New Zealand is a small economy, but it is something of a trendsetter when it comes to central banking. The country was among the first to adopt an explicit inflation target. The government’s mandate for the Reserve Bank of New Zealand is to “keep future annual inflation between 1 and 3% over the medium term, with a focus on keeping future inflation close to the midpoint of 2 %” and to “support maximum sustainable employment”. In February 2021, the government formally added a clause to the RBNZ’s mandate, directing it to take house prices into account when making monetary policy decisions. The change has caught the attention – and some raised eyebrows – of central bankers around the world. Here’s what its about.
What changed?
Like the US Federal Reserve, the Reserve Bank of New Zealand (RBNZ) is responsible for keeping prices stable and pursuing full employment. On February 25, 2021, Finance Minister Grant Robertson announced that “the Bank will need to take into account the government’s objective of supporting more sustainable house prices, in particular by curbing investor demand for the existing housing stock to help improve affordability for buyers of a first house”. With this announcement, the scope of the central bank’s mandate was extended for the first time to real estate prices. (To read the official mandate at the RBNZ, click on here.)
What led to this move?
The New Zealand government has come under pressure to calm the housing market as the median house price increased by 22.8% from February 2020 to February 2021. Prime Minister Jacinda Ardern has rolled out a program to build 8,000 new houses as part of Budget 2020. After his Labor Party won a landslide victory in October 2020, Ardern renewed his commitment to increase housing supply. Critics said it was lacking. March 22, the Labor Party announced new policy initiatives, targeting first-time buyers. Ardern raised income thresholds for existing programs that provide grants and loans to first-time homebuyers and adjusted policies aimed at containing demand for investment properties. All of this contributed to the government’s decision to involve the central bank in its efforts to make homes more affordable.
What does the change mean for the central bank?
RBNZ Governor Adrian Orr unsuccessfully tried to avoid the move. In December 2020, he said: “Adding house prices to the monetary policy target would be unique internationally, which could make monetary policy less effective and impact the effectiveness of financial markets “.
On March 4, 2021, Orr played down the implications of the changed mandate for future monetary policy decisions. “It is important to note that the objectives of the mandate of the Monetary Policy Committee remain unchanged. We remain focused on keeping consumer price inflation low and stable and contributing to as many sustainable jobs as possible. Orr signaled that the RBNZ is likely to pursue its housing targets with macroprudential policies rather than rate hikes. “We will examine the parameters of our financial stability policy via our prudential tools – such as loan-to-value ratios, bank stress tests and capital requirements – in relation to particular types of mortgages. This is done with the aim of moderating the demand for housing, especially from investors, in order to best ensure the sustainability of housing prices.
In his November 2020 Financial Stability Report, the RBNZ had expressed concern about the boom in the housing market. On March 1, 2021, he reinstated loan-to-value restrictions on mortgages – seeking to protect borrowers and global financial stability from the potential risk of a medium-term price correction.
What does the change mean for central bank independence?
News of the RBNZ mandate change sent New Zealand 10-year government bond yields higher, perhaps signaling that the additional factor in house prices will force the bank to raise. its rates earlier than expected. This concern may be overstated, given Orr’s commitment to using macroprudential tools rather than interest rate adjustments to address the housing problem. However, economists have also expressed concerns about the wording of the mandate change. Cameron Bagrie, founder of Bagrie Economics, told the Financial Times: “The use of the terms ‘government policy’ and ‘government objectives’ in relation to property prices risks impinging on the independence of the RBNZ. They should have just said that house prices should be a consideration, an explicit mention of what is already happening. I think tying it to government policy/goals is going too far.
Should central banks take asset prices into account when designing monetary policy?
In making monetary policy, central banks generally focus on the prices of goods and services, but there are sometimes calls for them to pay more attention to the prices of assets, such as houses or the stock market. This debate is not new; as early as 2000 it was a topic of global discussion – the second Geneva report on the world economy was titled “Asset Prices and Central Bank Policy”.
There has long been a call to use interest rates as a tool to burst asset bubbles. However, in his first speech as Federal Reserve Governor in 2002, future Fed Chairman Ben Bernanke argued that it was crucial to use the right tool for the job when developing policies. “As a general rule, the Fed will do its best to focus its monetary policy instruments on achieving its macroeconomic objective – price stability and maximum sustainable employment – while using its regulatory, supervisory and lender powers. last resort to help ensure financial stability.”
In the same 2002 speech, Bernanke directly addressed the idea that the Fed should interfere directly with asset prices: “I think the Fed needs to be an ‘arbiter of speculation or securities values’ is not neither desirable nor feasible.” However, asset prices can have implications for the Fed’s goals of full employment and price stability — as well as its responsibility to avert financial crisis — so a central bank cannot ignore developments. of these markets. Bernanke favored the use of macroprudential tools to deal with financial market excesses, rather than preemptive interest rate hikes. Identifying asset price bubbles is difficult, and taming them with conventional monetary policy tools has implications for macroeconomics.
This is particularly clear if one considers the extent of monetary policy tightening that would be required to reliably control asset prices. San Francisco Fed Research found that it would have taken 8 percentage points of monetary tightening between 2002 and 2006 to completely avoid the housing bubble that preceded the global financial crisis of 2007-2009. For context, the federal funds rate has not exceeded its April 2021 level by 8 percentage points since October 1990. Such tight monetary policy would certainly have slowed the recovery from the 2001 recession and likely pushed the economy back into recession.
Why can real estate bubbles be costly?
The costs of preemptive rate hikes still need to be weighed against the costs of financial instability associated with asset price bubbles. Historically, expensive bubbles have been associated with credit booms, while other bubbles are less damaging. Housing price spikes can be particularly dangerous because they are largely financed by the granting of credit by the mortgage market. These factors – along with other threats to financial stability – need to be considered by central bankers when analyzing the balance of risks in the economy.
However, the mandate given to the RBNZ by the Minister of Finance seems to have a different priority. Rather than portraying house prices as a potential threat to financial stability, the government’s mandate asks the RBNZ to consider the impacts of its policy decisions on housing affordability. Governor Orr said the RBNZ should consider house prices as they relate to financial stability with its macroprudential toolkit instead of trying to lower house prices for first-time buyers, a goal best achieved by increasing housing supply and targeting fiscal policy.
What are current Fed leaders saying about asset price considerations for monetary policy?
Like his predecessors, Federal Reserve Chairman Jay Powell is skeptical of using interest rates to deal with asset price bubbles and prefers to turn to macroprudential tools for this purpose. In one January 2021 press conference, Powell said: “We don’t really understand the trade-off between if you raise interest rates and thus tighten financial conditions and reduce economic activity now in order to fight asset bubbles and things like that – will this even help? Will it actually cause more damage, or will it help? So I don’t think it’s resolved. And I think that’s something that we consider not to be theoretically ruled out, but not something that we’ve ever done and not something that we plan to do. We would rely on macroprudential and other tools to address financial stability issues.
In his updated statement of its monetary policy strategy, the Fed said it views financial stability as part of its risk assessment, not one of its primary mandated objectives: “[S]Sustainable achievement of maximum employment and price stability depends on a stable financial system. Therefore, the Committee’s policy decisions reflect its longer-term objectives, its medium-term outlook and its assessments of the balance of risks, including risks to the financial system that could impede the achievement of the Committee’s objectives.
