The RBA will be watching closely as New Zealand introduces innovative regulations designed to protect its banking system
This week New Zealand beat Australia on two measures. First, the same-sex marriage law came into effect; and second, its reserve bank introduced some "macro-prudential" tools for its banking system.
There aren't many buzzwords in financial policy circles, but for the past two or three years "macro-prudential tools" has been the key phrase for many on how the financial system needs to respond to the global financial crisis.
Macro-prudential tools are essentially regulations imposed by the central bank or regulator, but different from those usually put in place to protect individual borrowers. They have a broader focus (hence "macro") and are designed to protect the banking system as a whole – and in turn the broader economy.
They include limits on the loan-to-value ratio (LVR) that banks can hold on mortgages. LVR measures the size of the loan against the value of the property.
The idea is that capping the LVR reduces the level of risk in the banking system as a whole. If someone buys a house for $500,000 and needs to take out a $490,000 loan, that is a more risky loan for the bank than a loan of $400,000. In the first case the loan-to-value ratio is 98%, in the second it is 80%.
But curbing risky lending practices and keeping the financial system more secure is only part of the value of macro-prudential tools, the theory maintains. They are also designed to limit housing price bubbles because, in effect, they put a cap on the amount of borrowing.
And so this week the New Zealand Reserve Bank announced that "from 1 October banks will be subject to restrictions on high loan-to-value ratio (LVR) housing mortgage loans".
The banks will "be required to restrict new residential mortgage lending at LVRs of over 80% to no more than 10% of the dollar value of their new housing lending flows".
It justifies this move by suggesting that it is "concerned about the rate at which house prices are increasing and the potential risks this poses to the financial system and the broader economy".
Central banks worry about rapidly increasing housing prices because they increase the risk of an equally rapid move in the opposite direction at a later date.
The NZ Reserve Bank also notes that its country's household debt amounts to 145% of household income.
This figure might give some in Australia pause for thought, because its total debt to disposable income is 147% (down from a record high of 153% in June 2007).
New Zealand isn't the only place where such measures are being advocated.
Last week, the Nobel prize-winning economist Paul Krugman for the first time advocated macro-prudential tools for the US in his widely read blogthe New York Times. He argued that the tools of fiscal and monetary policy had failed.
The "great moderation" of the 1990s and 2000s had been shown to be a bit of a dream, he wrote. And the GFC was the wake-up.
Krugman noted: "At the very least it means that we need 'macroprudential' policies – regulations and taxes designed to limit the risk of crisis – even during good years, because we now know that we can't count on an effective clean-up when crisis strikes."
So is Australia's Reserve Bank thinking of implementing such measures?
While our housing market is improving, it remains much weaker than in previous booms. In the minutes of the August monetary policy meeting (where interest rates are decided), the RBA notes that while building approvals had increased, "dwelling investment had thus far experienced a muted recovery relative to past cyclical upturns".
So they don't seem too worried about the current 40-year low mortgage rate spurring a boom.
In a speech in July on "Economic Policy After the Boom", the Reserve Bank governor, Glenn Stevens, said that while he wasn't personally "averse" to macro-prudential tools, he did not think Australia had reached the point where they needed to be considered.
One indication of how different the housing market is compared with the early 2000s is the increase in credit by investors and owner-occupiers.
But for the RBA, the use of macro-prudential tools has another advantage. If low interest rates do not lead to a housing price boom it means they can keep rates down even while the economy improves. This, in turn, helps make conditions easier for export industries by preventing the exchange rate rising.
Regardless of what the RBA executives say now, you can bet they will be watching closely to see how it works out in New Zealand.