Alexander on Labour’s monetary policy

BNZ Chief Economist Tony Alexander analyses the likely impacts of Labour’s monetary policy. Some surprises as he summarises:

• Long tern Kiwisaver returns will be reduced as savers are forced to buy more shares when prices are high and fewer when they are low. 
• Volatility in the sharemarket will rise. 
• Investors will have extra incentive to purchase residential property, thus pushing house prices higher. 
• Overseas debt will tend to be boosted. 
• Bank profits will rise.

Alexander explains:

In fact the policy as proposed would probably act as an incentive to raise one’s debt level thus boosting New Zealand’s external debt rather than lowering it as Labour would like. Why? Because the explicit reduction in the heights to which interest rates would go over the monetary policy cycle means the income shock from that tightening would be less. Borrowing money would become safer as interest rate variability would be reduced and the incentive to fix one’s mortgage interest rate reduced.

Thus while some of the commentary from Labour and others has been negative toward banks, their proposed monetary policy would actually boost bank profits because more people would stay on floating rates than going fixed and bank margins are greater on the former than the latter. In addition because people would borrow more money bank business and profits will be boosted. Plus earnings from managing the larger Kiwisaver accounts would be greater.

So Labour’s policy will boost bank profits. Excellent.

Now look at this from a portfolio investment point of view. The policy would boost Kiwisaver contributions when the economy was booming and presumably asset prices like shares rising firmly and at high levels. The tightening of monetary policy would lead to more asset buying out of the contributions and this would amplify the equity price cycle while forcing people to buy more when equity prices are high. Then when the economy is weak and Kiwisaver contributions get cut people would be buying fewer shares thus amplifying the falls in share prices while seeing people buy fewer long term assets when their prices were low. Thus Labour’s policy would achieve exactly the opposite of what is recommended for long term savers with regard to purchasing equities, namely steady monetary value purchases through the economic cycle or even boosting purchases when prices are cyclically low rather than running with the herd and contributing to boom then bust asset price cycles.

And lower average returns for KiwiSaver investments!

The policy would also tend to boost house prices because the risk of having a large mortgage posed by the potential for high interest rates would be reduced. Additionally, because of lower average borrowing costs and because of reduced returns on the likes of term deposits plus the increased volatility in share prices we would expect to see more investors divert toward residential property. This would again tend to boost house prices, reduce home affordability, and again bias the housing market against young buyers.

Not starting to look such a great idea, is it.

He is also unimpressed with blaming house prices on immigrants:

And is it migration which has been pushing Auckland house prices in particular higher? Not at all. Auckland house prices rose by 38% between January 2009 and July last year. It was in July that the net annual migration flow for NZ rose above the ten year average of 10,000 people on its way to the latest reading near 32,000. Thus prices soared during a period of below average migration gains.

And he also points out the stupidity of a certain statement by a certain spokesperson:

Also, if one were a spokesman on matters economic then it would probably not be a good idea to suggest one has low understanding of how monetary policy works by saying low inflation in the most recent quarter means no need for any change in interest rates. Monetary policy looks forward and cannot affect what has already happened – though with a time machine as proposed by Mr Wells one might give it a go. Monetary policy changes now affect inflation a year and a half down the track.

Ouch.