Solution to the house affordability problem - Myassignmenthelp.Com

Questions: 1. In your own words, summarize the IMF report article, Australia,  IMF Country Report No. 15/275, September 2015 (pp. 1-21 only). In particular, what are the main messages of the article? 2. Using appropriate diagrams, figures and data collected to answer Are Melbournes housing prices overvalued?  a question raised in the above IMF report. Why or why not? 3. Examine the impacts of an increase in the foreign buyers stamp duty (tax) on the equilibrium housing prices, consumer surplus, producer surplus, and total surplus (or social welfare). Can an increase in the foreign buyers stamp duty (tax) raise social welfare? Why or why not? Can an increase in the foreign buyers stamp duty (tax) raise city governments tax revenue? 4. Discuss, explain and comment at least three other housing policies or measures to stabilize the housing markets and the economy. Answers: Answer 1 The article discusses rapidly growing price of houses in the Australia. The incidence of price rise is often considered as overvaluation in the housing market. However, some commenters discard the argument of overvaluation on the ground that measure used to value houses are actually flawed. The article critically evaluate argument and counter argument for housing price inflation in Australian housing market. It is argued that housing prices in the nation have increased at a faster rate than other contemporary countries indicating overvaluation of the equilibrium prices. In response to a rapid growth of per capita GDP housing price picked up a rising trend in mid 1990s. Housing prices had accelerated so fast that it soon overstate income growth leading to a rise in the ratio of housing price to income. Traditional measures such as ratio of price and income and that of price to rent have shown an overvaluation of houses by more than 20 to 25 percent. The growing price of houses attracts people to investment in property market. The fund requirement to make investment on houses results in a rise of debt to income ratio. The figures for debt to income ratio are consistent with is competitor countries such as Canada, New Zealand and UK. High debt ratio is an indicator of instable financial status and associate risk for the concerned industry. The argument of overvalued housing price is countered by stating price is computed based on absolute values. The use of difference of average housing price across countries to estimate housing price valuation is a problematic approach. According to this argument after a persistently low housing price for a period, the abruptly rising house price indicates a catch up rather than overshooting. Price to income ratio has recorded an increase in terms of all its measures. Despite having discrepancies in housing price with a comparatively high price of houses in coastal areas and capital cities, the price to income ratio is highly consistent within the nation. When comes to international platform, the comparison of price to income ratio becomes difficult because of differences in housing coverage and measures of disposable income. When comparison has made in international scale then Australia broadly appears in line with other competing nations. Not only house prices exceeds its equilibrium level but also the equilibrium itself rose to a considerably high level. Disinflation and financial liberalization are two factor contributes to a rise in equilibrium level of house price and consequent rise in debt. The changing dynamics of equilibrium make it difficult to devise a comparative analysis of property price across different countries. A low level of price and financial liberalization along with a low interest rate increases availability of credit and the serviceability of high debt levels increases leading to rising indebtedness and high ratio of house price to income. A suitable approach for estimating house price is to model housing price at times when transition to housing price has done completely. Under this approach, basic economic concepts of demand and supply side factors and difference between actual and forecasted value both are taken into consideration. In order to correctly asses housing prices econometric approaches are also used. Time series analysis based on suitable explanatory and explained variables, User cost approach and trend approach are some of the econometric methods for computing house prices. The general equilibrium framework illustrates the relation of real interest rate with debt or income ratio. Studies found clos inter-relation among high prices of housing, low interest rate and household debt. High house prices reflect the supply side constraint. Housing supply falls in short of demand creating an upward pressure on prices. One major factor contributing to high demand of housing is the rapidly growing population. The average population growth of Australia is greater than OECD average rate. Residential investment is consistent with OECD level with a low vacancy rate since 2006. Geographic constraint such as low availability of land or lack of infrastructure make housing supply inelastic. The relatively low response from the supply side result in a high proportional rise in housing price. Apart from geographical obstacles, household preferences and political factors further restrict housing supply. To address the issue of supply shortage, planning has been made for construction of new houses that can be added to existing supply. The relatively small response of supply to the growing demand though reduces the risk of overvaluation but fail to eliminate the concern. The crisis in housing market is more intense in Sydney than that in the national level. Prices in the property market has grown rapidly in the aftermath of Global Financial Crisis. Hike in housing price in Sydney is proportionately higher than that in other capital cities. Sydney having a relatively high income face huge pressure on demand as more and more people willing to stay in the city. Doubling investors loan in combination with low interest and intense competition have driven up housing prices in Sydney. Demand generated from foreigners is found to be an important factor pushing up prices in Melbourne and inner city of Sydney. No evidences are found on a weak lending standard or speculation. During this phase, a strong growth in mortgage lending is experienced while also lending growth remained strong. The loan to value ratio remain stable with a high quality of assets, increase in mortgage buffer and a high debt ratio among high income household is found. The relatively small credit gaps fail to mar any significant credit boom. Some specific areas of credit market needs special attention. Such as investors credit concentrating mainly on Sydney credit market has grown significantly. The overvaluation of houses does not matter, as Australian banks are able to stand with a big fall. The existing level of capital of banks though are likely to be enough to remain sorted in the phase of declining house prices but it is not sufficient to counter the worsening macroeconomic scenario. Answer 2 Sydney and Melbourne are two important capital cities in Australia that have experienced a massive gain in the housing prices. In these two capital cities, housing prices are overvalued between 25-50 percent (Baur and Heaney 2017). The figure bellow shows trend in median house price of some capital cities in Australia. As show from the above figure in terms of median house price Sydney outpaced most other capital cities. Melbourne stands after Sydney when compared with respect to median house prices. Housing price in these two regions exceeds prices in eight other capital cities. The data clearly evidenced an overvalued price of housing in Sydney and Melbourne. In terms of residential property prices, Melbourne outpaced most regions except Sydney. Various factors contribute to a rising housing price in Melbourne. The mismatch between supply and demand causes a disequilibrium in the housing market. The growing need of housing in Melbourne is not temporary rather it is due to permanent increase in population. The estimated population of Melbourne for 2020 is nearly over four million marking an approximate population growth of 25 percent in last 13 years. The massive increase in population creates additional need for residential houses. Another factor contributing to huge demand for houses in Melbourne is urbanization. Australia is one of the most urbanized nations of world. The population in capital cities is more two third of total national population. Among these Sydney and Melbourne alone have 40 percent population. In Melbourne urbanization has spread rapidly. There are favorable environmental conditions that affect urbanization. These are a stable temperature, access to natural resources and favorable agriculture. To enjoy the relatively stable temperature in Melbourne many people migrate to Melbourne leading to urbanization (Windsor, La Cava and Hansen 2015). An environment favorable to farming is one of the primary factor for urbanization in the city. Apart from these, various social factors work in favor of urbanization in Melbourne. With rapid spread of urbanization, Melbourne has become the second most populous region in Australia. Urbanization by attracting many people create an upward pressure on housin g price. In addition to rising pressure on housing demand from domestic buyers, growing demand also generated from foreign buyers. The foreign purchase of houses is more likely to occur in highly dense inner city of Melbourne. The recent rise in foreign investment in residential market leads to a considerable rise in price. The low interest rate in Australia allow people to borrow more funds and raise housing demand. A 10 percent rise in median price of house is equivalent to an increase in owners wealth of $817 per week. The supply side response to the growing demand of housing is relatively less. Because of shortage in suitable land and permit processes the supply capacity for housing is limited. The building industry in Melbourne cannot supply more than 140,000 accommodations in year. The estimated demand of housing in Melbourne is approximately 170,000 accommodations per year. This disparity between demand and supply of housing lead to overvaluation of housing price in Melbourne Answer 3 In Melbourne, demand from foreign buyers is one significant factor contributing to a rise in housing prices. There is not sufficient supply of house to meet housing demand. The foreign buyers have higher affordability than domestic buyers do. In order to meet demand for domestic buyers and making more house available to them, the stamp duty charges on foreign buyers have increased (claytonutz.com 2016). The effect of increased taxation is given in the following figures. In figure 5, DD is the demand for housing for foreign buyers. SS indicates the available supply of houses. The initial equilibrium price in the housing market is E. At this price, consumer surplus enjoyed by foreign buyer is given by the area of the triangle EP*G. By supplying houses at this price, sellers receive a surplus equal to the area of the triangle EP*H. Total surplus combines consumer and producer surplus together and is indicated by the area of the triangle EGH. Now suppose stamp duty at a rate of t is imposed on foreign buyers. The stamp duty surcharges increases from 3% to 7%. Because of increase in stamp duty surcharges, the demand curve will shift to the left from DD to D1D1. The demand curve shifts by the magnitude of change in tax rates that is by (7% - 3% = 4%). (Baumol and Blinder 2015). The tax raises the price payable by buyers from P* to P1. The price received by the seller is reduced from P* to P2. The difference between the two amounts is the amount of tax. Th e tax reduces consumer surplus from triangle EP*G to FP1G. As the seller receives a lower price, the producer surplus reduces from EP*H to IP2H. As all the reduced consumer surplus is not transferred to producers, total surplus in the market for foreign buyers reduces. Moreover there is a deadweight loss equals to the area of the triangle EFI. Once the demand for houses from foreign buyers reduces, there will be more house available for domestic buyers. This is shown by an outward shift of the supply curve from SS to S1S1. With the shift in the supply curve, a new equilibrium point E1 is obtained. At the new equilibrium point, price of housing to domestic buyers reduces from P* to P1 and available housing supply increases from Q* to Q1. Both consumer and producer surplus in the market for domestic buyers increases at the new equilibrium level (Fine, 2016). Total surpluses in the market increases. There are two effect on total surplus or social welfare. In the market for foreign buyers, total surplus reduces and there is a deadweight loss resulted from distortionary effect of taxation. In the market for domestic buyers, total surplus increases. The ultimate effect on total surplus depend on the magnitude of this two effect (Frank 2014). If effect in the market for domestic buyers dominate that on the foreign buyers, then social welfare increas The increased stamp duty raises tax revenue of the city government. This is explained in figure 5. The difference in the price paid by buyers and that received by seller is the amount of tax. With tax, the number of houses sold in the market is Q1. The tax revenue is given the area of rectangle FP1P2I. FP1P2I = (P1 P2) * Q1. Answer 4 From the IMF country report, it is seen that housing market in Australia has become highly instable in the last two decades. The housing price though initially started to grow in line with increase in per capita income, but the growth rate of housing price soon outpaced the income growth making house price to income ratio to grow. The speculative demand of housing increase peoples willingness to spend on property and the household debt as a percentage of GDP shows a recorded growth. Such speculation in housing market pull up prices. There is an associated risk of housing bubble burst that will create a wide spread recession in the nation. The instability in the housing market is not evenly spread across the countries. There are some capital cities where the problem is more severe as compared to others. Melbourne is one such city suffering from a rapidly growing house price. As analyzed above the instability in housing market is mainly due to its demand outpacing the supply. The rapid spread of urbanization and resulted population growth contribute to a massive growth demand for suitable accommodation. Supply on the other hand is limited due to geographic constraint, lack of infrastructural development and political factor. Therefore, to stabilize housing market, reforms should be initiated on the supply side. Given below are some of the policies that can resolve the supply side issues and help to stabilize housing market. Reduction in infrastructure cost Planning of infrastructure, their cost and provisioning lead to an added cost of housing. While the real housing cost should reflect the ongoing living cost. The living cost automatically y increases if the house is at a disadvantageous location indicated by unavailability of public transport, school, services and other job opportunities within its close-proximity. These days there are growing differences between house prices at expensive locations and in urban areas reflect hat people while buying houses not only value the infrastructure but also taken into consideration associated locational facilities. Therefore, before funding infrastructure government should first identify suitable location and then channelize funds to the most needed areas. To reduce locational disadvantage government should invest to made adequate availability of public transport, build school and offices. Increasing availability of land and relaxation of regulation The driving factor for new house supply is the resulted profit which in turn generated from an increased demand. There are several barriers to increase the supply of new houses. One such barrier is the limited supply suitable land for undertaking housing construction. One primary solution is to increase the supply of land and reduce regulatory complexities to use land. This does not mean to allow for random use to develop construction. The policymakers should understand the fact that availability of more land is not always positively associated with development of new houses. There is no use of flooding local market with same type of houses as this only reduces price and increase profitability of suppliers. Coordinate infill projects at a large scale should be conducted to add quality of houses in urban areas. The large-scale construction reduces cost of construction because of advantages of scale economies. However, such large-scale projects require government intervention to financ e initially high fixed cost. For this government should allow access to some of its owned land and provide other necessary support. Choice of appropriate location for building new houses Proper planning is an important tool to reduce housing price and make it available at an affordable range. There is an existing policy that focuses on making housing construction reasonable easy within a certain range on Central Business District (CBD). However, difficulties arise for subdividing or creating additional residences in the inner and middle range of CBD. The current policy provides such facilities up to a range of 20 km from CBD (abc.net.au 2016). However, residences are built unevenly in this range. The construction of houses within this range should be made uniform so that demand based on locational advantages should be uniform. References ABC News. (2016).Solutions to the housing affordability problem. [online] Available at: https://www.abc.net.au/news/2016-10-24/solutions-beyond-supply-to-the-housing-affordability-problem/7960710 [Accessed 5 Jan. 2018]. Baumol, W.J. and Blinder, A.S., 2015.Microeconomics: Principles and policy. Cengage Learning. Baur, D.G. and Heaney, R., 2017. Bubbles in the Australian housing market.Pacific-Basin Finance Journal. Claytonutz.com. (2016).New duty and land tax surcharges for foreign buyers of land in Australia - Knowledge - Clayton Utz. [online] Available at: https://www.claytonutz.com/knowledge/2016/june/new-duty-and-land-tax-surcharges-for-foreign-buyers-of-land-in-australia [Accessed 5 Jan. 2018]. Fine, B., 2016. Microeconomics.University of Chicago Press Economics Books. Frank, R., 2014.Microeconomics and behavior. McGraw-Hill Higher Education. Imf.org. (2018). [online] Available at: https://www.imf.org/external/pubs/ft/scr/2015/cr15275.pdf [Accessed 5 Jan. 2018]. Windsor, C., La Cava, G. and Hansen, J., 2015. Home price beliefs: Evidence from Australia.Journal of Housing Economics,29, pp.41-58.