House price inflation

A quick primer: from the RBA website:

The Governor and the Treasurer have agreed that the appropriate target for monetary policy in Australia is to achieve an inflation rate of 2–3 per cent, on average, over the cycle.

Now for the first letter:

David Collett
XXXX
XXXX VIC 3XXX

11 December 2016
Dr Philip Lowe
Reserve Bank of Australia
GPO Box 3947
Sydney NSW 2001
Australia

Dear Dr Lowe,

May I ask why the RBA does not consider house prices when deciding whether to raise rates, lower them or leave them as they are?

My understanding is that it’s your job to keep inflation under control.

Kind regards,

David Collett

Reserve Bank of Australia
65 Martin Place
Sydney NSW 2000

GPO Box 3947
Sydney NSW 2001

T: (61 2)9551 9700
F: (61 2) 9551 8041
E: [email protected]

Anthony Dickman
SECRETARY

19 December 2016

Mr David Collett
XXX XXX
XXXX XXX VIC

Dear Mr Collett

The Governor of the Reserve Bank, Philip Lowe, has read your letter of 11 December and asked me to respond to you on his behalf.

The Reserve Bank’s responsibilities are set out in the Reserve Bank Act 1959 and further elaborated in the Statement on the Conduct of Monetary Policy agreed with the Government. The duty of the Reserve Bank Board to set monetary policy in pursuit of medium-term price stability relates to the prices of goods and services, the movement of which constitutes consumer price inflation. This incorporates due consideration of potential risks to financial stability, but it is not a mandate to target the prices of particular assets.

Housing prices are an important input to the Reserve Bank Board’s decisions. They are an indicator of activity in the housing sector, which is an important part of the real economy; they also provide some information about potential risks to financial stability from that sector. As such, housing prices are analysed extensively by Bank staff and discussed in detail in both the Statement on Monetary Policy and the Financial Stability Review.

Yours Sincerely
Anthony Dickman

David Collett
XXX XXXXX
XXXX VIC 3XXX

7 January 2017
Dr Philip Lowe
Reserve Bank of Australia
GPO Box 3947
Sydney NSW 2001
Australia

Dear Dr Lowe,

Thank you for your letter of 19 December 2016.

In your letter you stated that the duty of the RBA is to pursue medium-term price stability related to the prices of goods and services, excluding the prices of particular assets.

In April 1993 Bernard Fraser said, “Like central banks everywhere, the Reserve Bank attaches a high priority to price stability. Our role as guardians of low inflation is important in part because there is no strong, natural lobby for it in Australia.

As you are aware, Section 10 (2) of the Reserve Bank Act 1959 states, “It is the duty of the Reserve Bank Board, within the limits of its powers, to ensure that the monetary and banking policy of the Bank is directed to the greatest advantage of the people of Australia…”

While I am not a lawyer, the way I read the above section of the Act is that it’s the RBA’s duty to make sure monetary policy is directed to the greatest advantage of the people of Australia and that the RBA must also, in the opinion of the Reserve Bank Board pursue currency stability, full employment and the economic prosperity and welfare of the people of Australia.

Let’s say there’s a young man in the Australian workforce right now called Bernie. He’s 26 years old, has a university degree with a corresponding HECS debt, has been working full-time for three years and is already earning the average wage of $78,832 (1) which means that after tax, medicare and his HECS repayments, Bernie has a net income of $1,086.21 per week and he lives in Melbourne.

Let’s also assume that Bernie’s parents are not in a financial position to be able to help him in any way, that no relatives are going to pass away in the near future and that all his friends are busy dealing with their own financial situations. The point being that if Bernie wants to purchase something, he has to save the money himself or borrow from an Australian lender.

Bernie is currently living by himself in a one bedroom unit in Ascot Vale VIC, paying $275 per week in rent.

Bernie’s primary financial goal is to enter the property market and purchase a one bedroom unit that he can live in as an owner occupier.

Bernie currently has $47,840 in a three month term deposit earning 2.50%. He saved this money by putting aside $200 per week in his first year of work, $300 per week in his second year of work and $420 per week in his third year of work.

His weekly expenditure is as follows:

Bernie's weekly expenditure

Bernie has seen his local mortgage broker who has told him he could borrow up to $410,000 based on his current income, living expenses above, and a stress tested interest rate of 7.40% and a 25 year term.

However, his mortgage broker also told him that given his current deposit and the transaction costs associated with purchasing an owner occupied dwelling in Victoria, his maximum bid should be no more than $323,400 assuming a loan to value ratio of 90%. This would result in a weekly mortgage repayment of $393 at a comparison rate of 5% and a loan of $291,000.

As Bernie is living in Ascot Vale, he checks some recent local sales of one bedroom apartments and finds there are examples that have sold for less than his maximum possible bid of $323,400 over 25 years.

Bernie is at a decision point and is deliberating about what he should do next.

He can either enter the housing market now, or continue to save so that he can purchase a better home in the future.

After speaking to his broker, Bernie calculates that if he continues to save for one more year, his total deposit will be $69,680 and he’ll be able to buy a two bedroom apartment instead of a one bedroom apartment.

If someone said to Bernie that the RBA is supposed to keep inflation under three percent over the medium term should he believe them or dismiss such views as simply spin?

If he was going to believe them, should he assume that the biggest purchase of his lifetime is also being tracked by the RBA and accurately factored into the inflation figure the RBA uses to set the cash rate each month?

If someone said to Bernie that the measure of inflation the RBA uses from the ABS presumes workers such as Bernie are only spending $101.72 in rent per week (2) should he believe them or dismiss them?

If someone said to Bernie that the measure of inflation the RBA uses from the ABS presumes people only buy new houses without land and workers in his situation usually spend $131.44 per week on their new house, should he believe them or ignore them?

If someone said to Bernie that when the Reserve Bank Board meets each month to carry out it’s duty of setting the cash rate to the greatest advantage of the people of Australia, the board members consider “the people of Australia” to only refer to homeowners who are about to downsize and property investors who own multiple properties (as they are the main two groups who will receive a net benefit from rising house prices), should he believe them or dismiss them?

Given all of the above, let’s assume there was a change of Government and both the new Treasurer and the Governor-General were of the opinion that inflation was currently above three percent per annum and that the RBA should increase the cash rate, but the RBA believed inflation was currently below three percent and therefore that the cash rate should remain unchanged.

If the Governor-General ordered the RBA to increase the cash rate today (3), in fifteen days from now a statement would be laid before each House of Parliament from the RBA and the Government in relation to the difference of opinion.

Assuming the Government had argued that inflation is above three percent (because the new Government was factoring in how changes in house prices flow through to first home buyers) how would the RBA argue that inflation should not include changes in houses prices as experienced by workers such as Bernie?

I look forward to your response.

Kind regards,

David Collett

1 ABS 6302.0 – Average Weekly Earnings, Australia, May 2016

2 ABS 6440.0 A Guide to the Consumer Price Index: 16th Series 2011, page 28

3 Reserve Bank Act 1959, section 11

65 Martin Place
Sydney NSW 2000
GPO Box 3947
Sydney NSW 2001
T:(61 2) 9551 9700
F:(61 2) 9551 9700
E: [email protected]

Anthony Dickman
SECRETARY

28 February 2017

Dear Mr Collett,

Thank you for your further letter dated 7 January, addressed to the Governor, Philip Lowe, and the hypothetical example you cite. 

As noted in our previous response, dated 19 December 2016, the Reserve Bank Act 1959 and the Statement on the Conduct of Monetary Policy mandate the Bank to target consumer price inflation, that is, the rate of change in the prices of a basket of goods and services. The rate of inflation at a point in time is not a matter of belief or perception; it is calculated by the Australian Bureau of Statistics, an independent Commonwealth agency. The Reserve Bank does not target the level of asset prices, although housing price are taken into account in the Bank’s policy deliberations.

The Reserve Bank Act does indeed give the Government a mechanism to override a decision of the Reserve Bank Board, but it has never been used. It would be a significant event if this were to happen.

The Board’s duties in setting monetary policy relate to the welfare of the people of Australia as a whole. It would not be consistent with that duty to set policy in a manner that favours people living in a particular city, or those who already own property or who do not but would like to do so.

Yours sincerely

Anthony Dickman

RBA reply 28 February 2017

7 March 2017
Dr Philip Lowe
Reserve Bank of Australia
GPO Box 3947
Sydney NSW 2001
Australia

Dear Mr Dickman,

Thank you for your reply of 28 February 2017.

Which Statement on the Conduct of Monetary Policy are you referring to?

On the RBA website at Home > Monetary Policy > Agreement on Framework the following statements are listed:

-September 2016 Statement

-October 2013 Statement

-September 2010 Statement

-December 2007 Statement

-September 2006 Statement

-July 2003 Statement

-August 1996 Statement

Are the above seven statements the only statements I should be referring to in order to understand the existing agreement between the Government and the RBA on monetary policy?

I look forward to your response.

Kind regards,

David Collett

 

RBA letter 7 March 2017

David Collett
PO Box 133
Kew VIC 3101

17 March 2017

Consumer Price Index Section
Australian Bureau of Statistics
PO Box 10
Belconnen, ACT, 2616

Dear Sir/Madam,

May I ask why the current Series CPI does not include mortgage payments, mortgage interest payments and the price paid for a dwelling?

Surely the current CPI figures cannot be used as a realistic measure of inflation for households for macroeconomic policy decision making when the largest purchase most consumers will make in their lifetime is excluded from the index.

While I presume dwelling purchases by investors who are only acquiring an income producing asset should be excluded, the same should not be true for an owner-occupier purchase because there is a large amount of utility in owning one’s own home.

I look forward to your response.

Kind regards,

David Collett

Australian Bureau of Statistics letter image 17 March 2017

ABC NEWS 20 April 2017:

Inflation data ‘very poor’ cost of living measure due to house price exclusion.

Australia’s main official cost of living measure, the consumer price index, is failing young Australians by excluding home purchase costs, argues an economist from Australia’s largest bank.

Read more.

5 May 2017

David Collett
Post Office Box 133
Kew
VIC 3101

Dear Mr Collett, 

Thank you for your letter of 17 March 2017 regarding the Consumer Price Index.

In response to your question on housing and the Consumer Price Index (CPI), I have enclosed a copy of a feature article published by the ABS in the March quarter release of the Selected Living Cost Indexes (ABS cat. no. 6467.0) on 3 May 2017.

The Australian CPI is primarily used as a macro-economic indicator to monitor and evaluate inflation in the Australian economy. Assessing changes in the cost of living faced by Australian households is best achieved by analysing the ABS Selected Living Cost Indexes (SLCIs).

The feature article: What role does housing play in the Consumer Price Index and Selected Living Cost Indexes? describes the role of housing and how it is measured in the CPI and the SLCI.

Yours Sincerely, 

Andrew Tomadini
Director
Consumer Price Index
Australian Bureau of Statistics

ABS response letter 5 May 2017

David Collett

PO Box 133
Kew VIC 3101

8 July 2017

Consumer Price Index Section
Australian Bureau of Statistics
PO Box 10
Belconnen, ACT, 2616

Dear Mr Tomadini,

Thank you for your reply of 5 May 2017.

As of writing I have not received a response to my email to your office dated 8 June 2017 via [email protected]

Could you please point me to a publicly available document that sets out how “6467.0 Selected Living Cost Indexes” has been constructed, just as “6461.0 Consumer Price Index: Concepts, Sources and Methods” helps to explain how “6401.0 Consumer Price Index, Australia” is constructed, which is used by the Reserve Bank of Australia to make macroeconomic policy decisions.

I look forward to your response.

Kind regards,

David Collett

ABS reply letter 8 July 2017

David Collett
PO Box 133
Kew VIC 3101

8 July 2017

Dr Philip Lowe
Reserve Bank of Australia
GPO Box 3947
Sydney NSW 2001
Australia

Dear Dr Lowe,

Thank you for your letters of 19 December 2016 and 28 February 2017.

I write this letter knowing that ultimately the Treasurer is responsible for administering both the Reserve Bank Act 1959 and the Australian Bureau of Statistics Act 1975 as ordered by the Governor-General on 1 September 2016.

The purpose of this letter is to pose the following question for your consideration:

Could the Treasurer challenge you on monetary policy?

The question is not whether the Treasurer should challenge you. Obviously, if the Treasurer had a difference of opinion with the RBA on monetary policy the first step should be a series of private discussions. Making a challenge as per section 11 of the Reserve Bank Act 1959 should be viewed as an absolute last resort.

The question is not whether it’s likely the Treasurer will challenge you. Even though it would be unlikely for the current Government to hold a difference of opinion with the RBA board on monetary policy, there are signs a Labor Government could, given their interest in tackling more substantive issues such as negative gearing. Nevertheless, for the purposes of this letter, the question posed is whether the Treasurer could challenge you on monetary policy today.

Possible grounds for a challenge

A) Price instability

According to the Statement on the Conduct of Monetary Policy of 19 December 2016 (Statement 2016) the first objective of monetary policy is to focus on price (currency) stability.

Relative to the value of Australian house prices, the Australian dollar is unstable.

Relative to house prices for the weighted average of eight capital cities in Australia (1), the Australian dollar depreciated by the following:

Australian dollars vs house prices
Does house price inflation create the conditions for households to make bad decisions with regard to purchasing or not purchasing a home?

From Statement 2016:

Both the Reserve Bank and the Government agree on the importance of low and stable inflation. Effective management of inflation to provide greater certainty and to guide expectations assists businesses and households in making sound investment decisions.

…They agree that an appropriate goal is to keep consumer price inflation between 2 and 3 per cent, on average, over time.

If an appropriate environment for households to make spending decisions on food and clothing is an aggregate maximum annual price change of 2-3 per cent, then would it not be likely that a maximum annual price change in average house prices of up to 3 per cent would be a better environment to make purchase decisions in compared with 7.5%, 9.1%, 10.7% and 11.5% annual price changes?

The answer is obvious. If house prices were stable over the medium term, consumers would give more weight to whether they wanted to live in a house, not whether they can own the house for a few years while it’s value increases by 10% per year because others are willing to take on more debt than they are. If house prices were stable over the medium term, workers who do not own a home would be less disadvantaged compared with workers who already own a home in terms of saving for a deposit.

If Statement 2016 clearly states that the effective management of inflation should help to guide households to make sound investment decisions, then that logic should surely apply to the biggest investment/purchase decision most households ever make, namely, the purchase of their residential home.

B) Turning a blind eye to deficiencies in how the CPI series is constructed.

Let’s say it’s your first day with the RBA and your job is to keep inflation under control in Australia. You’re handed a factsheet with two tables. The first table shows the annual percentage change in food prices in Australia and the annual percentage change in private sector wages and the second shows house prices and wages.

Food prices vs wages

Given the above, which one of the following responses would be most appropriate?

  1. Do nothing because you assume the Australian Bureau of Statistics includes food in the CPI figures with an appropriate weighting relative to other household items so you can simply wait to see if the CPI figure is either within the 2-3% range or above/below.
  2. Check for yourself whether the ABS has an appropriate weighting for food in their CPI series to make sure the increases in food prices are not being under represented in the final CPI figures.
  3. Talk up wages.

House prices vs wages

Given the above, which one of the following responses would be most appropriate?

  1. Do nothing because you assume the Australian Bureau of Statistics includes house prices in the CPI figures with an appropriate weighting relative to other household items, so you can simply wait to see if the CPI figure is either within the 2-3% range or above/below.
  2. Check for yourself whether the ABS has an appropriate weighting for house prices in their CPI series to make sure the increases in house prices are not being under represented in the final CPI figures.
  3. Talk up wages.

I look forward to your response.

PS. I have included a copy of correspondence with the Australian Bureau of Statistics dated 17 March 2017, 5 May 2017 and 8 July 2017.

Kind regards,

David Collett

1 Australian Bureau of Statistics 6416.0 House Price Indexes: Eight Capital Cities

2 Australian Bureau of Statistics 6345.0 Wage Price Index, Australia

RBA letter page 1

RBA letter page 2

RBA letter page 3

RBA letter page 4

 

14 July 2017

Mr David Collett
PO Box 133
Kew VIC 3101

Dear Mr Collett

Thank you for your most recent letter of 8 July to the Governor of the Reserve Bank, Philip Lowe. He has read your letter, including your correspondence with the ABS, and asked me to respond on his behalf. 

I have little to add to my letter to you dated 28 February, in which I noted that the Reserve Bank Act 1959 does indeed give the Government a mechanism to override a decision of the Reserve Bank Board. This mechanism has never been used and it would be a significant event if this were to occur. Furthermore, the Governor is not inclined to speculate on possible responses to hypothetical scenarios. As noted in my previous letter, the Reserve Bank does not target the level of asset prices, although housing price are taken into account in the Bank’s policy deliberations. The inflation target is specified in terms of consumer price inflation, which is measured by the ABS, an independent Commonwealth agency. It is not the Reserve Bank’s role to verify calculations made by the ABS.

Yours sincerely,

Anthony Dickman 

RBA letter 14 July 2017

AUSTRALIAN FINANCIAL REVIEW 18 July 2017:

RBA sets 3.5% as new normal for official cash rate

The Reserve Bank of Australia looks to be shifting tentatively towards ending more than four years of emergency monetary policy support, putting households on notice it has pegged 3.5 per cent as the new normal for the cash rate, equivalent to eight rate hikes above today’s level.

Read more.

 

 

 

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