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W & K

Proposed Tools to Control Inflation

Last week Labour announced its policies to help the Reserve Bank to control inflation, including a variable savings rate (VSR). This would increase the level of KiwiSaver contributions to ease the pressure to increase the Official Cash Rate (OCR), being the benchmark against which almost all borrowing costs are set. The policy outlined that the variable savings rate would be one of several measures, which also included a capital gains tax, controls on migration "at the hot part of the cycle" and the impact of the transition to compulsory KiwiSaver.

Labour should be congratulated on thinking outside of the box. Like many people since the announcement, we have been thinking about the potential implications of a proposed VSR. It appears that the architects of the policy conveniently forgot one of the golden rules of financial planning. That is, under normal circumstances, you should pay off your non tax deductible debt before you use your money for other savings. Only a high risk investment strategy really has the potential to provide after tax and fee returns similar or greater than mortgage interest rates.

Compulsorily diverting additional monies into KiwiSaver will be a real bonus for KiwiSaver providers. The vast majority of KiwiSaver funds under management are in schemes owned by Australian financial institutions. In most cases, their New Zealand banking offshoots will also be providers of mortgages.

The variable savings rate scheme could effectively increase the term of your mortgage because you will have less available money in which to make voluntary additional mortgage repayments as the money has gone into your KiwiSaver account. It is possible that the banks will simply make more money from you, and overall your net wealth at retirement may be less than what you would otherwise have expected because you could still have a large debt on your home.

In some situations, those KiwiSavers with mortgages would need to get their lender to agree to decrease their mortgage payments because they simply could not afford to lose the equivalent of the additional KiwiSaver contributions from their take home pay packet.

As they say, the devil is in the detail. It appears that under Labour’s proposed scheme, those who are self-employed, low income workers, beneficiaries, or those on National Super would be exempt from the scheme. So it looks like compulsory KiwiSaver would actually have a participation rate similar to the current situation. We also know that a lot of people are effectively taking contribution holidays due to financial hardship.

In order for VSR to have any significant impact on either reducing the inflation rate or the exchange rate, there would need to be billions of dollars removed from the public’s discretionary spending. If this were to be achieved, there would be a massive taxation shortfall, which somehow will need to be offset. It is unlikely that a capital gains tax would be a significant contributor to this shortfall until the regime had been in effect for close to a decade. That then leaves a combination of tax rate or GST increases or reduced government spending to mitigate the shortfall.

The Reserve Bank successfully introduced a new management tool last year, being the cap on loan to valuation mortgages as a means of cooling inflation. This could be remodelled using a combination of a variable rate and geographic region to target house price inflation. This would reduce the unintended consequences that are often felt in provincial New Zealand when Auckland property prices boom. It would also keep interest rates low reducing upwards pressure on the exchange rate.

Economics is an extremely complex area and care needs to be taken to avoid unintended negative consequences. In our opinion it is better policy for the independent Reserve Bank of New Zealand to develop and implement tools to maintain price stability rather than political parties.

Disclaimer

Steven Barton (FSP 32663) and Susan Pascoe Barton (FSP 32382) are Certified Financial Planners and Authorised Financial Advisers.  Their initial disclosure statements are available free of charge by contacting them on (07) 3060080 or they can be downloaded from www.pascoebarton.co.nz. This column is general in nature and should not be regarded as personalised investment advice.