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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41 Responses to There goes the neighbourhood

  1. Derek R says:

    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.

  2. Lyonwiss says:

    @ 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.

  3. Lyonwiss says:

    @ Adit November 2, 2011 at 2:14 pm

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

  4. Endless says:

    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!

  5. RickW says:

    @ 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 DEBT – HOW 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.

  6. Endless says:


    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…

  7. Steve Keen says:

    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.

  8. peterjbolton says:

    @ 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.

  9. Philip says:

    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.

  10. Hacktuary says:

    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.

  11. Scott Govoni says:

    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.

  12. Pingback: House prices fall for first time since February

  13. RJ says:


    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

  14. RJ says:

    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

  15. Pingback: There goes the neighbourhood | Steve Keen’s Debtwatch – link bits

  16. Magnus says:

    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.

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