House prices are out of control in some Australian capitals. And this week comes a proposal that this should be countered by halting interest rate cuts, a move that would not only fail to solve the problem but also have detrimental impact on the rest of the country, where housing is not booming.
In 2016, the prices of dwellings rose by 16 per cent in Sydney, 14 per cent in Melbourne and 11 per cent on average across all the capitals, according to CoreLogic, but prices fell by 4 per cent in Perth.
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The ABS has capital city prices almost doubling since 2003, with Sydney prices increasing by 50 per cent since 2013.
Certainly, this rate of increase cannot be sustained. House prices in the booming cities are growing much faster than incomes, and are either going to slow or fall. It may not happen soon, but it will happen.
But are we in a house price bubble right now? We can't say for sure.
'Unsustainable' house prices
Market bubbles are never perfectly clear at the time, otherwise the galloping price increases would stop. So don't let anyone get away with 'claiming conclusively' that there is a housing bubble.
Regardless, price growth is unsustainable and will come to an end. The economy will suffer a hit if prices suddenly stopped growing, but the effect could be severe if prices started to fall.
While the regulators think that banks can absorb a hit to house prices, the effect on construction and real estate could be large, and price falls are expected to cause homeowners to cut consumption, meaning the impact spreads throughout the whole economy.
![One thing is certain - the current price growth is unsustainable and will come to an end.](/web/20170115161823im_/http://www.smh.com.au/content/dam/images/1/3/2/k/r/q/image.related.articleLeadwide.620x349.gtp9qi.png/1484453383969.jpg)
This is an important risk; what should be done in response? In addition to the suggestion that planned interest rate cuts should be cancelled, the OECD has even suggested rates should increase to cool the housing market.
However, this is exactly the wrong solution to the problem.
![No one should be claiming we are definitely in a housing bubble right now.](/web/20170115161823im_/http://www.smh.com.au/content/dam/images/g/t/q/p/v/b/image.related.articleLeadwide.620x349.gtp9qi.png/1484453383969.jpg)
While housing in some areas is going gangbusters, the rest of the economy is not. Economic growth is sluggish, particularly with the negative quarter of growth in September 2016. Wages growth after inflation is almost non-existent, forecast to be 0.5 per cent during this financial year and the next.
There goes our next holiday.
And business investment is terrible. Mining investment is expected to halve over the next three years, but non-mining investment isn't replacing it.
As a result, overall business investment is set to be at near-record lows: lower than the levels reached in the 1970s and 1980s recessions, and only barely above the levels reached in the depths of the 1990s recession, as shown in the graph below. And yet interest rates are lower today than in each of these previous recessionary periods.
Timing not right
Meanwhile, the Reserve Bank is forecasting underlying inflation to be less than two per cent for the next two years, below their target range of 2-3 per cent.
This hardly seems a time to prohibit lower interest rates, or, worse, push for higher rates. The collateral damage to the non-housing economy is not worth it. "But we must have higher rates to prick the housing bubble," the cry will go out. However, this knee-jerk response ignores other tools that are much better targeted at the housing market.
In particular, the rules about mortgage lending could be changed directly. The blunt tool of interest rates affects both housing and business lending. However, the regulations on bank lending can be targeted at particular parts of the market.
Banks could be required to hold more capital against home loans, and stricter standards could be required for loans with low deposits, while standards for non-housing lending remain unchanged. While these might be onerous regulations on banks, they won't cause substantial collateral damage to the rest of the economy, but will raise the cost of borrowing for property buyers.
Thinking outside the box
There are plenty of other ways to restrain housing price growth, including shortening planning delays - which have blown out substantially in Sydney - and trimming population growth, which is a fundamental driver of demand.
Releasing more land and relaxing planning laws are also important solutions, but these take considerable time to change. Building transport infrastructure to underpopulated areas takes even longer.
And despite what some claim, changing negative gearing or CGT won't have a large effect on house prices; but will cause other problems.
Most property is owner-occupied, so is unaffected by these tax changes. In addition, the tax changes won't substantially change the total demand for properties, it will just change the mix between renters and homeowners. Tax changes won't suddenly mean the population grows or shrinks; the need for property (whether rented or owned) will remain broadly the same.
It is worthwhile to try to dampen runaway house prices (I say this as a homeowner myself) but slower house price growth harms existing owners. And any dampening strategy should not be at the cost of inhibiting economic growth, investment or wages, which are currently weak and need all the help they can get.
Michael Potter is a Research Fellow in the Economics Program at the Centre for Independent Studies and author of 'The looming crisis in business investment' in the Summer 2016?17 edition of Policy journal.
This story first appeared in Business Insider. Read it here or follow BusinessInsider Australia on Facebook.
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