Brian Fallow: Will increased wealth rub off on spending?


New Zealanders — or at least those who own property or financial assets — got a whole lot richer over the past year.

National accounts released by Statistics New Zealand tell us that the collective net worth of households — assets minus debt — increased by a cool $464 billion, or just under 25 per cent, over the year ended June.

And it was not a case of rebounding from a depressed base. Net worth in the June 2020 quarter was still higher than it had been pre-Covid.

For businesses chasing the consumer’s dollar, and for the Reserve Bank making monetary policy decisions, this raises tricky questions. How strong was the wealth effect from that startlingly swift increase in asset prices? And how long will it last?

The wealth effect is people’s willingness to spend a few cents in the dollar of their increased wealth.

It is one of the main channels the Reserve Bank relies on when it is trying to rev up demand in the economy: that lower interest rates will have an inverse, seesaw effect on asset prices, and higher household wealth will flow through to higher consumption.

A key driver of the increase in wealth over the latest June year has, of course, been runaway house price inflation.

What the national accounts call “produced and non-produced non-financial assets” — buildings and land in other words — increased by 24.2 per cent to $1.15 trillion.

But financial assets make up an even larger share of household wealth: $1.46t, up 21.8 per cent for the year.

This includes equity in businesses whether held directly or via managed funds like KiwiSaver. It also includes bonds and bank deposits and pension schemes.

At some point, surely, gravity will overpower momentum in house price inflation. The Reserve Bank believes house prices are at unsustainable levels.

And financial markets, which have been on a tear, will adjust to central banks tightening policy as they shift from the need for emergency support to the need to counter inflationary threats.

Rob Everett, who is moving on from heading the Financial Markets Authority, had some sage and sobering comments on this in a Radio New Zealand interview.

For a bull market to run this long, with only one short-lived correction when Covid-19 broke out, was extremely unusual, he said.

“So you do look at asset prices and think they are pretty frothy. You are starting to see interest rates move in a different direction. You are starting to see quantitative easing being taken off,” he said.

“My best guess would be that during the tenure of my successor, markets will have a more pronounced wobble. And it will test the confidence of those people who have gone into markets in the past five years or so.”

The national accounts tell us that in the June quarter households collectively spent more — about $900 million or 2 per cent more — than their disposable income. The saving rate was negative.

This may have been pent-up demand from the involuntary saving of last year’s lockdown.
But it may also be evidence of the wealth effect.

Research published by the Reserve Bank in 2018 and 2019 came up with estimates of the average “marginal propensity to consume” around 2.2c or 3c out of a $1 increase in housing wealth.

When we are talking about 464 billion of those marginal dollars in the year ended June, that would represent a hefty boost to household consumption.

But how long can that last? There are already signs of slowing in house price inflation and the Reserve Bank is set on withdrawing the monetary policy stimulus it put in place in response to the arrival of Covid-19.

In a speech on housing on Tuesday, governor Adrian Orr pointed to the fact that over the past year or so house price inflation has been the steepest since the early 1980s in nominal terms and since the early 1970s in real terms.

“Over recent years New Zealand house prices have risen significantly, mimicking a global trend in asset prices. Over the past 18 months both share prices and house prices have risen around the world, houses more in New Zealand than elsewhere,” he said.

Orr acknowledged that movements in interest rates do affect demand for — and ultimately the price of — housing assets.

“However it is mostly the long-term trend in interest rates, as opposed to short-term changes in rates related to monetary policy.”

He argues that it has been a long-term trend decline in global interest rates over recent decades, as inflation expectations declined and productivity growth stalled, that has driven asset prices up globally, including house prices.

New Zealand is a price-taker when it comes to long-term interest rates. “We are a small economy and must accept the fact that saving and investing decisions in the rest of the world determine the bulk of our interest rate levels,” he said.

“But I am not avoiding all responsibility.” The Reserve Bank’s monetary policy committee does set shorter-term interest rates and hence determines the shape of the yield curve. But “the role of the Reserve Bank is a bit part”. How much house prices have reacted to changes in housing demand is mostly related to the ability of housing supply to respond, he said.

“Houses have been scarce at a time when demand was strong.” But now the reverse situation is evolving, with building at record levels while population growth has been throttled back by the closed border.

All of this is a rather different story from the bank’s line when it was easing monetary policy.

Then, the emphasis was on the wealth effect as a channel for transmitting lower interest rates into economic activity, via a boost to asset prices and thence into consumption growth.

Now that the focus is on unsustainable and unaffordable house prices and consumer price inflation is running hot, the story is: “Look, there are lots of influences on house prices, and okay interest rates are one of them, but they are mainly driven by global factors, so don’t blame us”.

A more edifying message would be that house price inflation has been an unfortunate side effect of monetary policy needed to fend off the danger of a nasty, deflationary, job-killing recession.

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