Unemployment and house prices (revisited)

Back in May I published an article, Unemployment and house prices, that sought to determine whether changes in employment levels in Australia are likely to lag/lead changes in house prices.

The purpose of this article was to test the commonly held view that Australian home values won’t fall significantly until unemployment rises, since people that have jobs will continue meeting their mortgage repayment obligations.

The article presented charts showing changes in home prices against unemployment rates in five other nations that have recently experienced housing bubbles – the US, the UK, Ireland, Spain and New Zealand – and found that the claim that home prices will remain supported as long as unemployment remains low does not accord with the recent experience of these nations.

In three of the cases – the US, UK and Ireland – declines in home values began 6 to 9 months prior to unemployment rising. In the other two cases – NZ and Spain – the declines in home values more or less occurred simultaneously with the rises in unemployment.

In no case did unemployment rise before home prices began falling.

Last week’s “shock” rise in Australia’s unemployment rate, from 4.9% to 5.1%, raises an interesting observation: the increase in June’s unemployment rate appears to have taken place around a year after the peak of the ABS Australian house price index in June 2010 – similar to the experience of the US, UK and Ireland  (see below chart).

While one month’s unemployment data certainly does not represent a trend, and the unemployment rate could just as easily reverse next month (particularly given the large sampling error), the data as it exists currently tentatively supports the hypothesis that the unemployment rate lags house price growth.

The reasons behind this hypothesis have been explained previously (for example, here and here). In a nutshell, changes in housing values are a leading determinant of household consumption expenditure, consumer confidence, employment and growth. This is because when house prices rise (fall) in value, households feel wealthier (poorer) spurring consumer confidence (pessimism), spending (saving) and employment growth (job losses).

The housing ‘wealth effect’ can be seen from the below charts showing how changes in real private consumption has tracked the changes in real house prices very closely.

First, there’s this spectacular chart from the ANZ Bank’s New Zealand economics team confirming the housing “wealth effect” in a very explicit way for New Zealand:

And this chart from Deloitte shows a similar relationship between house prices and consumption in the UK:

Finally, there’s my attempt at recreating the above charts for Australia:

Granted, my chart is not as sexy as the others, but it still reveals a high correlation between changes in real house prices and changes in real household consumption expenditure, thereby suggesting that the wealth effect is in play.

In what could be an ominous sign for Australian retailers, the decline in real home prices over the past year has yet to be reflected in the household consumption figures, which have yet to turn down from their post-GFC bounce. If the recent correlation between home values and household consumption holds, then Australian retailers could face several quarters of declining sales growth ahead.

And to make matters worse for retailing, Delusional Economics recently showed that mortgage credit growth usually leads house prices by up to six months. So with mortgage credit growth having fallen recently (see below chart), Australia can expect further house price weakness, which should also depress household consumption and retail sales going forward.

Therefore, household consumption and retail sales are likely to remain subdued relative to the pre-GFC norm, thanks in no small part to household disleveraging and the sluggish state of the nation’s housing markets.

Ultimately, this weakness in consumption is likely to result in further job losses and a move upwards in Australia’s unemployment rate.

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Leith van Onselen

Comments

  1. did you mentioned 10% of our economy directly related to housing construction and 5-10% more indirectly, plus high percentage of government revenue?

  2. While I agree with the correlation statistic here I don’t agree that the wealth effect is its only cause.

    Other articles on this site (i.e a recent one on CAD’s) highlight the bigger picture. Housing debt drives the economy in other areas as well. The correlation will probably stick not just with people with houses and mortgages but with everyone. And the reason why is because this economy despite what everyone thinks about mining and whatever is mainly powered by debt for the majority of the population. And most debt is secured against housing in this country.

    So its not the wealth effect – rather the money that is being used to finance jobs is not growing as it once was. People see it in their workplaces that things are not as they once were and they cut back.

    • A lot of loans to small businesses are secured against their owners’ properties. It’s therefore quite possible that falling house prices affect small business financing.

      • That is a consequence….I was in the UK in the late 80’s when the economy stalled and the flow on through small business was considerable and rapidly created unemployment. I would think the same impact will occur in Australia as many people have borrowed against properties to support a business.

        The other thing that will come into play if the stock market continues a longer term decline is margin calls as people will have to liquidate assets to pay the margin calls and again this may flow through into the property market (de-leveraginging)and employment as businesses may go under.

    • When people are paying 2 – 3 times in housing cost through mortgage payments( when compared to renting), they are expecting house price growth to negate this loss. When it does not happen , they try to pay off the loan as fast as possible in-order to lessen the interest burden. This pulls dollars away from non discretionary spending.

    • My point was that it isn’t just the wealth effect that causes this correlation. New housing debt issued is correlated with house price growth which is also correlated with economic activity (.e the credit impulse as some people mentioned). The new credit created from housing debt goes into the economy keeping it ticking. It isn’t simply people feel wealthier, in terms of the credit flowing through the economy they actually do have more money to spend as long as credit growth continues.

  3. The chart would look a lot better if you graph ’employment’ instead of unemployment. It’s hard to see any ‘trend’ right now.

    Rather than ‘fall in house price causes unemployment’, it’s more likely that the same economic climate which causes a fall in house price also cause unemployment. (e.g. credit shock). Logically speaking, A -> B, A -> C != B -> C, although on the chart it will look like they’re related.

  4. Thanks Leith.

    Yes 🙂

    We have an economy is structurally dependent on 20 years of a housing boom.

    Hence, if housing changes, our ust unwind its current structure and also change – and that likely will result in significantly increased unemployment as part of the process of adjustment.

    My 2c

  5. Gavin R. Putland

    The “commonly held view that Australian home values won’t fall significantly until unemployment rises, since people that have jobs will continue meeting their mortgage repayment obligations” is patently illogical because prices are determined not by those who merely CONTINUE their mortgage repayments, but by those who make new purchases.

    Now excuse the self-quotation, but I’ve been on this case for quite a while…

    From http://ow.ly/2PJg2 (Oct.1, 2010):

    The recession of late 1975 occurred while home prices were still falling from the 1974 peak. The double-dip recession of 1981-3 followed the home-price peak of early 1981. The “recession we had to have” followed the home-price peak of 1989. The dip in economic growth in 2004, and the subsequent period of ordinary growth in spite of the historic improvement in the terms of trade, followed the home-price peak of late 2003. The near-recession of late 2008 (which was a recession by almost any measure except the official one) followed the home-price peak of late 2007.

    From http://is.gd/terrigenous (June 1, 2009):

    5. Conclusions

    …A downturn in the property market, especially in turnover (sales) of properties, is a leading indicator of recession, with a lead time of up to 9 quarters…

    In the property market, a fall in turnover is a leading indicator of a fall in prices, and the lead time is usually one to two quarters…

    Recessions are mostly home-grown…; in most countries the recession was preceded by a downturn in the domestic property market.

    …If, as I contend, recessions come mostly from domestic property markets, then the real significance of globalization lies in international arbitrage by property investors, which causes property bubbles and bursts to form global waves: recessions are global chiefly because property bubbles are global.

    • They will send in their army to administer our populations’ return to employment working on new mines for them 😀

    • MontagueCapulet

      I’m coming round to the view that the mining boom accounts for a suprisingly small proportion of our recent “prosperity”. It was a story we told ourselves to justify the housing bubble. It’s not like 95% of the population actually saw any money from minerals. It was really about credit growth.
      .
      If so, its quite possible for our economy to slump dramatically even while BHP continues to rake in billions for iron ore. And the dollar with it, once interest rates are cut in response.

    • MontagueCapulet

      I’m coming round to the view that the mining boom accounts for a suprisingly small proportion of our recent “prosperity”. It was a story we told ourselves to justify the housing bubble. It’s not like 95% of the population actually saw any money from minerals. It was really about credit growth.
      .
      If so, its quite possible for our economy to slump dramatically even while BHP continues to rake in billions for iron ore. And the dollar with it, once interest rates are cut in response.

  6. NOT A ''TRUE BELIEVER"

    Unemployment is not the major determinant of house prices; it is the speculative ponzie scheme that has come to its inevetable end. Look at the tech bubble for instance. Once the punters realise they are on a turkey, they start dumping their bets on the market in increasing numbers and we run out of new fools to replace the old ones. Don’t be fooled by the smoke screens of the property spruikers!

  7. I am not arguing against the facts or data presented here, but comparing “official” unemployment rates between different countries is dangerous. Its assumed that there is a standard method of calculating the unemployed in different countries but its anything but standard.
    In Australia, if you work even 1 hour per week, you are “employed”. In Germany anyone working less than 20 hours is “unemployed”. In the UK there are plenty of ways to hide jobless people in various “training schemes” to make the figures look rosier.
    So whatever the official rate is in Australia, I would add a few points to it to get the real number.

  8. Robert Sherlock

    Housing does effect GDP, Australia will find it hard to grow every quarter with a declining retail and housing sectors. We could go into a technical recession (2 qrts of negative growth) next year, with negative growth in the second half of the this year. Wait to see what that annoicement would do to the dollar, interest rates and the economy.

  9. I’m not sure if you have the causality quite right and explained properly. If we are saying the same thing…its all fine and dandy.

    Increased confidence leads to higher bids for houses and growth in loans. The increase in loans feeds through to demand in the rest of the economy, refurbishments, house flippers living it big etc. This increases employment, confidence and a spiral of increasing house prices.

    Decreased confidence leads to lower bids and less demand for loans. The lower demand for loans eventually feeds through to demand in the wider economy and finally employment.

    Fairly obvious employment lags increase in loan growth unemployment lags decrease in loan growth. There are other factors impacting employment growth such as fiscal stimulus and business investment so you have to be careful.

  10. Oooooohhhhhh- You are all so wrong!

    Wayne Swan made another Parliamentary statement today saying we are in a fantastic possition, and that “we are very different here”, and the Prime Minister reiterated that herself.

    How many time a week does poor Wayne or Julia have to tell you this important information before you believe him.

    Its like no one trusts them!