Robert Shiller on Australia’s House Price ‘Bubble’

Robert Shiller has an op-ed in the WSJ that attempts to use Sydney as an example of a house price ‘bubble’ gone bust:

Real home prices in Sydney, Australia, rose 12.8% in 2003 and then dropped 2.5% in 2004, a pretty sharp bursting of their bubble.

The Q1 data released today actually show an even larger fall in real terms of 5.8% y/y (-3.4% y/y in nominal terms).  But if a 2.5% fall in real terms following double-digit growth rates is enough to satisfy the definition of a ‘burst bubble,’ then this is in fact a fairly routine occurrence for Sydney.  This is just another way of saying that real house prices cycle and any given boom needs to be interpreted with reference to the cycle as a whole, not taken out of context.  Much of the run-up in Sydney house prices in recent years is arguably compensation for previous cyclical weakness, in which house price growth was well below trend.  Since Shiller’s Irrational Exuberance was little more than an argument in favour of mean reversion in stock prices, none of this should be surprising to him. 

Shiller is nonetheless right to suggest that Sydney provides an example of how house price inflation might end: benignly.  None of the doomsday scenarios based on an end to house price inflation have been realised (many of these forecasts were just publicity seeking exercises by economic consultancies).  Sure, the economy has slowed on some measures, but there is an important issue of causality here.  As I have argued previously, Sydney real house prices have at best a contemporaneous and often a lagging relationship with economic activity. 

As always, ‘bubble’ talk is just a distraction from fundamentals.  If Shiller had done a search for stories about fundamentals rather than bubbles, he would have come up with no end of stories like this:

Sydney will need to squeeze in 7000 extra apartment blocks to house the million-plus new people expected by 2030…

UPDATE: Alan Wood is also unimpressed by the claim that a 2.5% decline in real terms constitutes a burst bubble (no link):

Really?  Australia’s house prices more than doubled in real terms, and a fall back of 2.5% isn’t that nasty, although it may be having some effect on household spending.

There have in fact been no less than 10 quarters since Q2 1987 in which Sydney house prices fell by more than 2.5% y/y in real terms, although this probably says as much about consumer price inflation as it does about house prices.

posted on 03 June 2005 by skirchner in Economics

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Housing and the National Accounts

The Q1 headline GDP outcome of 0.7% q/q sparked none of the hysteria attaching to the Q4 result (now revised up to 0.3% q/q).  Yet domestic final demand contributed nothing to headline growth in Q1.  Consumption and investment were a wash, leaving a large run-up in inventories to fully account for the growth in gross national expenditure, before the subtraction from net exports.

Another little remarked upon feature of the national accounts was that ownership transfer costs, a reasonable proxy for turnover in the established housing market, did not subtract from growth for the first time since Q4 03 (rounding to a tenth of one percentage point).  One of the reasons I have been so dismissive of the gloom and doom scenarios in relation to house prices is that weakness in the housing market is seen on volumes as much as prices.  Ownership transfer costs in chain volume terms have fallen by 17.1% over the year to March, but the decline has moderated every quarter since March last year.  While weakness in house prices still has further to run (see this Friday’s release of the ABS series), the worst of the decline in transaction volumes would appear to be behind us based on past cyclical experience with this series.  The stylised Australian house price cycle of recent decades would point to a bottoming of house prices relative to trend by the end of 2006.

posted on 02 June 2005 by skirchner in Economics

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Gloom, Doom and Boom Competition: We Have a Winner!

This week’s record current account deficit once again provided rich pickings for our quarterly Gloom, Doom and Boom competition for overwrought reporting.  AAP deserves the Speedy Banana Award for referring to a ‘banana republic’ in a story just minutes after the release: 

As a proportion of GDP, the current account deficit is around a record 7.2 per cent, prompting analysts to warn Australia is in danger of becoming a “Banana Republic”.

Of course, no analyst was actually quoted as saying anything of the sort, suggesting that AAP was engaging in the usual colour-by-numbers financial market journalism.

John Garnaut gets some credit for running a (somewhat selective) version of the consenting adults view of current account deficits, but then disappoints when he says:

The current account deficit, or CAD - which reflects the shortfall between exports and imports as well as financial transactions with the rest of the world - showed Australians paid foreigners $15.6 billion more than they received from them in the three months to March.

In fact the CAD shows the opposite – that foreigners lent us $15.6bn to make-up the shortfall between domestic investment and saving.

John Quiggin (in comments) seemed almost ready to concede the consenting adults view, noting:

Past experience would suggest either a recession or a sustained period of low growth, particularly in consumption. But we’re in uncharted territory here, and the optimists say global financial markets will look after us.

As RBA Governor Macfarlane noted in his most recent testimony to the House Economics Committee, many people were declaring the US current account deficit unsustainable at 5%.  The new cyclical highs in the US and Australian current account deficits suggest that there has also been a structural deterioration in the current account balances of both countries.  Quiggin questions whether we are heading for a current account deficit of 10% of GDP.  In a world of floating exchange rates and mobile capital, there is no reason why such large deficits should not be possible.  Indeed, deficits of that size would be a massive vote of confidence in the Australian economy.

The lucky winner of our competition, however, goes to…

continue reading

posted on 01 June 2005 by skirchner in Economics

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Non!  Right Decision, Wrong Reasons

France has made the right decision for the wrong reasons on the EU Constitution.  As David Carr puts it:

To all French crypto-communists, syndicalists, marxists, trotskyites, leninists, stalinists, national socialists, socialist nationalists, primitivists, Trade Union dinosaurs, student activists, greenie nutters, neo-fascists, old fashioned fascists, quasi-crypto-troglodyte-Pol-Pottist-year zero-flat-earthers, looney tunes and enviro-goons….Merci Beaucoup!!!!

I could kiss every single one of you.

You first Dave!  Unfortunately, we can take little comfort from the result because, as incredible as it may seem, many French people saw a ‘no’ vote as a rejection of market liberalism. 

It is disturbing the extent to which the EU project is still taken as given among elite opinion, despite being rejected on most occasions when EU institutions are actually put to a popular vote and growing evidence that foundational EU institutions like the euro are hopelessly flawed.  A good example of this thinking is Anatole Kaletsky’s analysis attributing the failure of the referendum to the European Central Bank’s monetary policy:

Europe’s economic failure can be blamed largely on the mismanagement of the euro project and the incompetence of the European Central Bank (ECB)…[and] do-nothing monetarist dogmatism of the ECB…The next recourse should be to call for the resignation of the ECB management, since they should be held accountable for the public rejection of the European project.

It apparently does not occur to Kaletsky that problem is the euro project itself, no matter how well managed, and that maybe the ECB is doing the best we could reasonably expect within the constraints of a single currency.  Critics of the euro having been warning of these very outcomes for years.  An easier monetary policy would do nothing to address Europe’s structural problems.

The danger is that the more EU institutions fail, the more politicians will resort to ad hoc fixes, rather than re-thinking the EU project itself.  The euro has already seen the Stability and Growth Pact effectively junked, removing an important institutional protection of monetary stability in Europe.  Kaletsky calls for European finance ministers to direct the ECB to engage in foreign exchange market intervention and even goes so far as to suggest that the legislative basis for ECB independence should be renegotiated.  It is in fact Kaletsky who is blinded by dogmatism in refusing to see that the euro project is fundamentally flawed.  In Europe, nothing succeeds like failure.

posted on 30 May 2005 by skirchner in Economics

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Gloom, Doom and Boom Competition

It’s time once again for our Gloom, Doom and Boom Competition based on the quarterly current account (released Tue).  Nominations for the most ridiculous and overwrought reporting on this release are now open.  Bonus points for gratuitous ‘banana republic’ references.  Can Tim ‘Australia is still borrowing heaps’ Colebatch make it a double with his adolescent prose? 

The current account should post a new record deficit, although the Q2 headline GDP outcome should see an upside surprise relative to current market expectations, so this should keep the worst of the doom-mongering in check.

While on the subject of nonsensical reporting on current account balances, it should be mentioned that the less than efficient people at The Economist magazine have finally caught up with the fact that I haven’t paid my bill in more than a year and switched off my access to their web edition.  It would seem perverse to subscribe just to continue poking fun, but I would nonetheless be grateful for reader tips on the Economist’s contents.  This goes for other publications too of course.  I can only keep tabs on so much, so if you think I have missed something, feel free to bring it to my attention.

posted on 29 May 2005 by skirchner in Economics

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HKSAR’s Dysfunctional Currency Board

There is a minority tendency in classical liberal circles that retains a fetish for fixed exchange rate regimes, inspired by various hard money doctrines, despite the terrible havoc these regimes have wrecked on emerging market economies in recent years.  Contrary to what Steve Hanke might have you believe, Hong Kong’s currency board is no exception.  Yeung Wai-Hong totes up the damage:

since the peg was put in place there have been repeated bouts of speculative runs on the Hong Kong dollar…In the name of defending the peg, the government ended up nationalizing more than a tenth of the blue chips traded on the stock market.

A quarter of a century should be time enough to prove the validity of any theory. The verdict on the Hong Kong dollar peg is out: It has flunked. The need to defend the peg has led Hong Kong down an increasingly interventionist path that is incompatible with a free market economy.

posted on 26 May 2005 by skirchner in Economics

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Mankiw on Clueless Pundits

Greg Mankiw interviewed in Fortune:

There are a lot of preconceived notions from people in the media who write stuff based on no knowledge at all. There are a lot of people who just make stuff up…Let me give you example. This is as I was arriving [as the new chair of the White House Council of Economic Advisers]. Glenn Hubbard, my predecessor, was leaving. I read one of Paul Krugman’s New York Times’ columns, and he said something like, “Hubbard said he was leaving to be with his family, but you could see the knives sticking out of his back.” The suggestion was that he’s being kicked out. I knew that wasn’t true. I knew I got the job in large part because Glenn recommended me. So here we have Krugman sitting in some office in New Jersey making a supposition about what’s going on in Washington and then writing for the New York Times, with readers presuming that he knew something.

posted on 25 May 2005 by skirchner in Economics

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Hubbard Brand Tax Reform

Glenn Hubbard’s brand of tax reform:

My brand of reform would tax all income only once—wages at the household level and business income at the business level. That’s a big improvement over the convoluted mix of preferences (special provisions or tax shelters) and biases (double taxation or worse) under current law.

Indeed, unlike today’s devilishly difficult code, landmark changes can be simple. First, individuals would pay a tax on compensation, but not on income from savings (dividends, capital gains, and business interest). All businesses would be taxed on sales, less the costs of materials, wages, and a portion of capital expenses. Under an income tax, that capital expense would be a depreciated value over a period of years. Under a consumption tax, it would be 100% expensed. But both would end the double taxation of income on savings.

Following the link for the AEI’s Toward Fundamental Tax Reform.

posted on 24 May 2005 by skirchner in Economics

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Libertarian Party HQ Discovered

It’s the tinfoil hat house.

(via Tim Blair)

posted on 24 May 2005 by skirchner in Politics

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Budget Deficit Myths & Realities

Alan Reynold’s Cato Policy Analysis on the subject of budget deficits, interest rates and taxes is a useful antidote to the small cottage industry of blogs trafficking in all sorts of nonsense on these subjects in the US context.  Just some of the myths neatly dispatched by Reynolds:

In reality, neither actual nor projected budget deficits raise real or nominal interest rates, steepen the yield curve, reduce national savings, cause trade deficits, or make the dollar go down or up.

posted on 21 May 2005 by skirchner in Economics

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The Real Costs of Taxation

Ross Gittins is criticising the budget tax cuts by appealing to the seemingly common sense notion that the rich do not need an incentive to work.  Yet high marginal tax rates do not need to have a negative effect on labour supply to be costly.  The welfare costs associated with high marginal rates have more to do with distortions to decision-making.  These distortions can be costly simply by changing the way in which labour is supplied, they do not need to have a negative impact on supply per se.  This applies not just to decisions about labour supply, but also saving and investment, tax avoidance and evasion.

Gittins contradicts himself in making this argument, since he has been at the forefront of those arguing that the concessional treatment of capital gains has been a major culprit in the investment property boom and house price inflation.  Of course, Gittins sees this as an argument against the concessional treatment of capital gains, rather than one in favour of lowering high marginal rates, but he readily accepts the notion that taxes can have a significant distortionary impact on decision-making when it suits him.

The literature suggests that behavioural responses to changes in marginal tax rates are concentrated at the top end of the income scale, where most revenue is collected, which is why the welfare costs of taxation are so high (see Alex Robson for some US estimates in this regard).

posted on 19 May 2005 by skirchner in Economics

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Intrade Fed Chair Contract

Intrade has opened contracts on potential replacements for Greenspan as Chairman of the Federal Reserve Board.  My sentimental favourite would be John Taylor.  My non-sentimental favourite would be Martin Feldstein.

posted on 19 May 2005 by skirchner in Economics

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CIS Liberty & Society Seminar in Sydney

The Centre for Independent Studies is recruiting for its July Liberty & Society Seminar.  As a graduate of both the IHS and CIS L&S programs, I can highly recommend the experience:

Liberty and Society, a unique programme for young people living in Australia, New Zealand and other surrounding countries. The goal of Liberty and Society is to create an intellectual environment where ideas and opinions about what makes a free society can be discussed, argued and learnt.

Liberty and Society is for young people who may be questioning the standard answers they are getting regarding social, political and economic issues. You may not see yourself as a fitting into the ‘left’ or ‘right’ mould. This is an opportunity to consider the classical liberal perspective. Classical liberalism promotes individual freedom, private property, limited government and free trade.

In other local seminar news, Bruce Caldwell, author of Hayek’s Challenge, will be speaking at the 18th HETSA Conference at Macquarie University, 5-8 July.

posted on 18 May 2005 by skirchner in Misc

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Another Great Post-Budget Address from Treasury Secretary Henry

Treasury Secretary Ken Henry’s annual post-Budget address to ABE is invariably one of the most interesting contributions to public debate about economic policy.  This year’s address is particularly pleasing for the fact that it echoes this blog’s criticisms of the popular hysteria about the current account deficit.  As Henry makes clear, the deterioration in Australia’s current account is a reflection of the fact that we are getting richer via the terms of trade:

The sustained gap between growth in ex post (realised) real domestic demand and real output over the past three years does not provide unambiguous evidence of ex ante (planned) demand for domestic product running ahead of increasingly constrained supply. Instead, it can, at least partly, be explained by strong substitution of relatively cheap imports for domestic product.

Needless to say, I am not convinced that there is a case for allowing the tax to GDP ratio to rise to off-set the income boost from higher export prices. I don’t think it obvious at all.

And don’t miss the none too subtle dismissal of Ross Gittins in footnote number 2! 

Tomorrow’s headlines will be full of hysterical beat-ups about differences between Treasury and the RBA over policy, which is unfortunate, because it only distracts attention from the substantive issues being raised by Henry.

posted on 17 May 2005 by skirchner in Economics

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The Political Economy of Tax Reform

This insider account of the how the budget tax cuts were framed is quite revealing about the political economy of tax reform in Australia:

All the savings and outlays were known. What had not been finalised was the size and shape of the tax cuts because the final revenue figures were not known.

Both Howard and Costello are Liberal leaders committed to a doctrine of returning revenue to taxpayers if they can do so after achieving a budget surplus and paying for services (emphasis added).

What this outtake reveals is that the government views tax relief as just a residual, to be funded only out of the surplus.  The government has given no thought to tax reform over and above what is made possible by the surplus.  What is missing from this formulation is any consideration of reductions in government spending as a means of lowering the tax burden.  In the absence of such spending cuts, a meaningful reduction in the overall tax burden, as opposed to just a hand back of bracket creep, is impossible.

As it happens, the government has used the Future Fund as a cloak of respectability for retaining a large part of the surplus, which will now be used to partially nationalise financial markets for the benefit of future consolidated revenue.  The absurdity of this arrangement is that it makes no difference whether public service superannuation liabilities are paid for out of current revenue or future spending.

Terry McCrann suggests a better approach to budget strategy (no link):

The best way to generate the revenues to meet all obligations of tomorrow, is to maximise contemporary output in the context of building the highest sustainable growth path for the economy.

And one of the best ways to do that is to devote all surpluses to tax cuts/reform so that the budget remains essentially balanced year-in and year-out.

Meanwhile, don’t miss this important letter to shareholders from John Howard, MD of Aust Ltd:

Furthermore, the Board has decided to change the Articles of Association to require all future profits to be applied to the staff superannuation fund which, thanks to over-generous employment agreements in the past providing for sumptuous lifetime pensions for all staff, is in the red to the tune of $91 billion.

The decision to apply all future profits to eliminating this liability means, unfortunately, that the moratorium on reinvestment in the assets of the business will continue for at least another six years.

posted on 14 May 2005 by skirchner in Economics

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