This is one of the reasons I love the Reserve Bank of Australia. Actually, truth be known, we have a bit of a “love-hate” relationship.
On some days I am the Bank’s firmest, and only, supporter; a case in point being the, in equal parts, flawed, jejune, and disgraceful media and political criticisms of the compensation of top RBA executives, which I have repeatedly railed against.
On others the Bank doubtless finds me rather frustrating, such as when I suggest that there is discord amongst its Board, or that the RBA is failing to properly fulfil its financial stability duties by holding Australian banks to account on the unnecessary risks they occasionally expose taxpayers to.
Today is one of those better moments in our union. Today I am able to objectively shower the Bank with praise. Why? Because it has just released an historic study with far-reaching consequences for our understanding of how Australia’s $3.6 trillion housing market works, and, more significantly, what specific policy measures might be implemented to cut the cost of securing well-located shelter.
On a more technical level, the study’s three authors—Mariano Kulish, Anthony Richards, who is head of the RBA’s economic analysis department, and Christian Gillitzer (hereafter “Richards et al”)—have furnished numerous theoretical, empirical, and general policy insights into the impacts of changes in infrastructure investment, zoning ordinances, frictions in the supply of new dwellings, and population growth on house prices, urban densities, land prices, and a city’s size, amongst other things.
Described differently, they have presented a range of “counterfactuals” that tell us what our big cities might look like were we to vary existing urban planning and infrastructure policies.
Unsurprisingly, Richards et al find that the “supply-side” of Australia’s housing market matters a great deal when it comes to determining housing costs. While I will discuss their individual results in a subsequent column, today it suffices to highlight their conclusion:
“While demand-side factors, especially changes in the cost and availability of finance, have clearly been very important in explaining developments in the Australian housing market over the past two decades, our results lend support to other [supply-side] work pointing to the role of structural factors in influencing housing market outcomes. There is a growing body of international evidence on the role of supply-side constraints in limiting construction and driving up prices... The evidence for Australia presented in Section 4 is also consistent with various supply-side aspects boosting the cost of housing..."
As a more personally interesting aside, Richards et al quite emphatically affirm (and cite) the arguments and analysis first tendered in my 2003 Menzies Research Centre report on the demand- and supply-sides of Australia’s housing market, which was commissioned by the Prime Minister at the time. They also subtly overturn previous RBA orthodoxy on this hotly contested subject, which resisted my 2003 supply-side thesis in favour of demand-side explanations for changes in housing costs over time.
I would submit that Richard et al’s contributions will emerge as the definitive body of work that future generations of policymakers rely upon when trying to make the case for greater public infrastructure investment, higher urban densities, speedier approval processes, reduced rigidities on supply-side delivery, and when explaining how we can cost-effectively accommodate a larger population without automatically inflating prices.
No other government agency could have unilaterally manufactured a study of this kind. No organisation has the human capital to yield unsolicited research of this quality in an area so far removed from its official mandate. No department would dare wade so directly and publicly into such a contentious policy realm without the imprimatur of its political masters.
For the avoidance of doubt, the RBA is telling us that politicians across the country are culpable for the housing costs that prevail today. There are, furthermore, tractable policy solutions to the affordability problems that exist, but weak-willed officials have mostly avoided them.
(One gripe I have is that the RBA does not approach the arguably more germane question of banking regulation with the same gusto. Where is the RBA-stimulated debate on the UK Vickers’ prescriptions, for example?)
A question that naturally springs to mind is, Why on earth did Australia’s central bank, which is ostensibly responsible for monetary policy, go to the trouble of publishing such time-consuming research on how to improve housing affordability?* The intellectual genesis of the Richards et al paper is, therefore, worth dwelling on.
Around a decade ago the RBA developed a finer appreciation for the hazardous linkages between asset prices, credit growth, and financial instability.
They recognised that rapid asset price appreciation could be both driven by, and insidiously feed back into, credit growth. That is, an economy could be struck by a period of interconnected asset price and credit growth that is divorced from more fundamental factors.
One might describe this as an “asset price-credit spiral”, which is the financial stability analogue of the “wage-price” spirals that have traditionally given inflation-focussed central bankers the willies.
Crucially, if these cycles cause prices to move materially away from their intrinsic values, they can result in highly distorted consumption and investment decisions (eg, overinvestment in risky (sub-prime) loans and assets like commercial and residential real estate), the eventual reversal of which—via the “bursting” of the so-called bubble—can have toxic implications for the health of the wider economy.
Here I am talking about plummeting collateral values in concert with rocketing default rates crystallising catastrophic bank losses, which, at the limit, can precipitate institutional failures in the absence of substantial taxpayer support (such as government guarantees of bank deposits, which, in Australia, account for around 60% of total bank funding, and of wholesale bank debts, which make up the remainder).
The RBA concluded that it may, as “a policy of least regret”, have to employ its very blunt interest rate instrument (both in terms of the direction and timing of its effects) against the more extreme iterations of these interwoven asset price and credit cycles in order to mitigate their serious risks.
For the policy wonks out there, the “house view” on this subject is perhaps best encapsulated in this recent article by eminent Columbia University Professor, Frederic Mishkin, which was released in the RBA’s June Quarter Bulletin.
With this background in mind, the Richards et al study is really about acknowledging the limitations of what the RBA’s monetary policies are actually capable of achieving. It is implicitly saying that the Bank would very much like to avoid the socially and politically challenging exercise of hiking rates in a low inflation environment simply to throw sand in the wheels of asset price bubbles. It is about formally quantifying the very meaningful economic relationships that prevail between Federal and State Government policies on urban planning, land usage. and infrastructure investment, and the prices that consumers are ultimately compelled to pay in the housing market. It is all but leading the political horses to water in canvassing a menu of constructive policy solutions that could help build more productive, efficient and lower-cost urban environments in the decades to come.
For this brave work, the RBA deserves its dues.
*I was, in fact, made aware that this research was coming down the pipeline since RP Data-Rismark supplied much of the data used in it. I had also briefly discussed some of these issues with the authors given my previous work in the field.
