The government of low interest rates hasn't done notably well in comparison to other western economies, writes Peter Browne
BURDENED by memories of 17 per cent interest rates in 1989-90, Labor has found it very difficult to challenge the Howard government’s apparent success in this most politically sensitive of policy areas. But the Coalition’s image as the party of low interest rates has suffered a series of setbacks since the last election, and this month delivered a further double whammy: another rate rise and news of an unprecedented number of mortgagees’ auctions in the outer suburbs of Sydney and Melbourne.
As election year approaches these are worrying developments for the Coalition. The only good news for the government is that Labor still hasn’t come to grips with the full extent of the government’s obfuscation over mortgage rates and housing costs.
Interest rates matter in Australian elections mainly because they are seen as a guide to housing affordability. But affordability relies as much on housing supply and demand, and these factors are heavily influenced by changes in government policy that promote or inhibit the inevitable fluctuations in the housing market. Low interest rates don’t necessarily mean that housing is more affordable.
Since 2001, according to a new report from the Parliamentary Library, a rapid growth in house prices has caused “an appreciable deterioration in affordability.” The report draws on the three best-known indexes of affordability - from the Real Estate Institute, the Commonwealth Bank and BIS Shrapnel - all of which support the same broad conclusion. In fact, says the paper, “the affordability indicator has fallen to a level comparable to that reached in 1989,” the year when morgage rates hit 17 per cent. On this measure, buying a new home is no more affordable today than it was in the bleakest of the Keating years.
Affordability mainly affects people who are trying to get a foothold in home ownership or have recently started paying off a mortgage. Over time, if interest rates stay steady and household income rises, then the affordability measure becomes less important to owner-occupiers. For these people, the prevailing interest rate and the value of their property are the key issues - which is why last week’s Reserve Bank decision and the increase in morgage defaults are so politically important. As the mortgagees’ auctions show, the cooling housing market has sent house values plummeting in some outer suburban areas.
The signs of all these problems - affordability, higher interest rates and a collapse in asset values - were clear well before the last election. A Productivity Commission inquiry into first home ownership in 2004 found that various features of the tax system, including negative gearing rules and the Coalition’s 1999 change to capital gains tax for assets held by individuals, had fuelled a boom in the housing market and put upward pressure on prices. Having set up the inquiry the Treasurer, Peter Costello, declined to adopt any of its recommendations.
Then, during the election campaign itself, the Reserve Bank itself and the International Monetary Fund warned that Australia’s housing sector was especially vulnerable to any drop-off in world growth. According to the bank, all the standard measures of financial vulnerability among households had reached “record highs.” A significant fall in house prices or an economic slowdown could lead to “a sharp fall in credit growth and a period of unusually weak consumption.” Or else the boom might continue, which could “reignite the housing market, increasing the potential for a difficult adjustment in the future.”
The International Monetary Fund, meanwhile, said that Australia was among a handful of vulnerable western countries in which a rise in interest rates “could trigger a much larger downward adjustment in house prices, with considerably more severe consequences for real activity.”
Neither these comments nor those of the Reserve Bank generated much discussion at the time, and the debate about which party was better at keeping down interest rates continued to dominate the election campaign.
But another paper, also released during the 2004 campaign, cast doubt on whether that debate had any real meaning at all. Rodney Tiffen from the University of Sydney placed Australia’s interest rates in an international perspective, comparing our rates with those in seventeen comparable western nations, including Britain, the United States, Canada, France and New Zealand.
Tiffen found that when John Howard took office, in 1996, Australia’s rate of interest on long-term borrowing was 8.3 per cent, or 1.4 percentage points above the average of the eighteen countries. In 2004, after eight years of Coalition government, Australia’s rate was 5.9 per cent - once again, 1.4 percentage points above the average. Interest rates had fallen in most countries, and Australia was in step with the fall, but our rates were still above average.
“There is no doubt that in the world of political perceptions the issue of interest rates holds a decided advantage for the Howard government,” Tiffen wrote. “In reality, however, its performance compared with other western governments has been average rather than superior.”
This is not as surprising as it seems. In an internationally exposed economy, interest rates will tend to reflect factors that are either directly or indirectly related to the state of the international economy. Most countries are experiencing low inflation, and that translates into low interest rates.
Interestingly, our performance worsened in 2005, the year after Tiffen published his figures. Interest rates began to rise in Australia but continued to fall in most western countries, and so the gap between our rates and those in the seventeen comparable countries grew to 1.7 percentage points by the beginning of this year. Figures so far for 2006 show the gap narrowing very slightly.
So the Howard government’s performance on interest rates has been underwhelming. Meanwhile, it has made a conscious decision not to deal with the flaws in the tax system highlighted by the Productivity Commission - flaws that have added to the problems faced by new home owners and mortgagees. In other words, over the past decade the federal government has successfully taken credit for lower interest rates, which reflect an international trend, while avoiding taking any practical action to deal with the dramatic deterioration in housing affordability.
Peter Browne is editor of Australian Policy Online. This article first appeared in the Canberra Times.