Should Central Banks be tasked with housing affordability?

Finance & Fury Podcast

Welcome to Finance and Fury. Firstly, sorry for the delay in episode, been over a week now – daughter was born last week, so been pretty busy helping care for her and trying to find a time to record in between work – should be back to normal from next week

Interesting episode today – as one central bank in particular has now been tasked with the problem of housing affordability – This is the New Zealand central bank (RBNZ) – Can Central banks make property more affordable?

1. If you are familiar with CBs – you would be familiar with the mandates that they get from the government – it is generally to keep annual inflation between a target range (1 and 3% for the RBNZ) and to also support maximum sustainable employment – trying to help job growth
   1. But in February 2021 - the NZ government formally added a clause to the RBNZ’s mandate, instructing it to consider housing prices in making monetary policy decisions
      1. The change has drawn attention – firstly, what this actually means from a policy decision point of view?
      2. Interesting – as it has the potential for governments to extend further into CB policy but also – goes in a contrary manner to the prime mandate of CBs -
   2. NZ has a history in being a canary down a coal mine - In 1989 it was the first to commit to a specific target for consumer price inflation – inflation target - target helped to lower self-fulfilling expectation of endless price rises that was occurring across most western economies in the late 70s and into the 80s
      1. From 1989 to 1991 - inflation fell from 8% to 2% - Soon after, most central banks had adopted targets
   3. Why extend the mandate to consider housing prices? The western world we have been experiencing inflation for years since the targets were brought out – not talking about CPI
      1. Today the runaway inflation rates are essentially asset price inflation
      2. consumer prices have been held in check by globalisation and automation – if anything deflationary fears have existed in regards to this – which is why interest rates have been reduced and, in the process, created easy money – but this easy money has been driving up the price of assets such as shares, bonds and housing
      3. Like many western nations - Home prices have risen steadily in the pandemic, and in 12 months through to the end of January were up 20%
         1. The price of a typical Auckland home gone to $720,000
         2. Inflation targets were brought out to reduce inflation below this level of price growth
      4. In NZ – The prime minister made campaign promises to provide affordable housing – so she has tasked the CB to consider the effects on housing as their policies have helped to push homes beyond reach for the lower to middle economic class – which includes younger first-time home buyers
         1. This isn’t only in New Zealand – in western nations, homes are considered “unaffordable” (more than three times median family income) in more than 90% of cities
         2. The $220tn global housing market is more than twice the size of the global stock market – but the housing market has much additional debt – so the risks of falling prices are compounded by failed mortgages and defaults – making economic downturns worse

I do find that there is some bit of irony of this policy -

1. New Zealand’s was the first CB with the inflation target – hence, interest rates became a tool to be moved to combat inflation – higher rates for higher inflation, lower rates for lower inflation – this monetary tool initially got inflation in line but over recent years, the inflation rate is below the target rage in many countries (in has been for 4 years in Aus, but not in NZ at the moment) – to help this and to try and stimulate the economy – rates keep getting lowered
2. We are in an era of ultra-low interest rates which may be the inevitable destiny of monetary policy – but whilst CPI was declining, asset price inflation has been on the rise at massive compounding rates over the past few decades as an order of consequences from this - inflates the value of the assets beyond what they might “reasonably” be worth if interstress rates were a flat 5%.
3. Governments worldwide have come to embrace easy money as a way to finance social programs and deficit spending, needing QE to make sure bond yields don’t go through the roof – but this has created a negative effect on financial stability and housing affordability.

Now the big question - Can central banks really make houses cheaper?

1. Technically – yes – all it needs to do is increase interest rates massively to the point it puts a downwards pressure on property – but this would have some major downsides that are too great to justify this type of policy
2. This becomes clear when considering the extent of monetary policy tightening that would be required to reliably control asset prices - Research from the San Francisco Fed found that it would have taken 8% of monetary tightening between 2002 and 2006 to completely avoid the housing bubble that preceded the 2007-2009 global financial crisis - For context, the federal funds rate has not been at this level since October 1990 – now that rates are near 0% in most countries, this would require a massive increase
   1. This move by the NZ governments move may not slow the housing boom soon – mainly due to the supply-and-demand dynamics being too strong
   2. Demand – low interest rates and lots of people wanting to live in major cities like Auckland
   3. Supply – Have a pretty urbanised country – technically not as urbanised as Australia
3. The RBNZ has said that “they will have to take into account the Government’s objective to support more sustainable house prices, including by dampening investor demand for existing housing stock to help improve affordability for first-home buyers.”
4. Monetary policy is unlikely to be the critical tool to ease New Zealand’s home prices – it could be, but it likely won’t be without abandoning their long running mandate of having an inflation rate of 1-3% and having full employment
   1. If rates are made tighter (in other words increased) the housing market could be dropped in price - but the entire economy could suffer. If growth slows and unemployment rises, it’s likely the price of homes will go down, but is that really what New Zealand policymakers want?
5. Also – consider the term ‘affordable’ for a second – homes are considered affordable based against the metric of a household’s income – if an economic slump occurs and employment drops, reducing the median household income by 30%, but in the process, you see a 30% decline in housing prices, is this really a more affordable situation?

This brings up another important question – should central banks consider the impact of their policies on hard assets, like property?

1. In making monetary policy, central banks generally focus on the prices of goods and services – which is CPI - but there are occasional calls for them to pay more attention to prices of assets, such as houses or the stock market
2. This debate is not new – in the early 2000s it was actually a topic of global discussion by the Centre for Economic policy research – done by the Geneva Report on the World Economy called Asset Prices and Central Bank Policy
   1. This looked at the use of interest rates as a tool to pop asset bubbles
   2. However – this was shouted down - in 2002, future Fed Chair Ben Bernanke argued that it was crucial to use the right tool for the job when making policy. “As a general rule, the Fed will do best by focusing its monetary policy instruments on achieving its macro goal – price stability and maximum sustainable employment – while using its regulatory, supervisory, and lender-of-last resort powers to help ensure financial stability.”
   3. In the same 2002 speech, Bernanke directly addressed the idea that the Fed should meddle directly with asset prices: “I think for the Fed to be an ‘arbiter of security speculation or values’ is neither desirable nor feasible.”
   4. Sounds funny today – but this is going back almost 20 years ago – before the days of QE or SPVs that buy corporate debt or ETFs in shares
   5. But the very nature of a CBs mandated goals of full employment and price stability come with the flow on effects on housing, shares and the bond markets – you cannot expect to move interest rates without having an affect on these assets – so through not considering this factor has led to runaway prices
3. However – now that the mandate given to the RBNZ from the Finance Minister appears to have a different priority - Rather than describing house prices as a potential threat to financial stability, the government mandate asks the RBNZ to consider the impacts of its policy decisions on housing affordability
   1. The RBNZ central bank officals came out against this – they are sceptical about the use of interest rates and instead prefer a macroprudential toolkit as opposed to trying to reduce housing prices for first-time buyers – as they believe this goal is better met by increasing the supply of houses and targeted fiscal policy
   2. Similar in the US - Federal Reserve Chair Jay Powell also thinks that using interest rates to deal with asset price bubbles is dangerous - prefers to turn to macroprudential tools for that purpose – in plain English, this means financial regulation from the governments end that aims to mitigate risk to the financial system – so it may mean that additional controls on lending are needed, or changes to deductibility on property – but this is unpopular for governments
   3. In a January 2021 Powell said, “We don’t actually understand the tradeoff between if you raise interest rates and thereby tighten financial conditions and reduce economic activity now in order to address asset bubbles and things like that—will that even help? Will it actually cause more damage, or will it help? So I think that’s unresolved. And I think it’s something we look at as not theoretically ruled out, but not something we’ve ever done and not something we would plan to do.”
4. It seems like the government and CBs are trying to pass the buck to one another
   1. RBNZ – “We will be considering our financial stability policy settings via our prudential tools – like loan-to-value ratios, bank stress testing, and capital requirements – against particular types of mortgage lending. This is done with a view to moderating housing demand, particularly from investors, to best ensure house price sustainability.”
   2. But this is a recommendation that they can make to the Government to then implement -

5. Looking at some of these other government-controlled factors outside the central bank’s
   1. In many developed economies, house prices are as affected by land-use regulations that limit the size and style of homes that can be built, which create artificial housing scarcity that in turn drives up prices - A 2017 New Zealand government study found that rules around building could account for 15% to 56% of a home’s cost depending on the area
   2. Also – things like taxes, with stamp duties are increasing the costs of housing – will cover this in another episode soon, as NSW is looking to replace stamp duty with an ongoing tax
   3. Directing central bankers to pay attention to the economic metrics of everyday life is always a good idea. But the problem of housing affordability is too complex to solve by tweaking interest rates alone

In summary – this policy from the Government of tasking CB to deal with it is smart – smart from a political stand point – when you campaign on affordable housing and the markets go up – then you need a scape goat

6. Technically - NZ Government has selected the correct scape goat – but are still passing the buck
7. I personally don’t think it will amount to much – the CBs power would be to increase rates, and crash the housing market – which may make homes unaffordable if the median wage gets hit in the process
   1. I mean, to lower property prices is simple – increase interest rates to 10% - people will default, be forced out of their homes and there will be a massive oversupply of property, pushing prices down – is that good for anyone? If you don’t own property, it may not be – as with this style of collapse also comes a wider spread economic collapse – if you are starting in your career, job opportunities may not exist, which could delay your home ownership journey further
8. So the NZ CBs have said that they will monitor the situation but in effect, have passed the buck back to the government and fiscal policy
9. It may hopefully bring more awareness to the issues that CBs play on our everyday lives – but as far as having an effect, it is a catch 22 – either way, it is an interesting development that may also spread to other CBS

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