RBNZ: fix housing supply & temper credit

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By Leith van Onselen

The Reserve Bank of New Zealand (RBNZ) yesterday gave a speech (below) entitled Perspectives on housing, which provided a useful overview of some of the factors driving New Zealand’s housing market and monetary/prudential policy. Below are some key extracts.

On housing and the New Zealand economy:

The RBNZ notes that New Zealanders have a disproportionate amount of wealth tied-up in housing, which makes the economy overly sensitive to swings in house prices:

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The most recent data on household balance sheets is shown in Table 1. Two observations are key: first, the value of housing is a large share of total household assets in New Zealand compared to Australia (and the United States) where financial assets play a much greater role in saving for retirement. Consequently, house price movements in New Zealand have a relatively large impact on household confidence and spending compared to many other developed countries where the state of the financial markets plays a larger role in driving consumer confidence and spending…

Housing cycles in New Zealand can have important macroeconomic effects. Figure 1 shows long-term house price cycles against GDP growth and the exchange rate.

Housing has often been associated with real activity cycles, and is even more correlated with financial cycles, as represented by changes in credit demand and the exchange rate.

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In the housing boom of 2003-07, for example, housing had a significant impact on the growth of aggregate demand and GDP through a number of channels: wealth and confidence effects where people felt richer, making them willing to spend and borrow more; direct effects on investment as higher house prices improved the return to residential construction; and financial accelerator effects where increased collateral values supported increased spending through credit expansion. The latter channel has created a strong link between house prices and the financial cycle. During the boom that link was accentuated with the emergence of widespread housing investment activity, bringing with it rapid credit growth, a high volume of offshore borrowing and upward pressure on the NZD exchange rate.

Supply pressures building:

The RBNZ also notes the building house price pressures in New Zealand’s two biggest markets – Auckland and Christchurch – where price inflation is running well ahead of incomes, growth and the rest of the country, due in part to constraints on housing supply:

We are again facing a strong housing market with median house prices having risen by 8 percent over the past year. So far, the nature of the current market is different to the boom of 2003-07. As seen in Figure 2, the current house price pressures are concentrated in Auckland and Christchurch. House price inflation in the rest of the country is less pronounced, around 4 percent over the past 12 months, although there is considerable variation among districts.

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Supply constraints in Canterbury and Auckland and pent up demand from first-home buyers are important factors. There is an element of investor demand and of new foreign buyers entering the market in Auckland, but these factors – at least as yet – are not as influential as they were back in 2003-07.

The relevance of housing supply constraints has been discussed in earlier Reserve Bank/Treasury reports and, most recently, in the Productivity Commission’s report on housing affordability.2 Contributing to the current national housing shortage has been the low level of residential construction activity in recent years. From 2007 to 2011, residential investment as a share of GDP fell by 2-and-a-half percentage points.

In Christchurch, the general shortage of accommodation is reflected in median house prices up 12 percent, rents up 16 percent, and the cost of building up 10 percent over the year to December 2012. These pressures are likely to persist for some time despite the insurance industry’s plans to finance 10,000 new houses over the next three to four years.

In Auckland the situation is more complex – and more uncertain. The Auckland Council puts the current shortfall at around 20,000 to 30,000 homes, with an additional 13,000 per year needed going forward. However, the current rate of building is hardly making a dent in that, with residential building consents for new dwellings in Auckland currently running at just 4900 per annum. The Ministry of Business Innovation and Employment estimates that land ready for subdivision in Auckland has the capacity for 14,500 new homes. But, while zoning and utilities infrastructure may be complete for those subdivisions, only 2000 sites are ready to build on – with utilities actually connected and consents approved. These numbers reinforce the complexity of supply constraints noted by the Productivity Commission. It is not just a zoning or Metropolitan Urban Limit issue. The cost and the duration of subdivision development and house construction are also major constraints, particularly for the supply of ‘affordable’ homes to first-home buyers.

Easier credit also pumping demand:

The RBNZ also notes that lower mortgage rates combined with loosening credit standards is also inflating demand, which is contributing to the price increases (obviously made worse by unresponsive supply):

Current ‘best in market’ rates are around 4.8-5.0 percent. These are down half a percent over the past year due to lower funding costs on international markets. They are the lowest mortgage rates on offer since the 1960s. While there are good reasons for this – low CPI inflation and very low international interest rates – the cost of credit is now only slightly above average rental yields of 4.5 percent per year. Added to this, credit has become easier to obtain, with banks competing aggressively to gain or protect their mortgage market shares.

An increasing proportion of new mortgage lending is going out at high loan-to-value (LVR) ratios: now around 30 percent of new lending is at LVRs over 80 percent, compared to around 25 percent of lending in late 2011-early 2012. Annual growth in housing credit is just over 4 percent and has been running at higher rates over recent months.

Easy credit conditions, combined with the upward trend in house prices, are strengthening the incentive for renters to become first-home buyers and for existing owner-occupiers to upgrade. With new construction still at a slow pace, this excess housing demand increases house price pressures.

Implications for RBNZ policy:

The RBNZ notes the risks inherent in New Zealand’s house price inflation:

We are left with concerns that the current escalation of house prices is increasing risk in the New Zealand financial system by increasing both the probability and potential effect of a significant downward house price adjustment that could result from a future economic or financial shock. The more that house prices continue to overshoot their long-run sustainable levels, the greater the prospect of an eventual significant downward correction…

We have seen in those countries most affected by the GFC the significant damage that can result from sharp declines in house prices, both in terms of financial system losses and the economic stresses placed on borrowers. The impact of such an adjustment could be worsened by existing economic headwinds in the form of an overvalued exchange rate, drought affected agriculture and the government’s significant fiscal consolidation.

We are not the only ones concerned. This view of increasing housing risk in the New Zealand financial system is shared by the International Monetary Fund in their recent ‘Article IV’ assessment  and was voiced during the recent OECD mission to New Zealand. It is also shared by Moody’s and Standard and Poor’s in their most recent risk assessments of the New Zealand banking system…

New Zealand needs to avoid another housing boom, which could potentially be more costly than the last, particularly at a time when the economy faces headwinds from an overvalued exchange rate, drought and a substantial programme of fiscal consolidation.

Fixing the imbalances:

The RBNZ sees freeing-up of the supply-side, as well as a combination of macro-prudential controls on lending, increased bank capital, and higher interest rates as keys to mitigating housing risks:

An important medium- to long-term policy response is to work on alleviating the housing supply constraints, particularly in Auckland. That means freeing up land for subdivisions and also reducing the time and cost barriers faced by developers. As recommended by the Productivity Commission, there is also a need to promote/facilitate productivity improvements in the building sector itself, in order to bring unit costs more into line with international norms. The Government is working on measures to address many of these supply constraints, but we know it could take many years to correct the supply/demand imbalances through supply measures alone…

In the short-to medium-term, we want to ensure that the banking system is adequately capitalised for the risks associated with mortgage lending and also avoid demand pressures that could exacerbate a house price overshoot that is in no-one’s best interest. A continued escalation of house prices would frustrate first-home buyers; it would risk drawing more investors into the market which would reinforce the price overshoot; it would likely reverse the recent improvement of household debt relative to income; and it would add a further layer of risk to the banking system.

From a Reserve Bank monetary policy perspective, if the house price and credit expansion begin to fuel excessive consumption spending and inflationary pressures, a monetary policy response would become more likely. The Reserve Bank’s flat interest rate outlook in our recent Monetary Policy Statement would need to be revisited.

In the financial policy area we are currently consulting on a potential increase in bank capital requirements against high LVR lending. We also expect to soon have in place a macro-prudential policy framework that could be used to increase resilience in the banking system against a future housing downturn while having a moderating influence on credit expansion to the housing sector. Macro-prudential policy is primarily aimed at enhancing financial stability, but it may also contribute to achieving monetary policy objectives. It is not seen as a replacement for monetary policy and it is not expected to be as powerful a tool as monetary policy. Macro-prudential policy could nevertheless have a stabilising impact on credit supply decisions by the banks as well as credit demand decisions by households…

While as yet untested in New Zealand, such [macro-prudential] policies are deployed in Canada, Switzerland, Sweden and Hong Kong, for example… Practically, this means that additional prudential requirements may be applied for a period during credit up-cycles and then removed during down-cycles. The tools operate directly to improve the resilience of bank balance sheets and indirectly to moderate the extremes of the credit cycle.

Full speech below.

RBNZ Perspectives on Housing (April 2013)

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  1. “….The more that house prices continue to overshoot their long-run sustainable levels, the greater the prospect of an eventual significant downward correction……”

    A central banker talking common sense? Who’d have thunk it?

    Mind you Don Brash was clear about all this stuff when he was RBNZ governor in the 1990’s.

    Strange that so many higher powered nations have utterly clueless central bankers, even now.

  2. “….. if the house price and credit expansion begin to fuel excessive consumption spending and inflationary pressures, a monetary policy response would become more likely. The Reserve Bank’s flat interest rate outlook in our recent Monetary Policy Statement would need to be revisited….”

    This is like having to give the cancer patient more overdoses of chemo when previous doses have already just about killed off all his vital organs and failed to kill the cancer.

    From the OECD report “Bird’s Eye View of OECD Housing Markets” January 2010

    “…..Another concern is about the ability of monetary policy to thwart the development of a housing bubble without causing widespread damage to the rest of the economy. In a house price boom, prices increase strongly – often at double digit rates – and expectations of future prices are similarly upbeat.

    Under these conditions, large policy rate hikes would be necessary to cool housing markets. High interest rates would crowd out sound and socially useful investments….”

    The productive/tradables sector is already seriously damaged by the urban planning and the high economic land rents that cause the price inflation in the first place. Higher interest rates is just the last nail in the coffin for them.

    When the wreckage has cleared and everyone is (hopefully) gazing around for actual “productive” sources of re-growing the economy and paying off debt and so on, everyone will (hopefully) ask “where has all the actual wealth creating industry etc gone while we were intoxicated by property Ponzi?”

    Hopefully accurate judgements can be formed and the right policy approaches instituted before it is too late for our civilisation itself.

    • That points to one of the asymmetries of monetary policy.

      The rate decrease to kick off a housing boom may be a lot less than the rate increase required to cool one.

      Having said that, once incompetent policy has allowed a massive increase in debt to render a financial system fragile (even if currently ‘stable’) even slight increases in interest rates from low levels may have unpredictable results.

  3. It would help public understanding if “experts” stopped talking about housing as “wealth”. Adam Smith said in his classic 1776 book, that it was not, and he was right.

    It is an “expense”, merely one that lasts longer than similar expenses such as clothing.

    It is only “wealth” to someone that “realises” it, and even then it is zero-sum in its effect on the whole economy. It is a wealth TRANSFER from the purchaser TO the person “realising” the “value” of the house.

    The use of “equity” to borrow against, is OBVIOUSLY zero sum.

    Economies in which “discretionary income” is higher in the long term due to LOW cost of urban land, are going to bury economies in which urban land costs are high, discretionary income is low, and temporary debt-based boosts to spending push the economy artificially ahead for a short period.

  4. Good posts, Phil. But here’s the crux of what will happen “.. the central bank released a discussion paper…“…. Nothing.

    • Yes, that is about right.

      Perhaps it is better to have the RBA with their heads deeply stuck in the sands of denial.

      At least they don’t spend time getting our hopes up that a bit of sense will prevail.

  5. Oh…but one things an almost certainty that they will do, though “…The Reserve Bank of New Zealand would raise interest rates if there were signs that an overheated housing market …was spilling over into broader inflation pressures and consumer spending, says Deputy Governor Grant Spencer.”

    • Yes, they seem to have given up trying to use monetary policy to contain the house price rises. Now they’re only worried about the spillover into “….broader inflation pressures and consumer spending….”

  6. “From 2007 to 2011, residential investment as a share of GDP fell by 2-and-a-half percentage points.”

    Continuing the theme that the problem at hand is more complex than one single issue (as Leith to his credit does acknowledge) I can suggest one possibility that may be exacerbating the situation – in addition to the fact that between those two years New Zealand experienced a fairly serious recession from which employment is yet to fully recover – :it’s a very short hop across the ditch (3 hours from Auckland to Brisbane) to a place where a skilled Kiwi tradie can earn over $150 000 a year in $AUSD plus other generous perks. I have plenty of friends and relatives working in the resource sector and am assured that our “cuzzy bro’s” have a strong presence in it. Might not such red-hot demand for tradies as we have had be capable of draining such a relatively small pool of skilled workers – and then sending them back home, with dreams of further financial gain through housing investment, plus the cash to back it up?

    • I don’t think they’ve started to go back home as yet. The NZ Builders Federation was warning recently that the longer the government and ChCh Council and other parties spend wrangling about the details of the rebuild of Christchurch, the more tradies would have left for Aussie by the time the rebuild did start properly.

      • A great deal of those workers are FIFO’s though Phil. In any case, with their very large wages paid to them in $AUSD, they would easily have the means to buy up overvalued property back home in NZ, regardless of the fact that probably most of them are temporarily stationed here in Oz.

        I think we do need to consider the dynamics of the interaction of a small economy with a small population stationed very close to a much larger neigbour whose mining sector has been shrieking out for a lot more skilled labour than it has been able to procure domestically, with a relatively loose, open door policy of labour movement between the two countries.

        Is it unreasonable to not simply dismiss out of hand the possibility of NZ suffering a double-whammy effect of being drained of skilled construction-type workers – local scarcity helping to push up the price – while those same absentee workers, thanks to their very hefty incomes which are further increased by the exchange rate, buy up land and investment property in their native country…also helping to inflate the price?

        Now don’t get me wrong – I’m not arguing that this is THE reason for increasing unaffordability in NZ. But I am saying that until it is conclusively proven that the proposition that high numbers of skilled Kiwi workers being paid very high wages in $AUSD to work in the Australian resource sector are both creating a scarcity of skilled labour in the NZ house building industry and also using their very large incomes to bid up the price of NZ housing and land (since most of them likely plan to return home sooner or later) is either wrong or somehow of no consequence, then we need to entertain the possibility that this unique dynamic may be significantly contributing to the price surge in NZ real estate.

        • It’s an easy fact to overlook – supply of land is only part of the supply-side equation. Supply of skilled labour is equally important. It might be easy to miss because a mining investment boom in one country that is large enough to lure away solid percentages of skilled labour from a smaller neigbouring country with the promise of huge $$$ is not something that happens every day.

          • Your point is quite sound. The NZ government does indeed need to ensure that a policy package is complete enough to keep the lid on house prices. Total liberalisation of land supply is an essential ingredient but other tools are necessary to keep the lid on inflation in the price of raw land while the supply chain is winding up – steep land taxes would be a good idea.

            Leaving the supply strangled because there is not enough builders around anyway is not a helpful approach. The builders need to be able to swing into action as they return, not wait for some bureaucrats to decide whether the time is right to drip feed a bit more land to the racketeers.

            My own recommendation to a small country like NZ is to cynically boost the economy with “growth” in returning citizens of the sizeable Kiwi diaspora, a building boom in housing (not just another price bubble) on land at guaranteed affordable low prices, and maximum opportunity for new businesses to get low cost commercial land too.

            Returning tradesmen could not bid up the price of houses on their own. Land prices, which are almost all the problem in the first place, CAN be “anchored” in rural values at the urban fringe with total liberalisation of freedom to build, and a stiff enough land tax.

            But your point is good; tradesmen being attracted in so as to help make the supply chain capacity large enough, should be part of the policy package. I think NZ could add 1 million people in a decade if it set the right conditions. Houston, a single city, did this 2000-2010.

            If Aussie kept its land prices inflated by its racket, you bet the building sector would gravitate across the Tasman to where house-buyers budgets could be spent 90% on construction and 10% on the piece of dirt, rather than 50-50 or worse.

  7. Is there a boom in some commodity in NZ that is helping to fuel the rising currency, stock markets and housing?

    I assume it is dairy or meat as well as minerals as minerals are relatively smaller proportion of exports.

    Is there also a debt funded investment boom designed to increase output of the commodity with boom prices?

    And if so what is the value of work in the pipeline over the next few years?

    “The trade-weighted index of the New Zealand dollar rose above 78 for the first time since it was floated in 1985 and the kiwi soared against the yen as Japan followed the US in flooding its currency market.”

    • When urban land supply is strangled, there is no need at all for any underlying economic growth, for house prices to go up. Just as there is no need for a cancer victim to be in better health, for his cancer to keep growing and taking over his vital organs. A house price bubble works the same way. It is a transfer of capital from the economy’s vital organs.

      And “stimulative” monetary policy all over the world is clearly “stimulating” share markets, inflation in the prices of non-productive assets, speculation in the same, finance sector profits, and finance sector executive bonuses – but it ain’t doing much for Main Street or for Joe and Jane ordinary citizen.

      I do not have any time for pinko anti-capitalism activists but it is high time that this worst ever case of the “crony” in “crony capitalism” ruining the name of “capitalism” was ended. Ayn Rand, quite the non-leftist, said crony capitalists do so much damage, they deserve to hang……

      If money is going to be “printed”, it should be put into the economy somewhere other than the banking sector.

  8. Putting aside the “how” (i.e. increasing supply, macroprudential, etc) after reading this speech, it’s obvious that NZ has only two option to choose from:

    1. Try to slowly deflate property prices, causing a prolonged recession due to the relationship between NZ house prices and economic activity

    2. Do nothing and let propoerty prices crash (due to a yet to be known external shock), causing a prolonged depression.

    I suspect current NZ policy makers and the government will go for the second option and hope it doesn’t happen while they’re still in power / responsible.