IMF Updates Global Housing Watch

The latest IMF’s Global House Price Index—an average of real house prices across countries—is now almost back to its level before the financial crisis. But there are significant variations, and policy responses.

imf-ghw-nov-2016Developments in the countries that make up the index fall into three clusters. The first cluster—gloom—consists of 18 economies in which house prices fell substantially at the onset of the Great Recession, and have remained on a downward path. The second cluster—bust and boom— consists of 18 economies in which housing markets have rebounded since 2013 after falling sharply during 2007-12. The third cluster—boom—comprises 21 economies in which the drop in house prices in 2007–12 was quite modest and was followed by a quick rebound.

imf-ghw-nov-2016-2Gloom = Brazil, China, Croatia, Cyprus, Finland, France, Greece, Italy, Macedonia, Morocco, Netherlands, Poland, Russia, Serbia, Singapore, Slovenia, Spain, Ukraine.

Bust and boom = Bulgaria, Denmark, Estonia, Germany, Hungary, Iceland, Indonesia, Ireland, Japan, Latvia, Lithuania, Malta, New Zealand, Portugal, South Africa, Thailand, United Kingdom, United States.

Boom = Australia, Austria, Belgium, Canada, Chile, Colombia, Czech Republic, Hong Kong SAR, India, Israel, Kazakhstan, Korea, Malaysia, Mexico, Norway, Peru, Philippines, Slovak Republic, Sweden, Switzerland, Taiwan.

Credit has expanded much faster in the boom group than in the other two.

imf-ghw-nov-2016-3Construction gross value added and residential building permits have stagnated in the gloom group relative to the other two.

imf-ghw-nov-2016-4Among the gloom group:

In China, excess inventory remains high. The IMF assessment points out that for lower-tier cities, where multi-year excess inventory levels are particularly acute, restricting new starts seems warranted, for example by tightening prudential measures on credit to property developers.

In Netherlands, the turnaround in house prices presents an opportunity to remove some of the incentives for excessive leverage—thereby reducing the likelihood and intensity of boom-bust cycles.

There are some concerns about sustainability in a few boom or bust and boom economies:

IMF assessments state that in Belgium, Canada, Luxembourg, Malaysia, Malta, and the United Kingdom, additional macroprudential measures may be needed or considered if housing market vulnerabilities intensify.

In the case of Norway, the IMF assessment points to a substantial overvaluation. In some other cases—Belgium, Korea, and Morocco—the assessments do not find overvaluation.

IMF assessments point to supply constraints as a factor driving house prices in a number of countries where prices have rebounded, including Denmark, Germany, New Zealand, and the United Kingdom.

Many countries have been actively using macroprudential tools to manage house price booms. The main macroprudential tools employed for this purpose are limits on loan-to-value ratios and debt-service-to-income ratios and sectoral capital requirements.

Figure 6 shows that macroprudential policies have been very active in the boom group, followed by gloom group, and bust and boom group.

imf-ghw-nov-2016-6Loan-to-value ratios: Gloom = Brazil, China, Finland, Netherlands, Poland, Serbia, Singapore, Spain. Bust and boom = Estonia, Hungary, Iceland, Indonesia, Latvia, Lithuania, New Zealand, Thailand. Boom = Canada, Chile, Czech Republic, Hong Kong, Israel, Korea, Malaysia, Norway, Philippines, Slovak Republic, Sweden, Taiwan.

Debt-service-to-income ratios: Gloom = Cyprus, Netherlands, Poland, Serbia. Bust and boom = Estonia, Hungary, Ireland, Latvia, United Kingdom, United States. Boom = Canada, Hong Kong, India, Israel, Malaysia, Norway.

Sectoral capital requirements: Gloom = Brazil, Croatia, France, Italy, Poland, Russia, Serbia, Spain. Bust and boom = Bulgaria, Estonia, Iceland, Ireland, Latvia, Lithuania, New Zealand, South Africa, Thailand, United Kingdom, United States. Boom = Australia, Belgium, Colombia, Hong Kong, India, Israel, Korea, Malaysia, Norway, Peru, Slovak Republic, Switzerland, Taiwan.

Longer-Term Challenges for the U.S. Economy

Macroeconomic policy does not have to be confined to monetary policy. Certain fiscal policies, particularly those that increase productivity, can increase the potential of the economy say Fed Vice Chairman Stanley Fischer who discussed the Longer-Term Challenges for the U.S. Economy.



Notwithstanding a number of shocks over the past year, the U.S. economy is performing reasonably well. Job gains have been robust in recent years, and the unemployment rate has declined to 4.9 percent, likely close to its long-run sustainable level. After running at a subdued pace during the first half of the year, gross domestic product growth has picked up in the most recent data, and inflation has been firming toward the Federal Open Market Committee’s 2 percent target.

Although the economy has moved back to the vicinity of the Committee’s employment and inflation targets–suggesting that the cyclical drag on the economy has been greatly reduced, if not largely eliminated–along some dimensions this has not been a happy recovery. Unease with the economy reflects a number of longer-term challenges, challenges that will require a different set of policy tools than those used to address nearer-term cyclical shortfalls in growth. Prominent among these challenges are low equilibrium interest rates and sluggish productivity growth in the United States and abroad. I will first touch on low interest rates before turning to productivity. The federal funds rate and policy rates in other advanced economies remain very low or even negative. Longer-term rates are also low by historical standards, even taking into account the increase of the past two weeks.

Such low interest rates, together with only tepid growth, suggest that the equilibrium interest rate–that is, the rate that neither boosts nor slows the economy–has fallen. Why does this matter? Importantly, low interest rates make the economy more vulnerable to adverse shocks by constraining the ability of monetary policy to combat recessions using conventional interest rate policy–because the effective lower bound on the interest rate means that monetary policy has less room to reduce the interest rate when that becomes necessary. Also, low equilibrium rates could threaten financial stability by encouraging a reach for yield and compressing net interest margins, although it is important to point out that so far we have not seen evidence that low rates have notably increased financial vulnerabilities in the U.S. financial system. More fundamentally, low equilibrium real rates could signal that the economy’s long-run growth prospects are dim.

Why are interest rates so low? In a speech last month, I identified a number of factors that have worked to boost saving, depress investment, or both. Among the factors holding down interest rates is the sluggishness of foreign economic growth. Another is demographics, with saving being higher as a result of an increase in the average age of the U.S. population. Also, investment recently has been weaker than might otherwise be expected, perhaps reflecting uncertainty about longer-run growth prospects, as well as the decline in investment in the energy sector as a result of the fall in the price of oil. Finally, and most important, weak productivity growth has likely pushed down interest rates both by lowering investment, as firms lower their expectations for the marginal return on investment, and by increasing saving, as consumers lower their expectations for income growth and borrow less and/or save more as a consequence.

Understanding the recent weakness of productivity growth is central to addressing the longer-run challenges confronting the economy. Productivity growth over the past decade has been lackluster by post-World War II standards. Output per hour increased only 1-1/4 percent per year, on average, from 2006 to 2015, compared with its long-run average of 2-1/2 percent from 1949 to 2005. This halving of productivity growth, if it were to persist, would have wide-ranging consequences for living standards, wage growth, and economic policy more broadly. A number of explanations have been offered for the decline in productivity growth, including mismeasurement in the official statistics, depressed capital investment, and a falloff in business dynamism, with reality likely reflecting some combination of all of these factors and more.

We should also consider the possibility that weak demand has played a role in holding back productivity growth, although standard economic textbooks generally trace a path from productivity growth to demand rather than vice versa. Chair Yellen recently spoke on the influence of demand on aggregate supply. In her speech, she reviewed a body of literature that suggests that demand conditions can have persistent effects on supply. In most of the literature, these effects are thought to occur through hysteresis in labor markets. But there are likely also some channels through which low aggregate demand could affect productivity, perhaps by lowering research-and-development spending or decreasing the pace of firm formation and innovation. I believe that the relationship between productivity growth and the strength of aggregate demand is an area where further research is required.

I will conclude by reiterating one aspect of the low interest rate and low productivity growth problems that I have mentioned previously–the fact that, for several years, the Fed has been close to being “the only game in town,” as Mohamed El-Erian described it in his recent book.5 But macroeconomic policy does not have to be confined to monetary policy. Certain fiscal policies, particularly those that increase productivity, can increase the potential of the economy and help confront some of our longer-term economic challenges. While there is disagreement about what the most effective policies would be, some combination of improved public infrastructure, better education, more encouragement for private investment, and more effective regulation all likely have a role to play in promoting faster growth of productivity and living standards. By raising equilibrium interest rates, such policies may also reduce the probability that the economy, and the Federal Reserve, will have to contend more than is necessary with the effective lower bound on interest rates.

Watch live: Leaving the Board

Business Lending Crunched – Investment Lending Apart

The final set of ABS data on finance for July 2016 includes all forms of lending, and does not tell a good story. Whilst investment housing lending grew, lending for productive business growth fell, again.

Here is the summary, having separated business lending for housing investment purposes, versus the rest. As normal we will focus on the trend data, which irons out some of the noise in the data, to see through to the underlying movements.

Lending for secured construction and purchase of dwellings fell 0.1%, or $20m, month on month, secured alterations rose just a little, personal finance rose 0.1% or $6m and overall commercial lending fell 1.75% or $671m compared with last month, and continues to fall.

Within the business or commercial flows, lending for investment property rose 1.1% or $127m, compared with last month, whilst lending for other commercial purposes fell 2% or $384m. Revolving commercial credit fell 5% down $416m.

So productive lending to business continues to fall, and overall lending is being supported by more investment housing. As a result, the proportion of business lending for investment housing rose again to 31% of commercial lending, whilst lending for other commercial purposes fell again to 48.2% of all commercial lending. These trends need to be reversed if we are to get real productive economic growth to kick in.

abs-fin-jul-2016-allFinally, for completeness, here is the housing data, once again showing the ongoing rise in the proportion of investment housing lending, up 1.1% or $127m on last month, and up from 35.9% to 36.1% of total flows.

abs-fin-jul-2016-housingWe think tighter macroprudential measures are overdue.

NZ Tightens Mortgage Lending Rules From 1 October

The NZ Reserve Bank today confirmed that new macroprudential rules tighten restrictions on bank lending to residential property buyers throughout New Zealand. Residential property investors will generally need a 40 percent deposit for a mortgage loan, and owner-occupiers will generally need a 20 percent deposit.


From 1 October, residential property investors will generally need a 40 percent deposit for a mortgage loan, and owner-occupiers will generally need a 20 percent deposit. In both cases, banks are still allowed to make a small proportion of their lending to borrowers with smaller deposits.

Confirmation of the new rules is in the Reserve Bank’s response to submissions to its public consultation about changes to Loan to Value Ratio (LVR) rules that was issued on 19 July.

The Reserve Bank is modifying its proposals in response to public consultation, and also through meetings and workshops with banks that are subject to the rules.

The new rules take effect on 1 October 2016, but banks have chosen to start following the new limits already.

Existing exemptions to LVR restrictions will continue to apply under the new rules and have been extended to include borrowing for a newly-built home, or to do work needed for a residence to comply with new building codes and rental-property standards.


BIS, FSB and IMF publish elements of effective macroprudential policies

The International Monetary Fund (IMF), Financial Stability Board (FSB) and Bank for International Settlements (BIS) released today a new publication on Elements of effective macroprudential policies. The document, which responds to a G20 request, takes stock of the international experience since the financial crisis in developing and implementing macroprudential policies and will be presented to the G20 Leaders’ Summit in Hangzhou.


Following the global financial crisis, many countries have introduced frameworks and tools aimed at limiting systemic risks that could otherwise disrupt the provision of financial services and damage the real economy. Such risks may build-up over time or arise from close linkages and the distribution of risk within the financial system.

Experience with macroprudential policy is growing, complemented by an increasing body of empirical research on the effectiveness of macroprudential tools. However, since the experience does not yet span a full financial cycle, the evidence remains tentative. “The wide range of institutional arrangements and policies being adopted across countries suggest that there is no ‘one-size-fits-all’. Nonetheless, accumulated experience highlights – and this paper documents – a number of elements that have been found useful for macroprudential policy making,” the publication says. These include:

  • A clear mandate that forms the basis for assigning responsibility for taking macroprudential policy decisions.
  • Adequate institutional foundations for macroprudential policy frameworks. Many of the observed designs give the main mandate to an influential body with a broad view of the entire financial system.
  • Well-defined objectives and powers that can foster the ability and willingness to act.
  • Transparency and accountability mechanisms to establish legitimacy and create commitment to take action.
  • Measures to promote cooperation and information-sharing between domestic authorities.
  • A comprehensive framework for analysing and monitoring systemic risk as well as efforts to close information gaps.
  • A broad range of policy tools to address systemic risk over time and from across the financial system.
  • The ability to calibrate policy responses to risks, including by considering the costs and benefits, addressing any leakages, and evaluating responses. In financially integrated economies, this includes assessing potential cross-border effects.

The document includes some data on the use of macroprudential tools; illustrative examples of institutional models for macroprudential policymaking; and a brief summary of some of the empirical literature on the effectiveness of macroprudential tools.

“Usage” counts the number of countries using the various instruments that comprise each group. Assuming that once a country introduces an instrument, it continues using it, the charts show usage of the various groups of instruments.

MacroPruCountsInstitutional arrangements adopted by a country are shaped by country-specific circumstances, such as political and legal traditions, as well as prior choices on the regulatory architecture. While there can therefore be no “one size fits all” approach, in practice, there has been an increasing prevalence of models that assign the main macroprudential mandate to a well-identified authority, committee, or interagency body, generally with an important role of the central bank. While each of these models has pros and cons, any one model can be buttressed with additional safeguards and mechanisms.

  • Model 1: The main macroprudential mandate is assigned to the central bank, with its Board or Governor making macroprudential decisions (as in the Czech Republic, Ireland, New Zealand and Singapore). This model is the prevalent choice where the central bank already concentrates the relevant regulatory and supervisory powers. Where regulatory and supervisory authorities are established outside the central bank, the assignment of the mandate to the central bank can be complemented by coordination mechanisms, such as a committee chaired by the central bank (as in Estonia and Portugal), information sharing agreements, or explicit powers assigned to the central bank to make recommendations to other bodies (as in Norway and Switzerland).
  • Model 2: The main macroprudential mandate is assigned to a dedicated committee within the central bank structure (as in Malaysia and the UK). This setup creates dedicated objectives and decision-making structures for monetary and macroprudential policy where both policy functions are under the roof of the central bank, and can help counter the potential risks of dual mandates for the central bank (see further IMF 2013a). It also allows for separate regulatory and supervisory authorities and external experts to participate in the decision-making committee. This can foster an open discussion of trade-offs that brings to bear a range of perspectives and helps discipline the powers assigned to the central bank.
  • Model 3: The main macroprudential mandate is assigned to an interagency committee outside the central bank, in order to coordinate policy action and facilitate information sharing and discussion of system-wide risk, with the central bank participating on the committee (as in France, Germany, Mexico, and the US). This model can accommodate a stronger role of the Ministry of Finance (MoF). Participation of the MoF can be useful to create political legitimacy and enable decision makers to consider policy choices in other fields, e.g. when cooperation of the fiscal authority is needed to mitigate systemic risk.

Monetary versus macroprudential policies

Monetary policy, as currently being implemented, is failing to deal with the current raft of economic issues, including low inflation, stagnant wage growth, high asset prices and ultra low policy rates. When coupled with politicians taking a back seat and their inability to tackle the core issues, macroprudential measures are being tried, in a massive real-time experiment. This coupling of monetary and macroprudential action is largely untested. Can they work in tandem?

Bank-ConceptA Bank of England working paper “Monetary versus macroprudential policies causal impacts of interest rates and credit controls in the
era of the UK Radcliffe Report“, attempts to look at this issues, with some interesting results. They conclude that macroprudential policy is better suited to achieving financial stability goals than monetary policy.

The Global Financial Crisis and its disappointing aftermath are widely  viewed as a major macroeconomic policy disaster from which lessons must be learned. Yet agreement on the precise failures and, thus, the necessary lessons, has been elusive in many areas, from mortgage regulation to fiscal policy, and from global imbalances to central banking. In the latter case, the role of macroprudential policies remains fraught, with doubts about whether they should exist, if they work, and how they should be designed and used.

Reflecting this range of skepticism, several countries have recently taken quite varied courses of action in retooling their policy regimes since 2008. For example, facing a heating up of their housing markets in 2010–12, Sweden and Norway took quite different policy actions. Sweden’s Riksbank tried to battle this development using monetary policy tools only, raising the policy rate, and tipping the economy into deflation, as had been predicted by the dissident Deputy Governor Lars Svensson, who subsequently resigned. Across the border, the Norges Bank implemented some cyclical macroprudential policies to crimp credit expansion and moderate mortgage and house-price booms, without relying as much on rate rises, and they managed to avoid such an out-turn. Elsewhere, other countries display differing degrees of readiness or willingness to use time-varying macroprudential policies. The Bank of England now has both a Financial Policy Committee and a Monetary Policy Committee, and the former has already taken macroprudential policy actions under Governor Mark Carney. As Governor of the Bank of Israel, Stanley Fischer utilized macroprudential policies against perceived housing and credit boom risks, but now as Vice-Chair at the Federal Reserve his speeches lament the lack of similarly strong and unified macroprudential powers at the U.S. central bank. Yet as one surveys these and other tacks taken by national and international policymakers, two features of the post-crisis reaction stand out: the extent to which these policy choices have proved contentious even given their limited scope and span of operation, and the way that the debate on this policy revolution has remained largely disconnected from any empirical evidence. And of course, the two features may be linked.

This paper seeks a scientific approach that might address both of these shortcomings, by bringing a new and vastly larger array of formal empirical evidence to the table. To that end, we turn to the last great era of central bank experimentation with the same types of macroprudential instruments: the postwar decades from the 1950s to the early 1980s when many types of credit controls were put in play. We go back and construct by hand new quantitative indicators on the application of such policies in the UK, including credit ceilings, hire purchase regulations, special deposits, and the “Corset.” To evaluate the impacts of these policies, and to compare them with the impacts of the standard monetary policy tool of Bank Rate, we then implement a state-of-art econometric estimation of impulse-response functions (IRFs) to the two policy shocks by developing a new approach to identification that is also original to this paper, one that we shall refer to as Factor-Augmented Local Projection (FALP). Our approach unites the flexible and parsimonious local projection (LP) method of estimating IRFs with the Romer and Romer approach of using forecasts to mitigate the selection bias arising from policymakers acting on their expectations of future macroeconomic developments. To ensure greater robustness, we also borrow from the factor augmentation approach that has been employed in the VAR literature  as a means to control for other information correlated both with changes in policy and future macroeconomic developments. We subject our results to a range of robustness tests, most of which give us little reason to doubt our main results.

We report three main results. First, we find that monetary and credit policies had qualitatively distinct effects on headline macroeconomic indicators during this period. Increases in Bank Rate had robust negative effects on manufacturing output, and consumer prices especially, and positive effects on the trade balance. However, the estimated response of bank lending to an increase in Bank Rate is not statistically significant. By contrast, we find that credit controls — liquidity requirements on banks, credit growth limits, and constraints on the terms of consumer finance — had a strong negative impact on bank lending. We also find some evidence that credit policies may have depressed output, improved the trade balance, and led to an increase in consumer prices. But our evidence here is less strong than for corresponding shifts in Bank Rate. Overall, our estimates suggest that monetary and credit policies spanned different outcome spaces during this period. This result supports the notion that today’s macroprudential tools, which are close cousins of the credit policies studied in this paper, might provide the additional independent tools required to help central banks meet both their monetary and financial stability objectives.

Second, we find that our estimated monetary and credit policy shocks were major drivers of macroeconomic dynamics over the 1960s and 1970s. A significant fraction of lending and output dynamics can be explained by these shocks. Moreover, we find that a large fraction of the pick-up in inflation in the 1970s can be attributed to expansionary monetary policy shocks — that is, interest rates were substantially looser in the latter part of our sample than would have been expected given available econonomic forecasts and the information about the state of the economy contained in our estimated factors.

Third, our impulse responses indicate that credit policies had moderating effects on modern-day indicators of financial system vulnerabilities, while the effects of monetary policy actions were less clear cut. Contractionary credit policies had large and persistent negative effects on the credit-to-GDP ratio; they also reduced banks’ loan to deposit ratios (a measure of their resilience), and increased the spread between debentures i.e. term corporate debt instruments and gilts (a measure of investor risk appetite). In contrast, we find that contractionary monetary policy led to a persistent increase in the credit-to-GDP ratio, as the fall in GDP exceeded the fall in credit. Contractionary monetary policy actions also led to a small reduction in banks’ loan-to-deposit ratios, but led to a large persistent increase in the debenture spread. Our results therefore provide some support to the view that macroprudential policy is better suited to achieving financial stability goals than monetary policy.

Note: Staff Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. Any views expressed are solely those of the author(s) and so cannot be taken to represent those of the Bank of England or to state Bank of England policy. This paper should therefore not be reported as representing the views of the Bank of England or members of the Monetary Policy Committee, Financial Policy Committee or Prudential Regulation Authority Board

Limiting the Effects of the Global Financial Cycle

Falling interest rates imposed on the Australian economy by the RBA have, so far at least, not been successful in driving the desired economic outcomes. Inflation is very low, alongside wage growth, household debt is sky-high, the dollar remains high, business investment is subdued, yet asset prices are inflated. Why might this be?

The phenomenon of national boom and bust cycles within countries is well known. The boom phase is associated with rising asset prices, easier access to finance, loose risk settings, and increased leverage. This may last for many years. But at some time, the worm will turn, leading to changed risk perceptions, a fall (often sudden) in asset prices and deleverage.

KeysHowever, recent analysis has shown than national financial cycles are partly subsumed by global financial cycles. These cycles are driven by the policy settings of large countries, like the USA and China, in the context of global financial markets. We see the longer for lower interest rate settings leading to global players searching for yield. As a result, the price of risk  falls. These forces collide with the local economies. So will central banks in smaller, open economies be able to make local monetary adjustments successfully when monetary policy transmission mechanism is affected by global risk factors and that these factors may move in the opposite direction to conventional monetary policy moves?

A timely Bank of Canada working paper “The Global Financial Cycle, Monetary Policies and Macroprudential Regulations in Small, Open Economies“, looks at this issue and draws some important conclusions.

Specifically, for small open economies, like Canada, and Australia, while there are large costs associated with financial crises, they suggest that the central banks’ leaning against the effects of the global financial cycle would typically be too costly. Central banks cannot rely on a combination of conventional and unconventional monetary policies alone to offset the effects of financial crises. Some form of micro- and macroprudential policies are also required to lower both the likelihood and severity of a crisis.

Here is their non-technical summary:

This paper offers an overview of the implications of the global financial cycle for conventional and unconventional monetary policies and macroprudential policy in small, open economies (SOEs) such as Canada. We start by reviewing the recent evidence on financial cycles. An important new finding is that national financial cycles may have been partly subsumed into a global financial cycle. The global financial cycle is driven, in part, by monetary policy decisions in the United States. Low-for-long U.S. policy rates cause global financial intermediaries to search for yield, which in turn leads to a decline in the cross-section of international risk premia. Risk premia form an important part of conventional and unconventional monetary policy transmission mechanisms in both large and small economies.

Next, we review the available policy actions that could be undertaken by SOE central banks and regulatory authorities to limit the effects of the global financial cycle. We show that conventional monetary policy actions in both large and small economies are affected by movements in global risk premia. The paper also examines the effectiveness of unconventional monetary policies originating in SOEs that are not coordinated with those in large countries.

If unconventional policies undertaken during financial crises are not completely effective in restoring output or inflation to their target levels, the question then arises as to whether central banks can use more aggressive conventional monetary actions to lean against the buildup of debt associated with the boom phase of the global financial cycle. We highlight new work that evaluates the potential for central banks to lean against the winds of the global financial cycle. This new work shows that the cost of leaning is quite high relative to the benefits of lowering the likelihood of either entering a house price correction episode or of triggering a new financial crisis.

We then assess to what extent macroprudential policy tools could be an alternative to curb increased risk-taking behaviour during the boom phase of the cycle. In large economies, a number of macroprudential policies are designed to break the chain that links asset allocation decisions by financial intermediaries with the resultant declines in risk premia. Such policies are likely to be less effective in SOEs, as global premia will likely not change in the face of portfolio switches by small institutions or by a relatively small number of households. At the end of the paper, we use our framework to provide suggestions for macroprudential policy reforms to improve the effectiveness of the current toolkit in SOEs.

They conclude:

New research illustrates the importance of accounting for the impact of the global financial cycle on both conventional and unconventional monetary policies as well as on macroprudential policies in small, open economies. The global financial cycle, driven in part by U.S. monetary policy decisions, affects the asset and liability allocation decisions of financial intermediaries and investors worldwide. Changes in these allocations cause time variation in global risk premia, which affects the domestic monetary policy transmission mechanism in SOEs. It also affects the conduct of macroprudential policies.

While the global financial cycle complicates the implementation of conventional and unconventional monetary policies, it does not imply that these policies are ineffective. The research does point out that the monetary policy transmission mechanism is affected by global risk factors and that these factors may move in the opposite direction to conventional monetary policy moves. This suggests that monetary policy may have to be more aggressive in the future, given the future lower level of the neutral rate. Unconventional policies may become much more conventional.
The buildup of debt during the boom phase of the global financial cycle raises the likelihood of a subsequent financial crisis. New research shows that the central banks can lean against the growth of the debt stock by keeping policy rates higher than warranted by current conditions. This is effective in lowering the likelihood of either a large house price correction or of a financial crisis over the long run. However, these effects are not large enough to overcome the negative consequences for borrowers who face a higher cost of debt. Thus the basic message of Svensson remains: In general, monetary policy should clean, not lean.

However, the costs of risk-taking behaviour induced by accommodative monetary policy should not be discussed in isolation from its benefits. The easing of monetary policy was needed to foster macroeconomic stability prior to and during the crisis, and premature removal of monetary stimulus to alleviate risk-taking behaviour could fall short of having a significant impact on the financial imbalance, hinder the recovery that it helped generate, or, under low capital or liquidity levels, even lead to a credit crunch. In addition, low interest rates may have direct positive effects on financial stability. For example, higher profit margins and lower delinquency and default rates may decrease risk aversion and raise prices of legacy assets or collateral assets, leading to healthier balance sheet.

Thus, central banks cannot rely on a combination of conventional and unconventional monetary policies alone to offset the effects of financial crises. Clearly, some form of micro- and macroprudential policies are also required to lower both the likelihood and severity of a crisis. The research surrounding the global financial cycle suggests that macroprudential policies in SOEs need to be coordinated carefully across borders and within the country itself. While capital controls may potentially diminish the impact of global financial cycles, the additional cost that they impose is likely too large. Discussions on potential use of capital controls should also be mindful of the limited evidence of their effectiveness, the absence of adequate cost-benefit analysis in the literature, their potential spillovers (i.e., the potential to divert capital flows to other countries), as well as the limited data available to assess their impact on developed-country capital markets.

Note: Bank of Canada staff working papers provide a forum for staff to publish work-in-progress research independently from the Bank’s Governing Council. This research may support or challenge prevailing policy orthodoxy. Therefore, the views expressed in this paper are solely those of the authors and may differ from official Bank of Canada views. No responsibility for them should be attributed to the Bank.


New Zealand Banks Will Benefit from Tighter Rules on High-LTV Mortgage Loans – Moody’s

According to Moody’s, New Zealand banks will benefit from tighter rules on high-LTV mortgage loans.It is also worth noting how the market responded to earlier less aggressive macroprudential measures.

On 19 July, the Reserve Bank of New Zealand (RBNZ) released a consultation paper outlining a proposal to limit bank lending to home investors at loan-to-value ratios (LTVs) above 60% to 5% of new originations and lending to owner-occupiers at LTVs above 80% to 10% of new lending. These restrictions are credit positive for New Zealand banks and their covered bond programs because they reduce their exposures to higher-risk lending at a time when house prices are at historic highs.

The proposal will be particularly beneficial to New Zealand’s four major banks, ANZ Bank New Zealand Limited, ASB Bank Limited, Bank of New Zealand and Westpac New Zealand Limited. These four banks hold approximately 86% of all New Zealand residential loans.

The tighter restrictions on LTV limits will benefit banks and their cover pools by providing a buffer against declining house prices before the size of the loan exceeds the value of the property. In the longer run, banks will have fewer high LTV loans to sell into their cover pools, which will strengthen the pools’ credit quality.

The new rules would replace existing limits that restrict new lending to investors in Auckland at LTVs greater than 70% to 5%, lending to owner-occupiers in Auckland at LTVs above 80% to 10%, and all other housing lending outside of Auckland at LTVs above 80% to 15%. The proposal is in response to the boom in New Zealand house prices, which are at historical highs, creating a sensitivity to a sharp reversal in home prices.

Moody-NZ1Although LTV restrictions protect banks against a sharp correction in house prices, it remains to be seen how effective these measures will be in moderating house price appreciation if interest rates decline further. In March 2016, the Reserve Bank of New Zealand reduced its policy rate by 25 basis points to 2.25%, the fifth reduction since June 2015, while also stating that further policy easing may be required. Furthermore, strong immigration and supply shortages continue to support house prices, particularly in Auckland.

The first of New Zealand’s macro-prudential measures, introduced in October 2013, had a sharp but temporary effect on house price growth. Further measures were introduced in 2015 that also immediately reduced house price growth in fourth quarter of 2015. However, prices rebounded and have appreciated in 2016.

Moody-NZ2 The Reserve Bank of New Zealand is inviting market feedback on its proposal until 10 August, after which, a final policy will be released to take effect from 1 September 2016.

Is The Root Cause Of High House Prices What You Think It Is?

A snapshot of data from the RBA highlights the root cause of much of the economic issues we face in Australia. Back at the turn of the millennium, banks were lending relatively more to businesses than to households. The ratio was 120%. Roll this forward to today, and the ratio has dropped to below 60%. In other words, for every dollar lent now it is much more likely to go to housing than to business. This is a crazy scenario, as we have often said, because lending to business is productive – this generates real productive growth – whilst lending for housing simply pumps up home prices, bank balance sheets and household balance sheets, but is not economically productive to all.

Lending-MixThere are many reasons why things have changed. The finance sector has been deregulated, larger companies can now access capital markets directly and so do not need to borrow from the bank, generous tax breaks (negative gearing and capital gains) have lifted the demand for loans for housing investment, and the Basel capital ratios now make it much cheaper for banks to lend against secured property compared to business. In fact the enhanced Basel ratios were introduced in the early 2000’s and this is when we see lending for housing taking off.

So how much of the mix is explained by tax breaks for investors? If we look at the ratio of home lending for owner occupation, to home lending for investment, there has been an increase. In 2000, it was around 45%, now its 55% (with a peak above 60% last year). This relative movement though is much smaller compared with the switch away from lending to business.  Something else is driving it.

RBA-Mix-HousingWe therefore argue that whilst the election focus has been on proposed cuts to negative gearing and capital gains versus a company tax cut, the root cause issue is still ignored. And it is a biggie. The international capital risk structures designed to protect depositors, is actually killing lending to business, because it makes lending for housing so much more capital efficient. Whilst recent changes have sought to lift the capital for mortgages at the margin, it is still out of kilter. As a result, banks seek to out compete for mortgages and offer discounts and other incentives to gain share, whilst lending to business is being strangled. This is exacerbated by companies being more risk adverse, using high project hurdle thresholds (despite low borrowing rates) and smaller businesses being charged relatively more – based on risk assessments which are directly linked to the Basel ratios. Our SME surveys underscore how hard it is for smaller business to get loans at a reasonable price.

The run up in house prices is a direct result of more available mortgage funding, and this in turn leaves first time buyers excluded from the market. But it is too simple to draw a straight line between negative gearing and first time buyer exclusion. The truth is much more complex.

We are not convinced that a corporate tax cut, or a further cut in interest rates will stimulate demand from the business sector. Nor will reductions in negative gearing help that much. We need to re-balance the relative attractiveness of lending to business versus lending for housing.  The only way to do this (short of major changes to the Basel ratios) is through targeted macro-prudential measures. In essence lending for housing has to be curtailed relative to lending to business. And that is a whole new box of dice!


Monetary/fiscal policy mix has implications for debt and financial stability

The mix of monetary and fiscal policies in an economy has important implications for debt levels and financial stability over the medium term, Bank of Canada Governor Stephen S. Poloz said.

In the Doug Purvis Memorial Lecture given at the Canadian Economics Association’s annual conference, Governor Poloz used the Bank’s main policy model to construct three “counterfactual” scenarios of events from the past 30 years that show how different policy mixes can influence the amount of debt taken on by the private and public sectors.

Tight monetary policy with easy fiscal policy may lead to the same growth and inflation results as easy monetary policy paired with tight fiscal policy in a given situation, the Governor explained. However, the consequences for government and private sector debt levels would be quite different.

Recent experience in Canada and elsewhere shows that debt levels—whether public or private—can provoke financial stability concerns, said Governor Poloz. The insight about policy mix is important as authorities worldwide work to incorporate financial stability issues into the conduct of monetary policy, he added.

The Governor stressed that the counterfactuals are intended to illustrate the impact of the policy mix on debt levels; they aren’t meant to be taken as an opinion about what the best policy mix was in the past or is now.

“Hindsight is always 20:20 and such a discussion would have little meaning,” Governor Poloz said. “The best mix of monetary and fiscal policy will depend on the economic situation.”

There should be a degree of coordination between the monetary and fiscal authorities that allows both to be adequately informed of each other’s policies and consider their implications on debt levels over the medium term, the Governor said. In Canada’s case, the central bank operates under an explicit inflation-targeting agreement with the federal government that enshrines its operational independence, while allowing for both parties to share information and judgment, Poloz said. This framework represents “a simple yet elegant form” of policy coordination, he noted.

The lecture honours Doug Purvis, a Canadian macroeconomist and Queen’s University professor. In 1985, Purvis delivered the Harold Innis Lecture, in which he argued that rising government debt levels would eventually compromise the ability of authorities to implement stabilization policies. Governor Poloz said his lecture today is meant to build on Purvis’ initial insights by bringing more advanced macroeconomic models to bear on the topic, and linking them to the topical issue of financial stability.