strong housing demand can add to financial stability risks, especially when accompanied by high household indebtedness. housing market exuberance can be particularly problematic when interest rate responses are not warranted because economic growth is well below potential, and inflation in factor and product markets is benign. macro - prudential policies can be helpful in addressing financial stability concerns in such circumstances. but the introduction of macro - prudential policy requires policy makers to be clear about its goals, the duration of the measures, and how such measures might interact with monetary policy. the reserve bank introduced macro - prudential policy in the form of speed limits on loan - tovalue ratios ( lvrs ) in the residential housing market, on 1 october 2013. house prices – which were already significantly overvalued based on historical and international indicators – were accelerating rapidly in our two largest cities ( that account for around half of the national market ). in addition, household debt was at high levels, and banks were competing aggressively for mortgage lending to borrowers with small deposits. at the time, annual consumer price inflation was running at 0. 7 percent, the exchange rate was strong, and the economy had a negative output gap. it was not appropriate to raise interest rates, but the potential for further rapid house price inflation was considerable as sizeable supply - demand imbalances seemed likely to continue for several years. we introduced a requirement that banks reduce their high lvr lending ( defined as lvrs over 80 percent ) to an average of no more than 10 percent of their mortgage commitments, and made this a condition of bank registration. the measure led to a significant reduction in high - lvr lending, a decline in house sales, and fall in house price inflation. while other factors, such as subsequent interest rate increases over the period march 2014 to july 2014 are also helping to constrain demand, annual house price inflation fell from around 10 percent to 5 percent currently, despite high levels of net immigration. we established clear and separate primary objectives for monetary policy and macroprudential policy. these primary objectives are price stability and financial system stability respectively. there is an appropriate role for coordinating the use of monetary policy and a macroprudential policy instruments provided they both affect outcomes relevant to the achievement of both policy objectives. this condition is likely to be met when the real and financial cycles are in sync and each policy can allow for the complementary effects of the other. the two policies will be in greatest potential

massive programme of reconstruction in canterbury, and the increase in house prices and residential construction in auckland, are boosting demand and output, and tending to exert upward pressure on inflation. one of the more complex analytical challenges for example, is whether new zealand can achieve the resource allocation needed for the rebuilding activity in canterbury and auckland without seriously damaging its tradables sector. this damage could occur if the relative price changes needed to induce the supply response spilled over into broad inflationary pressures, necessitating tighter monetary policy and creating further upward pressure on the exchange rate. this is one reason why reducing the government ’ s demand for resources through fiscal consolidation is so important. i will now turn to the issue of exchange rate pressures and the housing market. bis central bankers ’ speeches ii ) exchange rate pressures the high exchange rate continues to be a significant headwind for the tradables sector, restricting export earnings and encouraging imports over domestic tradables production. our real effective exchange rate is about 18 percent above its 15 year average1. there are several reasons for this exchange rate appreciation. foreign investors are attracted by our higher growth, commodity linkages into asia, and positive interest rate differentials in a low yield world. our economy is growing more strongly than most advanced economies, our terms of trade are 17 percent higher than their average level during the 1990s, and central banks in countries representing around two thirds of world output currently have official interest rates between 0 and 1 percent. in addition, various types of quantitative easing have added usd5 trillion of assets to central bank balance sheets over the past four years. these policies, which seek to stimulate growth by ‘ printing money ’, have negative currency spillovers for attractive investment destinations such as new zealand that experience foreign portfolio inflows and upward exchange rate pressure. fluctuations in investor risk appetite are also an important factor influencing our exchange rate. the surge in global liquidity, and especially that associated with quantitative easing, has led to rising equity markets in several countries. we see this most recently in japan and the us, where the nikkei and s & p indexes have increased by 40 percent and 16 percent respectively since the end of 2012. a close relationship exists between the new zealand dollar and international risk assets such as equities. a rise in the s & p 500 often reflects a broader ‘ risk on ’ trading environment that leads to higher exchange rates in the currencies of better performing advanced economies such as new zealand, australia, norway, sweden, and some