Housing Bubbles – eight questions and some answersThe peculiar nature of the housing market magnifies the price impact of changes in demand and supply.
The RBA will not be surprised by the house price response. Nor will they be overly alarmed.
The evidence on a house price “bubble” is far from compelling.
The housing market is a source of endless concern for financial markets, a central focus for policy makers and a fascinating
topic for dinner party conversation. This time is no different. This Issues piece looks at some of the questions we have
been fielding from our clients.
Economists are required to believe in the laws of supply and demand. But the housing market is different. Enter a
supermarket and everything on the shelf is for sale. In housing, however, the “liquid” part of the market is quite small.
About 4-6% of the dwelling stock is turned over each year and new construction adds 1½-2½% to the stock. The rest is
locked up. The limited amount of stock in play magnifies the price effect of changes in the supply-demand fundamentals.
The demand fundamentals are strong courtesy of rapid population growth. On the other side of the equation, competition
with the mining and infrastructure booms has limited housing supply. As a result, there is an excess demand for dwellings.
Rising affordability on the back of lower mortgage rates is now unlocking this demand. Higher house prices are an
inevitable outcome until supply starts to respond.
The RBA will not be surprised by the house price response. You do not embark on a mission to stimulate housing activity
without expecting some sort of price impact! Rising dwelling prices are indeed part of the transmission mechanism. Nor is
the RBA alarmed. The lift in dwelling prices needs to be put into some perspective. Current price growth around the 6%
per annum mark is in line with the long-run average. Dwelling prices are up by 8.7% from the mid 2012 trough but are only
0.7% above the previous (late 2010) peak. Price gains are concentrated in Sydney (where real prices were little changed
from 2004) and Perth (where population growth is still strong). Prices in Melbourne (where excess demand pressures are
weaker) remain below previous peaks. Price trends in other capitals and regional areas are more restrained.
Regulators are warning that intermediaries need to remain “prudent” given low interest rates and pressures to boost
revenues. But this is standard operating procedure. Any near-term implications for policy flowing from house price trends
lie along the lines of reduced likelihood of further RBA rate cuts.
Concerns about a potential housing “bubble” have lifted in tandem with dwelling prices. The momentum behind dwelling
price growth has risen. But that momentum is not exceptional by historical standards. And “bubble” conditions require
more than just the bald fact of an acceleration in house price growth.
The emerging consensus among economists is that in a true bubble rising prices need to be backed up by: an acceleration
in housing credit growth over a relatively short period; an easing in lending standards; and an expectation that dwelling
prices keep rising. The evidence on this bubble checklist is far from compelling.
The risk of a speculative price overlay highlights the concerns about rising investor interest in the housing market. But
investor interest is a rational response to the environment created by central banks.
The bubble debate is a recent development. The preceding housing debate centred on the relatively sluggish response to
the series of rate cuts pushed through since late 2011. And parts of the housing market are yet to respond in any
significant fashion. First-home buyers are an example. The share of new housing lending to this group remains at
historically low levels. The absence of first-home buyers is probably associated with the elevated level of job security
concerns. If these fears recede, then we will probably find that current interest rate settings are more stimulatory than they
currently appear. The resultant addition to housing demand may well give house prices a further boost.
Traditional monetary policy is often described as a “blunt instrument”. It can be deployed to deal with a range of problems.
But there can be significant collateral damage. Macroprudential policy may offer one way of dealing with the side-effects of
current extraordinarily accommodative policy settings on some parts of the economy, such as the housing market, without
damaging the rest. But we appear to be a long way from requiring such policies and regulators appear a little lukewarm on
the approach. This perception reflects the fact that such policies are not required right now. But no doubt they would be
considered if necessary.

Read more:
https://www.commbank.com.au/content/dam/commbank/corporate/research/publications/economics/economic-issues/australia/2013/151013-Housing_Bubbles.pdf