The RBA’s dodgy housing model

RBA researchers released a paper yesterday modelling urban structure and house prices under conditions of population growth, zoning controls, and the provision of transport infrastructure.  They use an Alonso-Muth-Mills model to demonstrate typical location, density and rent effects of housing in a mono-centric single land use disk-shaped model of a city (in fact their geographical scope is a hemisphere).

Given the debate surrounding price impacts of planning regulation on housing, this research input from our favourite central bank should be of some importance. However the gaping chasm between their descriptive model, the empirical evidence, and their policy conclusions leaves me concerned.  The model doesn’t have legs.

While this partial equilibrium model is a valuable tool to describe relative rents due to transport costs given a mono-centric, mono-sector city (housing only), I suggest that the assumptions required make it a poor tool for analysing changes to the parameters. Particularly, the following assumptions justify extreme caution when translating the model estimates to policy suggestions.

  • The wage rate and the rental rate on capital are taken as exogenous
  • The price of land at the city fringe is equal to the cost when used in agriculture
  • The units of this figure and subsequent ones are as follows: housing (rental) prices in dollars per square metre of living space per year… The model refers to the rental price of housing and land, but under an assumption of a given capitalisation rate, these translate directly to purchase prices, which we refer to in our discussion.

Like all models, the outcomes are set by the assumptions, so let’s consider each in turn.

First, the model suggests that wages do not respond to increased housing costs in a city.  While reality may be imperfect, with migration choices available to other cities one would expect that wage differentials between cities reflect housing costs differentials to some degree.  If house prices in Brisbane rise relative to other cities while wages stay constant, it makes Brisbane a less desirable city to live.  As people are attracted by better real wages in other cities (and globally), it provides feedback from house prices or rents to wages.

Second, the ‘rental rate on capital is taken as exogenous’ and ‘the assumption of a given capitalisation rate’ means that the yield is fixed.  In fact it implies that the real yield on a per sqm of dwelling basis is fixed. This allows rent to be used as a proxy for prices.  But reality has been nothing like this assumption would imply. The graph below shows the changes in real and nominal yields over time which need to be considered in the translation between modelled real per sqm rents and nominal prices.

Indeed it is quite odd to develop a model of per sqm rents, and then write a chapter entitled Empirical Evidence, and not examine the patterns of rental prices for housing on a per square metre basis – which is what the model itself actually estimates.

In fact the paper doesn’t publish impacts from increased transport costs, increased population and zoning changes on median rents (which could be calculated from model outcomes).  Rather it shows a graphical presentation of impact on geographical rental gradients.  If density restrictions lead to more people living in fringe areas (as shown in the second graph below), the changing composition of dwellings may leave the median (and mean) citywide rent unchanged even though the rents at each location are higher.  I have demonstrated this composition effect before using the table below.

Further, empirical evidence seems to suggest that Australian rents have been relatively stable, and indeed were declining in real terms for a decade prior to 2003.  The chart below shows Brisbane rents and prices from ABS data, which does have quality adjustment in rents.  However, given that the model itself is quality adjusted (using rents on a per sqm basis), I expect this to be a reasonable presentation of the intended modelled measures.  RTA data trends in rent prices for recent bond lodgements traces this trend almost exactly from 2006 when the data is first available. Similar trends are observed in other capitals.

The next assumption of marginal fringe land supply at agricultural rents is a little strange, since many of the arguments surrounding housing supply constraints use as evidence the difference between agricultural land values and fringe residential land values.  So having a model where this cannot occur seems at odd with other arguments surrounding housing supply price impacts. The fact that the model is has no competing land uses within the city limits is another factor likely to skew results towards steeper rent gradients between inner and fringe locations.

For me, the finding that “there is a trade-off between density and housing prices” is peculiar.  Their model suggests the opposite is the case (see graph below), with lower density creating higher prices.  Even though I think the model is flawed, the commentary accompanying this conclusion confuses the issue.

Additionally, the comparison of price impacts due to population growth simply compares two static ‘equilibrium’ conditions under the same model calibration with double the population.  The results of this comparison are in the graph below.

The question one asks is that if there is no constraint on density other than construction costs, and no constraint on urban sprawl other than transport costs, how can equilibrium rents increase for a population with the same income level?

The answer is found in the model parameters that define the equilibrium conditions for profitable dwelling supply  (as per the model calibration on p37).  This arbitrarily limits the scale of housing construction, and there is no argument why this parameter would be constant when comparing two real world cities of different populations with the same income.

The researchers also note the lack of evidence of price impacts of zoning in the academic literature. Their paper cites numerous articles suggesting that zoning, density and land use controls can be effectively implemented without price effects if they provide adequate scope for markets to operate.  I suggest this has been the case in Australia for some time.

Given the importance of the paper’s conclusions to planning regulation, one might consider that a better use of the model would be to determine whether ‘real life’ planning tools actually generate the patterns the model suggests.  We could then determine the degree of impact that current planning tools have on home prices compared to model estimates (even given its various constraints).

It bothers me that our central bank, with its influential standing in the policy community, can release research with such obvious flaws. I prefer models with legs.

Tips, suggestions, comments and requests to [email protected] + follow me on Twitter @rumplestatskin


  1. Why are you surprised?
    The RBA strikes as one of those organisations (the Federal Treasury is another) with an organisational mindset that has a tenuous grip on reality.

    Have a look at this one as a howler:

    Dec 2006 no less. Abstract (the last line is a kicker):
    “This paper draws together themes from work at the RBA, other national central
    banks, the BIS and elsewhere on recent developments in housing and housing
    finance. The general conclusion is that financial and macroeconomic developments
    have increased the demand for the stock of housing. Because the stock of housing
    is inherently slow to adjust, this has increased its relative price. Although this is a global trend, individual country institutions have affected outcomes, sometimes in ways that are not obvious. The resulting expansion in both sides of the household balance sheet is an important development for policy-makers to monitor, but it is
    probably not of itself a cause of financial instability.”

  2. Wasted Opportunities

    Say, but Old Skeptic, they said “probably.” Now there’s a weasel word even a consultant (like me) could be proud of.

    Rumpel, great work. It doesn’t take an expert to see those model outputs are dominated by boundary assumptions and unrealistic parameters.

    Bothering indeed.

  3. Wasted Opportunities

    Aah, but Old Skeptic, they said “probably.” Now there’s a weasel word even a consultant (like me) could be proud of.

    Rumpel, great work. It doesn’t take an expert to see those model outputs are dominated by boundary assumptions and unrealistic parameters.

    Bothering indeed.


    The major reason for getting the Annual Demographia International Housing Affordability Surveys ( ) underway back in early 2005 (with the 7th Edition released January) was to illustrate in the clearest terms possible, with the Median Multiple measure, just how “out of whack” housing prices are here in Australia and New Zealand, in comparison with the affordable housing markets of North America.

    The expection was that researchers in this part of the world would follow up, by exploring the detailed costs of housing development on the fringes of the affordable North American urban markets – and stack these up alongside the detailed costs of fringe developments of our Australian and New Zealand cities.

    These detailed comparative numbers would then tell us exactly where the problems are in this part of the world, so that the appropriate policy prescriptions could be put in place to address them.

    March last year I wrote a comprehensive article for New Zealanders on the interest co nz website “Houston: we have a housing affordability problem”, where I broadly broke out the fringe development costs of a Houston starter home of 235 square metres on a 700 square metre lot at $US140,000 ($US30,000 for the serviced lot – $US110,000 for the house construction, comparing it with New Zealand examples.

    The New Zealand costs are simply horrendous – and I would suggest the Australian ones are extremely bad as well.

    This important article is available within the Highlighted Articles Section of my website at .

    Also on that website, is an extremely clearly understood Definition of an Affordable Housing Market. Since the time of the creation of the modern residential production construction sector by the Levitts following World War Two, producing new housing stock has become a disciplined andf very formulaic business.

    None of it is “rocket science” and this effort by the RBA, can in the most diplomatic terms, be described as sheer nonsense.

    It is well past time housing researchers in both Australia and New Zealand came down out of the academic clouds and got their feet on the ground.

    The New Zealand Government has at least made a start by shutting down the time wasting housing researchers CHRANZ. The same thing should happen to AHURI in Australia.

    All we really need to see is the numbers of a fringe development starter house say in Houston, stacked up against comparable ones on the fringes of Sydney, Melbourne, Auckland and Christchurch and others, so that we can see clearly what the problems are here.

    Lets hope the New Zealand Productivity Commission with its Housing Affordability Inquiry does this, with its Report due for release February 2012.

    Hugh Pavletich FDIA
    Co author – Annual Demographia International Housing Affordability Survey
    New Zealand

    • You already ‘know’ what the New Zealand Productivity Commission Housing Affordability Inquiry is going to say, Hugh, “Property always goes up, and so it will remain expensive, and there’s not much we can do about it”. But I shall have another read of this Rumplestatskin piece; as it may take a bit for my feeble mind to absorb 🙂

      • Janet, I inherently share your skepticism, but I think well enough of the NZ Productivity Commission to believe that if they do indeed put out a “finding” like that, they will have been forced to do so against the evidence and their own ability to analyse it.

        • Janet and PhilBest – well I suppose if these “servants of the people” (they need to be constantly reminded who pays them) persist in generating quack academic drivel – then we will just keep hammering them, until they start acting responsibly.

          Hon Nick Smith, New Zealand’s Environment Minister, got a good hammering from me on Interest Co NZ following the release of his “Competitive Cities” bureaucratic mush last October.

          Murray Sherwin and his pals at the NZ Productivity Commission can expect the same (and more)if they screw up their Report due out February 2012.

          Indeed, if Sherwin & Co do make a hash of it, the newly formed NZ Productivity Commission can (following CHRANZ) be expected to be shut down as well.

          Even Roger Kerr of the New Zealand Business Roundtable said within their submission, that the newly formed NZ Productivity Commission is very much on trial with this forthcoming Housing Report.

          There is a massive problem in the training of economists as well – as I set out within a 2009 article “Housing Bubbles & Market Sense” – availablr within the Highlighted Articles Section on my website. The late Prof Paul Samuelson with his focus on mathematical modelling, has done enormous damage to the training of the past two generations of economists.

          The RBA Paper being discussed here, is a classic example of this.

          Thankfully though, increasing numbers of economists internationally are aware of these problems – and the need for changes with respect to education.

          Getting their faces out of computer screens and feet on the ground instead – talking to practitioners, would be a very good start indeed. Bill Lewis’s book “The Power of Productivity” would make good reading for them. And hopping on a plane to Texas as well.

          The real world is a good place to learn. There is a world of difference between being schooled in an issue and actually educated in it.

          As Mark Twain said (or was it Oscar Wilde?) – “Never let your schooling interfere with your education!”.

          We live in hope………!!!!

          • I think it’s got next to nothing to do with “real world education”.

            It is a simple play beween career minded executives, what they know the company wants to present and how much massaging the raw data needs to fit it.

            There is no escape from this until individuals and organisations are accountable for the consequences of being wrong. Impossible to implement ? Model it on the ebay feedback system.

            My personal contribution to the weasel words dictionary was to calmly comment, “No new failure modes found” after a round of testing. My boss at the time nodded and took a couple of steps away before he realised what I had said. “Mmm, that might be worth trying” was his only comment.

  5. I agree with Rumplestatskin on this comment:

    “……the gaping chasm between their descriptive model, the empirical evidence, and their policy conclusions leaves me concerned. The model doesn’t have legs.

    While this partial equilibrium model is a valuable tool to describe relative rents due to transport costs given a mono-centric, mono-sector city (housing only), I suggest that the assumptions required make it a poor tool for analysing changes to the parameters……”

    But I think Rumplestatskin’s critique, while excellent as far as it goes, misses the real issue. This is because Rumplestatskin has a bit of a blind spot surrounding the price of urban fringe land and the effect of regulatory boundaries (or proxies for them) on prices. So he does not give the RBA report the drubbing it deserves on this point.

    The RBA authors say “in the case of land at the city fringe, there is evidence of a very significant uplift in prices when land is included (or is considered
    for inclusion) in the urban growth boundary…..”

    I’d rather not rerun my arguments with Rumplestatskin regarding whether the boundary is or is not responsible for this uplift. He says it is not. I will leave it to readers to decide for themselves. Therefore, it is pointless trying to argue further with him, that low land prices at the urban fringe determine, via RE markets, the price of land in the entire urban area. Low fringe prices equals lower prices in the entire urban area. Inflated fringe prices equals inflated prices in the entire urban area. The RBA is floundering in the dark on this vital point too.

    The RBA seems to be attempting to focus blame for “housing unaffordability” per se, on minimum lot sizes and NIMBY resistance to higher density redevelopment in established suburbs. This is simply nonsense when one considers the real life prices of houses in US cities with no urban growth boundaries and a prevalence of large minimum lot sizes. The price of the land contained in the large lots, is a minimal input to the total “house plus land” figure. Typically, the cost of an acre under these conditions, is less than the cost of a tenth of an acre under conditions of urban growth containment. The price of urban land is actually depressed by the large minimum lot sizes.

    On the subject of the RBA’s model, William Wheaton, whose 1974 work they base their model on, repudiated this work in a 2002 paper, “Commuting, Ricardian Rent and House Price Appreciation in Cities with Dispersed Employment and Mixed Land Use”. Prof. Alex Anas and various colleagues at the State University of New York at Buffalo, have well and truly moved the art of urban economic modelling into close correspondence with reality in their work over the last decade, and it is unforgivable that the mainstream economics profession is still persisting with models and formulaic approaches that are KNOWN to be wrong and that cause damage to be done when policies are based on them.

  6. From a technical modelling point of view this breaks the first cardinal rule: test your model by predicting the past.

    In other words run through all past input data and the model should produce close to actual recorded results (within reasonable confidence intervals at least).

    If it can’t do that successfully then the model is rubbish.

    • Very true. Which is why I suggest

      “a better use of the model would be to determine whether ‘real life’ planning tools actually generate the patterns the model suggests. We could then determine the degree of impact that current planning tools have on home prices compared to model estimates (even given its various constraints).”

      It seems so very difficult to actually find evidence in the data that planning changes have significant impacts when we stick to the principle that prices are capitalised rents.

      • But exhibit “number one” or at least “number two”, that you have a bubble in land prices, is “prices” that have come unmoored from “capitalised rents”. It is the same kind of thing as the P/E ratio in the share market. When it is out of whack, it means that prices are being driven by expectations of capital gains rather than by “rents” or earnings.
        I know you will say that that is a “demand side” issue rather than “supply side”. But while the share market cannot introduce stability by simply continually issuing more shares at face value to whoever wants them, urban land markets DO have such a “stabiliser” available to them provided regulators allow – a de facto limitless supply of surrounding land at the “face value” of “agricultural use” rents.

        • How can the supply side affect prices but not rents? This is clearly where we disagree and why I am so strongly in the demand side.

          So you are saying it is a demand side issue that we could, should we want to, address on the supply side (rather than it being a supply side issue).

          Again, we disagree about land values being derived from marginal use (with my interpretation of reality being that land values are instead of highest and best use).

          • How can the DEMAND side affect prices and not rents, if “supply” were not limited? There is no point speculating in something of which there is plenty available at a near-fixed low price.
            But let’s not flood this thread with this argument, and concentrate on sticking it to the RBA, eh?

          • Phil, I think you hit the nail on the head when you say

            “There is no point speculating in something of which there is plenty available at a near-fixed low price.”

  7. Easy access to credit lowers people’s risk and they are willing to accept lower returns (higher PE ratio).

    The analogy with the share market is that a supply constraint on the product made by a firm (a patent of some such thing) should lead to an increase in the product price (and firm profits), which are then capitalised into the share price.

    In the spirit of keeping on track with teh RBA analysis, you can read a non-technical verbose alternative opinion here

    • But “easy access to credit” makes no difference to the price of something that is available at “cost-plus” prices in de facto infinite quantities. This is a real life observation as well as being theoretically sound.
      It is quite possible that in a competitive LENDING market, institutions will tend to become more and more risky in their lending behaviour, if there are supply side rigidities.
      I don’t get the relevance of your analogy re the share price of a firm with a PRODUCT whose supply is restricted. This would be more like the effect on the price of houses that are supplied by a developer who has a monopoly on some feature installed, such as double glazing.
      Thanks for the link to Chris Joye. NOW he is reminding us what he said back in 2003 about regulatory impacts on housing affordability? Actually he says a lot in that posting, that I can agree with, such as the RBA waking up to the effect on monetary policy, of supply side distortions in the RE market. Don Brash and Owen McShane got this right in NZ in the 1990’s, and the OECD and other institutions have now started pointing out this effect.
      Joye just seems to miss the point I make above, that the RBA is trying to divert focus from distortions at the boundary, which are highly significant, onto distortions in “redevelopment of established areas”. (Of course I disagree with his lunatic bubble spruiking over the years meanwhile, but he does not sound like the same lunatic in the present posting we are discussing).

      • “But “easy access to credit” makes no difference to the price of something that is available at “cost-plus” prices in de facto infinite quantities”

        Land is a second hand goods market, and an asset. It’s price is not set by ‘cost-plus’. It’s price is capitalised rents. And when that cap rate changes, the price of raw land rises as well. The market for raw land and housing is not separate – the are the same market linked by the cost of construction.

        Selling into the market by landowners is voluntary. They capture rising rents in the asset value, so there is no reason for higher prices to encourage more land selling. In fact the opposite can be true (as many studies have shown in asset market – which leads to suggestions of a downward sloping supply curve due to bankwagon effects).

        • The price of urban fringe land IS set by “cost plus” everywhere that there are no regulatory restrictions. Alonso/Muth/Mills models incorporated a smooth transition from “agricultural” land values at the urban fringe, for a good reason. That “good reason” being, that it reflected real life in the pre-Green-politics era in which they lived.
          The serious “steps up” in values at the urban growth boundary, associated with restrictions on development, render these models invalid with respect to those urban economies with these regulatory distortions. They are still valid for all urban economies that do not have these restrictions.
          What you say in your last paragraph would mean that SOMEWHERE in the world, there MUST be cities with no fringe growth restrictions, where “fragmented” development is the norm, where a bubble must still have occurred due to demand side factors, and the “fragmented” developments would have netted similar uplifts in value over their agricultural value, as in the cases with growth restrictions that we are considering.
          Over to you to show me such a city.

          • That proves my point, not yours.
            Where is the significant uplift (over and above the cost of development and infrastructure) in the PRICES of the raw land being developed? A level of uplift remotely comparable to the PRICE bubbles that result from regulatory induced supply inelasticities?
            i.e. a “tens of times” uplift?
            The famous Texas “bubbles” illustrate the “supply” response to a demand shock, rather than the “price” response we are discussing. Even if “supply” overshoots, the economic damage is minimal; housing affordability is affected favourably, not unfavourably, and the slightly lowered property prices are part of an “economic recovery” mechanism that we have seen in the very case you mention. This is completely different to the disastrous volatility involved in a “supply-inelasticity-induced” PRICE bubble.

          • I should add that while the chart of “house prices” in that document on Texas, looks impressively volatile, it very much helps to consider a chart of “median multiples” instead, to eliminate inflation and rising income effects. The Unconventional Economist has liberally provided us with such information, such as the chart on THIS thread:


            Even more helpfully, that chart from the UE shows the median multiples for cities in highly-regulated California for the same time period as the cities from Texas. Similar nationwide credit and monetary policy conditions underlay the TRENDS in both States markets.

          • Any uplift in the price of land, not reflected in rent, must, by definition, by a demand side problem.

            I agree that supply side constraints could, if they were very constrictive, have price effects, but these would be seen in rents.

            So if Houston prices went up 30% while rents were flat, this is simply the same bubble behaviour seen across the world in many asset markets.

            I think the other main point we disagree is about the use of comparing median prices to incomes. My view is that it is irrelevant because it tells us nothing about the actual cost of home ownership (given massive variation in holding costs between cities, and massive differences in interest rates between countries).

            You could have a city with expensive housing and a median multiple of one if there were high land taxes and other holding costs.

    • The International Economist really does make me want to vomit sometimes. He has an uncanny ability to make every article about him or how his imaginary opinion of what others think of him.

      “On others the Bank doubtless finds me rather frustrating, such as when I suggest that there is discord amongst its Board, or that the RBA is failing to properly fulfil its financial stability duties by holding Australian banks to account on the unnecessary risks they occasionally expose taxpayers to.”

      He does link to an interesting publication, ironically hosted on the RBA website at It seems that the RBA are happy to host the article but perhaps neglected to read it themselves. It even mentions the “structural changes” of financial markets that Joye et al are always claiming has les to a once-off, permanent increase in housing prices.

      “As pointed out in Mishkin (2010), not all asset-price bubbles are alike. Financial history and the financial crisis of 2007–2009 indicates that one type of bubble, which is best referred to as a ‘credit-driven bubble’, can be highly dangerous. With this type of bubble, the following chain of events is typical: Because of either exuberant expectations about economic prospects or structural changes in financial markets, a credit boom begins, increasing the demand for some assets thereby raising their prices. The rise in asset values, in turn, encourages further lending against these assets, increasing demand, and hence their prices, even more. This feedback loop can generate a bubble, and the bubble can cause credit standards to ease as lenders become less concerned about the ability of the borrowers to repay loans and instead rely on further appreciation of the asset to shield themselves from losses.

      At some point, however, the bubble bursts. The collapse in asset prices then leads to a reversal of the feedback loop in which loans go sour, lenders cut back on credit supply, the demand for the assets declines further, and prices drop even more. The resulting loan losses and declines in asset prices erode the balance sheets at financial institutions, further diminishing credit and investment across a broad range of assets. The decline in lending depresses business and household spending, which weakens economic activity and increases macroeconomic risk in credit markets. In the extreme, the interaction between asset prices and the health of financial institutions following the collapse of an asset-price bubble can endanger the operation of the financial system as a whole.”

  8. Phil, I think Nimby resistance to higher densities also plays a part in higher house prices, as it is also a restriction to supply. Today’s urban sprawl is tomorrows leafy urban heritage area….

    As far as zoning effects on fringe land prices, it’s not hard to find examples on the real estate for sale sites. I was looking for land in the Riverstone area of Sydney, and was able to find blocks available for as “low” as $75,000, slight problem, you cant build on them – yet – according to the add. Land zoned residential in the same area goes for at least twice that. Thing is, $75k is way too much for a few hundred sqm that can only be used for rural pursuits, not that it is or could be as it’s too small. So clearly there is quite a speculative element built into that price, the add even proudly states “Excellent land bank”.

    • Those bits of land would be worth $5000 or so without the aspect that they are the subject of speculative expectations of rezoning.
      NIMBY resistance to higher densities is not a “restriction to supply” per se, it just DIVERTS population away from those areas. I stand by what I said – cities in the USA with no limits to fringe development, have ridiculously cheap housing, regardless how large their “minimum lot sizes” are. It is also important to note that these cities have highly dispersed employment and other amenities, and there are few areas with the kind of advantage of “proximity” that the RBA’s monocentric model assumes. There will be some historically “upper class” enclaves, but these would be more expensive regardless of lot sizes; and there remain plenty of LOW cost large-lot suburbs.


    All this chatter about the direction of our housing market amuses me. Check out Youtube under the heading of “housing bubble Australia”. One of the vids shows a suburb in Queensland with virtually every house on the market, as you’ve probably seen in the U.S. or Ireland, etc.
    Queensland has plenty of mining and “the highest rate if internal migration”.

    The fat lady is singing very loudly, folks!

  10. The Hurst Exponent

    Richards isn’t really worth reading when it comes to models. As in his 2008 speech ( when he used a disturbingly inappropriate model to suggest:

    “…In the case of home buyers, concerns about affordability are typically about the accessibility of home ownership, or the ability of younger households to gain access to home ownership for the first time. The standard measures of accessibility show an improvement when average household income is growing faster than housing prices, or when mortgage interest rates are falling so that the borrowing power of households is increasing.”

    And if the fact that Richards believes interest rates, independent of costs are a key indicator of affordability doesn’t concern you enough…

    “Such measures suggest that there are cycles in affordability, but that it was at low levels by historical standards at the end of 2007”

    This deduction comes about through Richard’s (the RBA’s) own own “accessibility” indicator in which they calculated (in footnote 9)…

    “median gross household income for 25–39 year olds in the state capital and ‘rest-of-state’ for NSW, Victoria, Queensland, South Australia and Western Australia. We then calculate borrowing capacities based on these income levels and representative mortgage interest rates. Subject to a 30 per cent repayment/gross income ratio, we then calculate purchasing capacity assuming that the household had also saved a deposit of 10 per cent of the purchase price. ”

    Got that? The RBA’s own measure of affordability (accessibility) compares the prices of properties to that of the median “young” household’s access to borrowing – not their ability to pay, which is affected by a great deal more that what banks have been willing to lend. The shocking assumption is that two people can devote 30% of their gross income to their home repayments.

    So after tax, it’s more like 40-50% of their actual income, which means if one loses their job, or say decides to get pregnant it goes to 80-100% of net income.

    In 2008 I found it hard to believe the RBA would provide no critique of methodology, assumptions and scenarios for others that don’t fall in what they deem “representative” households.

    Reading this paper today it’s clear nothing has changed. When it comes to real analysis the RBA is a lightweight.

    • The Reserve Banks, Treasuries and economists of Australia and New Zealand, need to ask themselves why the public generally is suspicous and distrustful of business and the market economy.

      They need to consider what the costs are in failing to communiated in language people understand.

      Readers may like to go to the Articles of Note Section on my website at to read the Ref 110630 “Royal Society of New Zealand & Engineers Group Paper: Christchurch Earthquakes” as an example of how a REAL profession communicates with the public.

      Economics probably doesnt really pass the test to be considered a “profession” as such. A “messy art” would probably better describe it.

      • “The world’s biggest debating society” might be apropos? The ancient Greek “Sophists” come to mind.

      • Economics is haunted by more fallacies than any other study known to man. Henry Hazlitt

        The RBA is independant:
        1. From the public
        2. Reality

        Above: 1.

        2. Read article and comments above-the RBA’s dodgy housing model

        All central banks have only 2 tools:
        1. BS
        2. Inflation

        Above:Economist Dr. G. North

        “The last duty of a central banker is to tell the public the truth.” Alan Blinder, US Fed Vice Chairman 1994.

        An old anology has been to describe c.b.’s as generals fighting the last war. A worst anology could not be found. They are not generals.

        They are arms manufacturers. They produce copper swords. Sword manufacturers. They are guided by the beauty of their weapons. Listen to their sales pitch and if you end up on the frontline you will be slaughtered.

        Buy from the swordmasters not sword-manufactures. Swordmasters sell/offer steel weapons. These, even if second or third hand will do you more good that the beautiful, ornate and elaborately designed broken hilt in your dead hand.

        Maxim: never bring a government made knife to a professional gunfight. Take a gun to the holders of government made knives. They want to redistribute your wealth to themselves. If you don’t fight you lose.

        After reading this article, I now know why RBA Gov. Stevens demanded $1M p.a. Keeping castles in the air is an expensive business. So is defending it.

  11. Aside from the government handouts, there is one VERY key reason prices were able to rise so quickly.

    1997: The ABS removed mortgage interest from the CPI.

    With this key change, the RBA was working on flawed inflation data throughout the last decade. Rates were artificially low, the handouts weren’t mopped up, prices rose like a champagne cork at an F1 winners podium.

    • It’s almost as if this was a deliberate plot. Australia is not the only country that did this.
      The assumption probably was similar everywhere, that housing rentals would be included in the CPI figures and this would be sufficient. As I say above, rentals generally stay low in a housing bubble. If people were a bit more rational, they would rent until prices had resumed sanity, THEN buy their home. But there has not been enough historical cycles occur yet, for people to have worked this out.

      • It’s stupid, and because it’s been so poorly managed we’re in a situation I’ve written about before – where the RBA’s interest rate policy is applied with prejudice to some, and barely to others.

        Here’s a part of what I wrote a few nights ago, mainly for my own benefit to clarify my thoughts:

        The problems in Australia

        Misguided incentives
        Throughout the last decade, our governments have become dependent on some incentives that at face value appear to be good policy. Certainly politically, they are great policy, but they have left a legacy that makes flexibility in the face of uncertainty difficult.

        Probably the most well known such incentive is the First Home Owners Grant. Initially intended to offset the impact of the GST, it has been relied on far too much to foster growth, and to deliver state tax revenues. The FHOG has had several impacts. The most obvious is the ability for first home owners to bid up the price of property. This appears great for quite a while, but as we have seen in the USA, there is a huge potential for systematic collapse. During the stimulus of 2008, the FHOG was increased to entice more buyers. It worked. Many people took on mortgages at historically high prices.
        Our own Steve Keen has shown a remarkable correlation between GDP, house prices and debt. As debt goes up, the other two measures follow – with startling predictability. He shows that the rise or fall in the rate of financing proceeds house prices by approximately three months. The growth in debt has slowed recently.

        For a long time, this was a boon to the states. As each home is sold at a higher price, the council rates rise, and the state revenue from stamp duty rose. It could be said that the states, despite initially being state Labor governments under a federal Liberal government, were complicit in this programme. It was good for revenues, so if they had misgivings, they certainly never stated it.

        The situation now is becoming more apparent to the general population by the day. Steve Keen asserts that our prices will fall in a similar manner to other countries. They have started a minor slide, but more importantly, delinquencies are rising.

        A fatal decision
        The biggest contributor to this situation is something most people have overlooked. Indeed, it is easy to point solely at the FHOG as the cause of this problem, but we live in a country with checks and balances. If prices are rising too rapidly, we should expect this to show in the inflation figures, and thus be corrected automatically by the RBA’s interest rate policy. This once was the case, but in 1997 a change was made to the calculation of the CPI that removed mortgage interest from the figure. For 15 years now, we have been deliberately ignoring house price inflation where previously we did not. It is interesting to note that 1997 is the first year that the rate of house price appreciation moved sharply upwards.

        What this means is that the RBA was working on arguably flawed data. It was unable to make decisions necessary to prevent what many call a bubble. It is easy to apply the logic that if this change was not made, prices would have been unlikely to rise so far so fast. Instead, interest rates would have mopped up the FHOG, limiting its effects.

        More importantly, this decision affects policy today. The Reserve bank is charged with goals to limit inflation and also maximise employment. The problem is, this change has severely changed the distribution of its power. It no longer applies pressure more or less evenly to all home owners. Instead, it applies disproportionately more pressure on people who bought more expensive houses. Usually this means the recent buyers. The first home owners. The hardest hit are the buyers who bought during or after 2008. Just think for a moment, about this made up but plausible comparison.

        Joe bought a house in 2001 for $200k. He has been paying it off for 11 years now. He has built up substantial equity in the home – partly though repayments and partly through price increases. It was valued in 2008 at $420k.
        Joe has resisted refinancing, so he has only $100K remaining on the loan. At 7%, he pays approximately $7k per year in interest.

        Jane bought a house in 2008 for $420k. She has been paying it off for 5 years now. She has a little equity built up, but the loan is relatively fresh, so it’s not a lot. She still owes 400k. At 7%, she is paying 28k in interest per year.

        Both are in the same street. Both earn the same. Both have similar houses. But if interest rates rise, Jane is going to suffer 4x more than John.

        This puts the RBA in a very difficult position in the current global climate. They are unable to raise rates because cascading defaults will occur as the ‘Jane’s’ of the world hit their absolute financial limits. They are also unable to target the ‘Johns’ of the world to even out the load. This is why monetary policy is not only a blunt tool, but now an unprecedented uneven tool. It is diffucult to engineer a soft landing and moderate inflation with this tool.

        Outcome = stagflation?
        One possible and incrasingly worrying outcome of the current global issues is that Australia could enter a period of stagflation. With the RBA possibly unwilling to raise rates and trigger defaults, but international pressures pushing up the CPI, it is quite possible that we could be stuck with increasing prices and increasing unemployment if the global situation deteriorates.

        This could occur for a few reasons. One is simple. Our dollar is floating, and can trade rapidly up and down. The major factors that have held it high have been relatively high interest rates bringing foreign investment and speculation, and commodity prices. It is possible that our dollar will be traded even lower than it is currently (96c) due to a global rush to liquidity denominated in their own currencies. It is also possible that worldwide food prices continue to rise, and importantly, oil prices.
        We currently see an emerging and alarming disconnect between the two major oil indexes. The West Texas Intermediate which mostly supplies the US market, and the Brent Crude which is generally exported have diverged by $20 a barrel.
        This could be a critical sign for oil dependent nations like Australia. We could be facing a lower dollar and stable oil prices. This would translate to a marked increase in prices at the pump. If oil does not drop as it did last time, we could be in for a repeat of the 70’s.

        It is hard to predict, but this outcome is possible. If the RBA drops rates, our dollar drops and inflation rises.
        If it raises rates, defaults could occur.

        A possible solution to monetary policy in the face of stagflation.
        In the scenario above, we saw how monetary policy cannot have the same effects as it used to when house prices were relatively stable over the longer term. Ideally there would be a second tool for the RBA. Ideally it would be a fiscal tool. Giving the RBA a fiscal tool is politically safer than the government applying fiscal policy. When governments raise taxes, it is a major problem no matter how minor the rise. There is one tool though, that might be politically acceptable, and acceptable to the population.
        Superannuation. If the Reserve bank was given limited control over the superannuation guarantee, it could apply a fiscal-like tool far more evenly than it can apply a monetary tool. It might just be possible for superannuation to be increased while interest rates were decreased. In the above scenario, this would put greater pressure on John, while reducing pressure on Jane.

        If a crunch occurs again, it is also likely that our banks will again hunt for high quality tier 1 capital.
        It is likely that a lot of the superannuation will be put into our banking system.

        So this tool could allow Australia to moderate inflation, encourage growth through lower interest rates, and also capitalise our banks – without the federal government creating any more politically undesirable debt backed stimulus.

        • You sure said it:

          “…..Both are in the same street. Both earn the same. Both have similar houses. But if interest rates rise, Jane is going to suffer 4x more than John.

          This puts the RBA in a very difficult position in the current global climate. They are unable to raise rates because cascading defaults will occur as the ‘Jane’s’ of the world hit their absolute financial limits. They are also unable to target the ‘Johns’ of the world to even out the load. This is why monetary policy is not only a blunt tool, but now an unprecedentedly uneven tool. It is difficult to engineer a soft landing and to “moderate” inflation with this tool…..”

          Add to that, that as the OECD recently commented “….a deliberately high interest rate targeting a housing bubble, would crowd out many socially and economically useful investments….”

          Don Brash grizzled in the 1990’s when he was Governor of the RBNZ, that urban growth restrictions would lead to this state of things. He and his colleague Owen McShane should be celebrities akin to Peter Schiff and Fred Harrison for this insight – but it seems that predicting crashes is one thing, but being right about the detailed mechanisms does not make one a celebrity.

    • The Hurst Exponent

      Dont forget, by using the ABS definition of CPI, they also shockingly exclude land values![email protected]/0/2864F03A2E565F84CA25705F001ECAA1?opendocument

      “6.24 An additional factor that arises with housing is that houses, as well as providing shelter services to the owners, also include an investment element as houses typically appreciate over time. For the purposes of the CPI, the costs of housing should reflect only the service (or consumption) component. A common approach is to regard the cost of the land as representing the investment component and the cost of the structure as representing the consumption component. For the purposes of the CPI, the land component needs to be excluded from expenditure on housing.”

      This, during the biggest bubble in land values and associated housing costs in history (why else would there be such pressure to reduce rates?)

  12. I’m guessing its related to the same thing sales people think: dish out the blurb fast, don’t give them time to think about it and move on fast with the next thing before anyone notices its crap

  13. The thread got a bit “skinny” above where I was discussing supply and demand with Rumplestatskin.

    Joye (in his latest blog posting – thanks for the link, Rumplestatskin) provides a link to the Complete 2003 Task Force Report, which I had never seen before.

    There is pages of guff about innovative forms of financing home ownership which would be unnecessary if supply side issues were addressed.
    But on Page 283 (at last….!), the Report gets into the “Supply” Side, and on Page 279 they say:

    “……our basic conclusion is straightforward: the high cost of home
    ownership in Australia appears to be a function of growth in the
    extrinsic value of land. Furthermore, this is a disease that is rapidly
    spreading throughout our largest urban centres. And unless radical
    action is taken, there seems to be no respite in sight……”

    On page 288 they say:

    “……The industry believes believes that the cost of Australian
    housing has been needlessly magnified by three factors:
    1. A 314 percent (420 percent) increase in land (dwelling)
    related taxes over the last decade, which have been levied at
    all levels of government
    2. Ad hoc, inconsistent and highly restrictive planning
    processes that prevent developers from boosting existing
    capacity; and,
    3. Reluctance on the part of municipalities and State
    Governments to release new greenfield and brownfield
    sites, and fund the essential infrastructure necessary to
    service such areas……”

    They discuss some innovative ideas to incentivise local governments to release land and expedite development.

    In their summary on Page 304, they say:

    “…….there is an affordability problem, but it
    has nothing to do with the distribution of income or a dearth of
    exploitable land. Rather, it is the result of oppressive government
    regulations (often imposed with the enthusiastic support of proximate
    communities) that severely constrict the stock of low-cost properties.
    Combined with ever-growing demand, these artificial constraints on
    supply propagate price rises. And so, despite the fact that many
    Australians are increasingly concerned about the costs of home
    ownership, much more intellectual capital needs to be invested in
    fostering supply-side policies. The good news is that we can do so
    without spending a cent of public money…..”

    I am interested that Joye was so clear back in 2003, about the “supply” side being the issue for housing affordability; yet he has been such a bubble cheerleader in the intervening years. Now, he is referring us back again to his “2003 position”. Can someone please explain?

    • “I am interested that Joye was so clear back in 2003, about the “supply” side being the issue for housing affordability; yet he has been such a bubble cheerleader in the intervening years. Now, he is referring us back again to his “2003 position”. Can someone please explain?”

      I think it has an awful lot to do with the shared equity mortgages Rismark sell. Unless I completely missread how they work, he stands to make a handsome profit from rising prices.

      I think it’s sad he didn’t continue to pursue a supply side agenda, instead of the demand side route he has taken, as that would have demonstrated a genuine interest in solving the issue.

      • You know, I kinda suspect that Joye gave up bashing his head on the brick wall trying to get the people who matter, to listen to him about the supply side issues (ask Alan Moran or Bob Day or Hugh Pavletich about how frustrating this is).
        So he decided, if they won’t listen, I might as well profit from the mass stupidity that is going on. If you’ve read “The Big Short” by Michael Lewis, you might remember some characters in there who thought this way re the California housing bubble in the 2000’s.
        The interesting thing is that Joye has publicly been on the “long” side for all these years, while the clever people in Lewis’ book were on the “short” side. People who take the “short” side at the right time make the biggest killing of anyone; but those who were “long” for years before the bubble burst, do all right as long as they are not personally committed to “long” positions at that time. Joye may be aiming to profit solidly via fees and commissions, from the lengthy period that being “long” has “paid”, and may not be personally committed to these positions himself.
        It will be very interesting to know the truth about Joye’s positions in the market on all this, in a few years time. If he personally loses a significant amount when the bubble bursts, these surmises of mine are quite wrong. If he makes a killing by going “short” at the right time, Michael Lewis needs to write a book about him.

        • Well, he sold RPdata some months ago, so maybe that’s some indication.

          Interesting take on his apparent change of position, might be true. I have to admit I’ve lately started to think of how I can make the bubble work for me, rather than against if it doesn’t look like popping soon, or in any hurry. I certainly don’t expect change in planning controls any time soon. You just have to read the letters pages to see the level of scorn for both McMansion sprawl, and ‘overdevelopment’ of leafy established areas (yesteryears sprawl) to see the level of opposition, and the planning profession certainly believes sprawl is bad as a self evident truth. It’s even possible for some to hold both views simultaneously, and support immigration.

  14. Carrying forward what Rumplestatskin was arguing with me yesterday: he said:

    “Any uplift in the price of land, not reflected in rent, must, by definition, by a demand side problem.

    I agree that supply side constraints could, if they were very constrictive, have price effects, but these would be seen in rents.

    So if Houston prices went up 30% while rents were flat, this is simply the same bubble behaviour seen across the world in many asset markets……”

    We are getting at some important details of bubble analysis here. There are 2 significant types of demand: utilitarian and speculative. “Utilitarian” demand, based on population and incomes, will indeed push up the price of rents as well as the price of land, if supply side restrictions cause an outright shortage of homes. We see this illustrated in the long term TREND in Britain.
    But “speculative” demand will push up the price of land WITHOUT pushing up the price of rents, because the “speculative” demand is dependent on expectations of further price rises. I include in “speculative” demand, even those first home buyers who are leaping in “before prices go up some more”.
    RENTER demand is overwhelmingly “utilitarian”, not “speculative”. There is no comparable mania among prospective renters, to “get in and sign a rental agreement before rents go up some more”. Prospective renters can either afford to enter the market or they cannot. So the speculative “investment” house buyer does not count on increased rental returns for his profit, but on further capital gains.
    And more than one academic analysis has concluded that speculative demand has to be included in the formulas as ENDOGENOUS to supply inelasticity, otherwise the formula fails to explain cities with high demand and little price increase.
    It would be interesting to try and disaggregate the inputs into Houston’s 1980’s price “bubble”. “Overbuilding” has to be the result of speculative demand, yet in Houston’s case this can clearly be said to be due to underlying fundamentals regarding growth in Houston’s economy and incomes relative to other areas investors could consider.
    Rumplestatskin is clearly a bit confused about the incomes aspect. Next comment refers.

  15. Rumplestatskin also said:
    “……the other main point we disagree is about the use of comparing median prices to incomes. My view is that it is irrelevant because it tells us nothing about the actual cost of home ownership (given massive variation in holding costs between cities, and massive differences in interest rates between countries).
    You could have a city with expensive housing and a median multiple of one if there were high land taxes and other holding costs.”

    Firstly, there simply has to be historical “norms” for the relationship between incomes and housing costs, and indeed between total regional income and total regional land value. These things are self balancing. Elevated land costs relative to incomes, is a serious economic disadvantage to a region, and economic decline is inevitable over the long term until the norm is resumed. Britain has been declining due to this factor, for 6 decades now.
    If a particular region, due to weather or topography, always has had higher costs of “housing” or property generally, that is a serious economic disadvantage that will show in their overall performance relative to low cost regions.
    If a CULTURE or the politics of a third world nation means that land prices relative to incomes are always elevated well above the “historical norms under free market conditions”, that third world nation is doomed to never join the first world. It is that significant. The “first world” rate of development and social mobility and economic stability, was always severely constrained under conditions (complained of by the likes of Karl Marx and Henry George) of an entrenched land owning class who reaped the benefits of the rising incomes of the masses of non-property owners that capitalised into land rents.
    Urban development was mostly controlled by politically connected oligopolies. This was easy when urban growth was predictably low at the fringes due to “foot” being the main means of travel, apart from “rails” which were just as predictable in their location and adjacent land was easily “cornered”.
    “Housing” cost falling into a pattern relative to incomes, meant that under conditions of constraint on development and its capture by oligopolies, the great mass of people tended to have to pay more and more for “the same” amount of space. Rumplestatskin is right if he says that this is the logical trade-off that should be made today to “keep housing affordable” – but the unfortunate side effect of this, is that people WILL “buy their way out” of space constraints to whatever extent they have the incomes to do so. The longer time goes on under these conditions, the MORE of the “rationed” amount of urban land there is, will be taken up by wealthy people’s gardens, swimming pools, tennis courts, triple garages, etc etc, while those “priced out” will have less and less space per person. This is observable reality in Britain since the 1947 Act that contained their urban growth.
    It is the era of “automobile dependent development” that broke through this paradigm and allowed for “the same share of income” to buy INCREASING space per person, as incomes rose; AND that allowed for this effect to apply RIGHT ACROSS SOCIETY. This is because automobile based development can occur anywhere, and can utilise land for which no premium over and above agricultural rents need be paid – as long as the market is truly “free”.
    The AMOUNT of “supply of land for x years of urban growth” PRIOR to the auto era, could always easily be “cornered” by land owning oligopolies. The AMOUNT of this land AFTER “automobility”, increased dramatically, to the point that “cornering” it became pointless.
    We see in China today, the same effect where well connected corrupt people gouge massive capital gains out of every urban development, which will cause THEIR economy to “hit a ceiling” long before they are anything LIKE a match for the US economy’s level of development. China needs a “Bill Leavitt” before it can really seriously start catching the USA.

  16. Rumplestatskin also said:

    “…..You could have a city with expensive housing and a median multiple of one if there were high land taxes and other holding costs.”

    Aha, read Mason Gaffney, 1964.

    I have no argument with this guy. Why do environmentalists not run with these economically LITERATE suggestions for Urban Growth Containment, instead of being useful idiots for the “mercantilism” that Gaffney condemns? I suppose the inability of environmentalists almost to a man, to even SEE that mercantilism is being enabled and abetted by blunt instrument “negative” policies of Urban Growth Containment (as Gaffney calls them) is responsible for this.

    • Phil,

      I’ve reread that linked paper (I think you have linked to it before). I can’t say I applaud it as an example of high quality reasoning.

      However, he basically proposes a land tax and says the rest will work itself out without the need for zoning (and also some interesting redirection of tax expenditure towards the city core).

      I agree that land taxes are a preferred away of taxing due to the incentive they provide to use land at its most valuable use. It’s been a common theme here at MB.

      But he also says that zoning can be effective where it ‘undershoots’ the market – which I take to mean a situation where the zones are sufficiently large to allow for urban development demands of the market.

      I believe this has been the case in Australian capital cities for many decades.

      Also, you state “there simply has to be historical “norms” for the relationship between incomes and housing costs”

      Yes there are. But don’t conflate housing costs with house prices – they are not the same thing. If rents were 5% of incomes and prices where 7x annual incomes, would that be an unaffordable market?

      • I reckon Mason Gaffney’s reasoning on the various alternative ways of “urban growth containment”, especially his exposee of “negative” blunt instrument policies, are exactly what you most need to take on board. You and the other proponents of blunt “planning”, are wide open to accusations of vested interests.
        The media have largely given “Green” anti sprawl arguments a free ride. The public needs waking up on this.
        Certainly some international property magnates are well known to lavishly fund Green political movements. I suggest the Greens are the useful idiots who haven’t worked out that that is how they are being used. They probably think the property magnates actually CARE about their cause. Ha, ha, what a joke.
        The rationing of urban fringe land in Australian cities certainly has not been “undershooting” the market, even if other forms of zoning might have been. The effect of urban fringe growth containment is far more dramatic than the many other issues of zoning.
        In a market where “……rents were 5% of incomes and prices were 7x annual incomes…..” there would have to be enormous distortions at work. What would concern me about this situation, is that the underlying motivations of the distortions, would be working against “property ownership” and towards the creation of class-based political constituencies. This is something worth worrying about in the context of the future of “democracy”.