of the impact of such measures when house prices are increasing rapidly, but we believe that macro - prudential instruments could have played a useful role in building up capital buffers and reducing credit demand and asset price pressures in the housing price boom of 2003 – 2007. iv ) the exchange rate and the housing market the exchange rate and the housing market present difficult challenges for monetary policy when both the currency and asset prices appear to be overvalued and investor demand is expected to remain strong. generally, housing demand can be constrained by raising official interest rates and letting them feed through into higher mortgage costs. however, while this would help constrain the demand for mortgage finance, increasing the ocr would carry significant risks in new zealand in the current environment. it would increase the interest rate differential between new zealand and most of the advanced countries, and could lead to a further strengthening in the exchange rate and further downward pressure on tradable goods prices. this would, in turn, be expected to push cpi inflation further below the 1 to 3 percent target range. the exchange rate impact could be pronounced if investors believed that the increase in the ocr was a precursor to further increases and saw new zealand as leading other countries in the monetary policy tightening phase. viewing the issue from another perspective, if our exchange rate continues to strengthen on a trade weighted basis, in the absence of a corresponding improvement in new zealand ’ s economic outlook, inflation pressures would diminish and a reduction in the ocr might be warranted. however, with mortgage interest rates at a 50 - year low, large housing shortages in auckland and christchurch, and surveys indicating that home buyers expect price rises to continue, a lower ocr would quickly feed into higher house prices and further increase the risks to financial stability. this is where macro - prudential policies can play a useful role. capital and liquidity overlays can help build up buffers in the banking system while adding to the cost of bank funding. and loan - to - value restrictions may help to reduce the actual supply of mortgage lending. while these measures are aimed at financial stability objectives, their effects might also have the benefits of increasing the degrees of freedom available to the reserve bank in conducting monetary policy. for example, if house price pressures abate, all other things unchanged, it would increase the possibility that the ocr could remain at its current level for longer than through this year, which is the time profile built into the forward projections contained in the march 2013

the debt ratio after the global financial crisis was gradual relative to the build up over the 15 years prior to the global financial crisis, and the ratio has recently picked up. figure 4 : household debt as a percent of disposable income source : rbnz despite being over - valued, house prices could continue rising for some time. in this respect, the recently agreed auckland accord reflects the growing need to improve the responsiveness of housing supply. other measures can help. the adoption of the full range of supply side measures in the productivity commission ’ s recent report would lower costs, and the demand for housing could also be moderated by changing the tax treatment of housing to reduce its attractiveness as an investment relative to other assets. but the current imf, april 2013, “ new zealand – staff report for the 2013 article iv consultations ”. bis central bankers ’ speeches supply / demand imbalance in auckland is very large and it could take several years to address this through supply measures alone. adding to the challenge is the decline in capacity in the construction industry in the last five years. according to the latest business demographic statistics, in february 2012 there were 5, 000 fewer firms and 14, 000 fewer employees in the construction sector than there were in february 2008. despite this overall decline, construction sector employment in canterbury had increased by 15 percent. although the construction sector is a relatively fluid industry and attracts workers from other sectors, the level and pace of construction activity outside canterbury will no doubt be constrained by the pull of resources into the canterbury rebuild. a strong run - up in housing markets can be a risk to future financial stability because it can increase both the risk of a sharp correction and the consequent financial sector disruption. the reserve bank is concerned that the current escalation of house prices is increasing the probability and potential effect of a significant downward house price adjustment that could result from a future economic or financial shock. these concerns are shared by the oecd and by the imf in its recent review of the new zealand economy, and housing risks have been noted recently by all three of the major international credit rating agencies. we are responding to the financial stability risks around the housing market in several ways : by raising banks ’ capital requirements for housing lending ; conveying our concerns about risks to financial stability ; and putting in place a framework for macro - prudential policy to address those risks and increase the financial system ’ s resilience. earlier this month, following a review of the major