My Last Blog on Housing Prices in New Zealand, Australia and the US

Housing price increase and monetary impulse transmission mechanism explain the demand for housing and rising prices.

Economists in New Zealand recognize that the rising housing price is related to short supply of lands, zoning, council restrictions, etc. Thus the supply curve of housing is rather very steep (maybe vertical).

The demand curve for housing is downward slopping. When demand shifts up for any reason, the price of housing increases substantially because of the steepness of the supply curve.

Some people call the significant house price increase, a bubble, but it is just a natural result stemming from the steepness of the supply curve.

Others think that the increase in population growth, particularly because of immigration, increases the demand for housing, hence higher price. Not true, because the variations in total population growth are too small compared with the variations in housing price growth. Housing price variation is 14 times larger than population’s.[1]

Population growth cannot explain housing price.

The same is true in Australia; variations of housing prices 20 times bigger than population’s.[2]In the US, the variations is 24.75 times bigger than populations.[3]

The most likely shifter of the demand for housing (and demand for all assets), however, is an increase in the demand for money. The monetary policy regimes in New Zealand and Australia, among many other developed nations, ignore money totally. The Reserve Banks control the short-term interest rate so when the demand for money increases the central banks supply the required amounts at a particular interest. The story ends here for them.

In fact, the story does not end there in the market. The increase in the demand for money demand affects relative assets prices because it changes the marginal utility of money relative to the marginal utility of all assets, thus relative prices must change. This is the standard Portfolio Theory transmission mechanism, which has been totally ignored by central banks. Once relative prices changed people adjust their holdings of money, bonds, and other assets. This is a continuous dynamic process to establish equilibrium in the money and asset markets, and eventually money has to be willingly held.

With inflation and interest rates low, the cost of holding money is very small. Money demanded and supplied must be spent on the purchases of assets and goods, hence high prices.

The variation in money matches the variation in housing prices in New Zealand and in Australia and the US.[4] The scatter plots below show the relationships between money growth (Red), population growth (Blue) and house price growth. The variations along the 45 degree line clearly favor money as a likely driver of high demand for housing rather than population.

The same is true for Australia and the US.

In 2013 I wrote about Macro Prudential policy. One of my arguments to dealing with rising house price was to stick to monetary policy rather than venture into regulations. To do so I suggested a new price index, which includes house prices. It could also include other asset prices. The central bank could target that index because asset prices respond to monetary policy. Interest rate could reduce demand for all goods, services, and assets. The current inflation targeting regime does not recognize that a random increase in the demand for money increases demand for assets such as housing.

My paper (with Moosa) -Monetary Policy, Corporate Profit and House Prices - is  forthcoming in Applied Economics.

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[1] Using quarterly data from Mar 1991 to Jun 2017, the standard deviation of population growth is 0.001385 while that of housing price is 0.019592.

[2]  For data from Dec 2003 to Jun 2017, the standard deviation of housing price growth is 0.018 compared with 0.0009 for population growth.

[3] For data from Mar 1975 to June 2017, the standard deviation of housing price growth is 0.0124 compared with 0.0005 for population growth.

[4] The standard deviation of M1 growth and housing price growth in New Zealand are almost equal, 0.024 and 0.019 respectively. For Australia, they are 0.02 and 0.018 respectively. For the US, they are 0.0143 and 0.0124 respectively.