The role of house prices in our mandate
The state of the housing market is an important consideration for us in achieving our monetary policy objectives. House price sustainability is important for our financial stability objective of promoting a sound and efficient financial system.
How house prices affect inflation and maximum sustainable employment
Wealth is one driver of household spending, and equity in housing (the difference between what you owe on your mortgage and what the house is worth) represents 55% of household net wealth. A rise in house prices leads to higher household spending, which in turn influences economic activity, employment and consumer price inflation. Rising house prices also influence a number of components of the Consumers Price Index more directly, such as the costs of construction and rents. As a result, rising or falling house prices have an impact on general price stability and maximum sustainable employment.
How house prices affect financial stability
When house prices move well above their sustainable levels, they can pose a threat to financial stability, leaving the banking system at risk if there is a sudden shock. If house prices rise too far, too fast, that can lead to a sudden correction in prices, which would harm the financial system and slow the broader economy.
In addition, a rise in house prices often comes with increased mortgage lending. Mortgage lending represents 62% of total bank loans. If new lending is high risk, where the house deposit is small or where the amount borrowed is large relative to the person’s income, this increases the vulnerability of households and the financial system to future events.
New direction requires us to consider house prices
In March 2021, two things happened that made house prices an increased focus for us:
- The government issued a direction to the Reserve Bank under Section 68B of the Reserve Bank Act in respect of its housing policy objectives. The direction requires us to consider the government’s objective of supporting more sustainable house prices when setting financial stability policy, including bank lending rules. The direction also includes how our actions will dampen investor demand for existing housing stock, which would improve affordability for first-home buyers.
- The Monetary Policy Committee’s Remit (or key responsibilities) was amended to require the committee to assess how its decisions on interest rates and other monetary policy instruments affect the government’s objective of house price sustainability. This includes how its decisions might affect investor demand for existing housing stock and affordability for first-home buyers.
In response to the direction and the amended remit, we are developing our understanding of house price sustainability. In particular, we are looking at how interest rate changes feed through New Zealand’s economy and interact with housing affordability. We are doing this in discussion with the government agencies directly responsible for housing.