Our research paper examines the reason why housing markets have such unusual price and building activity cycles. It focuses on the quality dimension of housing demand – the shifts in demand for houses that are larger, better quality, or better located than others. These shifts can be caused by factors such as higher incomes or lower interest rates.

Read the discussion paper

The paper argues that temporary house price surges are often caused by interest rate movements. Lower interest rates can cause a rise in demand for better-quality houses, resulting in a price increase. As the construction industry adjusts by building more high-quality houses, the price surge ends and prices can fall as the supply of housing slowly increases. The slow pace of change in housing supply means that price rises caused by demand for quality are ultimately unsustainable – the supply response itself causes the price increase to be short-lived.

The declines in global interest rates over the last two decades are likely to have been a factor in booming housing markets around the world, and in New Zealand.

While higher interest rates can slow down housing market activity and attenuate house price and building cycles, central banks need to take into account much wider considerations than just the housing market (such as the inflation rate and employment) when setting local interest rates.

“The paper argues that the demand for better quality housing (which cannot be quickly met from new supply) is a major reason for unsustainable house prices, and a reason why house price cycles are often so different from price cycles in other industries,” Discussion Paper author Andrew Coleman says.

Why did we do this research?

Housing is included in our Monetary Policy and Financial Policy Remits. 

As a result, we have carried out a wide range of research on housing in the past 2 years, including 2 keynote speeches and 5 Analytical Notes in 2022. 

The wider context

These additions to the remits followed a 30-year period of persistent real house price increases during which time New Zealand experienced the most rapid increase in real house prices of any OECD country. 

By the end of the period there was growing concern that prices may have risen to unsustainable levels. These price increases were accompanied by a construction boom that saw employment in the construction sector nearly triple in size between 1991 and 2020.  

The construction boom was partly driven by an increase in population, and the Christchurch earthquake, but it also reflected a widespread demand for better quality housing. Since the late 1990s, the average size of a new houses has been approximately fifty percent higher than the size of the houses built in the 1970s and 1980s. 

More recently, house prices fell in 2022 and into 2023, coinciding with a rise in interest rates. From a peak in late 2021, house prices have declined by around 15% to date, and are assumed to fall by about 23% in total from their peak by 2024.