Working Papers

Fundamentals of House Price Inflation

There is a remarkable coincidence between Q3 capital city house price growth and growth in state final demand, as recorded in the Q3 national accounts.  House prices in Sydney have recorded the largest decline of the capital cities at -4.7% y/y.  NSW also saw the weakest growth in state final demand of 2.3% y/y.

The two cities with the strongest annual house price growth were Darwin, NT at 21.9% y/y and Perth, WA at 17.7% y/y.  These just happen to be the capitals of the mainland states that recorded the strongest growth in state final demand at 13.6% y/y and 6.7% y/y respectively.

This is an interesting test of causality. It has been common for analysts to attribute moderating economic growth nationally to a wealth effect from more subdued growth in house prices.  Yet we know that economic growth in WA and NT is benefiting strongly from the global boom in commodity prices, a development that is entirely exogenous to the domestic economy.  This would strongly suggest that it is broader economic developments that are driving house prices, not the other way around.  On a state-by-state basis, house prices would seem to have a firm connection with fundamentals.

posted on 07 December 2005 by skirchner in Economics

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On a state-by-state basis, house prices would seem to have a firm connection with fundamentals.

That could be true enough for small states like WA and NT where a small increase in income could generate a large asset price appreciation. But Sydney’s house price decline is more a correction to a previous inflation than a correspondence to weak growth.

Or is I-E suggesting that the post-Olympics bubble in house prices was related to a spurt in Sydney’s real income growth. That would be a big call.

PS What is I-E’s response to the OECD report that concluded Australia’s house prices, based on an analysis of fundamentals, were 50% overvalued? Tim Colebatch summarises:

on each of its three measures, Australia was one of four countries where house prices were most out of line with fundamentals.

Of 15 OECD countries compared in the study, Australia had the highest prices relative to rental levels, the third-highest prices relative to incomes, and the fourth-highest levels of household debt relative to incomes.

Posted by Jack Strocchi  on  12/07  at  04:53 PM

I suggest you look at the fine print of the OECD report, not Tim’s summary!

Posted by skirchner  on  12/07  at  05:02 PM

Its clear that the resources boom is fueling house price growth in WA and NT, but its a different story in NSW.  Sydney house prices peaked in late 2003, and I’m pretty sure there was no evidence of a slowdown in GDP growth in NSW until late 2004 or early 2005.

How about you post a chart that compares NSW house prices with NSW GDP growth, and lets see which line dips first?

P.S. I read the entire OECD report and I didn’t see anything suggesting Australia’s house prices are anything but overvalued.  Of particular interest was the long list of recent mortgage “innovations” in Australia.  In the US, Interest only loans are considered a recent mortgage innovation.  Aussie lenders are decades ahead!

Posted by .(JavaScript must be enabled to view this email address)  on  12/08  at  12:54 PM

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