Macro-prudential policy is intended to be used as needed, to reduce significant but transitory risks affecting the broad financial system.

“With some slack still in the economy, housing cannot yet be described as a threat to overall inflation. Higher interest rates are not the right policy response at this time,” Deputy Governor Grant Spencer said in a speech today to Business New Zealand.

While limited house supply is at the heart of the problem, strong demand supported by easy credit is underpinning the rapid escalation of house prices, Spencer said.

New mortgage approvals and loans have been growing at a faster rate and are now comparable with the pre-GFC peak levels.

“The new macro-prudential policy framework has been developed to address just this kind of macro-financial imbalance. The Reserve Bank is therefore seriously considering the use of macro-prudential policy,” he said.

The four potential macro-prudential instruments included in a Memorandum of Understanding between the Reserve Bank and the Minister of Finance all work in quite different ways to reduce financial system risk.

“Of the four instruments, the loan-to-value-ratio (LVR) instrument is the one with the best scope to dampen the current strong demand for housing, as well as reducing the risk to bank balance sheets,” Spencer said.

“While we believe that LVR restrictions could have significant benefits in terms of reducing systemic risk in the housing market, they are not a panacea.

We know that LVR restrictions could introduce market distortions. However, we need to assess inefficiencies against the potentially significant economic and financial damage that could result from a housing boom that ends in a severe housing downturn.

“While macro-prudential policy measures might make credit less accessible for a period, they should help to make house prices more affordable in the longer term,” Mr Spencer said.

In the pre-GFC housing boom, with hindsight and with the macro-prudential framework we now have, we would most likely have applied macro-prudential instruments with the aim of reducing systemic risk. In the current situation, with house prices and household debt ratios starting from much higher levels, and with interest rates at historically low levels, the risks to financial stability may well be greater,” Spencer said.