When RBA governor Glenn Stevens recently gave a speech on “Economic Policy after the Booms”, he was asked a seemingly innocuous question about macro-prudential regulation. Reserve banks around the world are increasingly citing the need for such regulation to help and stem “systemic risk”.

There are different sorts of macro-prudential regulation, but the primary tool discussed in central banking circles around the world, is loan-to-value ratios (LVRs). These are central bank-mandated ratios, which mean, for example, limiting the amount of loans a bank can write for borrowers with less than a 20 per cent  deposit.

In Wellington, the Reserve Bank of New Zealand (RBNZ) is pressing full steam ahead, seeing itself as an innovator and potential world leader in this new wave of policy making. Unlike Australia, the RBNZ is responsible both for monetary stability and banking regulation. Increasingly, the two seem like uneasy bedfellows.

In response to the perceived threat of a housing bubble in Auckland, the RBNZ, emboldened by a memorandum of understanding from the minister of finance, has set down the LVR path. After releasing a high-level discussion document, and a perfunctory consultation with the banks, an announcement in the near future looks likely.

The rationale is relatively simple: the bank is worried about the housing market, but from an overall monetary policy point of view, there is little reason to raise interest rates (the OCR has been 2.5 per cent since March 2011). Inflation is around 1 per cent and New Zealand’s jobless rate has still not fully recovered from the GFC, hovering around 6.4%. There is also the economic recovery which might be threatened by interest rate hikes.

From a macro-prudential point of view, the reasons for imposing LVR limits are cloudier. While there seems be perception at the RBNZ that banks are lending irresponsibly, this is a contested point, and the New Zealand Bankers’ Association point to a reduction in credit growth in recent months. The LVR policy also implies that the RBNZ basically doesn’t trust the banks’ assessment of risk. One thing is for sure; LVR’s will add to moral hazard as the government, through the RBNZ, will be effectively designing, then approving levels of bank probity.

The housing bubble concern seems primarily driven by Auckland, which like Sydney, has had a housing boom in the last decade. While pre-GFC prices hit their peak in 2007, they are now overtaking that peak and are growing up to 16% per year in some suburbs. But, as in Sydney, the growth is patchy, and there are localised effects. Talk of a pre-GFC style boom is premature.

This is against a political backdrop of ‘housing affordability’, which will be one of the battlegrounds in next year’s general election. At the root of the problem is a lack of housing supply in Auckland, and the difficulty and expense of building both there and in much of New Zealand. Years of dirigiste regulations under successive councils and central government, aided by New Zealand’s Resource Management Act, have meant building in New Zealand has substantially slowed. Supply is the problem.

But this “macro-prudential tool” could have the imprudent effect of stalling new housing supply in the short term and thereby increasing prices in the long run. The policy might actually create enough uncertainty to limit downstream supply by discouraging investment. And, of course, it is a policy that actively advantages those with houses and equity over those with no house and little equity.

There is also little international evidence it will work to restrain house prices, as results from overseas have varied greatly.

So while the government’s approach is largely about supply-side reforms to housing, the RBNZ has a different set of concerns and looks certain to engage in what amounts to an attempt at demand management and credit rationing. The problem with this sort of policy making is that it is ‘tar-handing’. That is, once the policymaker’s hands are covered in tar, it tends to be spread: why not regulate dairy farm finance next?

It also raises an uncomfortable high level question around Reserve Bank independence. While the government is essentially powerless to publicly disagree with the Reserve Bank Governor (who unlike the RBA is the Bank’s supreme decision-maker), there is also little practical accountability or oversight for the bank’s regulatory functions.

The bank using its independence to set monetary policy and achieve price stability is one (entirely appropriate) thing, leaning against that independence to effectively try and regulate the housing market is quite another.

Australian cities are facing the same growing pressures and New Zealand’s and as the bureaucratic equivalent of a priestly class, the RBA or APRA may find itself looked to for benign intervention in credit rationing decisions and help avoid ‘systemic risk’ and ‘bubbles’.

New Zealand may soon provide an interesting case study in how this could work. It is unclear what LVR’s will achieve, if anything, but they certainly signal new era of central bank activism.