It's Economics 101. When demand rises and supply does not, prices will rise. If demand rises at the same rate as supply, prices will stay the same. If demand is flat and supply rises, prices will fall.

So why is the Government planning to spend $218 million over five years to double subsidies to first-home buyers of new houses, adding demand to a market that the Government has been saying since 2012 is supply constrained?

Economics 101 says this will push up prices. That is exactly how the policy is designed to work.

The Government says this extra demand will encourage developers to bring new houses to the market, but Economics 101 says the only way this will happen is if prices generate the signal that it makesey economic sense to develop more houses. That price signal is an increase.


Critics from the left and the right have accused the Government of adding fuel to the fire of house-price inflation of 30 per cent in Auckland since the beginning of 2012.

It's worse than fuel. These subsidies for new home builds are rocket fuel, because they can be leveraged with a 90 per cent or even a 95 per cent home loan.

A couple on a joint gross income of $100,000 who have saved $20,000 in KiwiSaver over five years would be able to get a subsidy of $20,000 and withdraw their Government tax credit of $5210 as a deposit.

That $45,210 deposit can then be deployed with a Welcome Home Loan as a 10 per cent deposit to borrow $406,890 to buy a $452,100 home. Previously, they could only have borrowed $180,000.

Suddenly, someone who could not compete with a rental property investor or another buyer can afford $200,000 more for the same house. A couple with a pumped-up deposit who were able to borrow 95 per cent from a bank would be able to bid $904,200 for a house.

That is the power of leverage and it is unlimited power because the Reserve Bank has exempted new-builds from its high LVR (loan-to-value ratio) speed limit.

By targeting the doubling of first-home buyers' subsidies at new builds the Government has effectively over-powered the Reserve Bank's policy, which was designed to turn down the heat on the housing market.

It was no accident through 2012 and early last year that high LVR lending by banks surged from 20 per cent of all lending to almost 35 per cent of all lending. Banks were encouraging first-home buyers to raid their five-year-old KiwiSaver accounts and jump into the market.

The banks knew how big the KiwiSaver accounts were because many were administered by them.

The Reserve Bank had to react with its high-LVR policy in October last year and the Treasury rightly advised the Government, when it was considering expanding its first-home buyer subsidy, that it risked over-powering the Reserve Bank and forcing it to hike interest rates earlier and higher.

Treasury also pointed out such subsidies were "low value for money and tended to be regressive". That is bureaucrat speak for wasting taxpayers' money on subsidies for richer people.

Such subsidies are losing popularity in Australia, where $25 billion has been spent on them over the past 50 years without any improvement in affordability or home-ownership rates.

The Government's policy also flies in the face of its own logic. It has argued against the Labour and Green policy of introducing a capital gains tax on the grounds it has not worked in Australia. So if first-home buyer subsidies haven't worked in Australia, why would they work in New Zealand?

Housing Minister Nick Smith has until this week been the strongest supply-sider in the Government on housing, arguing he wanted to increase supply faster than demand to press down on prices and improve the house-price-to-income multiple in Auckland to four from seven.

That would require Auckland house prices to either fall 43 per cent or to be flat for 19 years while wage growth of 3 per cent nibbled away at the multiple.

The last thing the Government needed to do was pump more demand into a market the New Zealand Initiative said this week would be short 113,800 homes by 2031. It is madness to ignore the laws of supply and demand when spending taxpayers' money and trying to improve housing affordability.