The head of Europe’s central bank says monetary authorities should keep an eye on developing asset price bubbles, but raising interest rates is not the best way to address such problems.

Speaking to media at the end of the G20 finance ministers and central bank governors meeting in Sydney, the European Central Bank’s president Mario Draghi acknowledged that asset price bubbles are being generated in some countries, especially emerging markets, due to the record low interest rates in many advanced economies.

“These are localised bubbles and they should be coped with, they should not be ignored at all, but they should be coped with what we call macroprudential instruments,” he responded to a question from the ABC on whether central banks should act on asset price inflation, not just consumer prices.

Mr Draghi says preventing asset price bubbles is a key element of maintaining general price stability, which is the main objective of most central banks.

“Financial stability falls within the remit in the sense in the sense that each central bank looks at it in its own specific way, we view this as part and parcel of our objective of pursuing price stability, but the instruments with which you pursue this, the instruments with which you cope with localised bubbles, are macroprudential instruments that are properly crafted and designed to cope with that specific problem,” he commented.

Trans-Tasman example

Asked whether New Zealand, which has required its banks to cut back substantially on low-deposit home lending, is setting a good example of effective macroprudential policy, Mr Draghi replied: “It might well be if I knew it.”

When the New Zealand policy was explained to him in brief as putting a cap on the number of low deposit loans that can be issued by banks, Mr Draghi gave a general tick of approval.

“The loan-to-value ratio is a classical instrument for housing,” he added.

New Zealand’s policy was introduced on October 1 last year, because the central bank believed that the housing market was “posing a growing risk to financial stability”, due to a combination of more low deposit lending, surging home prices and the fact that mortgage lending is about half of all bank lending across the Tasman [and a similar proportion in Australia].

The New Zealand rules stipulate that no more than 10 per cent of the dollar value of new residential mortgages can be at a loan to value ratio of more than 80 per cent – in other words, 90 per cent of borrowers must have at least a 20 per cent deposit.

It is too early to tell how much of a break the lending limits will put on New Zealand property prices, but analysts say the rule has had an early impact on sales volumes.

Similar rules have been used in Canada, Israel, Singapore and Sweden.

Many analysts see the introduction of such a loan-to-value ratio limit on Australian home lending as an attractive alternative to interest rate rises if house prices keep surging at the same time as the economy struggles and unemployment keeps ticking higher.

However, a Bank for International Settlements report from November 2013 concluded that only a limit on debt service to income ratios (how much the borrowers repayments are relative to their earnings) had substantial effects on limiting credit growth, while loan-to-value ratio limits were far less effective.

The same report also found that “only housing-related tax increases (or subsidy reductions) have statistically significant effects” on limiting house price appreciation.