House prices and mortgage market liberalisation in Australia

Financial liberalisation and innovation (FLIB) in Australia over the 1980s and 1990s provided the institutional backdrop for one of the most rapid increases in household balance sheets and house prices in the world. An error correction model of quarterly Australian house prices for 1972-2006 identi…es the key long run drivers as real non-property income per house, the working age population proportion, the unemployment rate, two government policy changes, real and nominal interest rates and FLIB. All else equal, FLIB directly raised the long run level of real house prices by around 65 per cent while higher real interest rate subtracted 38 per cent from long run prices. Real interest rates are shown to have much greater impact after FLIB than before, while the opposite is true for nominal interest rates. These …ndings suggest that FLIB fundamentally relaxed binding credit constraints on households and enhanced opportunities for intertemporal smoothing. The paper also …nds that house price dynamics tend to be mean-reverting whenever lagged real house price growth is less than 4.6 per cent. However whenever lagged price growth is greater than this, especially during booms, house prices tend to display "frenzy" behaviour measured as a cubic of lagged house price changes. Key words: House prices, mortgage markets, …nancial liberalisation JEL classi…cation: E21, G21 This paper is a work in progress prepared for the American Economic Association’s annual meeting in San Francisco, 3-5 January 2009. I am grateful to Professor John Muellbauer for his supervision and to colleagues at the Australian Treasury, Reserve Bank of Australia and Department of the Prime Minister and Cabinet for their help with data. This paper has bene…ted from the helpful comments of seminar participants at the International Monetary Fund and Oxford University Economics Department’s Gorman Workshop Series. Any errors or omissions are my own. yDepartment of Economics, University of Oxford, Manor Road Building, Manor Road, Oxford, OX1 3UQ, UK [email protected]