As the monetary policy setter, the Reserve Bank of Australia (RBA) has the hard task of balancing our economy.  This is especially difficult when aiming to maintain inflation in a range of 2 to 3 percent.

The RBA attempts to tweak policy to stimulate the economy in order to see some inflation but not too much.  If inflation is too high or if deflation occurs, this impacts the consumer buying power.

The last 2 decades have seen home values increase at a higher rate than inflation, therefore reducing many consumer’s buying power to purchase homes.

Due to the diminished capacity to buy, many are opting to rent.  This highlighting the housing affordability issue in Australia once again.

The question remains, would a significant decline in Australian home values be the antidote to housing affordability and a good result for the economy?

The Australian Bureau of Statistics (ABS) estimated that as at June 2014, the total value of Australia’s dwelling stock was $5.2 trillion (estimated 9,366,800 dwellings).

To put this figure in perspective, over the 12 months to June 2014, the GDP, (the total output of the national economy), was recorded at $1.57 trillion. Hence the value of residential dwellings was more than three times greater than the annual output of the economy.

Whilst Australian’s choose to hold a large proportion of their wealth in residential property, this doesn’t mean that home owners could survive deflation in home values.  Nor does it mean that deflation in values would assist those that can’t afford a house to finally achieve ownership.

So why focus on deflating an asset which is more than 3 times larger than the annual GDP?  If home values were to deflate, it could be debated that the effect on households and the Australian economy as a whole would likely send Australia into a recession.

Rather than a housing bust, the RBA should opt for a moderate level of growth in home values whilst governments should address factors that drive high housing demand and constrain supply.