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Political & Economic week that was: 'wealth effect' or 'debt effect'

Rob Hosking breaks down the political and economic week that was on NBR Radio and on demand on MyNBR Radio.

NBR Radio
Fri, 30 Oct 2015

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Call it the “debt effect” rather than the “wealth effect.”

The last house price boom/bubble, in New Zealand as elsewhere, saw a huge surge in consumer spending. People looked at their property values, looked at the latest brochure from a bank offering them more loans – sometimes through a higher mortgage, sometimes through yet another credit card – and spent up large. 

By the middle of the decade, household debt was rising at more than 16% a year. 

Economists called this the “wealth effect.” People felt wealthier – and technically, they were, at least so long as their house price stayed high, and they didn’t take up all the extra debt banks were shoving their way. 

Readers can probably see the catch. In fact, New Zealand was luckier than most in that house prices did not take the dip experienced in many places. 

But it did leave a legacy of high household debt. Add to that the collapse of the finance companies, and the fact many New Zealanders diversified their saving by putting funds into such vehicles, and you have a large legacy of – at best psychological caution, and at worst, higher debt than anyone likes to be carrying in the second half of their life. 

So, this time around, the wealth effect is not happening. The house price surge over recent years – mostly but not, by any means, solely – in Auckland would, in the past, have seen a consumer spending surge. Even if people were not borrowing more, they would, at least, be prepared to buy a few extra “nice to haves.”

No doubt some people have been doing this. But, taken in aggregate, New Zealanders are keeping things tight. 

In fact, household savings are rising – despite the other economic factor which should mitigate against such behaviour: low interest rates. 

And those rates will probably, over time, have to be lower, and not just locally. 

 “Debt levels are higher so people are spending less, and people are less willing to borrow to fund spending, consumption or investment, so we are living in a world where interest rates have to be lower,” says Harbour Asset Management strategist Christian Hawkesby.

Global phenomenon
This is not just a local phenomenon: it is one reason the US Federal Reserve has continually postponed lifting interest rates in that country.

“People have become more risk averse, they’re not spending as much, they’re cautious about pushing for wage increases, they’re cautious about putting their prices up,” says economist Donal Curtin. 

“There seems to be a different set of behaviours and nobody has really got a handle on this, in New Zealand or elsewhere.”

But locally, that is putting increasing acid on the Reserve Bank. There was a hint, in yesterday’s official cash rate review, that New Zealand’s central bank is looking at some further measures to deal with the housing market – and thus give itself more room to slice interest rates. 

The new loan to value ratio  (LVR) rules take effect from next week: the government’s “brightline” test for taxing the capital gains on property investment kicked in this month. 

That property market remains one of two central points of nervousness for the Reserve Bank. 

But this is asset price inflation, not consumer prices index (CPI) inflation. Although the Reserve Bank’s monetary policy role is aimed at keeping the annual  CPI at between 1-3%, (it is currently 0.3%) it also has to pay heed to asset prices. 

And it also has, in its promotion of financial stability role rather than its price stability role, have to watch excessive house or other asset price surges. 

Which is why the sudden appearance of the term “financial stability” in yesterday’s official cash rate review is so intriguing.

The Reserve Bank normally avoids even using the term when it does any monetary policy assessment. 

True, the term appears – but it is either in relation to other countries (China and the UK and Europe) or simply as part of a general recitation of recent measures, such as higher capital requirements, and the much-discussed LVR rules, for banks. 

A quick scan of assessments over the past couple of years shows it last used the term in March 2013 relating to its own monetary policy assessment. 

The Reserve Bank’s next financial stability report will be released in just under two weeks' time. Governor Graeme Wheeler could well use that report to signal further efforts in that area aimed at the housing market. 

He is unlikely to announce anything new straight away: the practice has been to float proposals and seek feedback – and, in so doing, perform a kind of jaw-boning on the market. Anything more sudden risks generating a panic. 

After the double-digit house price inflation over recent years, the last thing the policymakers want is a sudden deflation, with all the concomitant effects on wider economic confidence. 

But any successful moves to take the edge of that market will give much greater breathing space for a lower official cash rate. 

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NBR Radio
Fri, 30 Oct 2015
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Political & Economic week that was: 'wealth effect' or 'debt effect'
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