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Q + A: ‘Fatal combination’ – immigrants, building shortage

Press Release – TVNZ

SIMON The Reserve Bank cut the Official Cash Rate again on Thursday, for the second time this year. Some critics say the bank should have been loosening up earlier, not least a former Reserve Bank economist whos been making a name for himself …

Q + A: ‘Fatal combination’ – immigrants, building shortage causes housing crisis

Episode 22


Interviewed by SIMON DALLOW

SIMON The Reserve Bank cut the Official Cash Rate again on Thursday, for the second time this year. Some critics say the bank should have been loosening up earlier, not least a former Reserve Bank economist who’s been making a name for himself as a blogger to read on all things economic. Michael Reddell worked at the bank for 32 years before taking redundancy earlier this year. His blog is called ‘Croaking Cassandra’. I spoke to him before the programme and asked how worried should we be about the economy?

MICHAEL I think in terms of the New Zealand economy, the risks to it relate a lot to what’s going on in the rest of the world. The sharp fall in dairy prices is a big contributor that will have more and more of an impact in the next year or so. I’m not one of those that says the economy is heading towards recession. But I do think that the Reserve Bank’s going to need to continue to cut interest rates to provide support for demand, and I do think they’re somewhat behind the game. Yesterday’s cut was welcome, but it’s only the first in many that they will need to do in the next nine to 12 months.

SIMON How long have we been behind the game, according to you?

MICHAEL Well, I was opposed to them raising interest rates last year, and I think it’s now pretty clear that rates didn’t need to go up last year. Reasonable people can differ as to what was needed, but the evidence how the economy’s unfolded over the time since then has suggested it was a mistake, and they were slow to recognise that they needed to start turning it around. So I think probably 12 to 18 months behind the game.

SIMON Why was it a mistake?

MICHAEL Because inflation was low and there was little sign of it rising. Inflation has been below the midpoint of the Reserve Bank’s target range now for roughly five years, depending on the measure that you use. And that ultimately is the job that the Reserve Bank has to target – its job mandated by the Minister of Finance and the Policy Targets Agreement is to keep inflation around 2% over the medium term. At the start of last year, dairy prices were very high, but it was always likely that dairy prices would come down. The Christchurch rebuild was building towards a peak, but it was never going to stay at that peak for very long. There just wasn’t the evidence there that inflation was going to pick up strongly. They made the same mistake, and I was involved in making that mistake back in 2010 when we raised interest rates prematurely and eventually had to cut them again.

SIMON Inflation being in the midpoint of that 1% to 3% target – why does it matter? Why should people care? How does it affect them?

MICHAEL I mean, I think it’s a fair question. I think the question is, in a sense, we delegate this job to the Reserve Bank, and the Reserve Bank is an unelected organisation; it’s got the governor in control. But we give them a responsibility, and the responsibility we’ve given them is to keep inflation at 2%. There’s no strong reason why it needs to be at 2 rather than 1.5 or 2.5. That’s the goal that the elected politicians have set for them, and it’s the Reserve Bank’s responsibility to deliver on that.

SIMON Is that goal in touch with the modern reality post-GFC?

MICHAEL Well, I mean, if anything, I think there’s an argument post-GFC for potentially a slightly higher inflation target. You know, leading people like Olivier Blanchard, the chief economist at the IMF, have suggested that if anything, we need a higher inflation target because interest rates in many countries have gone to zero, and central banks in those countries haven’t been able to cut interest rates as much as they would have liked to stimulate demand sufficiently. I’m not arguing at the moment for raising the inflation target here, but it is important that at least inflation is kept up to that 2%. And the consequence of not doing so is that unemployment stays higher than it needs to. The unemployment rate in New Zealand at the moment is still 5.8%. There’s a lot of people who are unemployed now who wouldn’t be if monetary policy had been run with lower interest rates over the last 12 to 18 months.

SIMON Interest rates are coming down, though – the OCR cut, as we know. How’s this fuelling the Auckland housing crisis?

MICHAEL I think the Minister of Finance put it this morning that at the margin, lower interest rates will tend to boost house prices in Auckland. That’s certainly a risk; it’s a consideration. But it’s only one part of the overall equation about the entire economy.

SIMON Does it concern you, though?

MICHAEL Well, yes and no. I mean, I think… It concerns me in terms of the affordability of houses for ordinary people in Auckland. But ultimately, house prices in Auckland are the outcome as I’ve described them, of blunders of our governments – successive governments that have made it really hard to develop new urban land, to build new houses, and at the same time, have brought in tens of thousands of new immigrants each year. The two of those in collision just drives house prices ever higher. With only one of them, you’d be okay. With two, it’s a fatal combination.

SIMON Is immigration really that big a factor?

MICHAEL Immigration in conjunction with supply restrictions, the difficulty in bringing new land to bear – yes, it is. I mean, the Reserve Bank has done modelling work itself in the past. It suggested something like a 1% boost to population will lead to around 10% lift in house prices. Reasonable people can come up with a variety of different model estimates of those numbers, but there’s no doubt, looking back through New Zealand history, looking at cross-country experience, looking at the experience within New Zealand, that when unexpected population pressures happen, it has a big impact on house prices.

SIMON Immigration’s one thing. What about foreign buyers – the ones who aren’t resident here? Should there be curbs on them?

MICHAEL I’m slowly coming to the view that we should be considering that. I mean, I think we are in this difficult situation at the moment where we don’t have concrete data as to how large that impact is. I’ve pointed out on my blog that even if it’s quite small, then it’s hard to bring new houses into the market, to build new houses. Even a small addition to demand can have quite a big impact on price. And it’s not as if there are any obvious gains for New Zealand as a whole for allowing those offshore purchases, particularly if the houses are being left empty here. So we don’t have enough data, but I certainly wouldn’t rule out the possibility of controls being appropriate.

SIMON Back here, though, did the Reserve Bank do the right thing with the LVRs?

MICHAEL No, I don’t think they did. The Reserve Bank’s job in relation to financial stability is to ensure not that the housing market is kept under control, but that the banking system is kept sound. They’ve got a provision in their Act that says they have to use these powers to promote the soundness and efficiency of the financial system. The Reserve Bank did what they call ‘stress tests’ last year, where they said to the banks, ‘Look at your housing portfolios. Assume that house prices fall by 50%; assume that the unemployment rate goes to 13%. What will happen? Even the Reserve Bank was surprised to find that banks were resilient to that. No bank lost money in a single year in that scenario. That was a really tough test. So we just didn’t need controls of that sort for the role that the Reserve Bank has been given. I’m not saying necessarily that the Government shouldn’t have done other stuff, but governments are democratically elected. We vote things through the parliamentary process, the challenge through a Select Committee process. The Reserve Bank’s an unelected body with a narrow responsibility.

SIMON After 30 years – more than 30 years – in the Reserve Bank in senior roles, you’ve been fiercely critical of the Reserve Bank, with the benefit of hindsight, and in particular the role of Governor Graeme Wheeler. Is this personal?

MICHAEL No, it’s not personal at all. In fact, when Graeme’s appointment was first announced, I was very positive. I worked with Graeme a bit when he was at Treasury in the 1990s, and I had a lot of time for his expertise and ability. I think the judgements that he’s been making over the last couple of years are wrong. I think the structure that he’s been given to operate within is one that any governor would risk making misjudgements. It just puts too much power in one person’s hand. But, no, it’s not personal at all.

SIMON You have accused him of ignoring data, though?

MICHAEL Yes. Well, reading data differently than I would look at. I’ve criticised him also for not commissioning more analytical work to actually understand the similarities and differences between the New Zealand experience and those in other countries. So, for example, Graeme’s spent a lot of time in the United States, and I think what shapes a lot of his views in these areas is the desire to avoid a crisis like they had in the US. I think that’s great; it’s a laudable goal. Nobody would want a repeat of that. But what he hasn’t done, and what the Reserve Bank hasn’t produced, is any analysis that says what actually caused the problems they had in the US and how similar or different is our situation in New Zealand today. I argue that they’re very different.

SIMON Well, can we expect an analysis?

MICHAEL I’ve seen no response. I’ve seen no hint from the Reserve Bank that they have it underway or are doing it. I would certainly like them to. I would encourage the Minister of Finance and the Select Committee to be putting pressure on them to generate it. I mean, these are major intrusions in people’s business choices, in people’s household choices that they’ve making with these LVR restrictions, both the ones in 2013 and the new ones they’re consulting on at the moment. And we just deserve a lot more scrutiny, a lot more robust analysis before such decisions are made.


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