Archive | Managing cycles

Some tampering with cycles proposed – but Reserve Bank & Treasury have looked outside the square

Published 7 April 2006


The Reserve Bank & Treasury see a number of ways they can tamper with the natural housing investment cycle to dampen inflationary trends, have suggested some radical changes to the nation’s financial policy structure but, in their joint report to Finance Minister Michael Cullen yesterday, didn’t consider capital gains tax.



The 2 organs of financial policy commissioned a team of senior staff last November to undertake their joint supplementary stabilisation instruments project.


Their report was aimed at finding possible extra instruments that would stop interest rates being the sole tool for managing demand pressures & inflation.


The team made some suggestions which Inland Revenue didn’t like because they’d require multiple objectives to be considered.


And – remarkably, if not farcically – the team worked out that supply might have something to do with demand.


Treasury would like to get more involved in some of the land supply issues, which shouldn’t be necessary – regional & local councils should be able to do the sums to ensure better supply of land. What Treasury might be better disposed to doing is to discuss with the Government its loopy behaviour in opening the immigration floodgates then strangling that supply, and telling the country what consistent policy is going to emanate.


One of the key propositions affects the independence of the Reserve Bank. It’s long been plain that using one tool, interest-rate manipulation, to keep the economy stable isn’t going to work. But for the Reserve Bank to go outside its set regime it would need new rules, including rules to allow it to do some things in partnership with the Government.


The Reserve Bank & Treasury team was to look at measures that could be taken to calm an extended housing boom (which by then was starting to ease of its own accord), so it would impact less badly on the export sector. While the team discounted some action because it couldn’t be implemented swiftly enough, it has also come up with ideas for the medium term, and some which would be longer term.


Key ideas


Key ideas in the report & the letter by Reserve Bank Governor Alan Bollard & Secretary to the Treasury John Whitehead to Dr Cullen:

There are no simple, or readily implemented, options that would provide large payoffs in the near-term, without significant complications & costs
Inland Revenue might consider broader cyclical stabilisation objectives when starts publicising tax law on property sales
Further measures could be employed to reinforce the existing income tax law applying to capital gains on housing
A reporting requirement could be imposed in respect of all sales of residential properties occurring within (say) 2 years of acquisition
The exemption for owner-occupied housing could be removed for properties sold within 2 years of acquisition
The Department of Building & Housing and Housing NZ Corp are working on identifying “a variety of measures that might increase the responsiveness of housing supply” and Treasury wants to take part too
A discretionary option is a comprehensive loan:value ratio limit, applicable to all loans secured on residential property by all lenders
An adjustable mortgage interest levy could be imposed on all residential mortgages as a wedge between the borrower’s interest rate and the returns available to the savers financing those loans (especially the interest-sensitive foreign savers); the letter doesn’t unscramble this message and doesn’t mention the importers of those foreign savings
This measure would have no international precedent
Treasury & the bank “remain interested in the possibility that additional discretionary instruments, including ones not directly related to the housing sector, might be able to mitigate the impact on the tradables sector of cycles in domestic demand, but further work in this area is not a high priority for us at present”

Some of the detail


Dr Bollard & Mr Whitehead said: “We remain interested in the possibility that additional discretionary instruments, including ones not directly related to the housing sector, might be able to mitigate the impact on the tradables sector of cycles in domestic demand, but further work in this area is not a high priority for us at present.”


They told Dr Cullen: “The review looked at whether there might be useful tools, directly affecting the housing market &/or the market for residential mortgage credit, which could supplement the central role of interest rates in managing inflation. If such additional instruments were available, which were targeted more closely to the housing sector than the official cash rate is, they might alleviate some of the pressures on the exchange rate which has been adversely affecting the performance of the traded goods sector.”


Several of the policy options involve permanent changes to features of the tax system or other regulatory arrangements: “The thinking here is to identify any structural changes which might help dampen the magnitude of housing cycles, without requiring ongoing discretionary involvement. The review team also explored 2 possible options for additional discretionary stabilisation instruments, which could be used to supplement the OCR in periods of particular pressure in the housing market.


“Many other possible options have been quickly ruled out, on the grounds either that they offered few cyclical benefits or that they were outside the terms of reference for the project. Among the latter, we did not consider a capital gains tax on housing or a more active counter-cyclical approach to fiscal policy.


“Having reviewed the report, we share the view of the authors that there are no simple, or readily implemented, options that would provide large payoffs in the near term. Moreover, it is important to stress that significant house price cycles have been a feature of many, perhaps most, developed market economies in the last decade or so. However, there are some specific measures that we recommend be adopted and a number of areas where we believe more work would be warranted. Any changes to the tax system would need to be discussed with the Minister of Revenue.


“2 features of the tax treatment of investment properties have been considered in the review. Under current tax law, income tax applies to gains realised on property sold when the property was acquired with the purpose or intention of resale (with an exemption, broadly speaking, for owner-occupied property). In practice, however, Inland Revenue has identified a variable level of non-compliance with the existing rules.


“In response, Inland Revenue has been actively raising the profile of these rules to improve taxpayers’ understanding of them and this is planned to continue. In choosing how to allocate resources, we recognise that the Commissioner of Inland Revenue’s current audit strategy is based with good reason on assessing revenue risks to the tax system.


“However, we consider that there could be merit in encouraging Inland Revenue to consider broader cyclical stabilisation objectives when determining the allocation of audit resources & the effort made to publicise the application of tax law to property sales.


“As the report notes, Inland Revenue has a number of concerns with this proposal and there are a number of issues to be worked through, including the impact on the department & the integrity of the tax system of having multiple objectives and the legislative basis for the commissioner adopting such an approach. To the extent this does not require legislative change, we think this option offers the best prospect for having some quick, albeit modest, impact on the current cycle.”


The report notes that further measures could be employed to reinforce the existing income tax law applying to capital gains on housing. “For example, a reporting requirement could be imposed in respect of all sales of residential properties occurring within (say) 2 years of acquisition, or the exemption for owner-occupied housing could be removed for properties sold within 2 years of acquisition.”


The project team also explored the option of ring-fencing operating losses on investment properties (that is, allowing losses on investment properties to be offset only against other property income, but not against, say, wage & salary income). This approach is adopted in a variety of other countries.


“At this stage, we do not consider that such changes would be warranted for reasons laid out in the report, but recommend that further work be undertaken to better understand the role of short-term holdings of investment & owner-occupied properties in accentuating housing cycles.”


Those constraints on land supply


Dr Bollard & Mr Whitehead said overseas literature highlighted the importance of regulatory provisions in shaping the ability of the supply of new housing to respond to signs of increasing demand. “Locally, there is some suggestive evidence that such constraints may have exacerbated housing inflation pressures in certain regions. Were such pressures to be alleviated, the amplitude of housing cycles might be diminished.


“We welcome the work programme that the Department of Building & Housing and Housing NZ Corp already have underway to help identify a variety of measures that might increase the responsiveness of housing supply, and we would expect Treasury to have an active role in encouraging & shaping the work programme.”


Aligning bank risk & capital adequacy


The Reserve Bank is implementing a new capital adequacy regime for banks (Basel II) designed to better align capital requirements with the underlying risks that banks take. Dr Bollard & Mr Whitehead said: “An important part of implementing that framework will be working with banks to ensure that the risk models they are using appropriately reflect risk profiles through the business cycle as a whole (and avoid generating incentives to assume larger & riskier loans near the peak of the cycle). The Reserve Bank will also be exploring the extent to which capital requirements under this regime may be designed to provide counter-cyclical macroeconomic benefits, consistent with the paramount consideration of promoting financial stability.”


The report examines 2 discretionary tools that could be applied to supplement the official cash rate at periods of particular stress in the housing market. “Both could provide some cyclical management benefits, easing house price inflation and hence reducing the need for higher interest rates and potentially reducing the extent of upward pressure on the exchange rate.


“However, both would also pose significant ongoing enforcement challenges. The first discretionary option is a comprehensive loan:value ratio limit, applicable to all loans secured on residential property by all lenders. This measure would have a direct impact on the most leveraged portion of the housing market. However, the rules for such a limit would be difficult to define and difficult to enforce. The pressure for disintermediation would be very great. The report also notes that the segment of the market most affected by this measure contains a high proportion of low-income earners & first-home buyers.


“The second discretionary option is an adjustable mortgage interest levy, which could be imposed on all mortgages on residential property and designed to force a wedge between the price paid for credit by mortgage borrowers and the returns available to the savers financing those loans (especially the interest-sensitive foreign savers).


“While such a measure might be expected to dampen the exchange rate cycle, it would be a step well beyond the mainstream of policy thinking, with no international precedent. In addition to significant disintermediation pressures, enforcement challenges & adverse distributional impacts, this measure would also raise a number of issues around the delegation of power to impose such a levy.


“Even if Parliament were to agree to it being set by the Minister of Finance on the recommendation of the Reserve Bank, this could impinge adversely on the bank’s operational independence, by involving the minister & Treasury more closely in short-term assessments of inflation pressures and the need for discretionary policy adjustments.”


Dr Bollard & Mr Whitehead told Dr Cullen more work was needed on that option, making it one for future cycles. “We would also advise that any further consideration of the mortgage interest levy should also include an assessment of other potential discretionary fiscal instruments.


“Some of these alternatives, for example a variable expenditure or property tax, might achieve the overall demand management benefits of a mortgage interest levy without giving rise to such significant ongoing enforcement & implementation challenges. These broader non-housing options were beyond the scope of the terms of reference for the current study.”


Website: Joint report


 


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Attribution: Joint release, report, story written by Bob Dey for this website.

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