McHouse prices, capital hoovering, and real exchange rate exposures

Abstract

House prices are both cause and effect of the real exchange rate. In the form of implied rentals or service prices, they are a good proxy for non tradables prices, which in turn are signs of generalised expenditure inflation and hence underlying real exchange rate pressures. The causal impact is because rising house prices suck in offshore funding, markedly so in recent times, creating a capital account driven nominal exchange rate. The hoovering effect is responsive to interest rate differentials, leading to a more focused view of the role of uncovered interest parity, as an offshore response to internally generated demand for funds rather than externally generated hot money chasing spot rate margins. The overall result is likely to be chronic macroeconomic instability over the inter run, creating challenges for corporate risk management, monetary control and industrial policy.

Notes

School of Economics and Finance, the Victoria University of Wellington, P.O. Box 600, Wellington, email [email protected] or roser.Bowden@,kiwicap.co.nz.