How Australia’s Soaring Housing Costs Affect The Economy

Question: Describe how Australias soaring housing costs affect the economy. Answer: Housing prices had various macroeconomic effects on the economy. Rising house prices is considered to be categorized as a wealth effect which makes owners feel wealthier inducing them to spend more on their private consumption. The soaring house prices also imply that households who are otherwise not able to borrow now can borrow against the increasing equity of their houses and hence further increasing private consumption. In recent times Australias housing prices had been soaring. Australias houses as estimated by the International Monetary Fund are overvalued by 10%. The housing price inflation occurred as Australia moved towards 2000s with low interest rates and the gush of mining related income leading to growing private credit and rise in housing prices. Increase in private borrowing to buy houses has also driven up the prices further. As per the article by Tom Bentley and Jonathan West, from 1985 to 2015, bank lending in Australia increased from 20% of the GDP to approximately 130%. This private debt accumulated by the households is largely for housing. Australia accounts for the highest ratio of housing debt to total lending of 54% in the world and second highest ratio mortgage debt to GDP of 99%. These indicate that Australia is placed at a risk of a downturn in housing prices, and also housing being an unproductive economic investment, excessive private lending for housing is siphoning way finance from productive business investments which shall bring forth new products and services. Housing finance increased from 25% of credit outstanding in the year 1990 to over 60% in the present time. While over the same period business lending declined from 65% to 35% reflecting the Australian economys changing structure. Considering the data and information given we look into the various effects of the rising housing prices both positive and negative on the economy. Higher housing prices as earlier mentioned act as a wealth effect and house owners feel wealthier which in turn results into greater consumption/spending and reduction of savings by these individuals which increase the aggregate demand of the economy boosting the GDP and growth. In Australia, real estate stands out as an important investment asset and increases in property prices above the construction costs, influences the building of new houses. This boom in the construction sector also boosts employment and the overall demand in the property related sectors. Turning to negative effects, the strength of the total wealth effect is not certain and depends on other factors too like the duration of the rise in house prices which may be temporary or permanent or ownership rates of houses in the economy. Hence the wealth effect varies in such situations. On the other hand, rising prices also reduces the number of people who can afford the houses at such prices and they have to increase their savings for higher deposits to get mortgage loans which in turn reduces their consumption spending subjecting them to incidences of housing stress and crisis. Hence, we see that the housing sector plays a vital role in the Australian economic growth. But the soaring housing prices is impeding investments in the real economy hinging the developments of skilled workers and further increasing inequality which has effects on Australias long term growth. The rising prices have driven up the wealth inequality and the article concludes on the note that this rising inequality should be curbed by redistribution of opportunity and reward widely. References: Bentley, T West J 2016, Australias soaring housing costs signal needs for a new economic consensus, viewed 18 May 2016. Carter A 2013, High house prices damage business and the economy, viewed 18 May 2016. Mankiw, G 2003, Macroeconomics, Worth publishers, New York. Samuelson, P Nordhaus, W 2010, Economics, Mc Graw hill, New Delhi.