a bunch of wonderful people who were interested in the issue, I thought I would do a blog post noting these points.  Here is what I said in the conversation:

Remember, New Zealand banks have already been stress tested on 30% house price declines – and found to still be solvent.

It would be fair to discuss risk if the conclusion was only a fall in house prices by itself.  But picking a gigantic recession for a small open economy, with a fragile global financial market, is virtually meaningless for planning purposes without a catalyst/narrative.  It sounds more like marketing than a real forecast.

We would need a situation with massive household bankruptcies for the NZ banking sector to struggle (loans aren’t nonrecourse).  To me that suggests our banks have strong power over consumers, and there are more important regulatory failings than banging on about bubbles.

Also, our external debt is mostly in NZD nowadays, with maturity of over 90 days.  Crisis happens, dollar drops, foreign investors have taken on that risk.  I find it surprising – but good for NZ.

The key points raised here:

  1. Unlike the US, NZ loans are not non-recourse.  People are still stuck with their mortgage if house prices fall.
  2. NZ banks have been stress tested on a large house price decline, and the banking system was still holding together.  We need to think about specific shocks to think about risk – the real fear is a massive drop in export prices, which leads to greater defaults in both agricultural and housing loans.
  3. Banks have changed their external funding significantly in recent years – with the maturity a lot longer and currency risk being shifted further towards overseas investors.  If a crisis strikes, this implies that the liquidity issues will be less severe, and the value of our gross debt will also drop (due to a lower currency) – a fortuitous situation!  These figures are all available on the RBNZ’s website if you want to check them out!

We aren’t like the US prior to their housing market imploding – we have our own sets of risks and concerns we need to think about.

Matt Nolan

Labour and monetary policy

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Labour has put a bunch of thought into its discussion on monetary policy – and there is certainly nothing wrong with discussing the issues and putting out a policy document, in fact there is a lot right with that.  Furthermore, over their entire document they recognise this is a multi-faceted issue we need to be careful with, I appreciate that a lot.

However, there are still a few glaring issues with the way they discuss monetary policy:

  1. They keep mixing “monetary” policy with longer-term “fiscal” policy.  It is not the RBNZ’s role to determine longer-term fiscal policy – this is undemocratic.
  2. On that note – the “external balance” is not an RBNZ target, and nothing they are suggesting actually helps that.  This is a general issue with medium-long term savings-investment imbalances, and we need to neatly define what the welfare relevant “problem” is before we go swinging around policy and reducing the ability to “judge” the Bank by giving it piles of targets.
  3. They don’t seem to appreciate how much monetary policy HAS changed during the last 25 years as institutions try to adapt to the changing world around us – their view that policy structures are no different than they were in 1989 is totally wrong.
  4. The variable Kiwisaver idea, controlled by the RBNZ, is horrible.  It comes from a good place IMO – they are looking for counter-cyclical tools that are used by an independent body.  But as I’ve explained, this is a particularly bad one, and will hurt the defacto independence of the RBNZ.  In addition, this “tool” won’t help the “external balance” – as the average savings rate should be unchanged.

Labour’s focus appears to be on exporters and manufacturers, as given there discussions with people they believe there is an issue there.  However, monetary policy, and the monetary policy choices of the Reserve Bank, are not the cause of this inherent S-I imbalance which forces NZ interest rates to be on average high.  Investigating why this is, and trying to understand it and base policy on issues in that, is the way forward.  This is why we’ve had a savings working group, a tax working group, and a productivity symposium – as all these structural issues, and the trade-offs they represent, are related.

These whys matter intensely for deciding policy – wasting time trying to mess around with one of the institutions that is working (in terms of keeping inflation in the band, and moderating the drop in output/employment, during the largest external shock since the Great Depression) to look like we are facing the issue is not doing this.

Matt Nolan

Discussion Tuesday

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This one is from the magical world of Twitter:

Once again, remember that these are points for discussion – I am not saying I agree or disagree with them.

Matt Nolan

Quote of the Day: Kolm on inequality

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One of the forefathers of modern income inequality analysis, Serge-Christophe Kolm, started one of his most famous papers (REPEC) in the following way:

Many people consider the reduction of economic inequalites as a basic aim of society. Such ideas are, however, largely nonoperational, sterile, and even meaningless, as long as what is called inequality is not stated with precision. This is so because, as well appear below, different measures of inequality give widely different, and even opposite, results. Such policy which diminishes some apparently reasonable measure increases other ones.

This is no small point.  While it is nice for us to bang on about “reducing inequalities”, it is nothing more than empty platitudes if we aren’t willing to discuss the trade-offs associated with individual policies.

Also, let’s not forget this quote:

Few concepts are as meaninglessly used as that of inequality.

But this is not because he thinks analysing issues of social justice don’t matter – in fact it is the complete opposite!  He believes that multi-dimensional ethical issues deserve careful and specific analysis, rather than being thrown into one broad, and close to meaningless, term.

Like exchange rates, productivity, GDP, and inflation, inequality is a broad macro(social/economic) term that can be used as a touch stone to go on to think about other real issues.  But it should not be allowed to become more important than these issues, and an understanding of the trade-offs that do exist when we go to make policy choices.

Matt Nolan

Other reviews of Capital

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Having looked into our own review of Capital, and discussed some of the common misconceptions of the book, now is the time to allow a bit more perspective.  Here are a bunch of other reviews of Capital in the 21st Century that I have hunted down.  There is no way I’m saying I agree with all the reviews here – as if I did, my opinions would constantly contradict!  Instead, I just want as broad a range of views here as possible.

There is no particular order, but it appears that the more critical ones are ‘on average’ at the top.  This is because they turned up later, and I tended to add things near the top of the list as I was too lazy to scroll down 🙂

Read more

Shamubeel Eaqub

Blogging vs sensationalism – Economic Bubble?

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Social media frenzy over the news-quiet Easter weekend. Blooger at Forbes.com says NZ economy is headed for a bubble! Hat tip to Jessie Colombo for creating a media storm.

While there are reasonable and often cited risks in his analysis, the substance is lacking. You will find any number of economists, including in the RBNZ and Treasury, highlighting the risks from high Auckland house prices, high household debt and concentration risk in exports (from our increasing exposure to emerging markets, China in particular).

Here are his 12 reasons and why I think there is reason not to panic:

1)     Property prices have doubled since 2004

In Auckland and Canterbury. They have fallen elsewhere.

2)     New Zealand has the world’s third most overvalued property market

Yes. Auckland is.

3)     New Zealand’s mortgage bubble grew by 165% since 2002.

Bit selective. Household debt to income has actually been going sideways, if a little down, in recent years. Although not paid down the rapid accumulation in the 2000s.

4)     Nearly half of mortgages have floating interest rates.

Actually 73% by value. But you can fix if you want to. Which borrowers have done in the past. This is not to say that rising interest rates wont bite, but they will be spread over a long period of time.

5)     Mortgages account for 60% of banks’ loan portfolios.

I haven’t verified this number, but presumably this is bad if this will lead to high defaults. New Zealand does not have the legal structure to allow borrowers to walk away from their debts. Also, even during the recession of 2008 and the early 1990s mortgage default rates in NZ were relatively small.

6)     Finance, not agriculture, is New Zealand’s largest industry.

Like any advanced economy services are a big part of the economy. This is not surprising. Although he misstates the data. The top 10 industries as per GDP are:

  • Information Media and Telecommunications    7%
  • Professional, Scientific and Technical Services                   7%
  • Owner-Occupied Property Operation (National Accounts Only)                  7%
  • Rental, Hiring and Real Estate Services                  6%
  • Wholesale Trade              5%
  • Construction      5%
  • Health Care and Social Assistance           5%
  • Retail Trade        5%
  • Transport, Postal and Warehousing       5%
  • Financial and Insurance Services              5%

Agriculture details are:

Production approach

  • Ag 3.2%
  • Fishing 0.6%
  • Forestry and logging 1.1%
  • Food manufacturing 4.6%
  • Wood & paper product manufacturing 4.6%
  • Total 11.1%

Export approach

Or Ag related exports are 43% of total exports and 14% of expenditure GDP.

Like most advanced economies the services sector is a large share of the economy. Ag, forestry and fishing is around 7% of GDP as at 2010, compared to the OECD average of around 2%. Finance & insurance directly account for around 10%, while the OECD average is around 6%. Most debt in NZ is intermediated by the banking sector (smaller equity market etc). Details available at oecd.stat

7)     New Zealand’s banks are exposed to Australia’s bubble

Not really. Banking regulation in NZ separates our banks from direct exposure. Although our cost of funding may rise if tarnished with a Aussie housing bust. Real economy threats too from a recession in our second biggest trading partner.

8)     Australian and Chinese buyers are inflating the property bubble

Really? I still haven’t seen evidence of this. So cant comment.

9)     New Zealand has a household debt problem

Same as number 4.

10)  Government overseas debt has nearly tripled since 2008

Government net debt to GDP is less than 30% of GDP and denominated in NZD. Whats the issue?

11)  The New Zealand dollar is overvalued

NZD is high relative to history. Export share of GDP is at a historically high level. A fall in the NZD would spur exports and reduce imports.

Here is what to expect when New Zealand’s economic bubble truly pops:

The property bubble will pop.

Sure in Auckland.

Banks will experience losses on their mortgage portfolios.

Like they did in the GFC? More than half of the housing market in NZ crashed in the GFC and bad debts peaked at a very low amount. Don’t buy this argument.

The country’s credit boom will turn into a bust.

We haven’t had this already?

Over-leveraged consumers will default on their debts.

Why? Its not America. You cant walk away from your debts. This did not happen in the GFC.

Stock and bond prices will fall; the New Zealand dollar may weaken.

Good.

Economic growth will go into reverse.

Ok. Thats what happens in a recession.

Unemployment will rise.

Ok. Thats waht happens in a recession.