Hard finding inflation tools beyond interest rates

A government commissioned report looking at alternative tools for controlling inflation in light of the prolonged housing market upswing has been released today.

Wednesday, April 5th 2006, 12:00AM

by The Landlord

The report has many ideas about how to control the property market, however it is unlikely any will see the light of day in the near future.

The Government's top financial agencies have struggled to find alternatives to raising interest rates that could be used to keep inflation in check.

In November the Reserve Bank and the Treasury commissioned a team of senior staff to look at alternative tools for controlling inflation in light of the prolonged housing market upswing.

In a report released to the public today they do see merit in the idea of making it easier to build more houses as demand rises.

And beyond that they showed interest in the idea of a mortgage interest levy of possibly up to 2 percentage points that would be imposed on all mortgages when needed.

Such a "wedge" between interest rates paid by domestic borrowers and those available to foreign savers would be used when the housing market was particularly stretched, and this country's interest rates were unusually out of line with those in other countries.

The report also suggested Inland Revenue could be encouraged to increase the publicity and enforcement of the income tax payment on house sales.

Under tax law, income tax applies to gains on property sold when the property was bought with the purpose or intention of resale, with an exemption for owner-occupied property.

Inland Revenue had found a "variable level of non-compliance" with existing rules, the report said.

When the report was commissioned in November there was concern that hiking interest rates was pushing up the currency, causing hardship for exporters, and helping blow out the current account deficit.

Finance Minister Michael Cullen pointed out that raising interest rates had become "clearly less immediately effective" at holding inflation than was the case five or 10 years ago. That is because more than 70% of mortgages are at fixed rates.

Since then the pressure has come off a little as the New Zealand dollar has slipped from around US70c in January to around US61c.

The report said house prices in this country, where housing was a much larger share of total household wealth than in most other countries, had risen by about 75% since 2001, with strong growth continuing through last year.

Rapid house price inflation had posed a considerable challenge for monetary policy because of the strong apparent connection between housing market activity, house price inflation, and inflation in the non-tradeable sector of the economy generally.

The current house price cycle was not ordinary, with the closest historical comparison probably being the house price boom of the early to mid-1970s, the report said.

The assessment of the report's authors was that house prices in this country had moved beyond levels that could be warranted by medium term economic fundamentals.

They pointed to a changing global financial environment as a probable contributor to the latest boom.

Financial liberalisation in a wide range of countries had improved access to credit, while a fall in nominal interest rates, as global inflation was brought under control, had made a difference to the ability of households to service conventional mortgages, the report said.

While several options explored in the report focused on investment properties, no comprehensive analysis had been done to determine whether that sector of the market had played a disproportionate role in the house price boom.

Arising from the report, Reserve Bank governor Alan Bollard and secretary to the Treasury John Whitehead made several recommendations to Dr Cullen.

They wanted him to agree in principle that Inland Revenue be encouraged to consider broader cyclical stabilisation considerations when assessing the priority of enforcing tax provisions covering capital gains on residential properties.

They also wanted Dr Cullen to agree that the Treasury should take an active role in shaping work being done by the Building and Housing Department and Housing New Zealand Corporation on factors that may be slowing the supply of new housing at times of strong demand.

On the issue of the discretionary mortgage interest levy, the officials said it could relieve exchange rate pressure at cyclical housing peaks.

But extensive further work would need to be done covering implementation and enforcement.

The report's authors were unimpressed with two other options considered.

One, a discretionary limit on the ratio between the amount of a loan and the value of the residential property securing it, was considered to be relatively poorly targeted.

The other, ring-fencing operating losses on investment properties so that such losses could only be offset against other property income but not against other income such as that from wages and salaries, was thought unlikely to have more than limited impact.

A spokesman for Dr Cullen said the minister had little to say about the report for now, other than it was valuable and that some areas needed more work.

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