Reserve Bank is helping make home ownership unafordable

The Reserve Bank has always denied that its manipulation of short-term interest rates to slow or hasten the growth in demand for goods and services plays any part in worsening the cost of home ownership. But I doubt this.

The biggest and most pressing economic problem Australia faces is nothing new: the ever-worsening ability to afford to own the home you live in. Young people feel this acutely, and it seems to be the single biggest factor causing their growing disillusionment with the deal they’re getting and the democracy that produces an economy run like ours.

In response, there’s a growing view among economists that, however many parts of the economy need reforming, the first thing we should fix is home ownership. Once most Zoomers are confident that they’ll be able to own their home the way their parents and grandparents do, they’ll feel a lot less alienated.

One thing we’ve learnt is that home unaffordability is the product of many factors: not just negative gearing artificially inflating demand; the home-building industry’s inefficiency reducing its output; nor zoning regulations used to stop newcomers living in the most accessible parts of the city, but all of them – and probably more.

So whether the activities of the Reserve Bank – our heavy reliance on fiddling with interest rates to manage the macroeconomy – are also contributing to the excessive rise in house prices is overdue for examination.

The Reserve’s denial that its ups and downs in interest rates have any lasting effect on house prices is based on the plausible claim that it’s ups and downs cancel each other out, leaving the average level of short-term rates little changed.

But it’s also based on a simplistic, mechanistic view of how markets work, with demand and supply responding to changed prices in a quite linear fashion. That is, it takes no account of the way people’s actions can be influenced by their expectations about how prices will move in the future.

The thing about the Reserve’s manipulation of interest rates is that it’s relatively predictable. What starts going down will keep going down, and what starts going up keep going up. We’re seeing the effects of such expectations at work right now.

In the less than eight months since the Reserve began it latest easing cycle on February 19, average house prices have jumped 5 per cent. Why? FOMO – fear of missing out. We’ve all been trained to know that, as soon as the Reserve starts cutting rates – and thus making it easier to afford a huge loan – many people will start buying places.

When they do, house prices will start rising. In which case, I’d better buy my place ASAP. And when many other people do the same, demand exceeds supply and prices rise – thus making the expectation self-fulfilling.

Now, if expectations were perfectly symmetrical, this wouldn’t matter. It would be offset when the Reserve made the initial rate rise of a tightening cycle. Demand for homes would suddenly drop because more rises were expected, thus pushing house prices down.

What’s more likely, however, is that house prices are “sticky downwards”. If so, “monetary policy” – the manipulation of interest rates – has a ratchet effect, pushing house prices up but not down. If so, that’s a serious unintended consequence of using interest rates to manage demand.

And I’m indebted to my former understudy, Gareth Hutchens, for noticing some remarks by Stephen Grenville, a former deputy governor of the Reserve, acknowledging another respect in which monetary policy leads to higher house prices. (By the way, please don’t look for Hutchens’ Sunday economics column on the ABC site. You might decide he’s smarter than his former master.)

Grenville said the Reserve had yet to resolve a problem with its use of interest rates to influence increases in the prices of goods and services: this also affects the prices of assets, including property.

The inflation-targeting framework encourages policymakers to keep cutting rates as the inflation rate keeps falling – even if it falls below the target range, as it did for more than a year before the arrival of COVID.

Grenville said an ever-lower interest rate does very little to increase growth in real gross domestic product, but it has a big effect on asset prices such as houses and shares (which are often bought with borrowed money).

He said people need to realise that monetary policy has its limits, and if we keep cutting rates below a certain point it can cause economic problems, especially with property prices.

Oh, dear. What can we do? Well, one simple response would be to abandon the convention that almost all the work in the short-term management of aggregate demand must be left to monetary policy. That is, more of the load should be carried by “fiscal policy” aka the budget.

But the episode we’re just leaving – where we laboured painfully for about three years using monetary policy to end the inflation surge caused by COVID and the response to it – has convinced me we’d be better off ditching monetary policy completely as an instrument for managing the macroeconomy and shift to one with fewer unintended consequences and adverse side effects.

Partly because the interest businesses pay is tax deductible, the effect of higher interest rates is concentrated on the one-third of households with mortgages. They get really squeezed, whereas people who own their homes outright, and even renters, are let off lightly.

This is obviously hugely unfair on home-buyers. We should be using an instrument that spreads the squeeze to a much higher proportion of households. But monetary policy’s narrow application makes it inefficient as well as unfair. Because so few people are directly affected, it takes much longer to work.

And the joke is that, unlike all the other rich economies, and as first suggested by Hutchens, we have at our fingertips a much fairer and more efficient instrument to restrain or encourage demand as required: a temporary increase or reduction in the 12 per cent compulsory superannuation contribution rate.

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With the US crazy on climate change, we're better off with China

When you hear that malevolent old fool Donald Trump tell the United Nations that climate change is “the greatest con job ever perpetrated on the world”, it’s hard to resist throwing up your arms in despair. If mighty America won’t set a good example, what hope is there for the rest of us?

But nature abhors a vacuum. And if the Americans are too busy making themselves great again to want to keep leading the world to a better future, my guess is that the aspiring great power China will be only too happy to take the reins.

Truth is, the Yanks have never been fully committed to leading the energy transition from fossil fuels to renewables. When the Democrats are in power, they make the right noises, but whenever the Republicans take over they revert to uninterest. Until now, they’ve been like our Liberals, never openly opposing action to limit climate change, but never keen to get on with doing anything.

You’d be hard-pressed to believe there was a majority of climate-change believers in Congress. It’s never taken over national leadership of the transition to renewable energy.

Rather, as our Climate Council lobby group has explained, what progress the Yanks have made has come from pro-climate action state governments, which cover more than half of the US economy, as well as many companies sticking to the goal of net zero emissions by 2050.

And America’s record on emissions of greenhouse gases isn’t as bad as you might expect. The world’s second-biggest economy (when you measure it correctly, taking account of the fact that $US1 buys a lot less in the US than it does in China) accounts for the second-largest share of annual global emissions, 11 per cent.

Its annual emissions have fallen a little in recent years, driven by a shift from coal to natural gas and increased use of renewables for electricity. Even so, the decline to date isn’t big enough to meet the Biden administration’s goal of reducing emissions by at least 50 per cent below 2005 levels by 2030.

But here’s the point: China is the great contradiction. On one hand, being the world’s largest economy (correctly measured), it’s the world’s greatest single emitter, accounting for about 30 per cent of global emissions. (Since you didn’t ask, Australia’s share of annual emissions is 1 per cent, although our emissions per person are an embarrassingly high 22 tonnes of carbon dioxide equivalent.)

On the other hand, China is the country doing most to move to renewables. The Climate Council says that, since 2020, China’s solar capacity has almost quadrupled, and its wind capacity has doubled. It achieved its 2030 renewable energy target six years early.

This momentum on clean energy is occurring at the same time as more coal-fired power stations are being built. But the new stations are replacing old ones, causing no net increase in coal-fired power. Indeed, in the first half of this year, coal-fired generation fell by 3.4 per cent compared with last year’s first half.

China’s climate pollution seems to have peaked in recent times, actually dropping in the first half of this year. This would be up to five years ahead of the Chinese government’s expectation. If this peak and downturn are sustained, this is, as the Climate Council says, “a major milestone in the worldwide shift to clean energy”.

Last week, while Trump was at the UN trumpeting his stupidity to the world, President Xi Jinping was there to announce China’s commitment under the Paris Agreement to reduce its emissions by at least 7 to 10 per cent by 2035.

The modesty of this promise prompted disappointment and disapproval. But before people’s righteous indignation reaches too high, there are a few points to remember.

First is the statisticians’ distinction between stocks and flows. Everyone tends to focus on this year’s flow of greenhouse gas emissions, which adds to the existing huge stock of gases in the atmosphere, which has been building up since the Industrial Revolution.

Obviously, if the stock is already too high, any annual addition is bad. We should be reducing our annual addition ASAP. But it’s the huge existing stock of gases in the atmosphere that’s doing almost all the damage.

If we ask which countries contributed most to the stock of gases, it’s the big rich countries: the US and parts of Europe. Our efforts over the past 200 years to make ourselves as rich as we are today created the climate disturbance. The poor countries during those 200 years, including China, contributed stuff-all to the problem.

China’s biggest annual emissions are explained by its population, 1.4 billion people, plus its success in raising their material standard of living from poor to middle-income in just a few decades. Its emissions per person are still only about half ours.

It would be the height of hypocrisy for the countries that got rich by wrecking the world’s climate now to tell the poor countries they must abandon their efforts to make their citizens even remotely as well-off as we are.

That’s why no one in the rich world is entitled to criticise the Chinese for their huge emissions. And it’s why we should be hugely impressed and grateful for their great effort and success in moving to renewables.

Next, remember that China is the global leader in renewable technology manufacturing. It supplies 80 per cent of the world’s solar panels and 70 per cent of electric vehicles. It’s also the leading world supplier of wind turbines. If it isn’t already the biggest in batteries, it will be.

China’s massive output of clean machines has slashed the world cost of renewables relative to fossil fuel energy, and is now powering the switch to renewables in many countries, including ours.

Finally, when tempted to criticise China’s modest promise to reduce emissions, remember that whereas our politicians tend to overpromise and underdeliver, the Chinese prefer to do it the other way – as their recent overshoots well demonstrate.

With the Yanks going off the reservation, we’re in safer hands with the commos.

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