The CIS is wrong on macroprudential

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By Leith van Onselen

Stephen Kirchner from the Centre for Independent Studies (CIS) has posted a convoluted article in Business Spectator lobbying against macro-prudential controls on higher risk mortgage lending:

…monetary policy is a blunt instrument, making it unsuitable for addressing what are seen to be excesses in credit growth tied to specific asset classes. Central banks have a poor track record when it comes to taking an activist approach to changes in asset prices…

When it comes to asset price booms and busts, central bankers can be divided into asset price ‘poppers’ and ‘moppers’, but the weight of historical experience strongly favours the mopping-up approach…

Macro-prudential policies are seen as providing policymakers with a more targeted set of policy instruments that might complement or even substitute for changes in official interest rates. However, these instruments also implicate policymakers in making much finer judgements about risks to financial stability as well as the more traditional concern of monetary policy with price stability.

A blunt instrument like monetary policy encourages caution in making such judgements… By contrast, more targeted counter-cyclical quantitative controls…[can]…create a false impression that a central bank’s price stability mandate has been subordinated to other objectives, such as house price inflation…

Macro-prudential regulation is often a second-best approach to dealing with the inflationary implications of supply-side rigidities in housing markets. It may also push borrowing and lending activities outside the regulatory perimeter altogether.

So, according to Kirchner, macro-prudential policies should not be enacted because:

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  1. Monetary policy (i.e. changes to the official cash rate) is unsuitable for managing asset bubbles, and attempts to use monetary policy in this way poses great risks for the broader economy. So it’s better to just let asset bubbles rip and then clean up the mess after they inevitably burst.
  2. Macro-prudential policies shouldn’t be implemented because they require policy makers to use their brains and make judgments about financial stability risks. Again, better to just let asset bubbles rip.
  3. Monetary policy, although useless in managing asset bubbles, is great because it somehow “encourages caution” in decision making, whereas the same cannot be said for macro-prudential.
  4. In any event, supply-side reform is the be all and end all, and the demand-side of the housing market can be ignored.

Am I the only one who perceives Kirchner’s comments to be nonsensical?

Surely his admission that monetary policy is useless in managing asset bubbles strengthens the case for a more targeted approach, such as loan-to-value or loan-to-income controls, in order to temper the credit cycle and dampen the the likelihood of damaging booms and busts in house prices? Moreover, his view that regulators should simply ignore risks and mop-up busts afterwards is a cop-out and not particularly clever. I am sure if the US, Ireland and Spain could have their time over again, they would have placed controls on housing lending in the lead-up to the GFC.

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About the only thing I agree with Kirchner on is that macro-prudential is a second best policy option to supply-side reforms to the land/housing market. Sure, if Australia operated Houston-style housing policies – i.e. liberal planning, minimal artificial restrictions on urban land supply, and adequate provision of housing-related infrastructure – then the opportunities for prices to boom and bust on the back of credit would be reduced significantly, since any extra demand would flow primarily into higher construction rather than increased prices.

But we also have to be realistic. Like it or not, supply-side constipation is, for the foreseeable future, a feature of the Australian housing market. Therefore, it makes absolutely no sense to simply let credit rip and, in doing so, sit back and allow a housing bubble to develop.

To only focus on supply-side distortions, while ignoring demand-side drivers is not particularly sensible from a policy perspective.

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About the author
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.