Australia's Broken Housing System Wreaks Havoc on Inflation Targets

The Reserve Bank of Australia (RBA) is grappling with rising inflation, but its efforts to control it may be misguided. The RBA's goal is to keep inflation between 2-3 percent, but recent rate hikes have had little impact on actual prices. The problem lies in the way they measure inflation, the Consumer Price Index (CPI) no longer includes mortgage costs, which makes it harder for people to understand how interest rates affect them.

In 1998, the RBA requested a change in how CPI was measured to exclude mortgage costs. This decision made sense at the time, as it helped the public understand the bank's actions by making the headline CPI reported in the news match the information used by the RBA to set interest rates. However, this change has contributed to a growing gap between economic theory and real-world experience.

The housing market is a major driver of inflation, and Australians have long sought to own their homes through mortgages. Until the 1980s, mortgage regulations made it harder for first-time buyers to get loans, but they also protected them from rising interest rates. Today, however, most home buyers have variable-rate mortgages that make them highly sensitive to changes in interest rates.

The RBA's attempts to control inflation through higher interest rates are having the opposite effect, reducing household spending and increasing debt. This has created a vicious cycle where households try to avoid risk by working more hours, further reducing demand and exacerbating the cost-of-living crisis. The RBA needs to rethink its approach and consider how its policies affect ordinary people.