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.

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Treasury thinks the unthinkable: yes, intervene in the gas market

If you think economists say crazy things, you’re not alone. Speaking about our soaring cost of living this week, Treasury Secretary Dr Steven Kennedy told a Senate committee that “the solution to high prices is high prices”. But then he said this didn’t apply to the prices of coal and gas.

How could anyone smart enough to get a PhD say such nonsense? He even said – in a speech actually read out by one of his deputies – that this piece of crazy-speak was something economists were “fond of saying”.

It’s true, they are. If they were children, we’d call it attention-seeking behaviour. But when you unpick their little riddle, you learn a lot about why economists are in love with markets and “market forces”, why they’re always banging on about supply and demand, and why (as I’ve said once or twice before) if economists wore T-shirts, what they’d say is “Prices make the world go round”.

At the heart of conventional economics – aka the “neo-classical model” – lies the “price mechanism”. Understand this, and you understand why the thinking of early economists such as Adam Smith and Alfred Marshall is still influential a century or two after their death, and why, of all the people seeking the ears of our politicians, economists get more notice taken of their advice than other professions do.

The secret sauce economists sell is their understanding of how a lot of seemingly big problems go away if you just give the price mechanism time to solve them.

A market is a place or a shop or cyberspace where people come to sell things to other people. The sellers are supplying the item; the buyers are demanding it. The seller sets the price; the buyer accepts it – or sometimes they haggle or hold an auction.

If the price of some item rises, this draws a response from the price mechanism, which is driven by market forces – the interaction of supply on one side and demand on the other.

The price rise sends a signal to buyers and a signal to sellers. The message buyers get is: this stuff’s more expensive, so make sure you’re not wasting any of it.

And see if you can find a substitute for it that’s almost as good but doesn’t cost as much. If you’ve been buying the deluxe, big-brand version, try the house brand.

On the other side, the message to sellers is: since people are paying more for this stuff, produce more of it. “I’m not in this business, but maybe now the price is higher, I should be.” If the price has risen because the firm’s costs have risen, maybe we could find a way to cut those costs, not put our price up and so pinch customers from our competitors.

See where this is going? If customers react to the higher price by buying less, while sellers react by producing more, what’s likely to happen to the price?

If demand for the item falls, and the supply of the item increases, the higher price should come back down.

Saying the solution to high prices is high prices is a tricky way of saying market forces will react to the price rise in a way that, after a while, brings it back down again.

When demand and supply get out of balance, market forces adjust the price up or down until demand and supply are back in balance. The price mechanism has fixed the problem, returning the market to “equilibrium”.

This is the origin of the old economists’ motto: laissez-faire. Leave things alone. Don’t interfere. Interfering with the mechanism will stop it working properly and probably make things worse rather than better.

There’s a huge degree of truth to this simple analysis. At this moment there are thousands of firms and millions of consumers reacting to price changes in the way I’ve just described.

Kennedy admits that “there are many conditions that underpin” this do-nothing policy, but “in most circumstances Treasury would support such an approach”.

There certainly are many simplifying assumptions behind that oversimplified theory. It assumes all buyers and sellers are so small they have no power by themselves to influence the price.

It assumes all buyers and all sellers know all they need to know about the characteristics of the product and the prices at which it’s available. It assumes competition in the market is fierce. And that’s just for openers.

However, Kennedy said, the circumstances of the price shocks caused by the Ukraine war are “different and outside the frame” of Treasury’s usual approach. Such shocks bring government intervention in the coal and gas markets “into scope”. That is, just do it.

“The current gas and thermal coal price increases are leading to unusually high prices and profits for some companies,” he said. “Prices and profits well beyond the usual bounds of investment and profit cycles.

“The same price increases are leading to a reduction in the real incomes of many people, with the most severely affected being lower-income working households.

“The energy price increases are also significantly reducing the profits of many [energy-using] businesses and raising questions about their viability.”

In summary, Kennedy said, the effects of the Ukraine war are leading to a redistribution of income and wealth, and disrupting markets. “The national-interest case for this redistribution is weak, and it is not likely to lead to a more efficient allocation of resources in the longer term,” he said.

(The efficient allocation of resources – land, labour and capital – is the main reason economists usually oppose government intervention in the price mechanism. Markets usually allocate resources most efficiently.)

The government’s policy response to the problem could take many forms, Kennedy said, but with inflation already so high, policymakers “need to be mindful of not contributing further to inflation”.

This suggests that intervening to directly reduce coal and gas prices is more likely to be the best way to go, he concluded.

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