Australia’s property bubble and the Wicksell spread

Interesting comment By Neils Jensen in The Absolute Return Letter on Australia’s property bubble and the Wicksell spread:

In practical terms, history has shown that the economy is in near perfect balance when the difference between the Baa corporate bond yield and nominal GDP growth (the proxy for the Wicksell spread) is about 2%. When the spread is much higher than that, bank lending grinds to a halt, and when it is lower, banks are increasingly eager to lend, and that eagerness increases, the lower the spread is.

….Take Australia, where the Wicksell spread is currently dramatically below 2% (Exhibit 10). I will challenge you to find a Wicksell spread anywhere that is lower than Australia’s is at present. And, as a consequence of years of a low Wicksell spread, Australia has enjoyed a phenomenal boom in property prices. Capital is widely misallocated!

However, because Australia targets 2% inflation, like almost all developed countries do, the alarm bells don’t ring (yet) at the Reserve Bank of Australia. Now, before you think this is a vendetta against Australia, I should point out that many other countries currently have Wicksell spreads that are almost as low. In Europe, the two most out-of-synch spreads currently are those of Norway and the UK. No wonder property prices have done very well in those two countries….

Basically, what Neils is saying is that nominal GDP growth (the average return on capital) should be 2% higher than the yield on lowest investment-grade bonds, not 2% lower.

Source: Two Sides of the Same Coin – The Absolute Return Letter

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