A year ago the Deputy Governor of the Reserve Bank, Dr Grant Spencer, made a speech entitled Action Needed to Reduce Housing Imbalances.

In that speech he said "while there are difficult issues and trade-offs to consider in this area, The Reserve Bank would like to see fresh consideration of possible policy measures to address the tax-preferred status of housing especially investor related housing".

At that point, the median house price in Auckland was already over eight times median earnings.

The 1989 Reserve Bank Act was drafted recognising that while the Reserve Bank would be delegated responsibility for delivering the Government's inflation target and protecting the stability of the financial system, the Government was expected to play its part with fiscal and other policies that would not frustrate the Reserve Bank in its roles.

In his speech Spencer explained what the bank was doing within its own mandate while also pointing out where the Government had levers to pull to provide monetary policy with mates.

The Government did respond, putting in place a capital gains tax on property investments held for two years or less and also requiring overseas investors to provide more disclosure regarding their ownership of property and their tax status.

This appeared to take some pressure off the Auckland house market for awhile, as the Government sought to increase the availability of new sections in Auckland.

Recent data from the Real Estate Institute suggests the price pause is over and double-digit house price increases look like returning and not just to Auckland.

It seems that investor expectations are such that investing in Auckland residential real estate is still seen as one of the best investments for capital appreciation available. With interest rates now going negative in some countries, Auckland will remain one of the destinations of choice for yield hungry investors around the world.

So what more could the Government be doing? As the Reserve Bank deputy governor pointed out last year, investor owned housing is a particularly tax-favoured investment class.

Contrary to popular opinion the effective capital gains exemption is not the major tax subsidy for rental property investors. The main tax subsidy derives from the full tax deductibility of nominal interest rates paid on geared up investment properties.

The part of nominal interest that compensates for inflation is simply returning the capital of the lender so only the real part of interest (above inflation) should be allowed as a deduction or counted as income. Here, two changes would make a difference in the relative attractiveness and thus demand for investment in rental property and reduce the prices that owner occupiers need to pay.

In the meantime the Government could also ease back on immigration levels so that they are more compatible with increases in the housing stock it can achieve.

The Government will also need to accelerate the access to greenfield and brownfield sections for more houses and apartments to be constructed to increase the supply.

The German Finance Minister recently called for a phased exit from the current low interest rate monetary policy being pursued by the European Central Bank.

The IMF and OECD are both pressing governments to move from relying on inflation targeting using quantitative easing which is no longer effective and start switching to using expansionary fiscal policy and supply side measures to stimulate economic growth.

When New Zealand, in line with other countries sees a normalisation of inflation and interest rates this will also increase mortgage interest rates and risks creating negative equity for many households.

If mortgage interest rates move back above 6 per cent with a normalisation of monetary policy then many householders will not be able to service their current mortgages and house prices will fall as they have to sell up.

This is likely to produce negative equity where a home owner finds that their mortgage is worth more than their house is worth if they had to sell up. More action to slowly deflate the housing bubble is necessary to prevent the arrival of negative equity.

While the disputes with the miners and the poll tax put demonstrators in the street it was negative equity that really ended middle England's love affair with Margaret Thatcher. If National wants to stay on and enjoy a fourth term it may want to restrain our housing bubble that will make negative equity almost inevitable when interest rates normalise.

Peter Neilson is an economist, was a Minister of Revenue and supervised the development of the Reserve Bank Act 1989 which established the framework for an independent central bank. Until recently he was the CEO of the Financial Services Council. The views expressed are his own and do not represent the views of either the FSC or its members.