The spectre of housing bubbles is starting to raise its head again, along with discussions about what the central banks, regulators and/or governments should do about it. House prices have been going through the roof in China, there is talk about a bubble in Australia and yet over there prices keep rising, Canadian house-prices are looking “toppy” and in Riyadh they are insane.

It’s not as if there are no tools for combating a bubble. Many countries that did not have the option of controlling the money supply via the blunt instrument of interest rates (typically because their currency is tied to the US dollar), have used those tools successfully for decades. A good example is Hong Kong which controls both the supply of land, the maximum LTV that mortgages can we written at, and also the amount of exposure that the banking system can have to residential real-estate. America (and other countries) that suffered from exploding house-price bubbles, had no excuse, the tools were there, just they chose not to use them.

The reason was mainly because there was no agreement on what is the correct or fundamental value of a house; even though some people were warning about potential problems with housing in USA and also in UK in 2003, there was no consensus. Alan Greenspan spoke of a “bit of froth” in 2005, but he had no courage in his convictions, and even as late as early 2008, just before the slump really started in UK, Gordon Brown was saying that housing in UK was “affordable”, and so there was no risk of catching the American disease.

Even now, after a cataclysmic wake-up call, there is no consensus about what is the “right” price for housing.

What is the right price?

At its simplest level (it gets more complicated), the “right”  price for housing is that which allows the population to spend a fixed proportion of their income on “shelter”, that proportion is broadly well-known, it works out somewhere between 20% and 30% (and I’m not going to argue-the-toss about exactly where it is, although there is a broad consensus in that the calculation of the weighting of “shelter” in the CPI analysis provides good base-line).

So in a stable population, the expenditure by people per house should be a function of the aggregate income, whether that’s disposable or not is debatable, or for example nominal GDP.…

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