The property market over the past decade has been volatile – mostly upward – both domestically and internationally. The IHT recently looked at what it called “global housing bubbles”, with Australia prominent. It concluded that although property bubbles present risks for the global economy, there is no need for extreme concern.

To focus on our own property bubble, Macquarie Bank’s Rory Robertson recently estimated that, over the past two decades, Aussie home prices on average have risen 75% faster than wages, meaning that the average price of an house has risen from four times pretax annual wages to about seven times in 20 years. What impact does this dramatic change have on the macro-economy?

The theoretical connection between the housing market and the macro-economy relies on the so-called “wealth effect”: Property values are supposedly closely linked to notions of economic prosperity and wealth. When property values rise, people feel wealthier and spend more; if property values decline, or even just stop rising, consumers are likely to reduce spending and economic growth goes south. (This neat story is complicated by the late Milton Friedman’s “permanent income hypothesis”, but let’s leave this alone for a moment.)

However, this simple theoretical link has been questioned recently with the flattening of property values seemingly having a limited impact on economic activity both here in Australia and in the US. It seems the much publicised housing slump in the US, which came at the end of 17 straight interest rate hikes, has failed to significantly impact upon other areas of the economy – indeed figures released last week showed retail sales continue to increase strongly. Maybe Milton Friedman was right all along – it is (permanent) income rather than wealth that matters more for consumer behaviour.

The Australian economy – well, household spending – has also apparently weathered the flattening of our property market over the past two years. But, of course, we have benefited from the “once in a century” commodity boom that has driven Perth and Darwin property prices through the roof and generally provided a buffer against the manufacturing and farming slump on the eastern fringe.

The REIA housing market outlook predicts that property prices will flatten Australia-wide, and even the Perth and Darwin powerhouses will flatten. As The Oz states today, the property boom in WA looks to be slowing – although a 4% rise in the December quarter is hardly signs of a slump. Housing finance data for November, released today, showed that the total value of dwelling commitments, seasonally adjusted, fell by by just 0.1% compared with October 2006.

While the link between the property market and the macro-economy as a whole is less than totally obvious, it is likely that an Australia-wide flattening of house prices will have some depressive effect on our economy. The enormous strength of the labour market, however, seems to be refuting the gloomsters.

Watch this space.

Read more at Henry Thornton.