Housing Prices Relative to Consumer Prices

Keywords: Macroeconomics & Money;

I was asked to provide the New Zealand equivalent in the graph showing US housing prices relative to consumer prices in Real Estate Roller Coaster .

The longest housing price series I could find starts at the end of 1979 and finishes in late 2006. I wont go into detail but it is not an ideal index (median prices for houses sold). However it will serve reasonably well for long run purposes. Deflated by the Consumer Price Index, the shorter graph for New Zealand appears as follows:

[Click to Enlarge]

I have put in a trend line for the 1979 to 2002 period. You can see there is a tendency for housing prices to race ahead of consumer prices, and then fall back. Its slope amounts to about 2.5 percent a year. That means there has been a tendency for house prices on this measure to rise faster than consumer prices. There are two basic reasons. First, houses are getting ‘better’ (bigger, lower maintenance, better designed …). Second land prices (which are included in the total house price) rise relative to inflation as the best locations are valued increasingly greatly: Mark Twain said ‘Buy land, they’re not making it anymore’.

After 2002 the line leaps up, well above the trend. Indeed by end 2006 it is 50 percent above it, so a $450,000 house would have been only $300,000 had the trend continued.

The extraordinary jump is almost certainly due to the fiscal deficit that the Bush tax cuts and expenditure expansion (not only to fight in Iraq) began generating at that time. That meant the US government was injecting a lot of dollars into the world economy. One of the places the increased liquidity leaked into were housing markets throughout the world, including New Zealand’s. People could borrow reasonably easily, and they did, lifting housing prices. This generated nominal capital gains which people speculated on, lifting the housing prices further, and so we got the speculative bubble which the graph demonstrates.

It cant go on upwards indefinitely, and as Stein’s law says, ‘If it can’t last, it won’t.’ There are two immediate problems. House prices have risen so far, that it is becoming increasingly difficult for new house buyers to purchase. Moreover, house rents have not risen to the same extent so that those into investment housing are struggling to find cover their outgoings from the rental incomings.

Moreover, the graph seems to suggest from mid-2006 the spectacular capital gains period may be over.

What might happen in the future? First if the graph flattens out (so that house prices rise at the same rate as consumer inflation), the trend line catches up in about 2023. If they flatten out in nominal terms. assuming consumer inflation of 2.5 percent p.a. the trend-line gets to the graph in about 2015, which is still a long way off.

These are just assumptions, not predictions, but they give you a sense of just how unusual the new situation is. Any forecaster has to be very cautious. It is true that house prices have fallen in the past, but never for long – and never dramatically. The biggest nominal fall on record is 3.5 percent in the six quarters between third quarter 1990 and first quarter 1992. There have been practical reasons why house prices did not fall rapidly: rather it takes a longer time to sell a house during a mild slump. (Remember that the house price index is not perfect, and does not adjust for improving housing quality so the quality adjusted fall is a bit more.)

But these are unusual times so past experience may not be too relevant. Focussing on the local housing market may miss the point. The situation is generated by the US fiscal deficit. The increased world liquidity is distorting other parts of the world economy. Recall that the Reagan deficits caused havoc in the world economy in the 1990s after Reagan had gone with a number of economies in deep financial strife: Argentina, Brazil, Indonesia, Korea, Mexico, Russia, Thailand, Turkey. The next round of financial stress may be companies rather than countries, we just cant tell. And we cant rule out that the bust will precipitated by the housing market in the US, which does not look healthy, even by New Zealand standards. But we just dont know.

Economists’ advice is hardly worth taking. but for what it is worth, I’d have thought it is something like dont overburden yourself with debt. That may mean deferring first house purchase (it may be better to rent and lock regular savings into the Kiwsaver scheme which starts in July), and if you are overburdened – struggling already to pay, or would struggle if interest rates went up further or your income fell a bit, then see what you can do to reduce the debt, including contemplating cutting back your consumption and saving more.

But as Leonard Cohen sang
Now you can say that I’ve grown bitter, but of this, you may be sure:
The rich have got their channels in the bedrooms of the poor,
and there’s a mighty judgment coming – but I could be wrong.
You see, you hear these funny voices in the tower of song.

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