Are the interest rate cut and the foreign investment crackdown linked?

In 2014, the RBA was loath to cut interest rates. But in 2015 it came out swinging, beating their previous record by knocking the official cash rate to 2.25 per cent!

Did the big bank decide:

a) the downside of a housing bubble isn’t that bad; or

b) the economy is in such dire shape that we need an interest rate cut even if it inflates house prices into a giant puffy monster; or

Screen Shot 2015-02-03 at 5.59.25 pm

c) the risks of a housing bubble can be contained?

Now, option a) seems unlikely. The US housing crisis is still very fresh in the minds of the globe’s central bankers. Just last year the Governor was warning in – for him – very strong terms about the risks flowing from housing. 

Option b) is not the answer either. This excerpt from Tuesday’s decision is not penned by an RBA frothing with fear:

“Overall, the Bank’s assessment is that output growth will probably remain a little below trend for somewhat longer, and the rate of unemployment peak a little higher, than earlier expected.”

So could option c) be the answer? They’ve found a way to contain housing risks?

It was only yesterday that Prime Minister Tony Abbott made a very public announcement about a crackdown on foreign investment in real estate.

“I am a friend of foreign investment but it has to come on our terms and for our benefit. The government will shortly put in place better scrutiny and reporting of foreign purchases of agricultural land and better enforcement of the rules against foreign purchases of existing homes so that young people are not priced out of the market.”

It was hard to process that announcement at the time, being bereft of context and detail. There had already been a crackdown announced. Was this new approach to have a louder crack, or push further down? It was a mystery.

Until the RBA rate cut.

I hadn’t though of a linkage here until I saw the question posed on Reddit. The person who asked the question in that forum sees causation running the other way, with an interest rate cut necessary to accommodate the deflationary effect of the crackdown.

But we know that the order in which things are revealed does not necessary accord with causation. Assuming so is to fall victim to the simplest kind of fallacy: post hoc ergo propter hoc.

The RBA may be betting that keeping Chinese money out of the market will help keep a lid on things.

Will that work? It might. Foreign investment represents only a tiny share of our market. But introductory economics textbooks tell you, economists think at the margin. A few extra bidders for a house can be what pushes the price of that house through the roof.

Think about it like this: if there 100 seat in lifeboats and the ship is sinking, the price of lifeboats will be zero if there are 99 passengers, and start to rise very rapidly if there are 101. The marginal bidder is important.

But that’s just the theory. The reality is that foreign buyers are scooping up very little real estate indeed.

which country bought most value held gorwing faster than value sold

pie chart

The RBA faces a market where investors are doing a lot of the lifting. They accounted for around 40 per cent of buyers late last year, a record. This interest rate cut could see auctions turn into a frenzy.

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thomasthethinkengine

Thomas the Think Engine is the blog of a trained economist. It comes to you from Melbourne Australia.

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