David Mayes: Patchy housing market makes case for tweaks

The difference now is that we do have some "tweaky tools" to try to tackle localised inflation without having to raise interest rates. Photo / Janna Dixon

Opinion

Over the past 20 or more years there have been periodic attempts to identify tools that government and the Reserve Bank could apply that would address inflationary pressure in parts of the economy without having an impact on activity across the board.

We now see this appearing with worries about inflation in the Auckland housing market. Not only does this pressure not reflect excess demand in the economy as a whole, but it does not even reflect excess demand in the housing market, even in parts of Auckland itself.

Previously the main ways to try to handle this would have been to seek means of making it easier to expand the number of properties in Auckland. But such policies have a slow effect and house prices would rise in the meantime, with prices in general given the overall importance of Auckland in the economy.

Exactly this debate is taking place now with pressure by government and the Auckland Council alike to seek change.

The difference now is that we do have some "tweaky tools" to try to tackle localised inflation without having to raise interest rates and hence the exchange rate, which would thereby slow the limited economic recovery.

These take the form of macroprudential tools that the Reserve Bank can use to focus on the problem at hand - namely the avoidance of a sequence of "bubble and busts" in house prices in Auckland, which destabilises the general increase in growth and reduction in unemployment.

These macroprudential tools work through the financial market, primarily the banking system. For example, if there is a danger that asset prices may rise too fast and hence banks will find they have overlent, the sensible thing is for banks to hold more capital against that risk.

Indeed, if the banks themselves knew what the risks were, they would hold the capital without being required to do so by the Reserve Bank. The Reserve Bank has to act when it sees that the actual response does not accord with its view of the risks.

A second new tool in the Reserve Bank's armoury is that if house prices start rising faster, it can require lenders to reduce the proportion of the property value they are prepared to lend - in other words, if it fears that a fall in prices will mean that the lenders do not hold enough collateral to cover the outstanding loan.

The trouble is that these measures need to be applied only where the Reserve Bank thinks the bubble is, and not to all houses across the country. However, that would imply not macro-prudential intervention, but micro-prudential intervention on a loan-by-loan basis.

But this is not how these new measures are supposed to work.

It is clear from the intervention in foreign exchange markets and from discussion of macroprudential tools that the Reserve Bank is uncomfortable with the macroeconomic balance as it stands. Using monetary policy to tackle the Auckland housing market would simply increase the discomfort.

Unfortunately, using macroprudential tools that apply across the whole market is not appropriate either, as the majority of people do not live or do not want to live in the parts of Auckland where there are the perceived house price problems.

Perhaps therefore there is a case for the "tweaky tools" that try to tackle the problem at the micro-prudential level, though they run the risk of becoming more complex as people work out how to get round them. At least this would not be harming many for the sake of a few.

David Mayes is a professor of banking and financial institutions, director of the Europe Institute and co-director of the New Zealand Governance Centre at the University of Auckland Business School.