Correlation vs Causation

April 15th, 2009 at 8:00 am by David Farrar

Matt Nolan at TVHE rips into an academic who claims higher mortgage rates lead to higher house prices, confusing correlation and causation.

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8 Responses to “Correlation vs Causation”

  1. big bruv (13,886 comments) says:

    Test

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  2. brucehoult (195 comments) says:

    Er .. it seems REALLY obvious to me that people will be able to spend up to some fixed proportion of their income on servicing a mortgage, and house prices will be bid to the maximum that the average working couple can afford at whatever current interest rates are.

    So decreasing interest rates will lead to increased house prices, all else being equal (incomes, size of deposit required)

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  3. dave strings (608 comments) says:

    Bruce
    That would be my thought too, so how the academic who claims higher mortgage rates lead to higher house prices came to that conclusion is beyond my logic.

    While it is true that interest rates and house prices have both increased over the recent past (say the years from 2000 to 2008), I certainly can’t see any causal relationship between the two, just the expression of a ‘buy now pay later’ attitude of those Gen Xs who entered the housing market ‘knowing’ that fully furnished with Harvey Norman’s best, and two SUVs in the driveway was their ‘right’, as illustrated by what their parents now had. To them credit, no matter the cost, was a basic entitlement as incomes ALWAYS rise to meet future obligations.

    How sad it is that they must now learn new lessons that they never imagined! When the reality of this depressing recession starts to really bite the ‘average’ gen X ‘family’ (two kids, no marriage), and the usual sources of credit refuse to correct their negative cash-flow, beware. Society might just take on a face not seen for a couple of decades – frugality – in a full pendulum swing reaction; THEN our negative growth will be seen as the shrinkage it really is!

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  4. lyndon (325 comments) says:

    xkcd – A Webcomic – Correlation

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  5. Owen McShane (1,226 comments) says:

    The conventional wisdom is that the low interest rates in the US helped fuel the excess borrowing in those markets.

    But in my report to the Reserve Bank in 1996 that in NZ, a long term inflation in house pricing would led to excess borrowing which would be inflationary and our Reserve Bank would have to increase interest rates to try to dampen the market and this would lead to an overvalued dollar.

    So the different behaviour in NZ and the US is part of the evidence that inflated land prices caused by restraints on supply, and excessive compliance and holding costs have been the main driver of the real estate bubble.

    But people would much rather attack the bankers than their own behaviour which still cheers on people who stop every housing development they can.

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  6. PhilBest (5,121 comments) says:

    I posted this earlier today on the general debate thread as I could not get onto this one.

    Meanwhile, I have got a discussion underway with Matt Nolan.

    PhilBest (4902) Vote: 0 1 (What motivated that negative karma point…?) Says:

    April 15th, 2009 at 10:54 am
    DPF, I am completely unable to get onto the adjacent thread concerning Matt Nolan’s condemnation of Philip O’Connor’s analysis of house prices and interest rates.

    I note that no-one else has made a comment so perhaps everyone has the same problem.

    I have just followed the link to Matt Nolan’s thread and made the following comment:

    PhilBest says:

    This was very thoroughly aired on interest.co.nz:

    http://www.interest.co.nz/ratesblog/index.php/2009/04/02/opinion-why-lower-interest-rates-wont-lead-to-higher-house-prices/

    At the end of the thread, Philip O’Connor makes a very interesting statement of where he stands, considering that I suggested near the start of the thread that he was being mischievous. The point he was trying to make, was the “correlation” between LOW interest rates and HIGH house prices, which is pretty much “received wisdom”, is actually completely invalid.

    I am very sorry that his subtlety has been completely missed because he has an extremely valid point, which supports the argument that Hugh Pavletich and others including myself have been making for years. I have made a fuller development of the argument of what is really responsible for the recent severe house price bubbles, on THIS “thread”:

    http://www.interest.co.nz/ratesblog/index.php/2009/04/09/housing-special-why-the-march-housing-market-surge-is-an-indian-summer/#comments

    (And no, I am not Philip O’Connor and have never known the guy).

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  7. PhilBest (5,121 comments) says:

    Owen, you are onto it as usual. Here is what I have further commented to Matt Nolan a few hours ago:

    What Philip O’Connor says, far too late, at the end of the thread on interest.co.nz, is THIS:

    “…Saying “higher interest rates caused high house prices,” is wrong, of course. But why do I read in the press, and hear so much, that “lower interest rates will HELP house prices”? This statement implies causality, and appears to be accepted by *everyone*. I challenge that statement in this blog. Believers in “lower interest rates support house prices” DO NOT EVEN HAVE CORRELATION ON THEIR SIDE! Their mistake is far far more serious than “correlation does not imply causality”: they believe in a relationship that is complete fantasy and does not exist in the real world…..”

    I think he is right, and I think that in that comment, he has contributed a valuable part of the jigsaw puzzle that is property price bubble analysis. What do you think of the analyses I link to in my later argument, that eliminate all other causes except land rationing? I think that most analysts are looking in the wrong place, like the guy in the joke who was looking for the wallet he had dropped, only he was looking for it where the light was better than in the place he actually dropped it.

    I agree 100% with your “expectation formation” conclusion. But I defy you to find that “expectation formation” regarding house prices, occurring anywhere other than where there are conditions of land use rationing.

    One of the problems analysing what the historical literature calls “housing bubbles”, is that the term is also used for “supply” manias, where too many houses got built.

    I am arguing that property PRICE bubbles, with home affordability deteriorating and prices increasing way out of proportion to incomes, have developed subsequent on “Green” land use restrictions.

    “Bubbles” where house building occurred at too high a rate, had a positive effect on affordability. Hugh uses the term “building boom”, to describe this. These “booms” contain their own safety valve; the economic fallout from them will always be limited to the comparatively small (percentagewise) “malinvestment” in building too many houses.

    But the price bubbles that are a result of land rationing are a different beast altogether. They feed their own mania, and will only blow up when a range of economic factors have played out, by which time the whole economy is nearly destroyed. We can have years of declining productivity and declining real incomes (when the cashing out of property value increases is removed) along with property prices ramping up year after year?

    I gather from Steve Keen’s recent analysis of the Australian situation, that they have actually had both a boom and a bubble; driven by greed-crazed speculators who bought up overpriced new houses. We have the absurd situation that existing home owners use the increasing value of their own homes, as security to buy more overpriced homes. What eventually happens to first home buyers in this situation? Can anyone say “Ponzi”? The result will be interesting as it unwinds.

    The same situation possibly applied in some of the other parts of the world such as Ireland and Spain where “enough” new homes have been built but prices remained severely unaffordable. This is an absurd defiance of all laws of supply and demand. Clearly there is serious interference occurring with the “supply” mechanism.

    The case is clear that only a completely free supply of land would prevent such a situation from starting in the first place.

    I would argue that to periodically have an oversupply of housing, with low prices as a result, is of substantial net benefit to society and the economy. No “planners” are going to get it right; and avoiding PRICE bubbles is clearly of all importance to our economic future.

    We avoided them up till the last decade or so, simply because we were not sucked in by Green conservation mania and “local community” “empowerment” policies, and we constantly had new homes being supplied on land at affordable prices.

    I would further argue that the inhabitants of particularly desirable areas should NOT be “entitled” to prevent further in-migration to their area through policies that make property unaffordable.

    This is just as basically anti-human as the “Green” conservation policies are. It says in effect, that if these policies are the only right ones, that not only are humans not wanted here, they are not wanted anywhere. I am not joking or exaggerating. Sanctimonious Californians condemn Texas for its policies of cheap housing, growth, and high energy living (due to the heat and aridness).

    If these sanctimonious and anti-human (essentially fascist) policies were in the trashcan of history where they belonged, California would be a lot more populated and the people living there would have smaller environmental footprints than if they were forced to live somewhere unpleasant like Texas. As usual, the sanctimonious policies have the exact opposite consequences than what they are alleged to be in the purpose of in the first place.

    Greed and selfishness are clearly seriously destructive of humanity whether they occur on Wall Street or in green and pleasant neighborhoods.

    New Zealand could, and should, have ten times the population it does have.

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  8. TheMaster (8 comments) says:

    We know what Adam Smiths invisable hand has been up to.

    That is the greatest academic lie to believe that humanbeings are rational. We are not, we might try to be, but we’re not. Not to mention the arrogance to assume we know everthing with which we would need to know in order to be rational.

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