House prices and the role of the Reserve Bank

Purpose and background

1. On 24 November 2020 you wrote to the Reserve Bank inviting our views on how we can
“work together to address the issue of rising house prices”. 1 Your letter included a
proposal for consideration, which is to amend the Monetary Policy Committee (MPC)
Remit by requiring the MPC to seek to avoid unnecessary instability in house prices.

2. This briefing follows on from our interim letter sent to you on 24 November 2020. We
outline the influence of the Reserve Bank on the housing market, including house prices.
We consider the efficacy of your specific proposal aimed at your stated goal of
moderating house price inflation.

3. We recommend, amongst other things, that the Government’s specific housing objective
be issued as a factor for the Reserve Bank to take into account when setting financial
policy under section 68B of the Reserve Bank of New Zealand Act (1989) (“the Act”) and
articulated in the Reserve Bank’s forthcoming Financial Policy Remit.

Government’s Policy Objectives

4. The effectiveness of government policy depends on the clarity of the objective and the
choice of instruments. Your letter of 24 November 2020 acknowledges the objectives of
the Government and the objectives for the Reserve Bank’s Monetary Policy Committee
(MPC) set by the Government. These are summarised in Table 1 and highlight the
‘nested’ nature of the objectives i.e. the Reserve Bank’s policy objectives are a means to
an end, and not the end in themselves.

Table 1: Objectives - Labour Party, Government, and the Monetary Policy Committee
Objectives
Labour Party Housing policy That every New Zealander has a safe, dry, warm place to call
(2020 Manifesto) their own whether they rent or own.
Reserve Bank Act (1989) Purpose: To promote the prosperity and wellbeing of New
Zealanders, and contribute to a sustainable and productive
economy.

Economic objectives: Achieve and maintain stability in the

general level of prices over the medium term and support
maximum sustainable employment.

Promote the maintenance of a sound and efficient financial

system.

1
Available at https://www.beehive.govt.nz/sites/default/files/2020-
11/Letter%20to%20RBNZ%20Governor.pdf.
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Government’s economic Improve the well-being and living standards of New

objective: Zealanders through a sustainable, productive and inclusive
(Preamble to the Monetary Policy economy.
Committee Remit (2018))
The priority is to move towards a low carbon economy, with a
strong diversified export base, that delivers decent jobs with
higher wages and reduces inequality and poverty.

Monetary Policy Committee Future annual CPI inflation between 1-3 percent over the
primary operational objectives medium term, with a focus on 2 percent.
(Section 2a of the Remit)
Support maximum sustainable employment.

Monetary Policy Committee’s In pursuing the operational objectives, the MPC shall:
other considerations
i. have regard to the efficiency and soundness of the
(Section 2b of the Remit)
financial system;
ii. seek to avoid unnecessary instability in output,
interest rates, and the exchange rate; and
iii. discount events that have only transitory effects on
inflation, setting policy with a medium-term
orientation.

5. We noted in our response to you on 24 November that the Monetary Policy Committee
(MPC) currently gives consideration to house prices when setting policy. We also noted
that the Consumer Price Index (CPI) includes housing ‘consumption’ costs, such as
rents, rates, construction costs, and housing transaction costs.

6. The distinction between house prices and housing consumption costs is important when
considering the Government’s economic objectives, and the role of the Reserve Bank.

• House prices are an asset price and are driven by many factors, including monetary
and financial policy settings. House prices also have a variety of competing influences
on the Government’s wider goals of housing provision, and reducing poverty and
inequality.
• Housing costs, as captured in the Consumer Price Index (CPI), relate to the cost of
consuming (using) the asset i.e., being housed. The Reserve Bank’s monetary and
financial objectives have a direct link to the cost of being housed, and hence an
unambiguous link to the Government’s goals on housing, and poverty and inequality.

7. The many dimensions of government housing policy are show in figure 1 (adapted from
the 2017 Briefing to the Incoming Minister of Housing and Urban Development). Housing
policies span government housing provision, subsidies and rent-to-buy options, and
private market decisions regarding owning versus renting.
Figure 1: Aspects of government housing provision

Source: 2017 Briefing for the Incoming Minister of Housing

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Many factors affect house prices and housing affordability

8. Many factors are affecting house prices and housing affordability in New Zealand, as
summarised in figure 2.

Figure 2: Factors affecting house prices and housing costs (or affordability)

Source: Adapted from the Productivity Commission’s Inquiry into Housing Affordability (2012).

9. Previous government studies have identified housing supply as the most significant
determinant of house prices in New Zealand, with responsive housing supply essential
for ensuring positive and sustainable housing outcomes. 2 Suppressing housing demand
factors can reduce house prices, but will only prove to be a temporary intervention until
supply responsiveness is re-established. 3

10. Some factors that affect housing demand also affect housing costs or affordability, for
example employment, mortgage costs, and rents. As such, there are important policy
trade-offs to be acknowledged with house price inflation, and reducing poverty and
inequality. These trade-offs are summarised at the end of this report in Table 4.

Housing-related factors are affected by many parties

11. Solutions to any identified problem of high house prices or housing affordability require
the involvement of many government portfolios and agencies, as well as non-government
participants (see Figure 3 for example).

2 See, for example, the Productivity Commission’s 2012 Inquiry into housing affordability in New
Zealand, and Eaqub, Howden-Chapman and Johnson (2018), A Stocktake of New Zealand’s
Housing.
3 Briefing for the Incoming Minister of Housing and Urban Development (2017).

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Figure 3: Government ‘portfolios’ and other sectors related to the housing market

Source: Adapted from the 2017 Briefing for the Incoming Minister of Housing. The influence of various
groups is not evenly weighted.

12. Government agencies already have a wide range of levers that could be used to address
housing issues (see table 2). The key challenge is to clarify the policy ‘end-goals’, and to
select and coordinate the most effective policy levers.

13. Given the wide range and number of parties involved, and the complexity of underlying
issues, there is a need for a single agency or ‘clearing house’ to co-ordinate the
Government’s response across agencies. The Reserve Bank welcomes the
opportunity to participate within the Government’s wider response.

Table 2: Examples of existing government levers

Supply Demand
Tax policy Tax policy
Fiscal transfers Fiscal transfers
Social housing Overseas investment restrictions
Land availability / housing plans Rental standards
Building standards (including materials) Immigration
Infrastructure building Capital market development
Māori Development Kiwisaver policy
Immigration (for example, hiring foreign Monetary policy
builders)
Education (for example, training programmes) Financial policy

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The Reserve Bank’s current role in relation to house prices

14. As you identified in your letter, the Reserve Bank’s monetary and prudential policies can
affect house prices and housing affordability. In turn, the housing market can affect the
Bank’s monetary and financial policy objectives. This is summarised in Table 3, and
discussed in more detail below.

Table 3: Summary of the relationship between housing and the Reserve Bank

Monetary policy Financial policy

Objectives
Primary Price stability Promoting the maintenance of a
objective sound and efficient financial system
Support maximum sustainable
employment Avoiding significant damage to the
financial system that could result from
the failure of a registered bank
Other Have regard to the efficiency and Reduce the risk that the financial
objectives soundness of the financial system system amplifies a severe downturn

Seek to avoid unnecessary instability in Have regard to the impact of

output, interest rates and the exchange prudential policy on economic growth
rate

Discount events that have only transitory

effects on inflation
Impact of MPC takes housing market dynamics into The Bank takes housing market
housing on account when forming monetary policy, as dynamics into account when
objectives housing market-related prices are assessing financial stability risks and
included in the Consumer Price Index. forming prudential policies, as
mortgages are the NZ banking
system’s largest exposure and
houses are the largest household
asset.
Policy tools
Tools The level of retail interest rates relative to Capital and liquidity requirements
a ‘neutral rate’ as influenced by: Macro-prudential requirements
Official Cash Rate; Large Scale Asset Supervision of banks and other
Purchases; Funding for Lending deposit-taking lenders
Programme; and Purchase of Foreign
Assets
Impact of Monetary policy affects house prices and Prudential regulation affects the
tools on housing affordability by influencing availability and cost of mortgages by
housing borrowing and renting costs, economic placing requirements and restrictions
growth and employment. on mortgage lenders.

Current relationship between monetary policy and house prices

15. The Reserve Bank has a number of means by which to influence the level of interest
rates faced by households and businesses, and indirectly also the New Zealand dollar
exchange rate. The recent monetary policy-led decline in interest rates has contributed
to a rise in house prices. However, the lower interest rates have also supported housing
affordability, by lifting employment and household incomes, and by lowering the debt-
servicing costs of mortgage borrowers.

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16. Under the Reserve Bank’s current monetary policy framework, the MPC formulates
policy to achieve the primary economic objectives of achieving and maintaining stability
in the general level of prices over the medium term and supporting maximum sustainable
employment. In doing so, the MPC has regard to the factors set out in section 2b of the
Remit.

17. Monetary policy is a cyclical tool that adjusts interest rates relative to their underlying
structural level (known as the neutral interest rate). The neutral interest rate is determined
by factors outside of the influence of the Reserve Bank, such as demographics and
productivity. A long-term decline in neutral interest rates in many countries around the
world, including New Zealand (figure 4), has resulted in lower interest rates on average
faced by households and businesses.

Figure 4: 10-year Government Bond yields in selected countries

% %
20 20

18 18

16 16

14 14

12 12

10 Australia 10

8 UK 8

6 6
New Zealand
US
4 4
Germany
2 2
Japan
0 0

-2 -2
1981 1987 1993 1999 2005 2011 2017

18. When formulating policy, the MPC takes account of the impact of house prices on its
objectives in a number of ways. For example, housing demand affects the demand for
housing-related goods and services, such as property construction, rents, and property
maintenance. Together these components account for around one quarter of the CPI
weights.

19. Low interest rates can also influence asset values, including house prices, and the
decision to own or rent a house. Equity ownership in housing represents more than two-
thirds of New Zealand households’ total wealth. House price variation thus influences
perceived wealth, and hence households’ spending decisions. In addition, wealth gains
from house price inflation affects households’ ability to borrow against their homes to
finance consumption. These factors – increased wealth and leverage – eventually impact
on economic growth, inflation, and employment, amongst other factors.

20. Higher house prices, relative to the costs of house building, will also encourage increased
building activity, as it becomes cheaper to build new than buy existing. Increased house
price inflation can therefore encourage increased supply.

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21. The MPC is also required in the Act (and it is reiterated in section 2a of the Remit) to
have regard to the soundness and efficiency of the financial system when formulating
monetary policy.

22. Significant house price instability poses risks to financial system soundness, and can
cause instability in output and the exchange rate. For example, retail banks could create
overly concentrated mortgage lending portfolios, making their stability vulnerable to
variations in house prices and households’ ability to service their mortgages. The MPC
receives advice from both monetary and financial stability areas of the Bank when
formalising its policy decision.

Current relationship between financial policy and house prices

23. The Bank uses its financial policy to promote the maintenance of a sound and efficient
financial system, and to avoid significant damage to the financial system that could result
from the failure of a registered bank. The Reserve Bank has a number of financial
(prudential) tools to help address the risks that confront the financial system, including
instability in house prices. These tools include:

• Publicly highlighting the risks (e.g. in twice-yearly Financial Stability Reports);

• Imposing capital (including risk-weights) and liquidity requirements on banks;
• Restrictions on high ‘loan-to-value ratio’ (LVR) lending;
• Requiring banks to undertake stress tests with scenarios, including sharp house
price falls and unemployment increases; and
• Supervising banks to ensure they manage their own exposures to the housing
market.

24. House price instability can threaten the resilience of banks at the system and individual
level. Sharp declines in house prices during a recession can cause significant mortgage
defaults and large losses for banks. This risk is particularly acute when many mortgage
borrowers are highly indebted, relative to their incomes and home values. As interest
rates have structurally fallen over the last decades, debt serviceability has become more
affordable, while the amount of debt relative to income for new mortgagors has steadily
increased.

25. These trends have been outlined in numerous Financial Stability Reports. Banks and
households remain vulnerable to risks that may impair peoples’ ability to service their
mortgages, especially higher unemployment rates. If banks provide a large amount of
credit to higher-risk borrowers this can amplify the impact of a housing downturn on the
financial system. It is worth noting that restrictions on high-LVR loans over the past seven
years have improved the resilience of household and bank balance sheets.

26. The Bank has used LVR restrictions to cap banks’ mortgage lending to borrowers that
are highly leveraged (i.e. have low deposits). LVR restrictions were removed in May 2020
to help maintain credit flows and to support the mortgage deferral scheme. However,
since that time, the housing market has proved resilient and high-LVR lending has been
increasing, particularly to investors.

27. As commenced on December 8 2020, the Bank is consulting registered banks and the
public about re-instating LVR restrictions from 1 March 2021. This is to reduce the risk of
this higher-risk lending amplifying the impacts of a housing downturn on the financial
system.

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28. We have also previously consulted on introducing debt serviceability restrictions, such
debt-to-income (DTI) limits, on mortgage lending. Although we consider that restrictions
on high-DTI lending could complement the current LVR policy, we note that this tool is
not currently part of the Reserve Bank’s Memorandum of Understanding with the Minister
of Finance. We request that the Government gives consideration to adding
restrictions on debt serviceability (that would include DTI limits) to the permitted
tools in 2021.

29. Other prudential tools can also affect housing market dynamics. Increasing capital risk
weights on mortgage lending would be expected to marginally increase the cost to banks
of providing that lending.

30. While studies by the Bank have found that binding LVR restrictions can affect house
prices, 4 our prudential tools mainly enhance the resilience of the financial system to
shocks.

31. It is ambiguous as to whether increased LVR restrictions or the imposition of DTI

restrictions and higher capital requirements would assist the Government’s goal of
housing New Zealanders, and reducing inequality and poverty. Higher prudential
requirements generally imply higher deposit requirements, lower credit ceilings, and
higher interest costs for the mortgage borrower. All of these factors disadvantage lower
income and lower wealth households.

32. Finally, when implementing our financial stability policies, we must have regard for the
efficiency and soundness of the financial system under current law. Efficiency
considerations include aspects such as financial inclusion and the efficient allocation of
financial resources. 5 Under current law the Bank could not tighten prudential policies for
the primary purpose of dampening house prices, if that is not justified on financial stability
grounds.

Strengthening the Reserve Bank’s role in relation to house prices

33. Having considered your letter of 24 November 2020, we believe that there are two
possible options for strengthening the Reserve Bank’s role in relation to house prices:

a. Adding a house price consideration to the Monetary Policy Remit

b. Adding a house price consideration to the purpose of financial policy

34. The first option is not preferred by the Reserve Bank. Under this option the MPC would
be required to have regard to the house price consideration provided when formulating
monetary policy. This could be formalised by amending section 2b of the MPC’s Remit,
as suggested in your letter.

35. Under the second option, our preferred option, the Reserve Bank could be required to
have regard to housing issues in its financial policy settings. This could be achieved using
the Reserve Bank of New Zealand Bill (RBNZ Bill), which is due to have its first reading
this week. The RBNZ Bill contains a provision for you to issue a Financial Policy Remit

4
See Armstrong et al (2018), ‘Loan to value ratio restrictions and house prices’, Reserve Bank of New
Zealand Discussion Paper, DP2018/05.
5
For example, the Capital Review decisions, published in 2019, were calibrated so as to balance the
resilience benefits of higher capital with the cost anticipated from increasing interest rates.

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to which the Reserve Bank must have regard in its pursuit of its financial stability
mandate.

36. The RBNZ Bill is not expected to be enacted until the second half of 2021. However, a
house price consideration could be added to the Reserve Bank’s financial policy remit
more immediately using section 68B of the Act. This enables you to issue a direction to
the Reserve Bank to have regard to a specific government policy when forming financial
policy.

37. For both options, the house price consideration will have to be clearly articulated to
ensure the Reserve Bank’s actions support the Government’s housing objectives and to
ensure the Reserve Bank is properly accountable for its actions. Furthermore, if you
chose to issue a direction under section 68B, you would need to specify a clear
Government policy to which the Reserve Bank must have regard.

Assessment of the options

38. Our assessment of these options is summarised in table 4, below.

Table 4: Options for strengthening the Reserve Bank’s role

Option Possible benefits Limitations and challenges

Add a house It could justify MPC decisions that, at the The primacy of the MPC’s economic
price margin, result in higher interest rates and objectives of stable inflation and sustainable
consideration lower house price inflation. employment mean the impact on house price
to the inflation is likely to be limited.
monetary Commits the MPC to communicate how
policy Remit house prices are accounted for in its In situations where MPC action on house
decision making. price inflation would be justified, there are
potential trade-offs:
Strengthens the Reserve Bank’s
commitment to any broader Government • Higher interest rates, leading to lower
work on housing issues. employment and below target
inflation and inflation expectations.

• Lower employment most impacts

those at the margins of the labour
market e.g. Māori, Pasifika, women,
and youth.
• A higher than otherwise New Zealand
dollar exchange rate and a negative
impact on export earnings.
• Lower growth in housing supply due
to higher borrowing costs.
• Increased mortgage servicing costs
and decreased housing affordability.
Adding house prices to the monetary policy
objective would be unique internationally,
which could make monetary policy less
effective and impact financial market
efficiency, by reducing public understanding
of the objective of monetary policy.

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Add a house It would justify financial policy decisions Financial policy actions to address house
price that lower house price inflation, alongside price concerns could result in the potential
consideration strengthening the soundness and trade-offs with monetary policy. This could
to the efficiency of the financial system. increase the need for a resolution between
financial the Reserve Bank’s financial policy and
policy remit Policy decisions will be consistent and monetary policy.
publically understandable, as few trade-
offs between the financial system Financial policy actions would need to be
soundness and efficiency objective, and justified by achieving financial stability.
a house price consideration.
Some financial policy actions could reduce
Allows for a whole-of-Reserve Bank the availability or increase the cost of finance
response to housing market issues, and for some borrowers.
provides a wide range of policy actions,
including some that can targeted at
specific drivers of the housing market.

Strengthens the Reserve Bank’s

commitment to the whole-of-Government
suite of work on housing issues.

39. As summarised in Table 4, both options would strengthen the Reserve Bank’s role in
relation to house prices and support our ongoing participation in the whole-of-
Government response to New Zealand’s housing issues.

40. Adding a housing consideration to the monetary policy remit could lead to MPC decisions
that moderate house prices. However, our assessment is that there are strong reasons
why it would be unlikely to result in significant policy changes.

41. First, the MPC already takes account of house prices when formulating monetary policy,
as previously outlined.

42. As an illustration, the 2012 Policy Targets Agreement (PTA) included a clause for the
Reserve Bank to “monitor asset prices” in pursuit of its general price inflation objective.
This inclusion was a specific reference to the role that asset prices played in the domestic
and international financial cycle leading up to the global financial crisis. 6 This clause was
removed from the 2018 PTA on the basis that it was redundant given the long-standing
regard to financial stability contained in the Act. 7

43. Second, if there were trade-offs between the house price consideration and the MPC’s
economic objectives of stable inflation and sustainable employment, the MPC would be
obligated to formulate policy that supports its price stability and employment objectives.

44. This is illustrated by considering the factors influencing the MPC’s design of the Funding
for Lending Programme (FLP), launched this week. A key element of the FLP is the
provision of a sufficient alternative source of funding for banks, which is necessary to
reduce the marginal cost of bank funding and, hence, interest rates for bank customers.
This is the same for central bank funding programmes implemented abroad. For
example the central banks in Australia, the Eurozone and the UK each provide retail
banks access to a large amount of funding without any sector specific lending conditions.

6
Kendall and Ng (2013), ‘The 2012 PTA: An evolution in flexible inflation targeting in New Zealand’.
7Treasury Report, available at https://www.treasury.govt.nz/sites/default/files/2018-04/pta-tr18-
176.pdf

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45. Restricting the FLP to only new business lending, for example, would limit its impact on
broader retail interest rates significantly. The FLP’s monetary policy effectiveness would
be impaired, as would the MPC’s ability to achieve their inflation and employment
objectives.

46. Finally, the addition of a housing consideration to the monetary policy remit could also
make the goal of monetary policy confusing and reduce financial market efficiency.

47. Adding a housing consideration to the financial policy remit could lead to policies that are
more effective at supporting the Government’s housing objectives, with lesser concern
for policy trade-offs. There are considerably less trade-offs between the Reserve Bank’s
financial policy objective, of a sound and efficient financial system, and stable house
prices. It would also enable the Reserve Bank to use financial policies that can be
specifically targeted at key drivers of the housing market.

48. A challenge of this approach is that it could increase the need for resolution between the
Reserve Bank’s financial policy and monetary policy. This challenge already exists and
is managed by the Reserve Bank, for example, by providing the MPC with advice from
financial policy experts prior to finalising their decision.

49. Given this assessment, if you wish to strengthen the Reserve Bank’s role in relation
to house prices, our recommendation is that this would be best achieved by
amending our financial policy remit. This could be achieved permanently by issuing
the Financial Policy Remit provided by the RBNZ Bill, and temporarily by issuing a
direction under section 68B of the Act.

50. We are keen to engage with you on the definition of the house price consideration. It is
important that it accurately captures the Government’s concerns about the housing
market and the unique role of the Reserve Bank in relation to the complex and
multifaceted drivers of housing market.

Hon Grant Robertson Adrian Orr

Minister of Finance Governor
Date: 9/12/2020

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