The housing cost problems faced by Australians can be resolved mostly by elastifying the supply side. That is, by building more homes.

I first argued this in a 2003 report to the Prime Minister, and the RBA’s Phil Lowe has given an excellent speech today that touches on this.

This thesis was explicitly rejected by the RBA in 2004, which at the time claimed that supply-side impediments were not driving up the cost of housing in this country. But, of course, they were and have continued to do so.

The RBA’s 180 degree turn, which officials privately acknowledge, is a welcome development.

Critically, Lowe did not claim that Australia suffers from a house price ‘bubble’. In fact, the RBA has recently gone to great lengths to reject any such terminology. Anyone who uses the bubble moniker is generally doing so because they do not understand the underlying fundamentals.

What Lowe did say is we should expect house prices to rise in order to ‘balance’ demand and supply. This is precisely what fully functioning markets are intended to do. Price rises are signals to the supply-side to encourage more investment in new housing. The problem is that housing supply has been sluggish in Australia for many decades now, and may require large price changes to stimulate the allocation of scarce investment to the sector. This is undesireable.

What we and the RBA would like to see is the elimination of as many obstacles as possible to efficient construction. This means relaxed zoning restrictions, speedier approvals processes and a reduction in local and state government levies on new development. We also have to have concurrent public sector investment in the infrastructure required to enable or liberate new supply.

The RBA is looking to the future. Despite the often misplaced media hyperbole, Australian house prices have only grown by 6.1% per annum over the last five years, according to RP Data-Rismark’s Capital Cities Dwelling Price Index. What the media never tells us is that disposable household incomes rose by a much greater 7.9% over exactly this same period.

The Governor of the RBA has made exactly this point in speeches of late. Even accounting for the 2009 recovery, Australian house price growth has materially underperformed incomes.

An inconvenient truth.

*Christopher Joye writes an economics, finance and real estate blog for Business Spectator. His ‘after-hours’ blog can be found here.