Should the Bank of England be jacking up interest rates whenever the housing market starts to run away with itself? That is what the Reserve Bank of New Zealand has in effect just been asked to do by Jacinda Ardern’s government: to take into account a ‘sustainable housing market’ when fixing its monetary policy.
If such a policy were to be adopted in Britain it would have profound consequences for homebuyers and investors – threatening to cut off the supply of cheap loans whenever prices started getting frothy. It is over two decades since the Bank of England was set the task of tracking an inflation target – increasing interest rates to cool an overheating economy and reducing them to warm up a cooling one. Since then, the bank has largely succeeded in keeping inflation – in the shape of the Consumer Prices Index (CPIH) – within a bound of one per cent either side of a central target of 2 per cent (the original target was to keep the Retail Prices Index, RPI, within a bound of one per cent either side of 2.5 per cent. CPIH is currently 0.9 per cent - just a little below the target range.
But the Bank of England has only succeeded in this because for much of the past two decades it has been asked to track an inflation index which excluded house prices. CPI (which excluded any element of housing costs) only became CPIH (which includes an element of owner-occupier housing costs) in 2017. During the long property boom of the late 1990s and early 2000s, by contrast, house prices were allowed to let rip (at up to 30 per cent a year) without ever bothering the Bank of England’s Monetary Policy Committee. Pretending that the cost of living didn’t involve housing thus kept interest rates low and allowed a speculative bubble to continue to inflate – at least until the credit crunch of 2007.
Over the past decade, the divergence between consumer price inflation and asset price inflation has continued. The former has been subdued, while housing markets and stockmarkets have soared. The money created through quantitative easing, which many feared would lead to hyperinflation in the shops, has instead been sucked into assets.
It makes sense for a central bank to want to use monetary policy to calm runaway housing markets. Too often we have had laissez-faire policies when housing markets have been on the way up, and interventionist policies when they have been on the way down. Many will argue that we should leave markets alone to do as markets will – boom and bust of their own accord. But if policymakers are not brave enough to do that, and we are all going to be forced to bail out investors when markets turn to bust, then at least we might expect policy makers to seek to rein in the preceding boom.
But would a central bank really dare to add to businesses’ borrowing costs in order to calm down a boom in residential property? As we have seen over the past year it is easily possible for a strong housing market (with prices up seven per cent over the past year in Britain) to co-exist with a collapsing economy. My guess is that, when it really comes to it, the Reserve Bank of New Zealand wouldn’t want to jack up interest rates in such circumstances. Neither, I think, will the UK government rush to follow the example of Ardern’s government – although it should be noted that it was New Zealand which pioneered inflation-tracking in the first place.
One thing which might happen, however, is that the rampant asset price inflation of the past decade might eventually feed through to consumer inflation – in which case interest rates will be going up regardless.