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A former chairman of the Reserve Bank of New Zealand has criticised the bank's low interest rate policy, telling MNI it is fueling financial instability by inflating a housing bubble.

Arthur Grimes, chairman of the RBNZ from 2003 to 2013 after previously serving as chief economist, said "absurdly low" interest rates would increase social inequality and ultimately poverty.

The Real Estate Institute NZ House Price Index increased 11.1% year-on-year in September to 3,145, marking a new high and the first time the index has gone over 3,000.

The RBNZ's Official Cash Rate is at a record low 0.25% and the Bank has signaled that zero and even negative official rates are under consideration. Housing mortgages can be had for around 2.0%.

Grimes, now a senior fellow at Motu Public Policy and Research, said in an interview that fiscal policy and not monetary policy was the most effective way to deal with the economic impact of the pandemic.

FINANCIAL STABILITY RISK

"If you are wearing a financial stability hat you wouldn't want to be doing what they are doing now," he said. "There is a major financial stability risk which is being pumped up by the RBNZ."

The situation was "going to get worse" and housing prices were headed for a major fall, leaving bankrupt borrowers and bad debts behind.

"At some stage it will happen, it is just a question of when, not if," Grimes said.

The RBNZ's most recent Financial Stability Statement, from May this year, noted high levels of household debt but said "household stress could be accentuated by declining house prices."

"A major correction would test the resilience of households and lenders," the RBNZ statement said.

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