Macro-Prudential Decision Framework

From the latest Reserve Bank Bulletin. There are many subjective assessments of the factual situation at hand in this diagram. I think 2013 marked the beginning of the end for inflation targeting in New Zealand. Even if Labour/Greens don’t win the election, the median voter first home buyer now thinks of the Reserve Bank as the government agency that stopped them from buying their first home with LVR restrictions.

The precious snowflakes of my generation don’t like being told no, and will now be ripe for the picking as the election looms – promises of affordable housing would have nothing on any major party campaigning on “forcing the Reserve Bank to consider ordinary Kiwis” or other nebulous feel good nonsense.

Despite the success of inflation targeting and the low levels of inflation we see now, I’m worried that we’ll look back to this year and mark it as the start of a new chapter in independent monetary policy that ends up looking like a complete rollback to the 1970’s.

Diminishing Marginal Returns To LVR Restrictions

This paper from the RBNZ on the potential impact of LVR restrictions is interesting.

The net effect of this is that credit growth is expected to be about $3.2 billion lower over the first year that LVR restrictions are in place. This would lower annual housing credit growth by 1.7 percentage points in the first year. The longer LVR restrictions are in place, the more likely it is that borrowers would be able to find alternative sources of funding and alternative buyers would enter the market. As a result, we expect that LVR restrictions would have a diminishing effect on credit growth after the first year.

While I think that loan to value restrictions are basically saving young dreamers from negative equity and restricted options in the labour market (can’t move for higher wages if you’re stuck with a mortgage), the Reserve Bank is putting its independence at risk.

Nothing is more sacred in New Zealand than the home ownership cow. It’s even more sacred than dairy cows themselves, and that’s saying something considering the handouts dairy farmers get to help their capital gains farming.

Thus, as the election comes closer, I would not be surprised if there was a bipartisan consensus on a raft of further exemptions for “struggling young first home buyers” without any consideration of how stupid the obsession with home ownership is.

It’s almost as if politicians didn’t learn anything from the Global Financial Crisis, the sub-prime mortgage market and what happens when you start giving exemptions and subsidies and special treatment to facilitate a policy outcome that has fuzzy outcomes attached.

How To Protect Monetary Policy From A Labour/Green Government

It is not clear that John Key will be able to keep the external image of National together until the election. If we look at the policies of Labour, Greens and likely coalition party NZ First on monetary policy, anyone who cares about central bank independence should be extremely worried.

How can we protect monetary policy from a Labour/Green government when the Reserve Bank is producing a lot of content and policy that is making it easier and easier for Labour/Green to sell the idea that the Official Cash Rate decision should be made by committee?

A starting point would be highlighing the ridiculousness of the US Federal Reserve when it comes to clear communication around quantitative easing. What journalists often gloss over is that each individual “Fed” has its own Governor whose opinion counts for a lot because they vote!

There is a hierarchy in the Federal Reserve system – with the Federal Reserve Bank of New York holding the position of power as it carries out the open market transactions the committee decides on and because New York is the centre of the US financial system.

If the Reserve Bank moved to a committee form, then monitoring the Reserve Bank would be costlier. Instead of keeping track of what Graeme Wheeler and occasionally Grant Spencer say, in order to arrive at some indication of where the RBNZ’s thinking is I’d have to follow every single committee member.

If these committee members were unionists, businesspeople, farmers or other non-economists then the monitoring costs would be even higher. What this does is lower the credibility of the Reserve Bank in carrying out its core function – price stability.

It also makes it a target for politicians because it would face more “top down” pressure for “targeted interventions” the committee thinks need attention. Also, there are officials at the Reserve Bank and Treasury pushing for more “targeted intervention”. As their notes and publications are released they need to be carefully examined by the economics blogosphere.

My non-negotiable position on the Official Cash Rate is that the Governor of the Reserve Bank is the only person who communicates the Reserve Bank decision and intentions.

There must be no committee! Obviously the Governor has a team of close advisors who help him out, but the unintended consequences of committee decision making would be horrendous.

Clarity of communication is far more important than many people realise. Imposing costs on everyone in New Zealand because your favourite sector can’t compete in a global marketplace is not acceptable, and over the next few months I’m planning to do some longer posts on monetary policy.

I Don’t Think The Banks Realise What They’ve Just Acknowledged

New borrowers negotiating home loan terms over roughly two years are likely to pay more than 1.5 percentage points more for their mortgages annually if they have a deposit of less than 20 per cent, including a higher headline interest rate and an increased low-equity margin of 0.75 per cent.

They’ve told us that if your deposit is less than 20% they need to tack on 150 basis points to cover the risk of low equity mortgages.

When you add it to comments by Reserve Bank Governor Graeme Wheeler, who said last week floating mortgage rates could go to 8% by the end of next year, you have a problem for low equity buyers who aren’t fixing their interest rate.

Why? Because 800+150=950 or 9.5% per annum floating rate for low equity borrowers. That will change the affordability equation for a non-trivial proportion of low equity mortgage holders.

I hope all of these buyers are adjusting their Excel spreadsheets regularly to keep track of these things. Do home buying types even use Excel to model their personal finances over time? Bueller? Bueller?

Graeme Wheeler, Policy Pioneer, America’s Cup – Wait, What?

There is an interesting article over at Bloomberg that looks at Graeme Wheeler’s first year as Governor of the Reserve Bank. But then something really, really stupid appeared:

Policy makers are preparing for an economic recovery even without the additional boost that could have come from a win by Emirates Team New Zealand in the 2013 America’s Cup. A Kiwi victory might have boosted confidence and housing demand in Auckland, home to about a third of the country’s 4.5 million people, as it would have become the venue for the next defense of the sailing title. Oracle Team USA overcame New Zealand’s lead to win the contest this week.

On a scale of 1 to 10 derp, that’s a 10 in my book. In terms of “economic impact”, disregarding all costs borne by ratepayers and taxpayers in hosting large sporting events, even oil exports are several orders of magnitude higher each year in terms of economic impact against hard to calculate, often negative, returns on big sporting events.

The confidence fairy is a bit of a silly indicator. You might be really confident about the prospects for the New Zealand economy, but that doesn’t mean you’re going to change your consumption or investment patterns. It’s almost as silly as asking what you think about the weather – you have things that need to get done in your firm regardless of whether it’s raining or not.

We have to remember that the world markets get their news from Bloomberg. If it seems like there is no criticism of the macro-prudential framework, then the impression is that there is no criticism of the macro-prudential framework. There are unintended consequences of the Reserve Bank’s press releases being rewritten without critical inquiry.

Is The Reserve Bank On A Mission To Lose Its Independence?

The role of a central bank is to implement monetary policy. The role of a central bank is not to act as an arbiter of what credit allocation decisions are good and what credit allocation decisions are bad.

Matt Nolan has a very good overview of the issues around the level of discretion the Reserve Bank is claiming mandate for with respect to macro-prudential policy.

I’d point out that on top of the level of discretion the Reserve Bank is engaging in, the Basel III framework which includes provision for unexpected losses, is just as discretionary and distortionary when it comes to capital allocation decisions in the economy.

The idea that a bunch of officials can forecast market tops better than private industry is hilarious. If they could they’d be hired by hedge funds in the US straight out of graduate school and would never set foot in a central bank because the opportunity cost in terms of wealth accumulation would be too high.

Even though I’m still just an economics student, I follow the literature and blogosphere closely. I know that since the global financial crisis, a lot of the stuff the Reserve Bank talks about in its bulletins has been dealt to by private actors.

How so? Banks are only going to give large mortgages to large earners in stable careers. If you run a business or are self-employed, you are subject to credit rationing because banks have been burned so often. Although Rob Hosking is correct in saying that LVR restrictions will save some people from themselves, the unintended consequences of discretionary policy are where the real welfare losses lie.

At the heart of the housing affordability issue is that in 2008 a lot of banks prematurely pulled the plug on residential development funding that was plugging the supply and demand deficit in Auckland and other places around the country.

New Zealand is a poor country – someone on wages is unlikely to be able to save up enough capital to take a risk on a speculative property development so banks need to match up developers with loans. It’s risky – but it’s a societal benefit because without this activity, there would be no downwards pressure on house prices.

In the most cynical of analyses, I think the RBNZ could be pre-empting the possibility of a Labour / Greens / NZ First coalition government ripping up the already expanded memorandum of understanding and throwing in a whole lot of additional policy objectives for the RBNZ to achieve.

Are they on a mission to lose their independence? It sure seems that way. I’m not convinced that there is enough discussion about the trade-offs involved in making arbitrary decisions on what sort of lending is good and what sort of lending is bad.

In terms of efficiency, risk should be managed by those closest to the coalface. I think there has been a bit too much hysteria over the finance sector and not enough examination of how substantial changes in how they do business in light of their regulatory changes makes the Reserve Bank’s new clothes an awkward fit.

Leave The Reserve Bank Act Alone David Cunliffe

Now that David Cunliffe is leader of the Labour Party, a defence of the Reserve Bank Act has to be mounted.

Inflation targeting has worked, price stability is a whole order of magnitude better than it was pre-inflation targeting and our central bank is remarkably transparent.

I am skeptical over the introduction of macro-prudential tools. They require Reserve Bank officials to make judgments about where we are in a business cycle. That’s risky business.

But I am definitely against a rewrite of the Reserve Bank Act. When you make wholesale changes to something that has been working exactly as intended, there will be unforeseeable consequences.

David Cunliffe has been a key driver of the left wing derp on monetary policy, he is almost as bad as Russel Norman and that’s saying something.

Leave the Reserve Bank Act out of your policy proposals Mr Cunliffe. Monetary policy is not some plaything with which to achieve objectives better left to fiscal and regulatory policy if you so choose and the electorate votes you in.

Tomorrow Graeme Wheeler Is Giving A Speech About Macro-Prudential Policy

Tomorrow Graeme Wheeler Is Giving A Speech About Macro-Prudential Policy.

Macro-prudential policy includes the high LVR speed limits I wrote about last week.

I wonder what Russel Norman will make of it? Apparently the release of the speech notes will be after 1400.

By the way, I think it’d be really cool if the Reserve Bank could upload more content to their YouTube channel.

Substituting reading a Reserve Bank document for watching a speech by a senior official would be lots of fun.

Monetary policy matters folks! We can’t let politicians like Russel Norman interfere with New Zealand’s Barro-Gordon compliant institutional arrangements by letting another government agency interfere in monetary policy decisions.


Reserve Bank Responds To Submissions On LVR Speed Limits

Today the Reserve Bank released their response to submissions on the LVR speed limit “macroprudential tool” they intend to implement to curb what they see as risky lending.

If you want to know the full story read the long document over at the RBNZ.

Key Points:

  • There were only 20 submissions, mainly from banks. Interestingly, small banks with an average of $100M / month in residential mortgage lending over a rolling 3 month won’t face speed limit
  • The RBNZ will restrict the proportion of high LVR lending as opposed to high LVR lending itself – presumably in recognition of the reality that many high LVR mortgages will be to very high earning couples
  • There will be a transition period because some banks think they’d breach the rules even if they stopped all high LVR mortgage approvals tomorrow
  • There will be an anti-avoidance rule so banks can’t get around the speed limit – the detail can be found in section 7 of the updated BS19 document (Framework for restrictions on high-LVR residential mortgage lending)
  • It will take time for banks to process their backlog of pre-approvals if the speed limit is applied and time for them to forecast high LVR loan flow to stay under the limit
  •  Disintermediation risk is acknowledged – people topping up deposits with credit cards or using multiple second tier loans to resemble a traditional residential mortgage – banks could be hit by anti-avoidance provisions if they try to get around restrictions

There is a lot of stuff that still needs to be worked out by the Reserve Bank and the banking sector. If we think about what the Reserve Bank is trying to achieve – dampening what it sees as risky lending in the housing sector – and then we think about what the government is trying to achieve – every special snowflake moaner being able to afford a house – I have to wonder why, in the light of how Basel III has already impacted the lending that actually matters to growing the economy i.e. commercial and agricultural lending – why they don’t save the expense and complications of this scheme with something simpler?

RBNZ Looks At Estimated Taylor Rules Post GFC

Here’s a new note from the Reserve Bank looking at estimated Taylor rules post GFC.

A Taylor Rule is a way to describe how a central bank changes short-term interest rates through the policy rate in response to changes in economic conditions.

There is an interesting finding the Australia and New Zealand conduct monetary policy in a similar fashion. Kendall and Ng say that this could be because Australia and New Zealand have achieved a level of price stability that means deviations from inflation expectations are expected to be short lived so there isn’t a need to respond as aggressively as a strong form Taylor Rule might suggest.



The Reserve Bank started inflation targeting and now most central banks use an inflation targeting model and other factors like financial stability in order to conduct monetary policy.

Look at the long term trend for interest rates in light of the previous graph.






Since the GFC hit the unexplained part of short term interest rates has been significant. This suggests that either the monetary policy rule has changed or there has been a substantial structural changes in the economy.

This basically means that NZ has had a lower policy rate than expected since the GFC struck. Kendall and Ng think that changes in bank funding costs, household deleveraging and even a view that investment returns will be lower could explain the gap.

This is a very interesting piece of analysis. While there isn’t a large amount of data to work with considering that the crisis period only started in 2008, it is very helpful stuff.

What I think the most interesting part of the note is the explanation that achieving a reasonable level of price stability means that aggressive policy rate responses to deviations from inflation expectations aren’t necessary because agents trust the central bank and don’t think deviations from inflation expectations will last long.

In Plain English, it means that inflation targeting and focusing on price stability has worked very well for New Zealand. It would be nice if housing bubble types focused on the supply and demand story instead of trying to attack the independence of the Reserve Bank.