Inflated Asset Prices in Australia - Case Study Example

REPORT: INFLATED ASSET PRICES IN AUSTRALIA By student’s Name: Code+ Course: Instructor’s Name: University Name: City, State: Date of submission: The Executive Summary Discussions on the affordability of housing in Australia have laid blame on the effects of the failure of markets. Particularly, the market that focus its attention on the sector of private rental and issues relating to housing distribution in residential areas, even if this could be the case there are also other factors that cannot be left aside such as those that lead to inflated prices in the real assets and the changes brought about by excessive demand of housing especially in residential areas. Housing market have been seen to contribute significantly to the economic growth in Australia in the recent past as more and more residential houses continue to constructed in urban areas. The rise in housing prices has a positive relationship with consumption where consumption accounts for about 60% of the economy’s aggregate demand. Therefore a rise in housing prices leads to a rise in consumption level and conversely a fall in housing prices leads to a fall in consumption. Introduction The main focus of this report will be based on the several economic effect related to the affordability of housing. The main aim of this report being the development of policies that can help solve the economic problems related to housing. Housing affordability in this context is being considered as a matter relating to national as well as the regional economies rather than a matter of social policy. The issue of housing as pointed out by traditional theory on public finance (Musgrave, 1959). focuses on three distinct fields the state need to intervene; that is the stabilization, distribution and housing allocation. These fields form the basis whereby the government can intervene to correct the failures and the imperfections brought about by the markets. Australian price inflation on houses has been caused by a number of factors that includes; the rural-urban migration, increase in population growth and the increase in the level of income. However there are some other factors that can be categorized as institutional that includes; The ease access to the capital markets where they have been liberalized, policies that have been put into place by the government for easier access to credit available for borrowing in order to facilitate people to buy houses and current policies that that have been put into place by the Australian treasury on financial innovations. Increment in the growth of the rental investment facilitated by easier credit availability in the financial institutions as evident in some that give mortgage loans. Increased participation of women in the labour force that leads to growth of households in to two distinct ways. Improvement in the stock market policies where the investor can easily change savings to property from equity. The prevailing housing boom is necessary phenomenon due to its correlation connection with the levels of consumption which forms the basis of economic growth. This correlation link is basically known as the wealth effect. Its implication being, that the more the households consume the more the more their wealth (Leung, 2004). This is basically derived from the “life cycle theory of savings” which is argues that people generally save form their income (current) so as be able to proper plan on distribution of their consumption over a period of time in order to maximize their utility. However if they happen to experience a sudden rise in their wealth for example brought about by the increment in house value they ought to save less than they would since its regarded as windfall income and where they save or not it may not affect their future consumption pattern much, however it raises the amount of current consumption (Haugen, 1995). The overall effect of this is that it boosts the general economic activity where there is increase in the levels of savings-meaning there is enough to borrow as the well as increasing the level of investment in the economy and also boost employment characterized by increase in real wages for workers again increasing the level of consumption. On the other hand should there be a fall of in the real prices of housing, the wealth of the owners of houses decreases, thereby saving more from their current income for future consumption. The overall effect would be the reduction in aggregate demand, employment as well as reduction in income. This can also be seen under other factors that link the rising real asset prices to consumption; Collateral effect-the households who could not borrow initially to cater for their current consumption due to inadequate wealth can now do so due to increase in wealth inform of the housing wealth (Modigliani; Blumberg,1954). This has a great impact on the as credit standing from the wealthier borrowers increases thereby motivating the lenders to access more credit rates that are relatively lower. In return there is a rise in aggregate consumption. The vice versa is also true. As prices declines there is less collateral on board to secure loans making the lenders to increase interest rates on loans to due to risk on borrowing thereby reducing consumption hence slowing down the economic growth. Consumer durables- increase in the demand of houses in residential areas due to factors such as rural-urban migration consequently increases demand for a number of goods that includes; carpets, furniture, television seta as well as other goods increasing the consumption rate and then rate of economic growth. However there a decrease in demand in case of an imperfection in the market slowing down the rate if economic growth. Residential construction-as existing housing prices raises the profit expected from the new houses shots up. Construction of new houses raises the GDP/aggregate demand. However in case of a fall in housing prices the aggregate demand slows down as well as the GDP growth. Evaluation Problems related to housing affordability arises when the income from the household’s is not adequate to cover up for the numerous non-housing costs the moment then household attains the standard dwelling place of the level that that the household can comfortably afford (Gordon, 1964). Thereby there is need for government intervention to address the problem by proper redistribution of income by use of a well taxation system and putting into place the relevant income assisted measures. This approach is based on the assumptions that the rental sector and the financial markets will reciprocate and supply houses at rather relatively prices which could be done through a method known as ‘market filtering’ (Brady, Canner and Maki,2000). Although as a matter of fact the prices of houses in residential areas go on increasing with no tendency of falling. However with the constant supply of housing that is of lower cost and especially in the urban centers the prices of housing may have a tendency to fall. Some of the major causes of housing problems can however be noted from a plan referred to as CRV 3. Changes in the population mostly the ageing which increases the number of households that is smaller in size and consequently smaller incomes too. Reduction in the supply of cheaper housing in private as well as in public sector. Changing preferences on matters relating to housing where some people can be seen to rent houses on long term contracts which excerts pressure on private housing rental sector. Lack of capacity to innovation in the construction sector and failure of households to rent cheaper houses that may be available in the community. Adverse changes in the labour market that raises the cases of job insecurity as well as earning inequality. Housing stress resistance to policies on redistribution signals to the government that there is need for direct intervention in the low cost housing provision through conventional public housing .As issues of constraints on the public expenditure has increased in Australia the government should encourage private investors to meet the increasing demand of housing especially in urban areas. This arrangement will be in line with the firm analysis that housing is a basic requirement for regional economies to operate effectively (MacLennan, 2004). These forces contributing to housing stress can have an adverse effect on the stability of the economy as a whole. Particularly they can have effects on the aggregate demand through the imports, savings, investments and consumption. Conclusion Over the last two years the Australian housing market have been seen to ease coupled with the recovery of equity markets with a slowed growth in consumption as well as the general economy. However this renewed hope is not meant to counter the recommendations in this report .The argument therefore can be that there has been slow growth in the economy although it has not reached a position of falling sharply the fact being that the housing prices seem to have flattened or rather seemed to fall slightly in many markets. Therefore in this framework housing affordability cannot be ignored as its contributions to the economic growth are significant. Factors that reduce the affordability as well as rising prices subject to income can contribute to stable economic growth. A monetary policy meant to increase interest rates in order to stabilize the economy will make the housing to moderate as well as cut on consumption on households. In case of a fall in the level of income, housing stress increases not unless the costs of the houses fall with the same magnitude. However the impact on the current home purchasers as well as the investors is that they may not enjoy the benefits of falling prices as the rent may not fall quick enough to compensate a fall in income as well as employment (Dornbusch, and Fischer, 1987). References Brady, P., Canner, G. and Maki, D. (2000). The effects of recent mortgage refinancing. Federal Reserve Bulletin July. Dornbusch, R. and Fischer, S. (1987). Macroeconomics. New York: McGraw-Hill. Gordon, R. (1964). Business Fluctuations. New York: Harper and Row. Haugen, R. (1995). The New Finance: The Case against Efficient Markets. Englewood Cliffs: Prentice-Hall. Leung, C. (2004). ‘Macroeconomics and housing: a review of the literature', Journal of Housing Economics 13: 249-267. MacLennan, D.( 2004). 'Housing Policies: New Times, New Foundations. York: Joseph Rowntree Foundation. Modigliani, F. and Blumberg, R. (1954). Utility analysis and consumption: An interpretation of cross-section data', in K. Kurihara (ed) Post-Keynesian Economics. New Brunswick, NJ: Rutgers University Press. Musgrave, R (1959).The Theory of Public Finance: A Study in Public Economy. New York: McGraw-Hill. Read More