Interpreting a (monetary) quantity – we need a cause

By Matt Nolan 21/06/2013


Over at Not PC I noticed that Peter is putting some of the “blame for the housing bubble” at the feet of the RBNZ.  His view shares similarities to the discussion I’ve been having – and will continue to have – with Lowell Manning (here, here, here).

Essentially, the view is that the Bank is allowing M3 to grow too quickly and this is showing up in excessive house prices.  By having “too much” fiat currency the central bank is devaluing the currency, and that is coming through the price of land/housing.  Now don’t get me wrong, look at monetary aggregates – they provide useful information.  Furthermore, I believe these guys deserve a response, and next month I’ll try to craft something a bit better than this.  But let me note down some points as an accidental “Reserve Bank apologist”.

This story provided does have a compelling narrative, it has a start, and end, a villian, a potential heroine, all the good elements of a believable story.  But for me, there are a few key things missing:

  1. The central bank doesn’t set the “quantity of money”, it sets the “price”.  In reality it doesn’t even do that – the interest rate is set by forces in the economy.  Instead, the central bank targets the rate of growth in the “general price level” – and it has stuck to that.   They are going to devalue fiat currency at a predictable and steady rate – and that is just what has happened.
  2. Where is individual choice in this model?  M3 growth is too high, and as a result people blindly borrow the floating $$$ to buy houses … knowing that the future real value will fall and burn them?  This sounds funny.  Instead, with individuals choosing to buy property M3 growth doesn’t seem like the cause here – so much as it is the SYMPTOM!
  3. Say that the RBNZ has been soft, why is it the relative price of housing … not general inflation … that is rising.   We may say “land is durable, and the price is high because of expected future inflation” – but then the question would be why we don’t see this across all asset classes in NZ, and more importantly why survey measures do not show these “inflation expectations”.
  4. Furthermore, if this has been a long last bubble (due to the persistent high growth in M3) why have the “relative prices” of other goods never caught up – if this has been one big long bubble due to “monetary policy” at some point we need to be getting that high inflation.  Monetary policy doesn’t keep relative prices out of whack forever.

This is the thing for me – it is a relative price of housing issue.  The money supply is “endogenous” and so, since “demand for housing” has risen, so has borrowing and M3 growth.  With no generalised inflation going on, the RBNZ isn’t printing money to cause a housing bubble – it is allowing the money supply to rise given the housing bubble, in order to not excessively constrain the rest of the economy.

Note the Bank will be concerned about a “housing bubble” if it is leading to “excessive consumption and/or investment” which creates inflationary pressures – in that case they will act with monetary policy.  They will be worried about issues of “financial stability” due to high gross debt levels, highly leveraged groups, or a concentration of debts in an asset class – in that case they will act with macroprudential policy.

Outside of this, this issue has nothing to do with the Bank.  In fact, outside of this this issue of a “bubble due to irrational expectations” is virtually IRRELEVANT for society as a whole – if people are determined to pay over the odds for something to other people, then that is just a straight transfer of goods and services.  If we really have an “irrational bubble” why are we so keen to punish the rest of the economy in a weak (and likely to fail) attempt to stop people making their own dumb mistakes – as we will be inappropriately lifting interest rates and making other forms of investment more expensive to “deal with” the fact that some people have strange ideas about the potential for house price appreciation in the future ;) [And let’s not start talking about foreigners – as this is just a transfer FROM overseas TO NZ].

As an Austrian economist I am sure that Peter is also concerned about a misallocation of capital.  However, in this context this would require “overbuilding” … if there is a “housing bubble” we will “overinvest in building houses” (remember trading houses between each other isn’t “investment” in this sense, it is a transfer).  Is this what we are seeing?  And if it was, are the welfare costs really that large … especially relative to the practical status-quo, since no-one truly knows how to pop bubbles outside of kidnapping people or taking their savings off them!