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APR 11

Ineffectual OCR reinforces need for change




The cut in the Official Cash Rate (OCR) stands to do little for New Zealand’s economy. It may take some pressure off the currency which will help exporters, but with the Christchurch earthquake and an economy in recession the dollar is likely to be on a downward track in any event. With interest rates already low another slight drop is unlikely to get further investment over the line.

The real issue is that an interest rate differential between New Zealand and other western countries over a number of years caused overseas credit to come in creating two problems. Firstly it overvalued the New Zealand dollar reducing the profitability of our exporters and secondly it fuelled the housing bubble that has blown out household debt levels.

A far more effective way of stimulating and restricting the economy to counter economic cycles would be Loan to Value Ratios (LVRs).

LVRs allow the Reserve Bank to specify a minimum deposit for the purchase of any type of asset. This prevents banks offering zero or low deposit debt in times of free credit that can lead to asset bubbles and eventually financial failures. The economy can be stimulated by loosening these requirements in tough economic times.

In a recent paper called ‘Policies for Macrofinancial Stability: Options to Deal with Real Estate Booms’ from the International Monetary Fund recognised that:
“macroprudential tools (such as maximum loan-to-value ratios linked to the real estate cycle) appear to have the best chance to curb a boom. Their narrower focus reduces their costs. And, in the case of measures aimed at strengthening the banking system (such as dynamic provisioning), even when they fail to stop a boom, they may still help to cope with the bust.”

The OCR is a blunt tool that has caused significant damage to the tradeable economy. It is time we looked at more targeted controls to ensure that we do not continue to rack up further debt and hinder the tradeable sector in the process. Canada are implementing such controls, we must too.
 


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