The Hidden Costs of Low Inflation: Savings, Tax and the Dearth of Home Ownership
It is well known that nominal interest payments made on a mortgage typically increase when inflation increases. It is less well known that these increases can badly distort the housing market, even when inflation is relatively low (0–3 percent). This seminar analyses two of these distortions. First, inflation leads to the mis- measurement of housing affordability and saving. Standard measures of the cost of financing the purchase of a house may be overstated by 50 percent when the inflation rate is 3 percent, while the national saving rate and the current account position may be understated by 2–3 percent of gross domestic product. These adjustments are sufficiently large that they should be routinely taken into account when formulating housing and saving policy. Secondly, inflation makes home ownership by young households difficult, because of the way banks limit credit and the way Government taxes the inflation component of interest earnings. The seminar reports the results of economic models that suggest that a one percentage point rise in the inflation rate may have reduced home ownership rates among young households by 5–10 percent, by making it more difficult for households to meet mortgage payments and by making it more attractive for landlords to enter the housing market to obtain tax-free capital gains. It also discusses how sensible and equitable tax reform can be used to counteract these distortionary effects.
Coleman, Andrew. 2008. "The Hidden Costs of Low Inflation: Savings, Tax and the Dearth of Home Ownership," Wellington Public Policy Seminar, October.
Motu code: WPS0810