Reserve Bank talks of early interventions

The Reserve Bank is warning that it might act to head off future house price booms.

It also claimed credit for the relative stability of house prices in Australia over the past five years.

Three Reserve Bank economists, led by Paul Bloxham, said lending curbs – jawboning – and tighter lending standards – could be used – as well as interest rate rises – to curb incipient booms.

Carefully graduated warnings, given by financial authorities like the Reserve Bank, are commonly known in financial circles as jawboning.

The bank also warned, very bluntly, that house – and other asset prices – can fall as well as rise.

In their discussion paper, the economists said the global financial crisis had provided “a stark reminder” of the fact that large falls in asset prices could “severely damage” entire economies.

House prices in the United States fell by 25-30 per cent between 2007 and 2009.

That, ultimately, had led to “the largest decline in economic activity in over 60 years.”

House prices had also fallen in the United Kingdom, Ireland and Spain.

The economists said the debate on associated issues had shifted from whether the authorities should intervene, when dangers like these arise, to how they should do so.

“The global financial crisis has clearly demonstrated that a policy of  ‘cleaning up the mess’ after a collapse in asset prices is problematic…’” the three economists said.

This was especially so if significant financial institutions are damaged as that happens.

“This strengthens the case for taking earlier action in order to avoid a damaging correction later on,” they said.

They noted that house prices  had been rising rapidly in Australia between 2002 and 2004.

That had been accompanied by a rapid expansion in home lending.

The economists recalled that the Reserve Bank had then increased interest rates.

“The boom ended in late 2003, with national housing prices broadly flat over the subsequent 18 months..” the economists said.

They noted that prices had actually fallen in that time in Sydney and Melbourne.

The economists said investor demand had also “eased significantly” at that time.

Since then, house prices had broadly kept pace with increases in disposable incomes, they said.

The economists conceded that the entire issue is still contentious.

However  the debate had moved on.

“An idea that appears to be gaining wider acceptance is that there is a case for policy to focus on financial imbalances more generally, rather than asset prices in particular,” the economists said.