There goes the neigh­bour­hood

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The last two days have seen the lat­est monthly data on credit growth in Aus­tralia from the RBA, and the lat­est quar­terly data on house prices from the ABS. Together they con­firm trends that I’ve iden­ti­fied on numer­ous occa­sions between the accel­er­a­tion of mort­gage debt and the change in house prices (see Hand of Gov report on the Aus­tralian Hous­ing Bub­ble, A much more neb­u­lous con­cep­tion, The Chop­ping Block, Updated Credit Accel­er­a­tors, House Prices and the Credit Impulse, This Time Had Bet­ter Be Dif­fer­ent: House Prices and the Banks Part 1 & Part 2).

Hous­ing credit increased by 0.5 per cent over Sep­tem­ber (see the RBA Release for details), but this involved a fur­ther decel­er­a­tion of mort­gage debt as Fig­ure 1 shows.

Fig­ure 1: Change and Accel­er­a­tion of Mort­gage Debt in Aus­tralia


As I explained in “A Much More Neb­u­lous Con­cep­tion”, there is a com­plex causal link between the accel­er­a­tion of mort­gage debt, and the change in house prices. In a nut­shell, the two sources of mon­e­tary demand are income and the change in debt; these then finance the pur­chases of both newly pro­duced goods and ser­vices, and the turnover of exist­ing assets. There is thus a causal link flow­ing from change in debt to the level of asset prices, and con­se­quently a link between the accel­er­a­tion of debt and the change in asset prices.

That rela­tion­ship is evi­dent in the pat­tern of change in Aus­tralian house prices over the last two decades. the most recent figures—that prices fell 1.2% over the June to Sep­tem­ber 2011 quar­ter, and 2.2% from Sep­tem­ber 2010 to Sep­tem­ber 2011 (see the ABS Release for details)—confirm that mort­gage debt accel­er­a­tion, and not “pop­u­la­tion pres­sure” etc., is the key deter­mi­nant of house prices.

Fig­ure 2: The Mort­gage Accel­er­a­tion and House Prices Change Rela­tion­ship (R^2 = 0.54)

Of course, one can’t for­get the role of gov­ern­ment inter­ven­tion in sus­tain­ing an asset bub­ble either, and here the Aus­tralian gov­ern­ment has a peer­less record—whether the con­ser­v­a­tives (Lib­eral Party) or pro­gres­sives (Labor Party) have been in power. When­ever the econ­omy was fac­ing a reces­sion, its favourite tool of macro­eco­nomic pol­icy has not been fis­cal stim­u­lus, but stim­u­lat­ing the hous­ing sec­tor via the “First Home Own­ers Scheme”.

It was first intro­duced by the Hawke Labor Gov­ern­ment in 1983, in response to the reces­sion that had swept the pre­vi­ous Lib­eral Gov­ern­ment from power; it was rein­tro­duced by the Hawke Gov­ern­ment after the Stock Mar­ket Crash of 1987, given fears then of a seri­ous reces­sion; the Howard Lib­eral Gov­ern­ment brought it back as a “tem­po­rary” mea­sure to counter the impact of the GST in 2000 (and it has never been removed!), and then dou­bled it in 2001 to counter an immi­nent reces­sion; and finally Rudd dou­bled (and for new homes, tripled) the grant as a counter-mea­sure to the Global Finan­cial Cri­sis in late 2008.

Though restart­ing the hous­ing bub­ble wasn’t the express intent of gov­ern­ment pol­icy, its “col­lat­eral dam­age” included spikes in house prices as well (see Fig­ure 3). The turn­around from an 8% p.a. rate of fall in real house prices to a 15% rate of increase was merely the lat­est (but not the great­est) such instance of gov­ern­ment manip­u­la­tion of house prices that has given Aus­tralia the most expen­sive hous­ing in the West­ern world.

Fig­ure 3: The First Home Ven­dors Scheme and House Prices

So will they try again? I’m sure they will be sorely tempted should Thursday’s unem­ploy­ment data reveal a rise in unemployment—against the con­ven­tional expec­ta­tion that Aus­tralian unem­ploy­ment should be falling. But I doubt that they will, for two rea­sons.

Firstly the “col­lat­eral dam­age” of such a policy—a fur­ther boost to our house prices—would be polit­i­cal sui­cide today. Though house price infla­tion was ini­tially very popular—and it remains pop­u­lar with those who are highly lev­ered into house prices today—it would evoke huge oppo­si­tion from the many who are now locked out of home own­er­ship. The entry costs into home own­er­ship in Aus­tralia are now prohibitive—even after the fall from its peak level, houses are still more expen­sive in real terms than they were before the Rudd Government’s spin of the house price boost bot­tle.

Fig­ure 4: Real House Prices are still above the pre-FHVB peak

Buy­ing a first home there­fore involves tak­ing out a mort­gage that con­sumes a pro­hib­i­tive share of the aver­age wage—when First Home Buy­ers can be expected to be earn­ing below aver­age wages.

Sec­ondly, the pol­icy has only worked because it has gone in con­cert with the bank­ing sector’s will­ing­ness to lever the Grant with addi­tional mort­gage debt. The very suc­cess of this process is now the best rea­son why it won’t be tried again—or why, if it is tried, it might not work as it has in the past. Aus­tralian mort­gage debt is now sub­stan­tially higher than Amer­i­can (when com­pared to GDP), and though banks may still be will­ing to lend, will­ing bor­row­ers are much harder to find. Our mort­gage debt is once again falling when com­pared to GDP, and I doubt that any­thing the gov­ern­ment can do can make it rise yet again from its already unprece­dented peak.

Fig­ure 5: Aus­tralian mort­gage debt grew more rapidly than US, & now exceeds it

The one trick that Aus­tralia does have up its sleeve for re-inflat­ing the house price bub­ble is inter­est rate pol­icy. Since the vast major­ity of Aus­tralian mort­gages are float­ing rate, a cut to offi­cial inter­est rates rapidly trans­lates into falling mort­gage pay­ments for bor­row­ers (see Fig­ure 6). If rates fell sub­stan­tially, this could encour­age Aus­tralians to take on yet more mort­gage debt, and thus re-ignite the Aus­tralian hous­ing bub­ble.

Fig­ure 6

Even this is, I think, unlikely—again, because the past suc­cess of this “asset price infla­tion as macro­eco­nomic pol­icy” game has made it unlikely that the same play will work again. Aus­tralian pri­vate debt lev­els have risen from the his­tor­i­cally low level of 25% of GDP in the period from 1945–1965 to an unprece­dented peak of almost 160 per­cent in early 2008. Gov­ern­ment policy—especially the First Home Ven­dors Boost—merely tem­porar­ily delayed the delever­ag­ing process from Peak Debt.

Fig­ure 7: Pri­vate debt ratio now falling from unprece­dented level

Since delever­ag­ing results in falling asset prices as well as ris­ing unem­ploy­ment, it is unlikely that even sub­stan­tially low­er­ing inter­est rates will encour­age Aus­tralians back into debt once more. Australia’s appar­ently stel­lar eco­nomic per­for­mance over the last 2 decades, which was pri­mar­ily dri­ven by accel­er­at­ing pri­vate debt, may soon drop back to the pack now that the inevitable delever­ag­ing can no longer be delayed.

Fig­ure 8: Credit Accel­er­a­tor dri­ves change in unem­ploy­ment (R^2 = –0.65)


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.
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  • Derek R

    RickW wrote:
    The major­ity of eco­nomic com­men­ta­tors fos­ter the view that the prob­lem can be solved overnight. They seem obliv­i­ous to the fact that Greece runs a cur­rent account deficit around 10% of GDP. The coun­try is insol­vent. That imbal­ance will not be cor­rected overnight.

    Totally agreed, Rick. I was look­ing at that same graph ear­lier today and think­ing just what you are. With­out a major turn­around in the Greek bal­ance of pay­ments they are doomed, no mat­ter what the politi­cians may con­coct.

  • Lyon­wiss

    @ Peter­jbolton Novem­ber 2, 2011 at 12:56 am

    My idea of a “cure” or a “solu­tion” is a sim­ple and prac­ti­cal action, which, if imple­mented, will make a sub­stan­tial dif­fer­ence to the prob­lem.

  • Lyon­wiss

    @ Adit Novem­ber 2, 2011 at 2:14 pm

    The­o­ries of mon­e­tary eco­nom­ics typ­i­cally do not include defaults and bank reg­u­la­tion.

  • End­less

    Joye’s take:

    An inter­est­ing final para:

    A final com­fort­ing thought for the hous­ing mar­ket, is that, con­trary to Steve Keen’s hys­ter­i­cal claims, there is absolutely no evi­dence of a cat­a­strophic plunge in credit growth caus­ing pre­cip­i­tous falls in dwelling prices. The hard empir­i­cal fact is that hous­ing credit growth has sta­bilised at a rate in line with pur­chas­ing power, as we would expect. ”

    And he has a nice graph to sup­port it!

  • RickW

    @ End­less

    An inter­est­ing final para:
    “A final com­fort­ing thought for the hous­ing mar­ket, is that, con­trary to Steve Keen’s hys­ter­i­cal claims, there is absolutely no evi­dence of a cat­a­strophic plunge in credit growth caus­ing pre­cip­i­tous falls in dwelling prices. The hard empir­i­cal fact is that hous­ing credit growth has sta­bilised at a rate in line with pur­chas­ing power, as we would expect. ”

    I take the oppo­site view regard­ing Steve Keen given his priv­i­leged posi­tion in actu­ally know­ing what is going on in the world econ­omy. It is regret­table that he does not have greater vis­i­bil­ity and is far more hys­ter­i­cal.

    His some­what triv­ial mod­el­ing (in terms of ana­lyt­i­cal meth­ods) has sim­ply, but ele­gantly, shed light on one cer­tain fact — DEBT CANNOT BE IGNORED in eco­nom­ics and finance. How stu­pid am I to think that econ­o­mists actu­ally under­stood this!!!. This fact is blind­ingly obvi­ous to any­one with an ounce of com­mon sense and the weak­est pow­ers of obser­va­tion regard­ing cur­rent world affairs over the last three years. And yet gov­ern­ments, banks and a vast array of finan­cial com­men­ta­tors do what­ever they can to encour­age MORE DEBTHOW STUPID ARE THESE PEOPLE??? 

    The best that can be hoped for is to have the time to pro­gres­sively de-lever. This is bet­ter than the chaos appar­ent in Greece for exam­ple. There has been a once in a life­time oppor­tu­nity in Aus­tralia to pro­gres­sively de-lever over the last four years and maybe the next two or three and yet we are col­lec­tively encour­aged to march toward the edge of the cliff fol­low­ing Ice­land, Greece, Ire­land, Por­tu­gal, Spain, Hun­gary, Italy, Bel­gium etc Order could change depend­ing on how much cur­rent pri­vate debt gov­ern­ments choose to back as the big­ger coun­tries unravel. Ger­many, Japan and US could be in the first 20 ahead of Aus­tralia.

    We could start a book on who is next after Greece. If the CDS mar­ket on sov­er­eign debt is accu­rately priced then Por­tu­gal is next in line.

  • End­less


    I’m with you on Debt, and Steve’s con­tri­bu­tion. I’m just not clear on the link between debt and house prices falling, or rather the cat­a­lyst.

    To date there has always been some event, FHOG etc, that stops house prices from falling sig­nif­i­cantly (although admit­tedly, some areas have had sig­nif­i­cant falls). 

    Joye is pre­dict­ing a boon for hous­ing as a result of the rate cut. On Steve’s analy­sis the rate cut should do lit­tle or noth­ing to the slide in house prices.

    My gut tells me Steve’s is right, my eyes want to see it…something about putting fin­gers in scars…

  • I’ve given up on get­ting through to Adam on that issue–amongst many oth­ers. Time con­stants han­dle the time taken for exam­ple in pro­duc­tion or con­sump­tion; time delays can also be incor­po­rated eas­ily in dynamic mod­els where there is an absolute delay in data col­lec­tion and response–as with a lot of gov­ern­ment pol­icy for exam­ple. It’s no big deal in con­tin­u­ous time, and a pain in the butt in dis­crete time, which is one of the many rea­sons I favour con­tin­u­ous time mod­el­ling over dis­crete time in eco­nom­ics.

    And I think that’s too clever in nam­ing Andrew, but I’m not too fussed. I’ll stick with MCT because it empha­sises two things econ­o­mists have ignored: money and dynam­ics. But ulti­mately peo­ple other than I will come up with an endur­ing name for it.

  • @ End­less Novem­ber 2, 2011 at 3:12 pm | #

    A rather reveal­ing arti­cle by Mr. Joye, indeed.

    Why would RBA find it dif­fi­cult to fore­cast infla­tion, when that is what they were estab­lished to do, but I assume that RBA’s def­i­n­i­tion of infla­tion is far dif­fer­ent to every­body else’s under­stand­ing.

    The RBA has more or less admit­ted that it is awfully dif­fi­cult to fore­cast future infla­tion with any degree of accu­racy.”

    And, what is so sur­pris­ing about the fol­low­ing state­ment? Does not Mr Joye under­stand the func­tional pri­or­i­ties of a Cen­tral Bank?

    Unfor­tu­nately, the deci­sion the RBA made yes­ter­day could only be jus­ti­fied by one lonely quar­ter of infla­tion data, which stands out as a strik­ing anom­aly when jux­ta­posed against the infor­ma­tion con­tained in the pre­ced­ing quar­ters, as illus­trated in the chart above.”

    Indeed a “game changer” and time to sup­port the hot money sweet spot for them flee­ing for­eign hordes of wealth and to prop up Aus­tralian houses prices beyond all dig­nity, com­mon sense, and afford­abil­ity.

    Yesterday’s bold deci­sion by the RBA to cut rates is a ‘game changer’ for Australia’s hous­ing mar­ket. Our mod­els imply that we should see a rebound in activ­ity one quar­ter ear­lier than expected (ie, in the first three months of next year). Any fur­ther rate cuts will only embolden this dynamic.”

    All this just indi­cates that RBA is a major part of that which will implode in Aus­tralia in the very near future; not as an event as that has already begun, but as a field of socio-eco­nomic dev­as­ta­tion.

    Long Live the Queen.

  • Philip

    RickW, End­less

    Joye’s argu­ment about Steve’s ‘hys­te­ria’ is non­sense, and so is the graph he pro­vides. The period timetabled is June 2008 — August 2011, whereas Steve’s pri­vate debt to GDP ratios go back to 1860! Fur­ther­more, it takes more than a cou­ple of years of delever­ag­ing to cause sub­stan­tial falls in hous­ing prices. The graph has an arrow sup­pos­edly point­ing out the recent trend — but Joye doesn’t bother point­ing out the obvi­ous trend in the graph: falling credit from April 2010 to today. A real hack job.

  • Hack­tu­ary

    Isn’t it exactly a year since the price of bananas went through the roof? Hmm. Last time (Cyclone Larry) we got a banana-dri­ven rise in inter­est rates, then a year later a “shock” reduc­tion in infla­tion as the rise in banana prices dropped out of the year-on-year infla­tion mea­sures. Truly the RBA and ABS are pathetic.

  • Scott Gov­oni

    The bot­tom line is that all eco­nomic the­o­ries are fun­da­men­tally flawed because they are all based on con­sumer con­sump­tion. No econ­omy can infi­nitely con­sume to grow an econ­omy.

    What is your response to my obser­va­tion Mr Keen?

    I didn’t pay to have you delete my com­ments. If you want to delete them, please just refund my money.

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  • RJ


    they are not stu­pid. Far from it

    credit always = debt

    We need bank credit for con­sump­tion and pen­sion sav­ings. As we age we need more credit and con­se­quently more debt

    The prob­lem at present is too much non Govt debt and not enough Govt debt

    And Greece’s prob­lem is being in the Euro. They no longer have their own cen­tral bank and are pay­ing the price for this. It will hap­pen to all euro coun­tries one by one unless the ECB buy Govt bonds as required

  • RJ

    As an exam­ple the USs accrued pen­sion and health care accrued lia­bil­ity is over $100 tril­lion

    They US Govt should run much larger deficits (by say mas­sive tax cuts) and then drain the extra money gen­er­ated by this extra spend­ing by issu­ing Govt bonds.

    Pen­sion funds can then buy these bonds. Prob­lem solved. Peo­ple could then relax about retire­ment as they would have their pen­sion invested in Govt guar­an­teed bond assets

    And the prob­lem of too lit­tle credit would be slowly solved. Non Govt debt would be replaced by com­puter gen­er­ated Govt debt

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  • Mag­nus

    Steve, I was won­der­ing if you could elab­o­rate on what the def­i­n­i­tion of “pri­vate debt” is, i.e. what kind of debt and insti­tu­tions are included in it. I’m doing some plots for Swe­den, but am unsure of exactly what data to use, to make it com­pa­ra­ble to your plots.