A chink of light broke through the clouds over our economy this week.
The Reserve Bank seems finally to be talking seriously about adding a few extra weapons to its rather bare arsenal. This week Deputy Governor Grant Spencer, who is widely seen as the likely successor to outgoing Governor Alan Bollard, revealed the bank is considering adopting so-called Macro-Prudential Policy tools to add to its main tool, the Official Cash Rate.
If adopted, this could break a Catch 22 that the NZ economy has been stuck in for much of the past decade. The Catch 22 goes like this:
1 A booming property market fuelled inflation and economic growth.
2 This forced the Reserve Bank to push up the Official Cash Rate to keep inflation within its 1-3 per cent target band.
3 This, in turn, pushed up the New Zealand dollar and reduced the competitiveness of exporters.
4 This reduced export employment and increased New Zealand's reliance on foreign borrowing to service its foreign debt.
5 The increased inflows of foreign funds pushed the New Zealand dollar higher.
6 Any attempt to cut interest rates simply fired up the property market, sucking in more foreign debt.
7 Rinse and repeat.
Breaking out of this cycle has seemed impossible.
Governments from both sides of the spectrum have tried to increase domestic savings, which would reduce the reliance on foreign borrowing and, in theory, reduce interest rates in the long run. The National-led Government's moves to make rental property investment less attractive by reducing the ability to claim depreciation on buildings was one of the attempts to break this cycle.
The current strength of the New Zealand dollar, despite weak commodity prices, shows the Catch 22 is still operating with a vengeance.
The Reserve Bank has been so frustrated by this that the outgoing Governor has even suggested in recent months he might cut the Official Cash Rate to try to drag the currency lower. This has only increased the heat in the property market.
Labour and the Greens have tried to spark debate about how to break this Catch 22, but until now the Government and the Reserve Bank have been reluctant to break away from the current inflation-targeting regime with the use of the single tool of the Official Cash Rate.
Now, the Reserve Bank is looking at tightening regulations for banks that would make it harder for them to lend heavily against property during booms. These suggested Macro-Prudential Policy tools include loan to value ratio limits, a counter cyclical capital buffer for banks and changes to the Core Funding Ratio.
Let's hope this study goes a lot further than the one that petered out in 2005 and 2006.
By Bernard Hickey
