Showing posts with label housing. Show all posts
Showing posts with label housing. Show all posts

Wednesday, February 21, 2024

Why fixing negative gearing would be a positive for our kids

Life wasn’t meant to be easy for our politicians – which is as it should be. Poor old Anthony Albanese. No sooner has he got away with breaking his promise on the stage 3 tax cuts than he’s besieged by people demanding more tax reform.

Trouble is, they all want different things, and every one of them could cost him votes as fat cats who stand to lose some tax break join forces with the opposition to run a great scare campaign, claiming it’s ordinary voters who’d be hit.

Despite the many things wrong with our tax system, the two big parties have wedged themselves into a corner on reform. Neither side’s game to do anything for fear of what the other side would say.

But when, unsurprisingly, polling showed that most people approved of Albanese’s decision to switch about $7 billion a year of the tax cuts away from those at the top and give them to those in the middle and bottom, the would-be reformers swarmed out of the woodwork.

First out was the (Big) Business Council, terribly worried about the lack of investment and the need for greater productivity. I’ll check their claims another day.

Then came two of our best economists, Professors Ross Garnaut and Rod Sims, proposing to bring back the carbon tax, only bigger and better. As I wrote last week, it’s a good idea.

But the one to watch, another old favourite, is the talk of finally doing something to curb the negative gearing of investment properties, which really took off 20 years ago after John Howard decided that the capital gain on property and other investments should be taxed at only half the rate applying to income from actual work.

A rental property is negatively geared when so much of the cost of buying it is covered by a loan rather than your own savings that the interest bill and other expenses exceed the rent you earn.

Why would anyone deliberately set up a business to run at a loss? Because the loss is deductible against your income from work. On a small investment of your own money, you sell the property a few years later at a big capital gain, only half of which is taxed. Not bad, eh?

Former Treasury secretary Dr Ken Henry reminds us that the rental property sector’s deductions are now so huge they exceed the rental income, making it not a net taxpayer. Taken together, all those landlords contribute nothing but are being subsidised by the mug workers.

What should worry Albanese is that the Greens are now pushing negative-gearing reform as part of their efforts to rebrand themselves as the party that cares about renters and first-home buyers.

If Labor doesn’t start showing it wants to improve the daunting prospects facing the younger generation, it risks losing its share of the youth vote to the Greens. The Libs needn’t worry, they’ve lost most of their share already.

Some years ago, the Grattan Institute proposed allowing landlords’ rental losses to be deducted only from other “passive” income, not wage income. There must be some recognition that capital gains shouldn’t be taxed at their full, inflated amount, so the 50 per cent discount should be cut to 25 per cent.

Another approach would be to allow losses to be deducted against wage income only if the investment property was newly built. This would overcome the objection that investors usually buy established homes, thus adding to the demand for homes without adding to their supply, and so pushing prices up out of reach of first-home buyers.

Now, the business people who see themselves as losing from the restriction of negative gearing – the real estate agents and home building companies – always claim it would do great damage to renters and home buyers alike. Don’t believe it. When economists try to estimate the likely effects, they find them to be small. Average house prices would fall by just 1 or 2 per cent, they say. So much for the death and destruction.

But these sums underestimate the likely benefit to young buyers. While the fall in the average price of all houses and units may be small, that’s because most house prices would be unaffected. Entry-level homes, the kind bought by mum-and-dad investors and first-home buyers, would become more affordable because those prices would fall by a lot more.

What’s more, a recent study finds that the share of households who own their home rather than renting it would increase by a huge 4.7 percentage points. Nor would it surprise me if, in practice, the effect was greater than the economists’ figuring suggests.

Even so, fixing negative gearing is no magic answer to housing affordability, and the Albanese government’s efforts to increase the supply of housing, particularly in the parts of cities where people prefer to live, is another part of the answer.

Albanese and Treasurer Jim Chalmers say they have no plans to change negative gearing, but that’s what they said about changing the stage 3 tax cuts – until they were ready to move.

And with the Greens using negative gearing as a bargaining chip in the Senate, progress is far from impossible.

Read more >>

Wednesday, August 23, 2023

Why Albanese's housing solution will help, but only a bit

If you rank our many economic problems in order of importance, the affordability of housing comes second – admittedly, a distant second – only to the need to limit climate change. And the good news is that Anthony Albanese’s latest deal with the premiers represents progress. The feds have made a start by offering the premiers a bag of money if they do the right thing.

What climate change and housing have in common is their great effect on the future wellbeing of our children. With housing, the fundamental problem is that our present arrangements favour those who already own a home (or two) at the expense of those who’d like to own one.

Those who are well set up in the property department love seeing the inexorable rise in their wealth. The more unaffordable their home becomes, the happier they are. Because there are double the number of home owners to would-be home owners and other renters, politicians on both sides have gone for decades professing great concern about the plight of would-be first home buyers while doing little or nothing to help them.

This means housing is becoming hereditary. Young people can afford to buy a home only with help from their parents, but parents can help only if they’re well-established home owners. Without so much help from parents, home prices would have to fall to make homes affordable.

So, the Bank of Mum and Dad has become an essential part of the system, but it works to keep home prices unaffordable to those without access to that bank.

Renting used to be seen as a temporary, transitory state. This is why state governments have never worried much about the treatment of tenants and have easily yielded to pressure from landlords to give them the upper hand.

It’s always been the case that poor people rented all their lives, but now the poor and the students are being joined by middle-class couples who’ve got on with having kids rather than waiting until they can afford a place. We’re acquiring a large underclass of people who’ll never manage to afford a ticket in the home owners’ club.

Until now, the problem of “housing affordability” has been seen as a problem for would-be home owners. Last week, the focus shifted to rent affordability and the poor treatment often dished out to renters.

Economically, this has happened because, at a time when the price of everything we buy is rising faster than our wages, rents have been positively shooting up. Why? Because, suddenly, there are so few vacancies; because the number of people needing to rent almost exceeds the number of properties for rent.

Politically, the spotlight has turned on renters because the Greens have been taking votes from the two majors by billing themselves as the party for renters.

Meanwhile, the nation’s economists, whose usual focus has been on the way tax and pension rules have pushed up home prices by adding unduly to the demand for homes, have reached a new consensus that it’s really the inadequate supply of homes that’s the problem.

Right now, that’s obviously true – especially in the supply of rental accommodation. But if you look at our record over recent decades, supply hasn’t had much trouble keeping up with demand, so it’s not the main thing that’s pushed prices so high.

So, on the face of it, Albanese’s new agreement with the premiers to facilitate the building of 200,000 more homes than the previous target of 1 million extra homes, over the five years from next July, doesn’t seem such a big deal. Most of those probably would have been built anyway.

What’s different is that they have to be new “well-located” homes. Well-located means “close to existing public transport connections, amenities and employment”.

Get it? “Well-located” is code for medium- and high-density housing. Most people want to live close to the centre of capital cities – or at least close to good public transport to the city – and economists now believe it’s council zoning restrictions on high-rise that’s done most to drive up home prices “where people want to live”.

So, premiers Daniel Andrews and Chris Minns have signed up to more high-rise. But agreeing to targets is one thing; delivering them is quite another. The premiers will meet plenty of objections, obstructions and foot-dragging.

That’s the other thing that’s different about Albanese’s new deal. He’s offering $3.5 billion in “performance-based funding” to those states that achieve more than their share of the original 1 million target. Each of the further well-located 200,000 homes their state’s builders produce will bring the premier a $15,000 bonus.

You’ve heard what they say about getting between a premier and a bag of money, so let’s hope it works. Ditto the premiers’ promises to reach a national agreement requiring landlords to have reasonable grounds for eviction, limiting rent increases to once a year, and phasing in minimum quality standards for rental properties.

When it comes to getting premiers to agree on harmonising regulations, I wouldn’t hold my breath – unless there’s more money on the table, of course.

Read more >>

Monday, August 7, 2023

Why you should and shouldn't believe what you're told about inflation

If you don’t believe prices have risen as little as the official figures say, I have good news and bad. The good news is that most Australians agree with you. The bad news is that, with two important qualifications, you’re wrong.

Last week the officials – the Australian Bureau of Statistics – reminded us of a truth that economists and the media usually gloss over: the rate of inflation, as measured by the consumer price index, can be an unreliable guide to the cost of living. Especially now.

But first, many people who go to the supermarket every week are convinced they know from personal experience that prices are rising faster than the CPI claims. Wrong. Your recollection of the price rises you’ve noticed at the supermarket recently is an utterly unreliable guide to what’s been happening to consumer prices generally.

For a start, only some fraction of the things households buy are sold in supermarkets. The CPI is a basket of the manifold goods and services we buy – some weekly, some rarely.

Apart from groceries, the basket includes the prices of clothing and footwear, furnishings, household equipment and services, healthcare, housing, electricity and gas, cars, petrol and public transport, internet fees and subscriptions, recreational equipment and admission fees, local and overseas holidays, school fees, insurance premiums and much more.

But the main reason no one’s capable of forming an accurate impression of how much prices have risen is our selective memories. Have you noticed that no one ever thinks prices have risen by less than the CPI says?

That’s because we remember the big price rises we’ve seen – they’re “salient”, as psychologists say; they stick out – but quickly forget the prices that have fallen a bit. Nor do we take much notice of prices that don’t change. We don’t, but the statisticians do – as they should to get an accurate measure of the rise in the total cost of all the stuff in the basket.

Sometimes the price of the latest model of a car or appliance has risen partly because it now does more tricks. Because they’re trying to measure “pure” price increases, the statisticians will exclude the cost of this “quality increase”.

My son, who watches his pennies, was sure the eggheads in Canberra wouldn’t have noticed “shrinkflation” – reducing the contents of packets without changing the price. No. This trick’s intended to fool the unwary punter; it doesn’t fool the statisticians. It counts as a price rise.

But now for the two reasons the CPI can indeed be misleading. The first is that averages can conceal as much as they reveal. Remember the joke about the statistician who, with his head in the oven and his feet in the fridge, said he was feeling quite comfortable on average.

The most recent news that, according to the CPI, prices rose by 0.8 per cent in the three months to the end of June, and 6 per cent over the year to June, was an average of all the households – young, middle-aged and old; smokers and non-smokers, drinkers and teetotallers, no kids and lots, renters, home buyers and outright owners – living in the eight capital cities.

Now note this. Economists, politicians and the media tend to treat the CPI and the “cost of living” as synonymous. But if you read the fine print, the bureau says that, while the CPI is a reasonably accurate measure of the prices of the goods and services in its metaphorical basket, it’s not, repeat not, a measure of anyone’s cost of living.

Why not? Partly because it does too much averaging of households in very different circumstances, but mainly because of the strange – and, frankly, misleading – way it measures the housing costs of people with mortgages.

The cost of being a home buyer is the interest component of your monthly payments on your mortgage.

But that’s not the way the CPI measures the cost of home buying. Rather, it’s measured as the price of a newly built house or unit. Which makes little sense. Many people with mortgages haven’t bought a new home.

And even those people who did buy a newly built home, did so some years ago when house prices were lower than they are now.

The bureau changed to this strange arrangement a couple of decades ago. Why? Because the Reserve Bank pressured it to. Why? Well, as you well know, the Reserve uses its manipulation of interest rates to try to keep the annual rate at which prices are rising, as measured by the CPI, between 2 and 3 per cent on average.

But, after it had adopted that target in the mid-1990s, it decided that it didn’t want the “instrument” it was using to influence prices – interest rates – to be included in the measure of prices it was targeting, the CPI.

So, the bureau – unlike other national statistical agencies – switched to measuring home buyers’ housing costs in that strange way. And the bureau began publishing, in addition to the CPI, various “living cost indexes” for “selected household types”.

The main difference between these indexes and the CPI is that home buyers’ housing cost is measured as the interest they’re paying on their loans, not the cost of a newly built house. But, of course, different types of households will have differing collections of goods and services in the basket of things they typically buy.

So, whereas the CPI tells us that prices rose by 6 per cent over the year to the end of June, the living cost indexes show rises varying between 6.3 per cent and 9.6 per cent.

Among the four selected household types (which between them cover about 90 per cent of all households), the type with the highest price rises was the employees, whose costs rose by 9.6 per cent overall.

That’s mainly because most of the people with mortgages would be is this category. Mortgage interest charges rose by 9.8 per cent in the quarter and (hang onto your hat) by 91.6 per cent over the year.

At the other end of the spectrum, supposedly “self-funded retirees” had the lowest living-cost increase of 6.3 per cent – mainly because almost all of them would own their homes outright.

Then come age pensioners, with cost rises of 6.7 per cent – few with mortgages, but some poor sods renting privately.

And finally, “other government transfer recipients” - those of working age, including people on unemployment benefits, on the disability pension and some students. They’re costs are up 7.3 per cent. Some of these would have mortgages, most would have seen big rent rises.

What this proves is that using interest rates to control prices makes the cost of living worse before making it better.

Read more >>

Friday, July 28, 2023

Why inflation is easing while rents are rising - and will keep going

It never rains but it pours. With the prices of so many things in the supermarket shooting up, now it’s rents that are rising like mad. Actually, while the overall rate of inflation is clearly slowing, rents are still on the up and up. What’s going on?

The Australian Bureau of Statistics’ consumer price index (CPI) showed prices rising by 0.8 per cent over the three months to the end of June, and by 6 per cent over the year to June. That’s down from 7.8 per cent over the year to December.

But rents in Sydney rose by 7.3 per cent over the year to June, up from 3.3 per cent over the year to December. Rents in Melbourne are now up by 5 per cent, compared with 2.2 per cent to last December.

But hang on. Those increases seem low. I’ve been reading and hearing about rent increases much bigger than that. What gives?

You’ve been reading about bigger rent increases than the CPI records because what gets most notice in the media is what economists call “advertised” rents – the asking price for presently vacant properties that have been listed with real estate agents.

So, this is the most relevant price for someone who’s decided to rent, or is wishing to move. Remember, however, in normal times landlords don’t always get as much as they ask for initially. Times like now, when the market’s so tight, they may end up with more.

But, each month, only 2 or 3 per cent of properties have a change in tenants. So most people are existing renters, wanting to sit tight, not move. It’s a safe bet they’re paying less that the price being asked of new tenants. And, though their rent will be increased soon enough, it hasn’t been yet.

The stats bureau’s increases are lower than the asking price because they include the rents actually being paid by all capital-city renters, not just the new ones.

But if the asking price is a lot higher than the average of the rents being paid by everyone, this is a good sign the average will keep going up. The rent increase is working its way through the system, so to speak.

But why are asking prices rising so much? Ask any economist, and they’ll tell you without looking: if the demand for rental accommodation exceeds the supply available, prices will rise.

That’s true. And the way we know it’s true is that vacancy rates are much lower than usual.

It’s when vacancy rates are low that landlords know now would be a good time to put up the rent. If the landlord has borrowed to buy the rental property, the rise in the interest rates they’re paying will make them very keen to do so.

But more than half of all rental properties are owned debt-free. Those landlords will probably also be keen to take advantage of this (surprisingly rare) chance to increase their prices by a lot rather than a little.

When demand is outstripping supply, the economists’ knee-jerk reaction is that we need more supply. Rush out and build a lot more rental accommodation.

But the economists who actually study the rental market aren’t so sure that’s called for. If you look back over the past decade, you see little sign that the industry has had much trouble keeping the supply up with demand.

If anything, the reverse. Until the end of 2021, rents went for years without rising very fast. Especially compared with other consumer prices, and with people’s incomes. Indeed, there were times when rents actually fell.

You didn’t know that? That’s because the media didn’t tell you. Why? Because they thought you were only interested in bad news. (And they were right.)

What’s too easily forgotten is all the ructions the rental market went through during the pandemic. What’s happening now is a return to something more normal. It’s all explained in one of the bureau’s information papers.

Official surveys show that renters tend to younger and have lower incomes than homeowners, and to devote a higher share of their disposable (that is, after-tax) income to housing costs. This is why so many renters feel the recent rent rises so keenly. And also, why the pressure is greater on people renting apartments rather than houses.

The pandemic, with its changes in population flows, vacancy rates and renters’ preferences, had big effects on rents and renters. Early in the pandemic, demand for rental properties in the inner-city markets (that is, within 12.5 kilometres of the CBD) of Sydney and Melbourne declined, as international students returned home, international migration stopped and some young adults moved back in with their parents.

Some landlords offering short-term holiday rentals switched to offering longer-term rental, further increasing the supply of rental accommodation. And the need to work from home prompted some renters to move from the inner city to suburbs further out, where the same money bought more space.

This is why inner-city rents fell during the first two years of the pandemic. Also, state governments introduced arrangements helping tenants who’d become unemployed or lost income to negotiate temporary rent reductions.

But inner-city rental markets began tightening up in late 2021, as the lockdowns ended and things began returning to normal. Some singles who’d gone back home or packed into a share house began seeking something less crowded. And, eventually, international students began returning.

So, we’ve gone from the supply of rental accommodation exceeding demand, back to stronger demand. Rents that were low or even falling are going back up.

As an economist would say, with the pandemic over, the rental market is returning to a new “equilibrium” – a fancy word for balance between supply and demand.

What we’re seeing is not so much a “crisis” as a catch-up. One reason it’s happening so fast is the higher interest rates many landlords are paying. But another reason renters are finding it so hard to cope with is that other consumer prices have risen a lot faster than their disposable incomes have.

Read more >>

Wednesday, June 14, 2023

Economy close to stalling, as Reserve hits the brakes yet again

It’s been a puzzling week, as we learnt the economy had slowed almost to stalling speed, just a day after the Reserve Bank raised interest rates for the 12th time, and warned there may be more.

According to the Australian Bureau of Statistics’ “national accounts”, real gross domestic product – the economy’s production of goods and services – grew by just 0.2 per cent over the three months to the end of March.

That took growth over the year to March down to 2.3 per cent, which sounds better than it is because the economy has slowed so rapidly. If it continued growing by 0.2 per cent a quarter, that would be annual growth of 0.8 per cent.

And the resumption of immigration means the population is now growing faster than the economy. Allow for population growth and GDP per person actually fell by 0.2 per cent. Over the year to March, it grew by only 0.3 per cent.

While a growing population is good for businesses – they have more potential customers – to everyone else, economic growth has been sold to us as raising our material standard of living. Not much chance of that if GDP per person is falling.

The Reserve Bank has been trying to slow the economy down because demand for goods and services has been growing faster than the economy’s ability to supply them, thus allowing businesses to increase their prices.

With additional help from the rising prices of imported goods and services, the rate of inflation has shot up. It’s started falling back from its peak of 7.8 per cent at the end of last year, but is still way above the Reserve’s 2 per cent to 3 per cent target range.

The Reserve’s been raising the interest rates paid by the third of households with mortgages, to reduce their ability to spend on other things. But, at this stage, probably the biggest dampener on consumer spending is coming from the failure of wages to keep up with rising prices.

“Demand” means spending, so if households find it harder to spend on goods and services, that makes it harder for businesses to raise their prices, thus bringing the inflation rate back down.

And remember that the full effect of all the interest rate rises we’ve seen is still to be felt. The pain will increase over the rest of this year.

But if I were Reserve Bank governor Dr Philip Lowe, I wouldn’t be too worried that the plan wasn’t working. The biggest single factor driving GDP is consumer spending, which accounts for more than half of all spending. In the June quarter last year, it grew by 2.2 per cent.

The following quarter its growth fell to 0.8 per cent, then 0.3 per cent, and now 0.2 per cent. Wow. I think the squeeze is working.

Although more people have been working more hours, real household disposable income fell by 0.3 per cent in the quarter, and by 4 per cent over the year to March.

It was hit by the failure of wages to rise in line with prices, by the doubling in households’ interest payments, and by the bigger bite that income tax took out of pay rises, caused by bracket creep.

How did households manage to keep their consumption spending growing despite their falling real income? By cutting the proportion of their income that they were saving from more than 11 per cent in March quarter last year to less than 4 per cent this March quarter – the lowest it’s been in about 15 years.

Household investment spending on newly built homes and alterations fell by 1.2 per cent, its sixth fall in seven quarters.

One bright spot was growth in business spending during the quarter of 2.9 per cent, led by spending on machinery and equipment, and non-dwelling construction – particularly on renewables and electricity infrastructure.

Unfortunately, much of the machinery investment was on imported equipment that had been delayed by the pandemic, so it’s not a sign of continuing strength. The volume of spending on imports was a super-strong 3.2 per cent, but imports subtract from GDP, of course.

Treasurer Jim Chalmers always blames the economy’s slowdown on higher interest rates (blame the Reserve, not me), high inflation (not me either) and “a slowing global economy” (blame the rest of the world).

A slowing global economy? Yes, of course. Everyone’s heard about that. Trouble is, the main way the rest of the world affects us is by buying – or not buying – our exports. And the volume of our exports grew by 1.8 per cent in the March quarter, and 10.8 per cent over the year to March. That’s because our miners have done so well (and our fossil-fuel-using households and businesses so badly) out of the higher world coal and gas prices caused by the Ukraine war.

Even so, this quarter’s growth in export volumes of 1.8 per cent has been swamped by the 3.2 per cent growth in import volumes, meaning that “net exports” – exports minus imports – subtracted 0.2 percentage points from the overall growth in real GDP during the quarter.

After Lowe’s decision on Tuesday to raise rates yet again, Chalmers wasn’t mincing his words. “I do expect that there will be a lot of Australians who find this decision difficult to understand and difficult to cop – ordinary working Australians are already bearing the brunt of these interest rate rises, they shouldn’t bear the blame too,” he said.

“The Reserve Bank’s job is to quash inflation without crashing the economy, and they will have a lot of time and opportunities to explain and defend the decision that they’ve taken today.”

Lowe has said repeatedly that he’s seeking the “narrow path” where “inflation returns to target within a reasonable timeframe, while the economy continues to grow, and we hold on to as many of the gains in the labour market [our return to full employment] as we can”.

After seeing the next day’s GDP figures, Paul Bloxham of HSBC bank observed that the narrow path “is looking extremely narrow indeed”. True.

Read more >>

Wednesday, June 7, 2023

It's not the wolf at the door that's driving women to work harder

Why do mothers go out to work? Why are more women doing paid work than ever before? And why are more of those women working full-time? At a time when so many are struggling with the cost of living, it’s easy to conclude that more women are having to work more hours just to keep up. But I think that sells women short.

Worse, it’s a fundamental misreading of perhaps the greatest social change of our age: the economic emancipation of women.

I don’t doubt that women are just as concerned about the cost of living as men, maybe more so if they’re in charge of the family budget. Nor do I doubt that, if you ask a woman why she’s been doing more paid work lately, the cost of living’s likely to be mentioned.

But things are not always as they seem. For instance, when people complain about the cost of living, their focus is on rising prices. But prices rise almost continuously. What matters more is whether wages are rising as fast as prices are – or, preferably, a little faster.

It’s true that the prices for goods and services have risen at a much faster rate than normal over the past two years or so. But the real problem is that wages – which usually do keep up – have been falling behind since the start of the pandemic. Yet people are far more conscious of the rising prices than of the weak wage growth.

Another distinction that’s clearer to economists than to normal people is between the cost of living and the standard of living. When people have trouble maintaining the same standard of living as their friends – a comparable car, comparable house, comparable private school – they would often rather blame the cost of living than their need to keep up with the Joneses.

No, what’s driving the change in women’s lives – causing them to behave very differently from their grandmothers – isn’t the cost of living, it’s education. And with education has come aspiration. Aspiration to put their learning to work, to have a career as well as a family, and to be treated equally with men.

I think it all started sometime in the 1960s when, for some unknown reason, the parents of the rich world accepted that their daughters were just as entitled to a good education as their sons. Everything flows from that fateful change in social attitudes and behaviour. What father today would dream of telling his daughter that, being a girl, she didn’t need an education?

The trouble for boys is that girls do education better. It’s now several decades since the number of girls going to university first exceeded the number of boys.

That being so, the figures for two-income families should come as little surprise. The latest report from the federal government’s Australian Institute of Family Studies, Employment patterns and trends for families with children, finds that in 2022, both parents were employed in 71 per cent of couple families with children under 15. This is up from 56 per cent in 2000, and 40 per cent in 1979.

Within those couple families, the proportion with both parents working full-time was 31 per cent in 2021, up from 22 per cent 12 years earlier. The proportion with one parent working full-time and the other part-time is unchanged at 36 per cent.

Only 4 per cent of these families involved fathers who weren’t working and mothers who were. (Which leaves the young men in my immediate family looking good.)

But there’s something else you need to understand. In the days when there weren’t many two-income families, this gave them a distinct advantage in the housing market. They could afford a better house than their peers.

Once most young home-buying couples have two incomes, however, their greater purchasing power gets built into the prices of the kind of houses they buy, so that what began as an advantage turns into a requirement.

Now it’s the couples who choose not to have both partners working who’ll have trouble affording a home comparable to those of other couples. They’ll have to accept a lower standard of living.

Similarly, it’s a misconception to say, as some do, that you need to have both parents working to afford a family. No, you just have to accept a lower standard of living.

I’ve long suspected that the rise of the two-income family helps explain the growing practice of sending kids to private schools. Two incomes make this easier to afford – though this, too, gets built into the size of the fees the schools can get away with charging.

There’s no reason a mother – or a father – who chooses to have a career should feel guilty about it. But I suspect some double-income couples find it easier to justify if they can say that the extra money is buying their kids a better education.

Sorry, a mountain of evidence says that, once you allow for the parents’ socio-economic status, private schools don’t add to students’ academic performance. Buyer beware.

Read more >>

Monday, June 5, 2023

For better housing affordability, try the premier, not the PM

People have been complaining about the unaffordability of houses for as long as I’ve been a journalist. In all that time, governments have professed great concern, while doing nothing of consequence. But I suspect their insouciance can’t last much longer.

Over the years, the prices of houses and apartments have risen much faster that household incomes have risen, gradually lowering the proportion of Australians able to afford a home of their own.

So the problem keeps getting worse and, with interest rates having risen so far so fast, as well as renters now feeling so much pain, it wouldn’t surprise me if, in coming federal and state elections, many younger voters – and some of their parents – were really steamed up about the issue.

If so, both Labor and the Liberals will be vulnerable to minor parties offering solutions – sensible or otherwise. But what could the major parties do to reduce the problem?

Well, nothing that some people wouldn’t vigorously object to. That’s why the political duopoly has done so little for so long.

The unending rise in house prices has been caused by various factors – some under the control of the federal government, some controlled by the states.

If prices keep rising, this suggests that demand is outstripping supply. In general, the feds have more direct influence over the demand for housing, whereas the states have more direct influence over the supply of them.

It’s wrong to assume that all the problems are coming from either the demand side or the supply side. But, of late, economists have been focusing on the supply side, which points the finger at state governments.

At first blush, if house prices are high and rising, this suggests not enough houses are being built. That’s probably true at present, with immigrants coming faster than we’re building new dwellings for them to live in.

But, over the decades, supply has eventually caught up with demand, so that doesn’t explain why prices have been rising for ages.

And, if it was just a matter of building enough houses to accommodate the growing population, cities would just keep spreading out for ever. That would be expensive – with all the extra transport and infrastructure you’d have to build – and not everyone wants to live that far out from the CBD.

So, the real supply issue is not that we should be building enough houses, it’s building enough housing where people want to live. And the truth is that many people want to live closer in.

As the NSW Productivity Commission explains in a new report, state planning systems make it “difficult to build enough new homes where people want to live – close to jobs, transport, schools and other amenities”.

“Instead, the system encourages urban sprawl, forcing people into longer and longer commutes. These policies increase inequality, especially for low and middle-income workers.”

Guess what happens if governments don’t allow enough homes to be built where people want to live? The prices of homes in, or nearer to, the most desirable areas get bid up relative to prices out in the boondocks, forcing up the median price.

As Australia’s population has grown so rapidly over the decades, the populations of Sydney, Melbourne and the other state capitals have increased greatly, but done so mainly by spreading out.

This has made housing more expensive, as people have had to pay more to live in the closer-in, more desirable parts of the city. Inevitably, it’s the better-off who get the best spots and the less well-paid who have to live further out, where the amenity is less.

Everyone’s paying more for their housing, but the well-off pay a smaller proportion of their income than those in the middle and at the bottom. This pushes families to compromise on where they live – further from family, friends and jobs.

The NSW Productivity Commission report says poor housing affordability brings four disadvantages to individual families and the community. It leaves families with less to spend on other things. It reduces the productivity of the nation’s labour because so many people who want to work can’t afford to live near their best employment prospects.

It adds to environmental damage because more workers live further from city centres and endure long, polluting commutes to their jobs.

And it reduces people’s quality of life because so much of our cities’ populations end up too far from the beach, sports arenas, big entertainment venues and other amenities.

So, what can state governments do to reduce these costs and make our lives better?

We should build more new homes in areas closer to the city’s centre. “These areas offer both the richest collection of job opportunities, and a supply of already-built infrastructure and other amenities whose capacity can be leveraged and expanded,” the report says.

What we need to do is build up, not out, and achieve more “infill” of unused or underutilised land close in.

Specifically, the report says, we need three changes. First, raise average apartment heights in suburbs close to the CBD (and to job opportunities).

Second, allow more development around transport hubs, such as train stations, and take advantage of our existing infrastructure capacity.

And third, encourage more townhouses and other medium-density development, and allow more dual-occupancy uses such as granny flats, where higher density is not an option.

The report argues that, even if the new supply of homes targets the high end of town, building more housing closer to the CBD, “downward filtering” means affordability improves everywhere.

The new, more expensive homes near the centre will be occupied by high-income families. But they will leave behind high-quality homes that middle-income families can move to, leaving their homes to be occupied by lower-income families.

NSW Productivity Commissioner Peter Achterstraat says that “if you believe, as I do, that today’s kids deserve the same shot at the Australian dream that my generation had, we need to change our planning system and build near existing infrastructure to make room for them”.

Read more >>

Monday, March 6, 2023

RBA inquiry should propose something much better

The inquiry into the Reserve Bank, due to report this month, will be disappointing if it does no more than suggest modest improvements in the way it does its job. The question it should answer is: should we give so much responsibility to an institution with such a limited instrument – interest rates – and with such a narrow focus?

In Reserve Bank governor Dr Philip Lowe’s lengthy appearance before the House of Representatives Economics Committee last month, he spent much of his time reminding critics that he only has one tool, so he can’t do anything to resolve the problems they were complaining about.

He’s right. But if the problems are real, and he can’t do anything about them, why should the central bank be the top dog when it comes to managing the economy, and Treasury’s job be limited to worrying about debt and deficit?

Shouldn’t the greatest responsibility go to an institution with more instruments, and ones capable of doing more tricks?

By the way, if you’re wondering why I’ve had so much to say recently about the limitations of monetary policy and the questionable convention of making it dominant in the management of the macroeconomy, it’s because it’s the obvious thing to do while we’re holding an inquiry into Reserve Bank’s performance.

Frenchman Olivier Blanchard, one of the world’s top macroeconomists, recently caused a storm when he tweeted about “a point which is often lost in discussions of inflation and central bank policy”.

“Inflation,” he wrote, “is fundamentally the outcome of the distributional conflict between firms, workers and taxpayers. It stops only when the various players are forced to accept the outcome.”

Oh, people cried, that can’t be right. Inflation is caused when the demand for goods and services exceeds the supply of them.

In truth, both propositions are correct. At the top level, inflation is simply about the imbalance between demand and supply. At a deeper level, however, “distributional conflict” between capital and labour can be the cause of that imbalance.

Businesses add to inflation when they seek to increase their profit margins. Workers and their unions add to inflation when they seek to increase their real wages by more than the productivity of labour justifies.

But this way of thinking is disconcerting to central bankers because – though there may well be a way of reducing inflation pressure by reducing the conflict between labour and capital – there’s nothing the Reserve can do about it directly.

Central banks’ interest-rate instrument can fix the problem only indirectly and brutally: by weakening demand (spending) until the warring parties are forced to suspend hostilities. So distributional conflict is the first thing monetary policy (the manipulation of interest rates) can’t really fix.

Then there’s inflation caused by other supply constraints, such as the pandemic or wars. Again, monetary policy can’t fix the constraint, just bash down demand to fit.

The next things monetary policy doesn’t do are fairness and effectiveness. When we’re trying to reduce inflation by reducing people’s ability to consume goods and services, it would be nice to do so with a tool that shared the burden widely and reasonably evenly.

A temporary increase in income tax or GST would do that, but increasing interest rates concentrates the burden on people with big mortgages. This concentration means the increase has to be that much greater to achieve the desired slowing in total consumer spending.

A further dimension of monetary policy’s unfairness is the way it mucks around with the income of savers. Their interest income suddenly dives when the Reserve decides it needs to encourage people to borrow and spend.

In theory, this is made up for when the Reserve decides to discourage people from borrowing and spending, as now. In practice, however, the banks drag their feet in passing higher interest rates on to their depositors. But it’s rare for the Reserve even to chivvy the banks for their tardiness.

Governments need to be free to encourage or discourage consumers from spending. But where’s the justification for doing this by riding on the backs of young people saving for a home and old people depending on interest income to live on?

The next thing monetary policy doesn’t do is competition. What’s supposed to keep prices no higher than they absolutely need to be is the strength of competition between businesses. You’d think this would be a matter of great interest to the Reserve, especially since there are signs that businesses increasing their “markups” are part of the present high inflation.

But only rarely does the Reserve mention the possibility, and only in passing. It gives no support to the Australian Competition and Consumer Commission’s efforts to limit big firms’ pricing power.

The final thing monetary policy doesn’t do is housing. The Reserve is right to insist that its increases in interest rates aren’t the main reason homes have become so hard to afford.

The real reason is the failure of governments to increase the supply of homes in the places people want to live – close to the centre of the city, where the jobs are – exacerbated by their failure to provide decent public transport to outer suburbs.

But the ups and downs of mortgage interest rates must surely be making affordability worse. To this, Lowe’s reply is that, sorry, he’s got a job to do and only one instrument to do it with, so he can’t be worried about the collateral damage he’s doing to would-be young home buyers.

Well, he can’t be worried, but his political masters can. And if they’re not game to fix the fundamental factors driving up house prices, they should be willing to create an instrument for the short-term management of demand that doesn’t cause as many adverse side effects as using interest rates does.

The one big thing going for monetary policy as a way of keeping the economy on track is that the Reserve’s independence of the elected government allows it to put the economy’s needs ahead of the government’s need to sync the economy with the next election.

But, as various respected economists have pointed out, there’s no reason the government can’t design a fiscal instrument, giving another body the ability to raise or lower it within a specified range, and making that body independent, too.

It’s the Reserve Bank inquiry’s job to give the government some advice on why and how it should make a change for the better.

Read more >>

Monday, February 27, 2023

The rich world should think twice about 'central bankism'

For the best part of 30 years, the governments of the advanced countries have outsourced the management of their economies to independent central banks. For many of those years, this change looked to have been a smart one. Now, not so much.

If the central banks’ efforts to get on top of the huge and quite unexpected surge in inflation that followed the pandemic go too far, and the rich countries end up in a severe recession, the inevitable search for someone to blame will lead straight to the door of the central bank.

After all, it was the central bank that, ignoring all the cries of pain, insisted on raising interest rates as far and fast as it did. And, as would by then be obvious, it misjudged and went too far.

It ignored the first rule for econocrats using a policy tool notorious for its “long and variable lags”: if you keep tightening until you’re sure you’ve got inflation beat, you’re sure to have gone too far.

You kept telling us it wasn’t your intention to cause a recession, but we got one anyway. So, were you lying to us, or just incompetent?

That’s my first point: if we do end up in recession, the independent central banks will get the blame, and there’ll be a posse of angry voters around the world demanding they be stripped of their independence.

But even if – as we hope - the worst doesn’t come to the worst, there’ll still be a strong case for our politicians to ask the obvious question: surely there must be a better way to run a railroad?

The rich world moved to central bank independence in the 1990s for strictly pragmatic reasons: because governments couldn’t be trusted to move the interest rate lever up and down to fit the economic cycle, not the political cycle.

Fine. But this is a democracy. How come a bunch of unelected bureaucrats have been given so much power? The fact is, independent central banking’s legitimacy comes solely because a duly elected government saw fit to grant it that freedom, and the present government hasn’t seen fit to take it away. Yet.

The trick is, if a central bank really stuffs up, voters will be furious, and they’ll turn on the only people they can turn on: the government of the day. You may think that, should a government of one colour be tossed out because of the central bank’s almighty stuff-up, the incoming government of the other colour would be mighty pleased with the central bank.

No way. What it would think is: if those bastards could do it to the others, they could just as easily do it to us. The new government’s first act would be to clip the central bankers’ wings.

The broader point is that independent central banking was not ordained by God. It’s just a policy choice we made at a time when it seemed like a good idea. When circumstances change, and we realise it wasn’t such a good idea, we’ll be perfectly equipped and entitled to change to a different policy arrangement we hope will work better.

Of course, moving away from economic management by interest-rate manipulation wouldn’t please everyone. It wouldn’t please academic economists who’d devoted their lives to the study of monetary economics (and right now, are hoping for a well-paid spot on the Reserve Bank board).

Nor would it suit the industry that, over the past 30 years, has grown up on the pavement outside the central bank’s building, so to speak. All the money market dealers who make their living betting on whether the central bank will change rates this month and by how much. Nor the economists who write the professional punters’ tip sheets.

And it’s a safe bet it wouldn’t suit the big banks, who’d much prefer the economy to be run by their mates down the road in Martin Place, rather than all those unknown bureaucrats and politicians in Canberra.

When you let one institution run the economy day to day for so long, it starts to get proprietorial. It’s in change of the economy and, when problems arise, it must be the outfit that takes charge and does what’s necessary to fix things.

There’s never a time when you admit that some other institution – the government and its Treasury advisers, for instance – should take the running because their instrument, the budget, is more multifaceted and suited to the problem than is your one-trick-pony instrument, interest rates.

And you do this even when the official interest rate is not far above zero. You tell everyone who thinks you’re out of ammo and should leave the running to Treasury and fiscal policy, they’re wrong, and resort to quantitative easing and other “unconventional measures”.

I reckon a big part of the reason what we thought was a problem of holding the economy together while we dealt with the pandemic turned into the worst inflationary episode in 30 years was the uncalled-for intervention of central banks, pushing themselves to the front of the fiscal parade.

And this from the institution that’s spend decades telling us it knows more about inflation than everyone else, cares more about inflation than anything else, and accepts ultimate responsibility to protect us from the supreme evil of inflation.

Today’s conventional wisdom says the present inflation surge was caused by big pandemic and war-caused supply shortages coming at a time when demand had been overstimulated. But a big part of that overstimulation occurred because central banks insisted on coming in over the top of those who were better equipped to respond to the pandemic and, indeed, were responsible for ordering and policing the lockdowns: the federal and state governments.

In Australia, nowhere was this overkill more apparent than in housing. While both federal and state governments were instituting temporary incentives to encourage home building, the central bank was not only slashing the official interest rate to near zero, it was lending to the banks at a hugely concessional rate, and buying second-hand government bonds, so the banks could offer home buyers two and three-year fixed-interest loans.

Throw in a temporary, pandemic-caused shortage of imported building materials, and you have much of our inflation surge being explained by an astonishing 27 per cent leap in the cost of a newly built home.

Why wasn’t there any co-ordination between the three arms of government that caused this avoidable inflationary disaster? Because the central bank is independent. It acts on its own volition.

But also because, when your only tool is a one-trick pony, you end up wearing blinkers. When you can only join the game by putting rates up or putting them down, you just can’t afford to worry about anyone who may be sideswiped in the process.

Read more >>

Wednesday, February 15, 2023

It's no wonder the young hate Boomers like me

As I get older, more parts of my body are giving me gyp and I spend more of my life seeing doctors, but the people I don’t envy are the young. They may be fit and keen, but everywhere they look they see problems.

The big advantage of capitalism is supposed to be that it makes each generation better off than the last. But that’s breaking down before our eyes. The really harmful problem we’re leaving them is climate change, of course, but there’s much more than that.

They’re better educated than ever but, for many, it doesn’t seem to get them a secure, decently paid job. Even so, they leave education owing big debts to the government.

But, coming well behind climate change, the biggest disservice the older generation has done to them is to let the price of a home keep reaching for the sky.

We’re now at the point where each successive age group contains an ever-lower proportion of people who’ve managed to buy the home they live in.

In contrast, the aged have never had it better. The only thing they have to fear – and the young have to look forward to – is still needing to rent privately in retirement.

We’ve turned housing into Lotto. If you manage to win, they shower you in wealth. If you don’t win, you get screwed. Renters have few rights because, as we all know, it’s just a temporary state for the young.

And then the Baby Boomers (like me) wonder why the young seem to hate them. It’s not true that all Baby Boomers are rolling in it. Some of them don’t even own their own home. But most of them (like me) were able to buy early in their lives, when first homes were affordable. Since then, they’ve just sat back in delighted amazement as their wealth has multiplied.

Of course, if there’s anything wrong with the way the world’s run, it wasn’t anything I did, it was those terrible pollies. Yeah, nah.

Since older home owners have always far out-numbered the young would-be home owners, the politicians have always run the housing game to favour those who love seeing property prices rise – and, now you mention it, wouldn’t mind buying another house as an investment.

At present, it’s easy to conclude the big problem with housing affordability is rising interest rates and so blame it all on the Reserve Bank boss Dr Philip Lowe. But, as I’ve written elsewhere, although it’s reasonable to ask whether putting interest rates up and down is a sensible and fair way to manage the economy, that’s a separate issue.

Home loans take two to tango: how much you have to borrow and the interest rate on the loan. The interest rate cycles up and down around a relatively stable average, whereas the amount you need to borrow has gone up and up, decade after decade.

True, house prices are falling at present, but this is just returning them to where they were before they took off during the pandemic. It’s a safe bet that, once they’ve finished falling, they’ll resume their upward climb.

This is why oldies are wrong to scoff at young people complaining about mortgage interest rates of 5 per cent. “In my day, I had to pay 17 per cent!” Yes, you did – for a year or so in the early 1990s, when the amount you had to borrow was much less.

What’s true is that, right now, it’s mainly younger people who borrowed huge sums in the past few years who’re really feeling the pain.

But the real question is why house prices have risen so far for so long. They’ve risen much faster than incomes. The Grattan Institute calculates that whereas typical house prices used to be about four times incomes, now they’re more than eight times – and even more in Melbourne and Sydney.

But why? Not because of anything the Reserve Bank has done. Nor so much because we’ve failed to build enough additional houses and units to accommodate the growth in the population.

More because our tax and social security rules have made home ownership a highly attractive, government-favoured form of investment, not just a place you can call your own and not be chucked out of as long you keep up the payments. People who buy investment properties out-compete would-be first home owners, bidding up the price.

But also because there’s more competition to buy homes in particularly desirable areas. Spots near the beach or the river, for instance, but also places near where the jobs are.

People have been crowding into the big cities, trying to get close to the CBD with all its well-paid office jobs, but the older home owners fight hard to discourage governments from making room for younger newcomers. “It’s so ugly.”

And the bank of mum and dad (yes, I’ve done it) is helping prices stay high, while widening the divide between those young people with well-placed parents and those without.

Read more >>

Sunday, February 12, 2023

Interest rates: Lowe's not the problem, the system is rotten

When interest rates seem likely to be raised more than they need to be, it’s only human to blame the bloke with his hand on the lever, Reserve Bank governor Dr Philip Lowe. But it’s delusional to imagine that fixing the problem with “monetary policy” is simply a matter of finding a better person to run it.

This assumes there’s nothing wrong with the policy of using the manipulation of mortgage interest rates as your main way of managing the economy and keeping inflation low and employment high. In truth, there’s a lot wrong with it.

It ought to be a happy coincidence that, just as our central bank is making heavy weather of its first big inflation problem in decades, the Albanese government had already commissioned a review of its performance.

Treasurer Jim Chalmers will receive its report late next month. But particularly because the review is headed by an overseas central banker, it’s likely to recommend relatively minor changes to the way the Reserve performs its present role – changing the composition of its board, for instance – rather than answer a more fundamental question: can’t we find a better way to manage the macroeconomy than relying so heavily on dicking around with interest rates?

It’s a pity you have to be as ancient me to know there’s nothing God-ordained about the notion that central banks must have primary responsibility for stabilising the economy, with the elected government’s “fiscal policy” (the manipulation of government spending and taxes) playing a subsidiary role, and the central bankers being independent of the elected government.

This arrangement became the conventional wisdom only in the mid-1980s, after many decades of relying mainly on using the budget, with monetary policy’s job being to keep interest rates permanently low.

The fact is that, as instruments for managing demand, monetary policy and fiscal policy have differing strengths and weaknesses. The switch from fiscal to monetary primacy seemed to make sense at the time, and to hold the promise of much more effective stabilisation of the economy as it moved through the ups and downs of the business cycle.

Then, we were very aware of the limitations of fiscal policy. But after 40 years, the limitations of monetary policy have become apparent. For one thing, we learnt from the weak growth in the decade following the global financial crisis that monetary policy is not effective in stimulating growth when interest rates are already very low and households already loaded with debt.

Now we have high inflation caused primarily by problems on the supply (production) side of the economy. Can monetary policy do anything to fix supply problems? No. All it can do is keep raising interest rates until the demand for goods and services falls back to fit with inadequate supply.

But as a tool for limiting demand, monetary policy turns out to be primitive, blunt and unfair. Its manipulation of interest rates has little effect on borrowing for business investment, and little direct effect on all consumer spending except spending on mortgaged or rented housing.

In practice, this means monetary policy relies on manipulating the housing market to influence consumer spending indirectly. When you want to encourage demand, you cut mortgage interest rates to rev up the housing market. When you want to discourage demand, you raise rates to smash the housing market.

Putting up mortgage interest rates discourages people from buying housing – including newly built homes, which hits the home-building industry directly. But by increasing mortgage payments and rents, it hits consumer spending indirectly, by leaving households with less to spend on other things.

See how round-about monetary policy is in achieving its objective? It hits some people hard, but others not at all. As a reader wrote to me: “It just doesn’t make sense to me that one segment of the population is going through financial pain and suffering when others aren’t affected. Surely, there are [other] ways the government or Reserve Bank can bring inflation under control?”

Good point. Why does stabilising the economy have to be done in such a round-about and inequitable manner? As other readers would tell me, why do older people dependent on interest income have to take a hit whenever the Reserve decides to encourage borrowing and spending by cutting interest rates?

Truth is, central banks can’t afford to worry about whether dicking around with interest rates is fair or unfair: it’s the only tool they’ve got. To someone with a hammer, every problem is a nail.

And although economists have forgotten it, there are other, less round-about and less unfair ways to discourage or encourage consumer spending. In the olden days, governments added a temporary surcharge or discount to the income tax scale.

These days, you could do the same to the rate of the goods and services tax. If you didn’t trust the pollies to do it, you could give the power to an independent commission.

The Reserve rightly asserts that many of the price rises we’ve seen can’t be explained by supply problems, but must be attributed to excessive demand, caused by all the stimulus unleashed during the pandemic.

It fits the monetary policy-primacy mindset to blame this on excessive fiscal stimulus via all the temporary government spending and tax breaks. But a much better case can be made that the excess came from monetary policy.

Indeed, the response to the pandemic may have been far less inflationary than it proved to be had the Reserve left it all to fiscal policy. Since, with the official interest rate already down to 0.75 per cent, it was already almost out of ammunition, I expected the Reserve to sit it out and leave the heavy lifting to fiscal policy.

But no, like the other rich-country central banks, the Reserve leapt in. And, not content with cutting the official rate to 0.1 per cent, it resorted to various unconventional measures, lending to the banks at discount rates and buying several hundred billions-worth of government bonds to lower also multi-year housing fixed interest rates.

While the Reserve was doing this, both federal and state governments were offering people special concessions to buy newly built homes. The combined effect was to give the housing industry a humungous boost. House prices soared, as did the cost of a new home once the supply of building materials and labour ran out.

Guess what? If you take the part of our rise in consumer prices that can’t be attributed to supply problems and imported inflation, you find much of it’s explained by the cost of building a new home, which rose by an amazing 27 per cent over the 18 months to December.

It’s reasonable to believe that our inflation wouldn’t be nearly as bad, had the Reserve left the coronacession to fiscal policy, as it should have. Why didn’t it? Because it, like the other rich-country central banks, now thinks it owns macroeconomic management.

It just had to be out there, pushing the treasurer and Treasury away from the microphone and showing it was in charge – while it made matters worse. This is the central banking problem we - and the other rich countries - should be grappling with.

Read more >>

Monday, November 7, 2022

The cost of living isn't as high as we've been told

So, as we learnt the day after the budget, the cost of living leapt by 7.3 per cent over the past year, right? Wrong. Last week we were told it’s gone up no more than 6.7 per cent for employees, and 6.4 per cent for pensioners and others on benefits.

The 7.3 per cent came from the Australian Bureau of Statistics, and was the rise in the consumer price index over the year to the end of September. The other figures also came from the bureau, and were for the rise in the “living cost index” over the same period for certain types of households.

Why weren’t you told about the second lot? Because the media wanted to avoid confusing you – and because they were better news rather than worse.

Huh? What’s going on? We’re used to using the consumer price index (CPI) as a measure of the cost of living. But the bureau knows it’s not. So, a week later, it always issues its living-cost indexes for key household types – which the media always ignore.

Usually, the differences from the CPI aren’t big enough to worry about. But now they are. Why? Because mortgage interest rates are increasing rapidly. And mortgage interest charges are the main difference between the two measures.

Before late-1998, the CPI measured the housing costs of owner-occupiers according to the interest they paid on their mortgages. But this was changed at the behest of the Reserve Bank, which didn’t want its measure of inflation to go up every time it raised interest rates to get inflation down.

So, since then, the bureau has measured owner-occupiers’ housing costs by taking the price of building a new house or unit. This doesn’t make much sense, since not many people buy a newly built home each quarter. Many of us have never bought a newly built home.

This is why the bureau also calculates separate cost of living indexes, using the same prices as the CPI, but restoring mortgage interest charges, as well as giving the prices different weights to take account of the differing spending patterns of particular household types, such as age pensioners.

New dwelling prices rose by almost 21 per cent over the year to September, meaning they accounted for a quarter of the 7.3 per cent rise in the CPI. By contrast, the mortgage interest charges paid by employee households rose by more than 23 per cent, but contributed only 12 per cent (0.8 percentage points) of the 6.7 per cent rise in their total costs.

Get it? Since mortgage interest charges are a more accurate guide to the costs of owner-occupiers than new-home prices are, the CPI is significantly overstating the rise in the living costs of everyone, from employees to people on social security (and the self-proclaimed “self-funded” retirees, for that matter).

This is a sliver of good news about the extent of cost-of-living pressure on households. It’s better news for people on indexed pensions and benefits: they’ll get what amounts to a small real increase.

But it raises an obvious question: why on earth has the cost of newly built homes shot up by 21 per cent over the past year? After all, this has added hugely to the Reserve Bank’s need to fight inflation by raising interest rates, to the tune of 2.75 percentage points so far.

It’s true the pandemic has caused shortages of imported building materials, but the real blame is down to the economic mangers’ appalling own goal in using grants, tax breaks and cuts in interest rates to rev up the home building industry far beyond its capacity to expand.

It got a huge pipeline of unfilled orders and whacked up its prices, adding no less than a quarter to our soaring inflation rate. Well done, guys.

This raises a less obvious question: federal and state governments were spending unprecedented billions to hold the economy together during the pandemic and its lockdowns. With the official interest rate already down to 0.75 per cent without doing much good, was it really necessary to cut the rate to 0.1 per cent and engage in all that unconventional money creation?

It makes a good case for the new view that, while monetary policy works well when you want to slow demand, it doesn’t work well when you wish to speed it up. Especially when rates are already so low and households already so heavily indebted.

This is something those reviewing the Reserve Bank should be considering.

Read more >>

Friday, September 30, 2022

The knowledge economy is behind the soaring price of land

Over the two centuries and more that people have made a serious study of how the economy works, economists have fallen in and out of love with land. At first, they thought it was at the centre of everything, then they decided it wasn’t terribly important. But the wheel may be turning again. In a major speech last month, the Grattan Institute’s Brendan Coates criticised his profession for its “longstanding intellectual neglect of the economics of land”.

You don’t have to think about housing affordability for long to realise it is not actually the high cost of building a house that’s the problem, it’s the high cost of the land it’s built on.

But why is the cost of land rising much faster than the economy is growing? And why don’t economists take more interest in why this is happening and what we could do about it?

Coates began the annual Henry George Lecture by summarising the history of economists’ waxing and waning interest in land as a resource used to produce goods and services.

The first economists – the Physiocrats – thought of almost nothing other than land, he says. Land was fundamental: agricultural labourers were the source of economic growth, while landlords simply commandeered what the workers produced and flowed it through to the rest of the economy.

The next generation of economists, the “classical” economists of the 18th century, broadened their focus to studying the complex interaction of three “factors of production”: land, labour and (physical) capital.

Adam Smith, a Scotsman known as the father of economics, argued that the “division of labour” – workers specialising in different occupations – and technological innovation were what drove economic growth. But land was still central.

David Ricardo, an English member of parliament, argued that landlords were simply the lucky beneficiaries of land’s natural scarcity (any country has only a fixed amount of it) and its productive capacity, to produce food and fibre and even valuable energy and minerals, Coates says.

And Henry George, the last great classical economist, argued that the rental income enjoyed by landlords must be socialised by taxing the unimproved value of all privately owned land.

Do that, and you wouldn’t need any other taxes. George campaigned hard, but never persuaded any government to follow his advice.

Coates says we “would have done well – possibly much better than we have done – if we’d heeded the lessons of Henry George and paid more attention to the economics of land”.

But in the 19th century the classical economists were replaced by the neo-classical economists, who were a lot less interested in land. And in 1956, the great American economist Robert Solow developed a theory of economic growth, which held that it was improvements in the efficiency with which labour and physical capital (machines and buildings) were combined that drove our standard of living.

The role of land in production - and in inequality - disappeared from the theories economists devised to explain the world, Coates says. Instead, land was treated as just another form of physical capital.

Coates says that “the shifting focus on land in the history of economic thought reflects the changing nature of the economies that economists were trying to explain”.

The Physiocrats observed a world dominated by agriculture. It was obvious that the ownership and use of land determined what got produced, in what quantities. And who got what.

The classical economists watched this world transition through the Industrial Revolution, and the neo-classical economists developed theories for a world that had made that transition.

Economic power started to gravitate towards those who owned capital (whether physical or financial) and away from those who owned land. Agricultural production made way for industrial production.

For most of the 20th century, the neglect of land was of little consequence. More important was the amount of capital invested (to make labour more productive) and the pace of innovation (ditto).

“But as the advanced economies of the world have transitioned again – from manufacturing to services – land is back,” Coates says. Economies powered by intangible capital – how much you know; how much information you can gather – strive or stagnate on the ability of individuals to come together and combine their knowledge and skills.

As any real estate agent will tell you, it’s about “location, location, location”. In Australia, it’s the Grattan Institute that’s done most to help us see that, these days, it’s big cities that drive the economy.

Eighty per cent of the value of all goods and services produced in Australia is generated on just 0.2 per cent of our land. Economic activity is concentrated in CBDs, with the Sydney and Melbourne CBDs accounting for 10 per cent of all economic activity in Australia – more than three times the contribution of agriculture.

This concentration reflects the rise in knowledge-intensive services, clustered together at the hearts of our major cities. The willingness of businesses to pay high rents to locate in the CBDs of our big cities shows the value they gain from access to high-skilled workers and proximity to suppliers, customers and partners.

Similarly, the willingness of workers to pay much higher prices for homes located close to those employment centres shows they, too, see value in being crammed in. Our experience of working from home during the pandemic has changed this a bit – three days in the office rather than five – but not a lot.

All this helps explain why house prices have risen about five times faster than average full-time earnings over the past 25 years. And it means the price of land is a much bigger factor in the economy than it used to be.

It’s leaving existing home owners seemingly much better off, but aspiring home owners much worse off. It’s the product of a clash between the rise of the knowledge economy and our longstanding attitudes towards the taxing and regulation of land.

It should not be beyond the wit of economists to come up with a better approach.

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Wednesday, September 28, 2022

Great Aussie Pipedream: rising house prices make us feel wealthier

I guess you’ve heard. Isn’t it great? Australians are now the richest people in the world. But if you find that hard to believe, congratulations. Your bulldust detector’s working fine.

According to Credit Suisse’s annual global wealth report, which tracks wealth in 20 countries, last year the typical adult Australian’s wealth – assets minus debts – reached almost $336,000.

Soaring property prices lifted our median wealth by $38,000, enough to put us just ahead of Belgium and New Zealand. Our residential property prices rose by almost 24 per cent during the year.

We had about 2.2 million millionaires – measured in US dollars – up from 1.8 million in 2020.

So, what’s the catch? Well, I’m sure there’s nothing wrong with the bank’s calculations. And there’s no denying we’re a rich country, whether by this you mean our annual income, or the value of the net assets, physical and financial, of our households.

No, the problem is that so much of our wealth comes from the value of our home. Do you believe our homes are so much bigger or better, or better located, than homes in North America or Europe?

I doubt it. If not, then what we’re really saying is that the land on which our homes are built is much better than the land on which the Americans and Germans – and Kiwis – have built their homes.

Really? We have better views? Better soil quality? Less chance of getting flooded or burnt out?

No. If the market price of our residential land is higher than their market price, it’s just because we’ve bid our prices up higher than they have theirs.

And how exactly does doing that make Australians richer than people in other countries? If it does, why don’t we keep bidding our prices up until we’re twice as rich as we are now?

See what I’m saying? It’s not something economists talk about much but, as former Reserve Bank heavy Dr Tony Richards explained in a speech many moons ago, the notion that the high prices we charge and pay each other for our homes makes the nation richer is an illusion.

“The increase in housing prices has been a mixed blessing for Australians. At one level, rising housing prices have made many people feel [note that word] wealthier and have contributed to higher levels of consumer spending than might otherwise have occurred. But they have also resulted in concerns about housing affordability,” he said.

“The difference in views reflects the fact that housing is not just an asset but also a consumption item. When housing is thought of purely as a consumption item, it would seem that in aggregate we would be better off if its price were lower.

“Because we all need to consume some level of housing services, either rented or purchased, a higher level of housing prices and rents allows less spending on other items.”

Get it? It seems that, as a nation, Australians value owning their own home, and making sure it’s a good one, more than the people in many other rich countries do.

In consequence, we devote more of our incomes to housing than they do, meaning we spend a smaller proportion of our incomes on everything else. So, to that extent, home ownership really is the Great Australian Dream.

It’s because, as a nation, we can never spend enough on improving our own housing position – although how much we can pay is held back by how much our income allows us to borrow – that house prices have become so sensitive to the rate of interest on home loans.

When rates come down a bit – even during a pandemic – our ability to borrow more prompts more aggressive bidding against other would-be owners, pushing prices up. When, as now, interest rates start going up again, thus reducing how much we can borrow, house prices fall back a bit.

Although there’ve been times when we’ve let our building of extra homes fall behind the growth in our population, over the longer term we’ve managed to keep the two pretty much in line.

So, house prices aren’t high because we don’t have enough houses to accommodate every household. They’re high because some houses are better than others – bigger, newer, flashier, or better located, nearer the beach, nearer other well-off people, or nearer the centre of the city – and we compete with others to get the best we can (barely) afford. And because many home owners want to own more than one, as an investment.

As well, prices in the most desirable parts of the city are higher because of government restrictions on packing in more households by building up rather than out.

But here’s the punchline. Just because higher house prices don’t make us wealthier as a nation, this doesn’t stop them making some Aussies wealthier than other Aussies. Which, for many of us, is what we’re after. Housing is one of the main things we’ve allowed to widen the gap between rich and poor.

And I thought we were supposed to be proud of our Aussie egalitarianism.

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Monday, September 26, 2022

Monetary policy is no longer fit for purpose

It’s an outstanding feature of the modern economy: the multitude of people who could do a far better job of running interest rates than the fool they’ve got doing it at the moment. Welcome to the inquiry into the performance of the Reserve Bank.

One small problem. About half governor Dr Philip Lowe’s critics complain he was too slow putting rates down, while the other half say he was too slow putting them up. Since interest rates are a cost to borrowers but income to savers, it’s hardly surprising that, whichever way the Reserve jumps, many will be complaining.

To be clear, it’s always a good idea to review regularly the performance of an institution with as much power over our lives as the central bank.

But equally, the inquiry needs to focus on the right question. Some critics just want someone to agree with them that the Reserve could have done a better job in recent years. Others – particularly academics specialising in monetary economics – want to argue about the mechanics.

Should we change the monetary target? Since the Reserve’s procedures aren’t identical to the US Federal Reserve’s, doesn’t that mean we’re doing it wrong? Why stack the Reserve’s board with business worthies when it would make much better decisions if you stacked it with academic experts like me and my mates?

Leaving aside those who just care about how much interest they’re paying or receiving, most of those who were pushing for the inquiry have a vested interest in monetary policy continuing to be the dominant instrument used in the year-to-year management of demand. They need monetary policy to stay dominant because their living depends on it.

But monetary policy’s role in the “policy mix” is the most important question. Just as much of the pomp and pageantry we’ve been watching isn’t as ancient as many monarchists imagine, monetary policy has been the main instrument used to manage demand only since the late 1970s.

Before then, fiscal (budgetary) policy was dominant, with monetary policy an afterthought, and the central bank a vassal of Treasury. The switch made sense then, but does it still?

And even then, we got off on the wrong foot, starting by trying to control the supply of money, which didn’t work. We didn’t switch the focus to controlling interest rates until the early ’80s. The inflation target came in the mid-90s, and it wasn’t until 1997 that the Reserve’s independence from the elected government was formalised.

It would be nice to imagine we’re gradually closing in on the one right way to manage the economy, but this would be a delusion. History tells us we keep changing the way we do it to better fit the particular problems of the era. Indeed, it wasn’t until the late 1940s that everyone agreed there was a macroeconomy that needed managing.

The two main “arms” of macro management (we abandoned the third arm, exchange rate policy, in 1983 when maintaining a fixed exchange rate became impossible) have different strengths and weakness.

The great advantage of monetary policy is that the econocrats who run it can ignore the electoral cycle. It can also be adjusted quickly and easily. But after acknowledging that, it’s otherwise inferior to fiscal policy. It can’t be targeted at particular regions or industries, and it takes longer to do what you need it to – with the notable exception of house prices.

Our present problem of sudden, high inflation – caused by disruptions to the supply (production) side of the economy being exacerbated by an overstimulated demand (spending) side – well demonstrates the bluntness, crudeness and unfairness of monetary policy.

This raises two questions. Did we need to use both arms of policy to respond to the pandemic? And how much of our present excess demand can be attributed to monetary policy?

The econocrats defend what, with hindsight, was clearly too much stimulus, by saying they didn’t know how much economic disruption the pandemic would cause, the medicos initially led them to believe it could be much worse than it turned out to be and, anyway, it’s better to err on the side of doing too much than too little.

But none of that says we had to overdo it on both barrels. With the official interest rate already down to 0.75 per cent before the virus arrived, it was clear the Reserve was almost out of ammo. I imagined it would have little more to contribute, leaving fiscal policy to do all the heavy lifting. As it did.

But no, the Reserve rode to the rescue as though it was the only knight that could find a horse. It slashed rates to near zero, offered cheap loans to the banks and, before long, joined the bigger central banks in buying government bonds with created money, to lower longer-term interest rates.

At the time, I wondered whether this was just institutional turf protection. It was the Reserve’s job to be the chief demand manager, and it wasn’t going to sit out the biggest crisis in ages just because it had run out of ammo. We’ll find something we can make into bullets.

Looking back, I suspect the Reserve’s determination not to be left out of the party has added greatly to our new problem and to the pain it’s inflicting on us to fix the problem. When you boil it down, one of the main “channels” through which monetary policy influences demand is by interfering in the cost of housing.

The Reserve is right to say interest rates aren’t the primary cause of high house prices, but because monetary policy is such a one-trick pony, it can only ignore all the pain it inflicts by causing prices to soar when it cuts rates and fall when it raises them.

Between the two arms, they’ve revved up the housing industry, only now to be hitting the brakes. They’ve caused surprisingly few extra homes to be built, but pushed up the price of new homes by 20 per cent, adding 1.8 percentage points to the 6.1 per cent inflation rate.

According to Professor Simon Wren-Lewis, of Oxford, the old consensus among academics that monetary policy should take the lead in demand management, has been replaced by one where interest rates are the favoured instrument to deal with inflation – as now – but fiscal policy should be the main weapon used to fight recessions. Or lockdowns.

Point is, had we followed that rule during the pandemic, we’d now have a much smaller inflation problem. Something the inquiry should ponder. And whether resorting to “unconventional measures” was ever a smart idea.

Read more >>

Wednesday, September 21, 2022

A home of one's own: So good only the rich need apply

Slowly – but sooner than you may think – this country, so proud to be a nation of home owners, is turning into a nation of renters.

Perversely, it’s happening because we value home ownership so highly. And we’ve never much worried about what happens to those who don’t make it onto the home owners’ merry-go-round.

Historically, the reason we want so much to own the home we live in is security of tenure. We don’t want to be beholden to a landlord deciding whether we stay or must go.

We don’t want to live in a place where someone else decides if we can have a pet, whether we can knock a nail into a wall, whether the place needs a coat of paint, or when they’ll get around to fixing the leaky toilet.

That’s always been the chief reason for wanting to own the place you live in. What’s changed is that a second motivation has become more prominent in our minds: homes turn out to be a good investment, a good place to put your savings and watch them grow.

Whereas the value of shares goes up and down with the vagaries of the sharemarket, the price of homes just keeps going up and up. (As we’re seeing now, that’s not quite true, but we still believe it.)

And because home ownership is such a national priority, it comes with many exemptions. When we decided to start taxing capital gains in the mid-1980s, we exempted the family home. And, unlike other assets, the home you own is largely ignored when assessing your eligibility for the age pension.

Any savings I invest in making my principal residence bigger and better won’t be subject to gains tax, as most other investments would.

Actually, homes are such a good investment, why don’t I invest in more than one? I’ll have to pay gains tax when I sell, but this time I’ll get a tax deduction on the mortgage interest I pay.

And naturally, being a home owner with a big investment, I’ll make sure the local council knows how opposed I am to people building those terrible high-rises anywhere near my place.

See what happens? The more benefits we attach to home ownership and the more people want to own a house or three, the more they bid up the price of houses. That makes being on the home owners’ merry-go-round an ever-better investment, but that much harder for others to climb aboard.

The more we favour home owners, the more we disadvantage renters. The more we encourage multiple home owning by those who can afford it – which most rich countries stopped doing long ago – the more unaffordable buying your first home becomes.

But not to worry. I’ll just give my kids a leg up in putting a deposit together. Of course, this just keeps home prices high and makes those kids without well-off parents worse off. Tough.

The other thing it does is more sharply divide Australia by making home ownership something only the well-off can afford.

Why don’t the politicians do something about it? Because that would involve reducing the privileges of existing home owners, who’d fight it all the way, led by real estate agents and developers.

There’s always been a minority of life-long renters but, home ownership being the national obsession it is, we’ve never worried about them. Renters have much greater legal rights in other rich countries than they do here, but that’s never bothered us. Renters, we happily assume, are just youngsters on their way to their first home.

This was never true, but it becomes more untrue as each census passes. In a major speech last week, the Grattan Institute’s Brendan Coates said “home ownership rates are falling fast, especially among the young and poor”.

Over the 40 years to 2021, home ownership rates among 25- to 34-year-olds fell from more than 60 per cent to 40 per cent. Among the lowest-paid 40 per cent of that age group, it has more than halved, from 67 per cent to 28 per cent, Coates said.

Last year’s census shows we’ve started seeing accelerating declines among middle-income households too, with noticeable falls in home ownership at all age levels, including older middle-income households.

The proportion of people who reach retirement never having been able to afford a home is increasing, as is the proportion of home owners retiring with unpaid home loans.

I wouldn’t like to be in the shoes of the 70-year-old pensioner living in a small town, who told Tenants Victoria she had to work two days a week to afford the ever-increasing rent on a granny flat in an old house.

We can keep ignoring the poor treatment of renters because they’ll soon get a place of their own, or we can take the controversial measures needed to stop housing from becoming ever-more unaffordable.

But even if we put through all the necessary changes tomorrow, we’d still end up with many more people spending most of their life as a tenant. Time we cared about renters.

Read more >>

Monday, September 19, 2022

Don't worry about inflation, the punters will be made to pay for it

Our sudden, shocking encounter with high inflation has brought to light a disturbing truth: we now have a dysfunctional economy, in which big business has gained too much power over the prices it can charge, while the nation’s households have lost what power they had to protecting their incomes from inflation.

It has also revealed the limitations and crudity of the main instrument we’ve used to manage the macro economy for the past 40 years: monetary policy – the manipulation of interest rates by the central bank.

We’ve been reminded that monetary policy can’t fix problems on the supply (production) side of the economy. Nor can it fix problems arising from the underlying structure of how the economy works.

All it can do is use interest rates to speed up or slow down the demand (spending) side of the economy. And even there, it has little direct effect on the spending of governments or on the investment spending of businesses.

Its control over interest rates gives it direct influence only on the spending of households. And, for the most part, that means spending that has to be done on borrowed money: buying a home. But also, renting a home some landlord has borrowed to buy.

Get it? The Reserve Bank of Australia’s governor’s power to manipulate interest rates largely boils down to influencing how much households spend on their biggest single item of spending: housing. Because no one wants to be homeless, using interest rates to increase the cost of housing leaves people with less to spend on everything else.

This means the governor has little direct influence over big business’s ability to take advantage of strong demand to widen its profit margins. He must get at businesses indirectly, via his power to reduce their customers’ ability to keep buying their products.

Get it? Households are the meat in the sandwich between the Reserve and big business (with small business using the cover of big business’s big price hikes to sneak up their own profit margins).

Join the dots, and you realise the Reserve’s plan to get inflation down quickly involves allowing a transfer of many billions from the pockets of households to the profits of big business.

On one hand, big business has been allowed to raise its prices by more than needed to cover the jump in its costs arising from the supply disruptions of the pandemic and the Ukraine war. On the other, the loss of union bargaining power means big business has had little trouble ensuring its wage bill rises at a much lower rate than retail prices have.

So, it’s households that are picking up the tab for the Reserve’s solution to the inflation problem. They’ll pay for it with higher mortgage interest rates and rents, and a fall in the value of their homes, but mainly by having their wages rise by a lot less than the rise in their cost of living.

The RBA’s unspoken game plan is to squeeze households until demand for goods and services has weakened to the point where big business decides that raising its prices to increase its profits would cost it so many sales that it would be left worse off.

It may even come to pass that households have been squeezed so badly big businesses’ sales start falling, and some of them decide that cutting their price to win back sales would leave them better off.

In economists’ notation, maximising profits – or minimising losses – is all about finding the best combination of “p” (price) and “q” (quantity demanded).

You don’t believe big businesses ever cut their prices? It’s common for them to “discount” their prices in ways that disguise their retreat, using special offers, holding sales, and otherwise allowing a gap between their advertised price and the price many customers actually pay.

But why would that nice mother’s boy Dr Philip Lowe, whose statutory duty is to ensure that monetary policy is directed to “the greatest advantage of the people of Australia”, impose so much pain on so many ordinary people, who played no part in causing the problem he’s grappling with?

Because, as all central bankers do, he sees keeping inflation low as his central responsibility. And he doesn’t see any other way to stop prices rising so rapidly. It’s a case study in just what a crude, inadequate and blunt instrument monetary policy is.

Lowe justifies his measures to reduce inflation quickly by saying this will avoid a recession. But let’s not kid ourselves. This massive transfer of income from households to business profits will deal a great blow to the economy.

After going nowhere much for almost a decade, real household disposable income is now expected to fall for two years in a row. And who knows if there’ll be a third.

Economists have made much of the extra saving households did during the pandemic. But during Lowe’s appearance before the parliamentary economics committee on Friday, it was revealed that about 80 per cent of that extra $270 billion in saving was done by the 40 per cent of households with the highest incomes. So, how much of it ends up being spent is open to question.

The likelihood that our measures to weaken household spending will lead to a recession must be very high.

Until Lowe’s remarks before the committee on Friday, his commentary on the causes and cure of inflation seemed terribly one-sided. The key to reducing inflation was ensuring wages didn’t rise by as much as prices had, so that rising inflation expectations wouldn’t lead to a wage-price spiral.

He warned that the higher wages rose, the higher he’d have to raise interest rates. He lectured the unions, saying they needed to be “flexible” in their wage demands. You could see this as giving an official blessing to businesses resisting union pressure and granting pay rises far lower than prices had risen.

Lowe could just as easily have lectured business to be “flexible” in passing on all the higher cost of their imported inputs, when these were expected to be temporary – but he didn’t. He’s always quoting what business people are saying to him, but never what union leaders say – perhaps because he never talks to them.

But on Friday he evened up the record. “It is also important to note that, to date, the stronger growth in wages has not been a major factor driving inflation higher,” he said. “Businesses, too, have a role in avoiding these damaging outcomes, by not using the higher inflation as cover for an increase in profit margins.”

That’s his first-ever admission that, when conditions allow, business has the market power to raise its prices by more than just its rising costs. Problem is, monetary policy’s only solution to this structural weakness – caused by inadequate competitive pressure – is to keep demand perpetually weak.

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