Source : THE AGE NEWS
Let me be the last to tell you: the Reserve Bank’s decision to raise the official interest rate for the fourth time this year, taking it to 4.6 per cent, will hurt people with mortgages. That rate’s the highest since 2011, and there may be another rise to go in a month’s time. But it will hurt more today than it did 15 years ago.
Why? Because house prices are now a lot higher than they were back then. This is an important part of the reason owning your own home has become so hard to afford.
When interest rates go up, many would-be home owners are unable to buy, but when interest rates start coming down – bringing some relief for existing home buyers – formerly frustrated buyers surge into the market, causing another burst of rising prices.
According to calculations by Curtin Business School’s Professor Alan Duncan, in June 2011, the average new owner-occupier home loan was about $363,000. In June this year it was more than double that, at $731,000.
For first home buyers, the average loan has doubled from $318,000 to $610,000.
This doubling in mortgage sizes and, hence, house prices, was matched by an increase in average earnings for full-time adults from $1305 to $2084. That’s only about 60 per cent. Now that’s unaffordability in action.
To put it another way, the average mortgage in 2011 was equivalent to about 5.4 years of average full-time earnings. Today it’s closer to 6.7 years.
If the income multiple had stayed at the 2011 level, the average mortgage would be $150,000 less that it is now.
Remember, however, that the interest rate banks charge on home loans is a margin above the Reserve’s official interest rate. That is, the interest rates you and I pay always have your bank starting with the official rate, then adding a margin to cover the bank’s costs and profits.
But get this: the margin added by home lenders was actually a bit lower before the latest increase than it was back then, going from just over 7 per cent 15 years ago to an average rate on new owner-occupier loan of 6.24 per cent.
It may interest you to know that the fuss we make about changes in the official interest rate is not matched in other rich countries. That’s because home loans in Australia tend to have interest rates the banks can vary at will.
In other countries, mortgages tend to charge a fixed rate of interest for the length of the loan. This means changes in the central bank’s official interest rate still flow through to home buyers but take a lot longer to be felt.
So changes in the official rate don’t cause the great stir they do in Oz. But that doesn’t mean other countries’ use of interest rates to control inflation is any less effective than ours is.
Even so, this doesn’t seem to have prompted our Reserve Bank to have given any thought to encouraging or requiring a move to long-term mortgage rates. My suspicion is that it’s come to enjoy the way all the recurring fuss about interest-rate changes has thrust it to the centre of our attention.
But when you think about it, the strange Australian way of doing it isn’t the only weakness in the use of interest rates – “monetary policy” – to slow down or speed up “demand” – our spending on goods and services.
In theory, a change in interest rates affects the borrowing and spending of the whole economy: households and businesses alike. In practice, interest rates have little effect on the behaviour of businesses. For them, the interest they pay is tax-deductible and there’s little sign that businesses’ decisions about investment are greatly affected by whether interest rates are a bit higher or a bit lower than they were.
So who is greatly affected by changes in interest rates? One group stands head and shoulders above the rest: people with mortgages. In particular, people with more recent, and thus much bigger mortgages. Such people will tend to be young. Older people usually have smaller mortgages because they bought when house prices were lower and have had more time to pay down the principal owing.
See what this means? Our use of interest rates to control inflation is yet another respect in which our economic system is biased against the young. Smart idea?
All of us – including oldies like me, who paid off their mortgage years ago and now spend freely – contribute to national consumer spending, but interest rate increases hit only the third of households with mortgages, particularly big mortgages.
If you think that’s unfair, you’re right. But it’s also wildly inefficient. All households spend, but only, say, a quarter of all households get punished whenever inflation’s too high. And this inefficiency means the poor young mortgage holders have to be squeezed a lot harder to make up for all those who don’t have a mortgage.
It surprises me that so little thought has been given to the idea that using interest rates is a dumb idea, so surely there must be some other way of controlling inflation that would be both fairer and more effective.
There is. I’m old enough to remember that it was only in the 1980s that the job got handed to the Reserve Bank. At the time it was expected to do the job better, but it’s turned out to have big disadvantages.
Before we switched to interest rates, we used the budget to handle inflation. When demand is too strong you increase income tax rates by a couple of per cent; when it’s too weak you cut income tax rates by a couple of per cent.
From memory, the main reason we switched inflation control to the independent central bank was that the pollies were reluctant to increase tax rates if there was an election in the offing. We could solve that problem by transferring decisions about the tax surcharge or discount to a new independent authority.
But don’t hold your breath waiting for the Reserve to suggest it be removed from the centre of the action. That decision must come from the federal government.
