Last week I
reported some estimates of the long-run magnitudes of the effects of demand and
supply measures on the New Zealand house price index. The question is what to
do with this evidence.
It seems
obvious from the data that the most effective way to dampen the house price
increase is to increase the supply of housing.
Demand
management is less effective and could be even damaging. It is rather silly to
argue that a recession, caused by tight monetary policy (i.e., higher interest
rate) or contractionary fiscal policy (i.e., new taxes), is needed to reduce housing
prices and resolve the affordability problem.
Specific taxes
may reduce speculative excesses. The Treasury knows all about the size, the
efficacy, etc. but this is an election year and politicians would be reluctant
to introduce new taxes.
Higher real
house prices (i.e., adjusted for inflation) imply higher wealth for Kiwis. Wealth
is not a bad thing, or is it? Recall that the main concerns about high house
prices are about affordability and financial instability. Just as many Kiwis
will benefit from having affordable housing many middle class Kiwis will lose
from lower housing prices. Policy errors could send the whole economy into a
deep recession because most of the assets held by New Zealanders are housing’s.
Also on the
demand management side, restricting immigration has a small effect on housing
prices as the data show, unless we have a huge reduction or shutting down the
immigration program completely. In addition to immigration, there could be
corporations, banks, or even nonresidents in additional to people buying houses
in New Zealand.
The price and
the quantity (the number) of housing are determined (simultaneously) by the intersection
of demand and supply. These curves shift up and down because of shocks. In
absence of interventions, restrictions and regulations both the price and the quantity
adjust until they settle at a new equilibrium.
That is not the
case in reality. We have two independent regulations affecting the quantity and
the price of housing.
First, we know
that there have been increasing building regulations, requirements, and land
restrictions among other regulations that affect the quantity of housing. These
regulations (interventions) increased the cost, and essentially altered the
slope of the supply curve of housing. When the demand for housing increases
because of the increase in income, population, immigration etc. most of the
adjustment to the shock, under such regulations, has to be in the price,
naturally, because the quantity is restricted by regulations. Thus, more demand
means higher prices.
Second, the
RBNZ intervenes with different regulations to deal with the house price
increase under the new, widely followed, international arrangements of
maintaining financial stability.[1] Central banks regulate credit flow. They
essentially try to manage demand for housing.
However, the problem is initially on the supply side really.
So what we have
is two different regulators regulating the price and the quantity in the
housing market, independently and fully discretionary, making it impossible for
prices and quantities to adjust to shocks. The natural mechanism of adjustment
in the housing market is impaired and it has no chance of working under these
sorts of regulations.
To resolve
the housing problem we have to allow the quantity
of housing to vary by increasing the supply of housing (i.e., relaxing
restrictions on the quantity of housing). This will bring the housing price
down. One hundred thousand new building consents reduce the price house index
by about 7000 index points. However, we should also allow the price of
housing to vary (i.e., by relaxing the restrictions on credit and the banking
system). Otherwise, we will continue to have adjustment problems in the housing
market.
New Zealand
banking system is good by international standards. Credit rating is Aaa. The
global financial crisis did not affect us because the banking standards are
high. Banks know best how to lend, to whom, and at what price, under the RBNZ’s
banking supervision guidelines. These guidelines have been in place for some
time; they are well tested. Therefore, to bring the housing market back to
normal by removing restrictions on the supply side, discretionary intervention
in the credit market needs reexamination.
razzakw@gmail.co
[1] Macro-prudential
policy is a discretionary regulatory intervention aims, in this case, at
restricting credit in housing market when the central bank thinks there are
“bubbles” or “speculative excesses” in order to prevent “systemic risk” and
financial instability. Read Lars P. Hansen “Challenges in identifying and
measuring systemic risk,” CEMFI working paper No. 1305 www.cemfi.es. I have written about this before
(see older blogs) and I still believe that it is quite murky area in economic
policy.
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