Rescuing the Economy or the Bubble?

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Many ele­ments of the recent­ly announced pack­age are jus­ti­fied. When the econ­o­my is about to go into a debt-induced reces­sion, gov­ern­ment spend­ing both boosts demand, and pro­vides the pri­vate sec­tor with cash flow need­ed to meet its debt repay­ment com­mit­ments.

Equal­ly vital was the guar­an­tee of all bank deposits. A run on the banks would be dis­as­trous, and this guar­an­tee ensures that this will not hap­pen.

But yet another increase to the First Home Buyers Grant???

Is this because, um, house prices are, like, maybe too low?

Oh please, some real­i­ty here: the root cause of this cri­sis is exces­sive debt that drove house and share prices to unsus­tain­able lev­els. Times appeared rosy as the house (and stock­mar­ket) bub­ble con­tin­ued, but this was only because bor­rowed mon­ey was adding to demand.

No-one wor­ried about this when it was easy to flog a house for a high­er price. But unfor­tu­nate­ly, this game had to come to an end, because debt ser­vic­ing became pro­hib­i­tive as house prices rapid­ly out­stripped incomes. The bub­ble burst first in the USA, and the car­nage it has wreaked there should warn us all that asset price bub­bles are dan­ger­ous.

And how does the Aus­tralian gov­ern­ment respond? By pro­vid­ing yet anoth­er stim­u­lus on the demand side.

A col­laps­ing hous­ing bub­ble may be a scary prospect, but the more it is inflat­ed, the scari­er the final bust. And Aus­trali­a’s, on any mea­sure, is big­ger than Amer­i­ca’s.

A sim­ple com­par­i­son of the ABS Estab­lished House Price Index (ABS 641601 and 641603) to the CPI shows just how large the Aus­tralian house price bub­ble is (see Fig­ure One).

Fig­ure One

Figure One: House Prices vs the CPI

House Prices vs the CPI

Since 1987–hardly a time when Aus­tralian house prices were low by his­tor­i­cal standards–house prices have increased two and a half times as fast as con­sumer prices (see Fig­ure Two). Medi­an incomes have fared lit­tle bet­ter than the CPI, so that hous­es are 60 per­cent less afford­able now than in 1987.

Fig­ure Two

Ratio  of House Prices to the CPI

Ratio of House Prices to the CPI

That’s also true even when we take into account low­er inter­est rates. Yes, rates are about half what they were in 1987 (see Fig­ure Three); but debt is six times larg­er as a per­cent­age of house­hold dis­pos­able income than it was then (see Fig­ure Four)–so that mere­ly pay­ing the inter­est on out­stand­ing mort­gage debt con­sumes 13 cents in the house­hold dol­lar, ver­sus a mere 3.5 cents back in 1987.

Fig­ure Three

Mortgage rates and payments

Mort­gage rates and pay­ments

Fig­ure Four

Mortgage debt to disposable income

Mort­gage debt to dis­pos­able income

Increas­ing the amount of mon­ey that first home buy­ers can slap down on a home may help those who can’t afford to get into the mar­ket do so–great. It will also increase com­pe­ti­tion for hous­es, and poten­tial­ly sus­tain the Great Aus­tralian Hous­ing Price Bub­ble. 

Not great. As the USA shows us, the pain of a burst­ing house price bub­ble can be pret­ty immense–especially since it’s fuelled by exces­sive lev­els of debt.

But that pain will only get worse if the bub­ble is dri­ven any high­er. The high­er up you are when you fall off a moun­tain, the more it hurts when you hit the ground. The Aus­tralian house price moun­tain, on any mea­sure, is sub­stan­tial­ly high­er than the USA’s was when it began its long, painful descent (see Fig­ure Five).

Boost­ing the First Home Buy­ers Grant is a mis­take, just as it was when Howard did it. It will mere­ly delay the day of reck­on­ing.

Fig­ure Five

Australian vs US Housing Bubble

Aus­tralian vs US Hous­ing Bub­ble

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About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.