alan bollard : housing debt, inflation and the exchange rate speech notes by dr alan bollard, governor of the reserve bank of new zealand, at an address to the employers and manufacturers association ( northern ) agm, wellington, 2 november 2005. the graphs for this speech can be found on the reserve bank of new zealanda€™s website www. rbnz. govt. nz * * * new zealand has enjoyed very strong growth over the last decade. gdp growth has averaged 3. 6 per cent over the last five years. but now it is starting to slow, causing some concern to businesses. we have enjoyed strong growth new zealand is an open economy and over the cycle we rely on important contributions from the export sector. but at the moment we observe that despite reasonable terms of trade the impact of net exports is weak, while the domestic sector has continued to grow extremely strongly, driving imports strength. driven by very strong domestic spending the inevitable upshot has been that the creditable positive trade balance we have enjoyed over the last decade and a half has now reversed. based on last week's trade data, the trade balance has now fallen to a deficit of 2 per cent of gdp. this trade deficit has been a principal ( but not the only ) reason for the severe fall off in the current account balance ( the balance of flows carried in the country and abroad. ) our current account deficit has now reached 8 per cent, the worst figure since 1986 and very marked by oecd standards. contributing to negative external balances another way of looking at this is to say that we are consuming and investing much more than we are saving. the government has had a strong saving record over the last decade, and more recently the business sector has been saving too. but the household sector, which represents a large part of the economy, has been running down its savings in spectacular fashion. while we may contest the validity of some of the data, there is little doubt we are now dissaving at about 12 per cent, very low by oecd standards. and very weak household savings an important part of what is going on relates to housing. over the last five years as capital has appeared cheaper and mortgages have become more accessible, the household sector has participated in a large housing boom, including : first time home buyers ; others trading up ; additions and alterations ; second homes ; investor houses ; investor apartments ; and rural property. the outcome has been unsustainably high house

available, and change their forecasts and policy settings when it considers it appropriate. we are satisfied that the bank met these tests. iv ) macro - prudential policy is valuable in addressing financial stability risks experience in several countries indicates that monetary policy is generally not a good vehicle for leaning against inflated asset prices. in these situations interest rates would have to increase very substantially in order to dampen asset prices and the rise in interest rates could do substantial damage to the economy by depressing spending, reducing risk taking, and undermining the competitiveness of the tradables sector. prudential and macro - prudential policies can play a valuable role in reducing the systemic risks to the banking system associated with inflated asset markets. we are likely to see macro - prudential instruments become even more important and widely deployed by countries in years to come. 6. prudential regulation on the prudential side, over the last five years we tightened prudential standards, adjusted inefficient or poorly targeted regulation and took steps to lower compliance costs. we completed the licensing of nearly 100 insurers. a year - long review of bank regulation, with a particular focus on policy development and regulatory processes, was undertaken with extensive consultation with the banking sector. we clarified and tightened the policy on outsourcing of banks ’ key functions and systems, and obtained government approval for the regulation of key financial market infrastructures. we are currently reviewing the quality of bank capital instruments and assessing whether banks are adequately capitalised, and reviewing the effectiveness of the insurance ( prudential supervision ) act, 2010. the imf ’ s financial sector assessment programme ( fsap ) conducted last year identified the types of banking sector risks ( high exposure to housing and inflated house prices, heavy reliance on external funding, exposure to commodity price fluctuations ) that are regularly discussed in our financial stability reports. it concluded that the banking system is well placed to withstand large but plausible shocks, as judged by a range of stress tests. however, the imf recommended, among other things, strengthening the macro - prudential regime to include a debt - to - income instrument, and addressing weaknesses in the approach to financial market infrastructures regulation and bank crisis resolution. there were no particular surprises in the imf ’ s recommendations, although they did comment that the bank is not adequately resourced to support its existing low - intensity approach to banking regulation and supervision. we are reviewing the imf ’ s recommendations. 7