Key to solving inflation woes eludes experts

The Reserve Bank and the Treasury have returned empty-handed from their search for a new tool to curb inflation in the housing market without damaging the export sector the way reliance on interest rates does.

"It should come as no surprise that there are no simple or readily implemented options that would provide large pay-offs," they say in a report to Finance Minister Michael Cullen.

The frustration for the bank and the Government is that borrowers' preference for fixed-rate loans, now more than 80 per cent of all mortgage debt, has created a long lag between increases in the official cash rate and in the average mortgage rate borrowers pay.

This has led to fears the bank's brakes no longer work.

And in the meantime, the fact that those fixed-rate loans are largely financed by overseas savers created a strong demand for the kiwi dollar, hammering the export sector.

Last year, the rest of the world needed about $31 billion to buy New Zealand exports but another $25 billion was needed to finance bank lending, largely to the mortgage market.

The bank and the Treasury found drawbacks to all of the options they examined.

They were not allowed to consider a capital gains tax on property.

But under existing tax laws, income tax may apply to gains realised on property, other than owner-occupied residential land, which was bought with the purpose or intention of resale.

Officials note that nearly a quarter of all sales last year were of properties owned for less than two years, compared with 10 per cent in 2001, suggesting people have been buying with the intention of selling on for a quick capital gain.

They acknowledge it is hard to prove intent. But they suggest the Inland Revenue Department should be encouraged to have regard to the economic cycle when deciding what priority to give to enforcing the existing law.

The IRD is dubious about being given multiple objectives.

John McDermott, ANZ National Bank's former chief economist and now at Victoria University, said: "If it is the law, it should be enforced fully all the time. But it may be that the temptation to engage in that activity is stronger at some parts of the cycle so the pay-off for the IRD's investigations might be higher then."

The idea of "ring-fencing" losses on investment properties, so that they could not be used to offset tax on other income, was not favoured.

Officials said it might reduce the supply of rental properties and there was little evidence housing cycles were less marked in countries that had such measures than in those that did not.

Another option considered was imposing at appropriate times in the cycle a discretionary mortgage interest levy that would push up what borrowers paid, without a corresponding increase in rates paid to savers.

But this raises constitutional and governance issues. Would Parliament be prepared to delegate to the Governor of the Reserve Bank the right to impose what is in effect a tax? And if it was delegated to the Finance Minister, that could undermine the Reserve Bank's independence.

There is also a concern that the banks would get around it by transferring ownership of the mortgages to their overseas parents, putting them out of reach of such an impost.

Bank of New Zealand chief economist Tony Alexander suggested such a measure, but with the proviso that the levy be given back to borrowers at the bottom of the cycle, not pocketed by the Government.

"Reliance on the [official cash rate] alone is risky because it leaves them as a toothless tiger unable to influence the domestic economy except by crunching the export sector through the exchange rate.

"In the end, the exchange rate becomes the primary instrument through which monetary policy is conducted. So the export sector gets whacked every few years."

Officials also considered giving the bank discretion to impose, at appropriate times in the cycle, limits on how much of a property's value banks could lend. But they concluded it would hit low-income and first-home buyers particularly hard.

And they acknowledged that in the past the bank had not been very good - or other forecasters, either - at picking when the conditions that would warrant such intervention had arrived.


Heat-stoppers

* Tax the gains on houses resold quickly, if not owner-occupied.
* Slap an extra levy on mortgage rates.
* Limit how much of a property's value banks can lend.
* Ring-fence tax losses on investment properties.