Reserve Bank should rethink anti-housing market policy

With the Reserve Bank (RB) cash rate review and Monetary Policy Statement due on 8 March, economists are criticising its likely punitive stance against the housing market.

Monday, March 5th 2007, 9:23AM

by The Landlord

By Andrea Milner

BNZ chief economist Tony Alexander says the RB has failed to properly take into account all of the factors affecting the economy when setting its monetary policy.

“This means not just what the government is proposing to do with fiscal policy, inflation overseas, recent movements in the currency, degree of tightness in the labour market and availability of other spare capacity etcetera, it must also take into account influences on interest rates other than movements in the official cash rate,” says Alexander.

“It has not adequately done so.”

There is nothing in economic data released over the past week to dissuade the RB from raising the cash rate. It is not getting the weakness in the housing market and domestic economy that it is seeking. Latest figures show household debt growth continuing at a firm pace, dwelling consents turning up slightly in January, businesses expecting average activity levels but planning to hire people and raise prices, and strong growth in imports of consumer goods and capital equipment, Alexander says.

“Had the RB properly factored in what was happening in the inflation operating environment over the past three years then it would have pushed interest rates up far more aggressively in 2004. Had they done that the slowdown in the economy over the second half of 2004 into the first half of 2006 would have been more aggressive, more capacity would have been freed up in the economy, and we would be looking at interest-rate cuts this year rather than the monetary policy tightening cycle having to be restarted next week.”

Macquarie Bank economist Hayden Atkins explains that the property market seems to have attracted the RB’s attention because it has been one of the major factors sustaining the entire economy in recent years.

“So, the RB might argue that it’s not the strength of the housing market per se that is driving monetary policy, but rather the capacity of the New Zealand economy to accommodate an increase in demand without it becoming inflationary,” says Atkins.

However, he says there are a number of problems with this argument.

“First, the domestic economy is not booming. To be sure, spending has remained more resilient than many analysts feared last year. And this resilience has resulted in an improvement in business and consumer confidence, as the worst-case scenario hasn’t materialised. But it remains the case that domestic spending is growing at a sub-trend pace.”

“In other words, the resilience of the property market has been one of the reasons why the economy is likely to experience a soft landing.”

“But instead of breathing a sigh of relief, some analysts seem to think that this provides policymakers with a rationale to undergo another round of tightening.”

Atkins says inflation has been declining rather than accelerating over the second half of 2006. “This suggests that while capacity utilisation levels are undoubtedly high, they are not sufficiently high to trigger widespread price pressures. And with domestic spending growth already below trend, it seems unlikely that capacity usage levels will tighten much further.”

“Again, this does not suggest that tighter policy is urgently needed.”

As the majority of home loans are on fixed rate terms, these mortgagors don’t face higher interests rates until their mortgages roll over. This is one reason why Atkins doesn’t think that a further increase in interest rates will precipitate a sharp decline in the property market. “But it does increase the risks surrounding the market, and so is probably undesirable from that perspective”

He says it’s “surprising” that the RB’s potential policy tightening has not aroused much criticism.

“Perhaps some analysts are reluctant to appear to be criticising the RBNZ as it might jeopardise their contacts with the organisation. Perhaps, they are attempting to portray themselves as being in the same mindset as the central bank, and it is possible that this might be the case.”

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