How to raise Australian interest rates
This caught my eye:
Reserve Bank of Australia Governor Philip Lowe has signaled a willingness to tolerate weaker price growth to avoid further inflating east coast housing that is already among the world’s dearest. His desire to avoid cutting interest rates further from the current record-low 1.5 percent is being challenged, however, by a third-quarter slump in the economy and recent gains in the jobless rate.
So Philip Lowe doesn’t like low interest rates, because they might inflate the housing market. OK, but what’s causing the low interest rates in Australia? This is:
Reserve Bank of Australia Governor Philip Lowe has signaled a willingness to tolerate weaker price growth
You raise rates by signaling an unwillingness to tolerate low inflation.
Somehow the normally sound RBA has things all upside down:
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26. January 2017 at 14:27
I suspect only reverse psychology works on economists. The more you say the RBA has their head on straight, the more they crook it up. Maybe you should try telling central banks that deflation and volatility are great, and then they’ll immediately adopt NGDPLT
26. January 2017 at 15:16
Didn’t read Sumner’s post, didn’t try to understand it, that makes me qualified to respond: Sumner’s map is upside down because of the bass ackwards logic employed by our host; the cart leads the horse in all of Sumner’s machinations.
26. January 2017 at 16:08
When I started reading this blog, I thought that the staff of themoneyillusion.com live in Australia
26. January 2017 at 16:29
Foreign demand has boosted the price of Australian housing, often beyond the reach of the Australian middle class. The Australians have three solutions: 1) suffocate the economy through higher interest rates 2) balance their trade deficit 3) build a lot more housing.
Well they are trying 4) tax foreign property purchades and ban bank loans to foreigners.
Like the U.S. the combination of property zoning with a bank system that considers appreciating property superior collateral …is well, the real issue.
26. January 2017 at 18:03
Add on:
If a nation wishes to consume more than it produces, it then must sell assets.
In Australia, this has translated into selling housing to foreigners.
Scott Sumner has correctly advised, “Aussies: No problem, build houses and sell in exchange for TV sets.”
But there is a rub: In Western economies, the propertied and financial classes are deeply wedded to property zoning, and limiting the supply of housing (or other real estate).
Bankers like the safety implied in lending on an asset that cannot run away and for which there is limited competition.
Property owners are not eager to see lots of more housing built in their neighborhood—which might not only crap on quality of life, but crap on property values through sheer supply and demand.
The “trade deficits don’t matter” crowd has not honestly faced these issues.
I have yet to see a “trade deficits don’t matter” advocate add on, “But, yes, we have to do everything possible to eliminate property zoning in Australia (or the United States) if we wish to keep on consuming more in trade goods and services than we produce.”
“The globalist imperatives of free trade then trump local imperatives of property zoning”—that is a theoretically and an ideologically sound argument…but takes real guts to state baldly.
Personally, I think given the realities of the US property and banking system (which are immutable), perhaps balanced trade is the better option….
It is clearly a debatable point.
26. January 2017 at 18:25
Sumner again fails to show any understanding of the relatinship between credit expansion and interest rates on the one hand, and capital structure sustainability on the other.
26. January 2017 at 18:49
The crazy part is there’s an oversupply in every major city’s housing market except Sydney.
Sydney has geographical and infrastructure constraints, combined with a strong NIMBY culture. It’s also the finance capital and real estate assets are being used as a foreigner wealth storage mechanism.
Melbourne’s skyline is dotted with cranes (I counted 6 skyscraper apartments in progress). I suspect if the RBA continues to set monetary policy for a specific oddity in Australia, we may see the natural market response – more economic resources towards alleviating capacity concerns – turn the other direction, exacerbating the problem countrywide. Let’s hope not.
26. January 2017 at 18:55
I’d also question the RBA’s ability to “nowcast” the economy:
https://pbs.twimg.com/media/C3JJTIPWYAIonWQ.jpg:large
from:
https://www.bloomberg.com/news/articles/2017-01-26/world-s-biggest-real-estate-buyers-are-suddenly-short-on-cash
26. January 2017 at 19:58
Ben, You picked the wrong country to use as an example of a place suffering from trade deficits. Just about any other place would love to be in Australia’s shoes right now.
But yes, the zoning laws there are too tight, as is the monetary policy.
Colin, Good points.
26. January 2017 at 22:05
@Colin – How do you define oversupply and where’s the evidence? All major Australian parties, even One Nation, support immigration. Our immigration debates are about source countries, not whether we want more people living here. Any short term over supply will be redundant in the medium term and are you really questioning whether the market isn’t allocating resources well? Would intervention – apart from basic macro-prudential tools like verifying income etc, – be any better?
I’m yet to see convincing evidence of overseas buyers distorting the market. A lot of the anecdotes turn out to be Australian residents of Asian origin as opposed to mainland Chinese avoiding capital controls.
Let’s face it. The east coast of Australia is one of the best places to live in the world, so why wouldn’t property prices reflect that?
27. January 2017 at 01:19
That doesn’t sound fair, he only seems to be saying he wouldn’t cut rates (loosen), not that he isn’t happy with nominal rates being as low as they are, especially given real rates (policy is appropriately tight).
27. January 2017 at 01:22
“Cost of living in Australia is 10.12% higher than in United States (aggregate data for all cities, rent is not taken into account). Rent in Australia is 8.44% higher …”
Sure, Aussies are productive, have a civil society, system of property law etc. I like ’em. Good folks.
Big country, and living costs 10.1% above the U.S. Oh, that.
But wages are lower than in U.S.
Given their system of property zoning, it may be the large trade deficits are pushing up housing costs enough to more than cancel out the benefits….
27. January 2017 at 03:22
Unfortunately, Phil Lowe gives every indication he doesn’t have a clue. The former RBA Governor, Glenn Stevens lost his way in the second half of his term (2011-16). But Lowe is even more of an anti-low rates ideologue. He wrote papers with Claudio Borio at the BIS, which is bubble-mangers central
27. January 2017 at 03:44
The comments section of this story are worth noting.
http://www.theaustralian.com.au/news/inquirer/the-politics-of-hot-housing-prices/news-story/52f7a4629cd79800000cf0430d9ae73a
27. January 2017 at 04:33
https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr541.pdf
“The boom-bust in U.S. house prices has been a fundamental determinant of the recent financial crisis. The securitization process that eventually lead the financial sector to the brink of collapse crucially relied on expectations of ever-increasing house prices. Understanding the causes of these house price dynamics is crucial for preventing a repeat of a similar situation in the future.
Large and widening current account deficits accompanied soaring house prices, especially during the five years before the eruption of the crisis (figure 1). These two variables were perhaps the most discussed indicators of U.S. imbalances (Greenspan, 2005). Interestingly, the negative correlation between house price dynamics and current account balances is not specific to the U.S. but rather a robust global phenomenon, affecting advanced and emerging market economies alike(figure2).1 Countries that witnessed house price boom and substantial external deficits (such as Greece, Iceland, Ireland, Spain and the U.S.) also experienced among the highest degrees of financial turmoil during the crisis.2”
Fascinating. Run a big trade deficit and boom your house prices….
Huge trade deficits lead to gigantic and unstable house price booms?
Who knew? But I think the mechanism still requires property zoning….
27. January 2017 at 06:20
Saturos, I agree with Rajat, this is a classic BIS position.
Ben, Funny how the lack of a “Great Recession” in Australia is completely off your radar screen while you obsess about housing prices. I thought you viewed America’s Great Recession as a big deal.
27. January 2017 at 08:37
Question from a non-economist: Lowering the interest rate would presumably raise housing prices (e.g. like in Sweden). Would it be better to lower taxes and print money to finance that? That should also give you inflation, no?
27. January 2017 at 15:24
@Colin – How do you define oversupply and where’s the evidence? All major Australian parties, even One Nation, support immigration. Our immigration debates are about source countries, not whether we want more people living here. Any short term over supply will be redundant in the medium term and are you really questioning whether the market isn’t allocating resources well? Would intervention – apart from basic macro-prudential tools like verifying income etc, – be any better?
I’m yet to see convincing evidence of overseas buyers distorting the market. A lot of the anecdotes turn out to be Australian residents of Asian origin as opposed to mainland Chinese avoiding capital controls.
Let’s face it. The east coast of Australia is one of the best places to live in the world, so why wouldn’t property prices reflect that?
Dave, it’s pretty clear that certain areas of Sydney are receiving large interest from foreign buyers. This has a ripple effect on the rest of the market. There is a parallel real estate industry (Chinese operated) that continues to grow. Would you say Vancouver is experiencing a special housing “boom” created by foreign buyers? The answer is most certainly yes, but Vancouver is much smaller than Sydney and more supply constrained, so the problem is worse. But if is Vancouver, why would Sydney not be effected?
As for oversupply, I mean that in the short-term sense. In the long run who knows. I don’t think it’s a major problem but some developers will likely eat losses, worst case we have some over-levered major developers who see some difficulties, but that seems very unlikely.
But if interest rates change, a lot of these projects will be put on hold very quickly, and although you “prick” the housing bubble, you’ve now ruined housing supply, much like what happened in the US – the building boom in Arizona etc destroyed the market for productive areas that needed housing. Once the market came around it was too late, and the original excuses for overinvestment – demographic changes – were now a real thing.
27. January 2017 at 17:35
Scott Sumner: well, if you are still reading, I do think Australia’s RBA did the right thing in not raising interest rates too aggressively in 2008.
However, that does not change the report from the New York Fed, and what seems to be a common sense observation, that huge trade deficits lead to skyrocketing house prices.
This problem of skyrocketing house prices in connection to large trade deficits needs to be addressed squarely by those who say there are no negative consequences to large trade deficits.
27. January 2017 at 20:48
Petter, Monetary policy should focus on NGDP and ignore housing.
Ben, You said:
“This problem of skyrocketing house prices”
What problem?
27. January 2017 at 23:40
Scott Sumner: Well, skyrocketing house prices are not a problem…if you own property already.
Or can swing the deposit before the next run up. Or even better, if you can buy a warehouse before it is rezoned housing (like me!)
But higher house prices mean lower living standards, and also send a false signal to central bank authorities, who try to flatten house prices by suffocating the economy. See 2008.
And what of xenophobia? Is it xenophobic to dislike wealthy foreigners buying the best housing, and driving prices up? Or is that merely a practical concern?
You know what the solution is for huge foreign capital inflows into tight property-zoned markets? Bring in lots of poor immigrants too. They are used to crowded housing.
I advise you read the NY Fed paper, which totally misses the property zoning angle, but correctly concludes that huge capital inflows equate to house price booms.
28. January 2017 at 07:46
Ben, You asked:
“Is it xenophobic to dislike wealthy foreigners buying the best housing, and driving prices up?”
Yes.
28. January 2017 at 11:42
Does anyone know how foreign investment in real estate flows through national accounts? If a foreigner buys a condo in Manhattan, they are consuming housing services through imputed rent, but that imputed income flows to them as the owner. I assume this gets recorded as domestic consumption and income to foreigners on FDI. But, the domestic consumption is basically funded by an imputed remittance inflow. Anyone have insights into this?
29. January 2017 at 08:39
Kevin, I believe that housing service is a part of GDP, but not GNP. Can anyone confirm?
29. January 2017 at 10:29
“imputed remittance inflow”?
Remittances are outflows, surely? Imputed or real.
The imputed rent is an expenditure in US GDP (as measured using the expenditure method), alongside real rental expenditure.
And the same number AFAIK is included in GDI an income.
If the foreign investor actually rents the property out the rent will appear as real rent expenditure and real income. The real income may then be remitted, or stay in the US.
If the foreign investor keeps the property empty, then both expenditure and income will be imputed, of course. But wouldn’t, shouldn’t really add to GDP or GDI.