Change of Australia Housing Prices is found to be mostly caused by Changes of Real Interest Rates

My recent article in Medium (Yiu, 2019) reviews my thesis that change of housing prices is mainly caused by the change of real interest rates, which refers to Australia housing markets. I have also written another article in HKEJ (Yiu, 2018) showing that the change of the housing prices of Australia is not caused by the change of housing supply. However, I did not conduct any empirical studies on Australia housing markets to test the hypothesis.

Fortunately, a recent study by Saunders and Tulip (2019) of RBA has confirmed empirically my thesis as follows:

“The model suggests that much of the strength in housing prices and construction over the past few years can be explained by the fall in interest rates — some of this fall reflects lower world real interest rates and some is cyclical. A large part of the effect of interest rates on dwelling investment (and hence real GDP) occurs through the channel of housing prices.” (Saunders and Tulip, 2019);

“The model estimates that the reduction in real interest rates (actual interest rates, less inflation) accounts for most of the boom in dwelling prices and a large part of the boom in dwelling investment,” (Chancellor, 2019).

Their Framework argues that housing supply (measured by building approvals) is also the consequence of interest rates and household income. (see box 4.1 in Figure 1)

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Figure 2 Key Model Relationships. Saunders and Tulip (2019)

Figure 2 below shows the strong resemblance between real interest rate, housing prices and building approvals in Australia (compare the red and the yellow curves).

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Figure 2 Real Interest Rates and Real Housing Prices of Australia, 1985–2018. Source: Saunders and Tulip (2019)

Figure 3 shows the empirical model of the Effect of Real Interest Rates on Building Approvals.

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Figure 3 Empirical Model of the Effect of Real Interest Rates on the change of Building Approvals. Saunders and Tulip (2019)

Figure 4 shows the empirical results. The change of real interest rates are found to impose a negative impact on the change of building approvals, no matter in detached houses, higher-density housing and alterations and additions. The results are statistically significant at the 1% levels and the 5% levels.

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Figure 4 Empirical Results of the Effects of Real Interest Rates on the Change of Building Approvals. Saunders and Tulip (2019)

Lastly, Figure 5 shows the empirical model and the results of the effect of real interest rates change on housing prices change. The change of real interest rate is found to impose a negative impact on the change of housing price. The effect is statistically significant at the 1% level.

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Figure 5 Empirical model and results of the effect of real interest rate on housing price. Saunders and Tulip (2019)

This paper is a timely piece of evidence supporting our hypothesis of real interest rate effect on housing price. This theory can explain the housing price plummets in Japan in the 1980s, in Hong Kong during the Asian Financial Crisis in 1997, in the US during the Subprime Crisis in 2007, and in Spain during the Sovereign Debt Crisis in 2008. Saunders and Tulip (2019) study further strengthen the generalizability of the Real Interest Rate theory.

References

Chancellor, J. (2019) Falling interest rates were the main factor in Sydney’s house price surge, March 15. https://www.news.com.au/finance/real-estate/sydney-nsw/falling-interest-rates-were-the-main-factor-in-sydneys-house-price-surge/news-story/909cd54fcbeeb074b5d94a97e36f91e7

Saunders, T. and Tulip, P. (2019) A Model of the Australian Housing Market, RDP 2019–01, March, RBA. https://www.rba.gov.au/publications/rdp/2019/pdf/rdp2019-01.pdf

Yiu, C.Y. (2019) Real Interest Rate Effect on Housing Price Cycles, March 12. https://medium.com/@edwardyiu/real-interest-rate-effect-on-hong-kong-housing-price-change-25a0cce8cd0f

Yiu, C.Y. (2018) 增土地供應遏樓價? 恐隔山打牛,HKEJ Oct 15 [in Chinese]. https://monthly.hkej.com/monthly/article/id/1967559/%E5%A2%9E%E5%9C%9F%E5%9C%B0%E4%BE%9B%E6%87%89%E9%81%8F%E6%A8%93%E5%83%B9%EF%BC%9F+%E6%81%90%E9%9A%94%E5%B1%B1%E6%89%93%E7%89%9B

Written by

ecyY is the Founder of Real Estate Development and Building Research & Information Centre REDBRIC

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