By Oliver Hartwich*
Last week, the Reserve Bank’s Deputy Governor Grant Spencer signalled that he favours more demand-side interventions in the housing market.
In a speech and in a radio interview he argued that increasing housing supply, though highly desirable, may take too long to have an effect on house prices. Meanwhile curbing demand, for example by means of a capital gains tax, could help to cool the housing market.
Spencer’s views triggered a highly critical response by one of the Bank’s ex-economists, Michael Reddell, who posted them on his blog in a mini series of articles (part 1, part 2 and part 3).
Reddell convincingly points out why Spencer’s focus on the housing market’s demand side is misguided.
It is well worth reading Michael’s posts and I will not attempt to summarise them here. Suffice to say, there are very good reasons to be sceptical about the need for demand-side interventions in the housing market, let alone their ability to effectively reduce house prices.
What I would like to ask instead is a completely different question: Was Spencer right that housing supply is only a long-term solution to New Zealand’s (or rather: Auckland’s) housing problem?
At first sight, Spencer is right. There are roughly 480,000 occupied dwellings in Auckland at the moment. To add between 3,000 to 7,000 to this large figure in a year (as Auckland did between 2007 and 2014), is a relatively minor variation in the total stock. Even if housing supply suddenly surged to, say, 15,000 consented units per year, it would take a while until these homes were built and sold. Correspondingly, it could take a few years until such a supply shock then had an effect on prices.
However, I would still be more optimistic than Grant Spencer that housing supply can produce much quicker price effects. How so? Because of the theory of rational expectations.
Developed in a macroeconomic context, rational expectations theory is a hypothesis that people start changing their behaviour today if they have good reasons to believe something will happen in the future. Say a central bank embarked on a monetary stimulus programme, people might anticipate higher inflation in the future and therefore behave differently today.
In neoclassical macroeconomics, rational expectations theory is typically used to argue that today’s policies do not yield the desired effects because people’s changed behaviour renders some policies ineffective.
However, rational expectations can also be the other way around: By committing credibly to future policies, you could change people’s behaviour today – even when the policy changes have not yet taken place.
The Auckland housing market is the perfect example for such reverse rational expectations.
Just imagine what would happen if (by some magic) central and local government found a way to guarantee that from 2016, Auckland’s housing market would be flooded with an extra 25,000 houses per year.
If there were no doubts about the implementation of this new, radical policy, it would have an immediate impact on house prices. Why?
If you were an Auckland homebuyer, or a property investor, you would know that future house price increases are now far less likely.
There would even be a possibility that they could go into reverse. If you are rational, you would respond to this plausible scenario by reducing your willingness to pay for Auckland property. As an investor, you may even take your money into a completely different market instead of committing to be burnt in Auckland bricks and mortar.
As theoretical as such reasoning may sound, this is exactly why countries with more price-responsive housing supply sides rarely experience rapid house price inflation.
Germany, for example, in recent years experienced an increased demand for housing; because of the ECB’s zero interest policy, savers were looking for alternative investment options. House prices increased a bit but so did housing supply. And house price increases were not nearly as strong as they would have been in a country with a more rigid housing supply side. The same kind of demand shock in New Zealand would have catapulted house prices into stratospheric heights.
Expectations matter, and therefore the best we can do about Auckland’s housing shortage apart from building more houses it to establish a rational expectation that houses will be built in the future.
In his speech, Grant Spencer said a lot about the importance of supply – and he was right. Unfortunately, the Reserve Bank cannot do much about it. He said some unhelpful things about demand management, and the Reserve Bank should not have a say in that.
In the end, there is only one way to solve Auckland’s housing shortage: By building more homes. Spencer should have underlined this very simple fact even more in his speech. He may have even contributed to a more rational expectation that we will eventually see an Auckland building boom.
Who knows what that could have done for house prices?
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*Oliver Hartwich is the executive director of the NZ Initiative.
18 Comments
Tiresome .. boring .. the battle lines are drawn .. out come the guns .. the tame rubber-stamp influence-peddlers have been tapped on the shoulder .. coming out and putting words in Spencer's mouth that he did not use .. he said "tax preferred status" yet in the brief space of a few days Nick Smith, Makhlouf, Reddell, and now the next blow-in Hartwich denigrate Spencer by translating Spencer's english into Swahili, accusing him of saying "capital gains tax" which he didn't say
Every single one of them did it - is that orchestrated or not?
Radio NZ did the interview with Spencer following his speech. They link to the interview with this "The Reserve Bank is urging the Goverment to think again about a capital gains tax to help quell the overheated Auckland housing market."
http://www.radionz.co.nz/national/programmes/checkpoint/audio/20174857/…
Reasonable people can differ on the merits of capital gains taxes (many of which depend on the details of the particular chosen scheme) but there really is not evidence anywhere that presence, or absence, of a capital gains tax has materially altered housing cycles, the probability of nasty busts etc. Indeed, as I pointed out on my blog, the Reserve Bank has previously made this point themselves. They may have fresh analysis on the topic, and I have lodged an OIA request asking for copies of any such material.
One could write a thesis on the topic .. being familiar with the Australian system .. can make this observation .. AU has a number of tax-gathering measures associated with housing and property and other real assets .. land tax, stamp duties, and capital gains tax ..
Capital gains taxes on property only apply to non-owner-occupiers and therefore have no affect on owner-occupiers decisions to buy or sell or move. As for investors, after 29 years (of the CGT regime), they have become desensitised to it and simply regard it as a cost of doing business and making a profit. However Stamp-Duties apply to everyone, and they have a significant influence on property buyers intentions, whether it be to buy or to sell. Most notably it slows people down should they choose to move, or downsize or upsize in a short space of time. They stay put for a long time. The decision to buy is a long-term decision. The stamp duty going in is on existing property only and the cost is on top of any deposit required. Stamp duty can be punitive if a home-owner is forced to sell and move due to say change of job or loss of job or changed family circumstances. Land-Tax is charged on aggregation of land and becomes expensive as your holdings grow. All holdings are aggregated for land-tax purposes, residential and non-residential. Raw land and property held in a trust structure is land-taxed at a higher rate than an individual
In short, CGT has had little behavioural effect
At 700+ k for that 2.5 bedroom house on 'our first home' out west of auckland on the fringe of forest, there must be some developers chomping at the bit to develop a few thousand plots of land, at cost to them of say 200k each, knock up a 300k house (easy something as good as what was on 'our first home') and pocket 200k profit per plot (200k x 1000 plots, lazy 200million profit... ) Best cure for high prices is high prices..
That makes sense. I purchased houses based on the belief that, irrespective of the renters/owners mix, households increasing faster than housing would mean prices go up - and they have. The only things that would make me nervous about keeping them is if I knew the supply of housing in the areas I own was going to increase or the population was going to decrease. I wouldn't sell if CGT or land tax was introduced as my perception (even if it's wrong) is it that more tax will increase prices - plus if one does sell a taxed capital gain is still a lot more than nothing.
What's very hard with increasing housing stock is balancing allowing new dwellings fast enough versus maintaining an adequate quality. My expectations are that APUP and redtape will continue the constraints on development in central areas. I guess if immigration or foreign ownership rules were changed my perception of what prices will do in the future would change.
Land tax does induce a supply response because it incentives intensification. More homes on the same size plot pays the same tax as the neighbor with less homes or no homes (land bankers).
It may not be the complete answer but it would be an effective tax change. Planning changes to lower the land cost curve also needs to be considered too. Decreasing demand by removing non resident buyers would also help.
I think the interesting point in the article is that prices will respond to expectations. We can argue all day about whether taxes will or won't increase property prices.
If people that own multiple properties believe that taxes will increase prices then they won't be selling. People that don't own property can believe as much as they want that taxes will decrease prices - but as they aren't controlling what goes on the market it's just wishful thinking.
I'm sure Andrew Little has noted this already:
Just imagine what would happen if (by some magic) central and local government found a way to guarantee that from 2016, Auckland’s housing market would be flooded with an extra 25,000 houses per year.
At last Labour have a leader to check the complacency of National. Six years in power and National have made no real changes apart from better housekeeping. Far better for Labour to just build 100,000 houses and just give them away, than for National to do nothing at all.
I think the accommodation supplement costs taxpayers around $2 billion a year (in other words the subsidy we are paying to private landlords) - and bear in mind, that amount doesn't include what we taxpayers fork out for income-related rents for social housing (in other words the subsidy we are paying to Housing NZ so that they can provide the government with an artificial "return").
So, just how many houses can you build for $2 billion in any one year?
Put a big dent in the market demand for low end rentals by building social housing en masse, and I suspect all kinds of suitable first-home properties will hit the market in a big way - and at a price FHBs can afford..
Actually, it's now likely to be $2.2 billion a year!
http://www.interest.co.nz/property/57062/accommodation-supplement-landl…
Just how dumb can this government be - a gaggle of ideologically driven idiots.
The reason why not enough houses will ever be built and prices won’t fall under the present system is because land bankers and developers, and council also work to a rational expectation.
And the rational is simple, most of the land banking cost, infrastructure cost and council costs are built into the system at the old pricing structure eg Govt. selling raw fringe land at Hobsonville at approx. $1.4 million per ha.
They will only build more while and when the system is prepared to pay for these inflated costs, and that means ALWAYS ensuring supply is lower (relatively) to demand to create an artificially high price.
They can build all they like, but all they are building is more expensive housing.
And if by rational expectation developers think that demand will lessen (relative to what it costs them to develop that stock) they will just slow down the release to keep a relatively lower supply.
Under this present system therefore, the only way prices will come down is if, unexpectantly, demand disappears and they are caught with unsold developed stock and have to lower prices to survive but by which time most developers have passed these costs/debt onto homeowners when they buy, especially those that buy off the plan.
A system that is based on unearnt income can only come down in price by an earnt loss, which the last into the system wear the brunt of.
They can build all they like, but all they are building is more expensive housing. So true!!!
And I note this comment by JK today about "use-it-or-lose-it" where these SHAs are concerned;
http://www.stuff.co.nz/business/industries/67898033/use-it-or-lose-it-g…
Fat lot of good that will be .. what are they losing anyway? Certainly not their land or their eventual profit - given profit is derived by scarcity in land supply in the first place. Do you think the land owners will be shaking in their boots - doubt it, more likely laughing their heads off.
That's for raw, unimproved land, ie farm land. That land is only worth $50,000 per ha max.
So it's suddenly worth $1.35 million more with no further value added just because some bureaucrat drew an line on a map.
And it's $70,000 per raw land cost if you take out roads and reserves.
That means every home owner (on a 400sqm site) is carrying about $67,500 extra in mortgage principle just on the land alone.
You miss the elephant in the room that people are getting money out of china now and over the next few years, Have you not seen whats happening to property prices there. They see NZ as a tax free haven as even aussie is tightening up on it.
A market is demand and supply of course Mr Hartwich
The easiest way to change market expectations is for the government to guarantee the urban land supply curve will stop inflating. The government has two options to achieve this. Either allow the freedom to subdivide rural land, say lifestyle blocks. Or the government uses the power of compulsory acquisition to stabilize the land rent curve.
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