Are central banks about to start targeting house prices?

Do you ever wonder how the idea of central banks targeting 2% inflation came about? Of course you don’t. You’re a normal person. But believe it or not, it’s quite an interesting story. And it’s relevant right now. Because the same pioneering central bank that started it all is now thinking about.

These days, central banks across the developed world are technically independent. Please note, I say “technically”. By that, I’m not implying that there’s any conspiracy and that the central bank or its governor is simply a puppet of the government. That’s not the case.

My point is that it’s difficult to be truly independent if the same entity that granted you your independence (the government) can retract it pretty much the instant that it decides it’s no longer politically convenient to have an independent central bank.

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One central bank to rule them all

Anyway, getting back to the main point. We elect politicians to make decisions about the economy. We don’t elect central bankers. So if you’re going to make a central bank independent, you need to give it a specific job to do. That’s the only way that technocrats can remain accountable in a democracy.

But what target? The primary focus of almost all central banks is to keep inflation under control (the Federal Reserve – America’s central bank – also has a line in there about employment, but you can read more about that here). And the figure that central banks (including our own) have mostly decided on is 2%, or a band that swings around 2%. Where did that come from?

In 1989, politicians in New Zealand passed a law to grant their central bank independence, and they also told it to target inflation of 0%-2%. At the time, New Zealand was coming out of a period of horrendous double-digit inflation. At the point of the law being passed, inflation was just under 8% (by the way, hard as it may be to remember, it was sitting at about the same level in the UK at the time, as judged by RPI rather than CPI). By the end of 1991, inflation in New Zealand had dropped to 2%.

Wow. Mission accomplished. (Never mind that inflation was falling around the rest of the world too). Central bankers and politicians around the world took note, and before you know it, we were all copying the Kiwis.

The thing is, the inflation target wasn’t really based on anything beyond a hunch. To be fair, it makes economic sense that low-ish and stable inflation is probably a good thing. It makes it easier in general to plan ahead if you can rely on prices being broadly stable. So it wasn’t exactly pulled out of the air.

But the point is, like almost everything else in macroeconomics, 2% inflation targeting is one of those things whose theoretical backing is very flimsy, but which assumes the solidity of Newtonian gravity by the time it’s been adapted around the world.

I’ll admit I find it funny that the nation which gave us the Lord of the Rings film trilogy also happens to be the home of the one central bank to rule them all. But I’m easily amused.

Will New Zealand lead the way to central bank control of house prices?

Anyway, you’re thinking: “That’s all very well, John, and it’ll definitely make for a cracking anecdote for my first post-Covid dinner party – thank you very much – but why are you bringing it up now?”

Well, earlier this week, New Zealand’s finance minister, Grant Robertson (their Rishi Sunak), suggested that maybe the central bank should have control of house prices added to its remit. “With an extended period of low interest rates, now is the time to consider how the Reserve Bank may contribute to a stable housing market.”

This is happening now partly because prices in New Zealand have gone wild in the last year. We think we’re having a boom in the UK – it’s nothing compared to theirs. New Zealand house prices are up about 20% over the past 12 months. It’s a lovely place, but even so.

Anyway, it's an intriguing proposal. There’s no doubt in my mind that the primary cause of all the political discontent of the last decade or more is high property prices. And the fundamental cause of high property prices is low interest rates. There are idiosyncrasies in each market, of course, but it’s the only common factor to explain the global property price boom.

The trouble with high prices is that it gets ever harder for those who are starting out to buy a home. In turn, that delays starting a family and generally feeling like a “grown-up”. Millennials (and those who speak for them in marketing agencies) sometimes talk about embracing a “rental lifestyle” and valuing experiences over things. But this is a post-hoc rationalisation of the simple fact that they feel they can’t afford to own some of the things that most of us regard as fundamental milestones in an adult life. Hence the anger.

So how might a central bank somehow temper property price rises? The obvious answer is to raise interest rates. Of course, that would result in a house price crash. It would also crash the rest of the economy. It’s hard to buy a house, however cheap it is, if you don’t have a job.

So the central bank would need instead to impose credit controls on mortgages. You impose lending limits (no more than three times your salary, regardless of monthly payment affordability) or you make sure that banks can’t issue loans except at “base rate plus 5%” say. Is this a good idea?

I think housing affordability is a serious problem. But no, I don’t think this is a good solution. If you hand this to the central bank, you are effectively setting an annual target for house price growth. It’s a price control, really. You’re adding another distortion to an already hideously distorted market. And you’re taking yet another step closer towards the full nationalisation of the economy and the financial system.

None of it addresses the fundamental problems which are rather too far-ranging to address here right now. Not to mention the fact that as soon as price growth limits are imposed, it’s hard to see how that wouldn’t have an impact on the market.

However, as Louis Gave of Gavekal points out, this doesn’t mean it won’t happen. House prices are now viewed as a political problem. When inflation was a political problem, politicians punted it to the central bank. Why not do the same with house price inflation? I guess we’ll all just have to keep an eye on New Zealand.

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