has grown very strongly. the result has been a higher average price of land in our major cities. another possible structural explanation is that the higher land prices reflect an upward revision to people ’ s expectations of future income growth and thus the amount they are prepared to pay for housing services. one possible reason for this is that the growth of our cities generates a positive externality – by bringing more people together competition is improved and productivity is higher. while this might be part of the story, i think it is unlikely to be a central part. real income growth per capita did pick up markedly from around the mid 1990s, but it has subsequently slowed substantially, with apparently little effect on the price of land relative to income. so the story is really one of increased borrowing capacity, strong population growth and a slow supply response. one might ask why it matters why land prices have risen. after all, regardless of the reason, higher land prices have delivered large capital gains to many australians and have made them better off. the complication here comes from the fact that australians are both owners of housing assets and consumers of housing services. we don ’ t just own housing and the land on which it is built, but we also live in that housing, and on that land. and that housing and land provide us with valuable services. if housing is fairly valued – in the sense that the price of housing is equal to the present discounted value of the future rents – then the rise in prices implies an increase in the expected future cost of housing services. so, from the perspective of society as a whole, much of what is gained on the one hand is lost on the other : there are windfall gains from higher land prices but then everyone pays more for housing services. 10 how any one individual is affected by all of this depends upon their own circumstances. productivity commission ( 2011 ) discusses the role of planning, zoning and development assessments. kulish et al ( 2012 ) use a calibrated model to study the effect of supply constraints on density and the price of land in an australian context, while gitelman and otto ( 2012 ) provide supply elasticity estimates for residential property in sydney. for a theoretical treatment of this point, see buiter ( 2008 ). bis central bankers ’ speeches for an older person who owns their own home and has no children, the capital gain from the higher land prices more than offsets the expected higher future housing costs. such a household is better off. the same is true for

currency. nor can we be sure that there is enough monetary stimulus in the economy to support the increases in household spending and business investment that would be required to return the economy to full capacity by early 2005. some important economic data are expected between now and our next fixed announcement date, on 20 january. these should give us a better sense of how canada ’ s export sector is doing, and how household spending went over the holiday season. we will be closely watching all the data ahead for evidence that the economy is growing at a rate solidly above the growth of potential. conclusion this past year, like the two years before it, was full of “ interesting ” economic challenges for canada and the world. it is tempting to hope that next year will be somewhat less “ interesting ” and bring fewer challenges. but regardless of what next year brings, what is critical is that we keep our eyes on the longer - term horizon and focus on the challenges ahead. these challenges include adapting to shifting demographics, raising productivity, and getting our microeconomic policy framework right. at the bank of canada, we remain committed to the sound monetary policy framework that will help us rise to tomorrow ’ s challenges. and that ’ s good news for all of us, no matter what the coming years may bring.