Independent On Sunday: House price rises are not growth

Tony Gosling tony at
Sun Dec 8 08:38:19 GMT 2013

Sunday 8 December 2013

There's too much reliance on house prices for growth

As the market continues to improve at a rapid 
rate, consumers are spending more - but a sharp 
rise in interest rates could make the bubble burst again

Another boom in house prices – followed by the 
inevitable bust? Or a series of steady but modest 
increases, reflecting the growth in the 
population and real demand for somewhere to live?

It matters hugely. It matters for the economic 
recovery. The present buoyant growth is driven by 
rising consumer spending, and that, in part at 
least, is on the back of the wealth effect 
generated by higher house prices. If the value of 
people's assets rise they feel more comfortable 
about spending more, even if that means running 
down other savings. This is the "wrong sort of 
growth" worry, which is genuine enough even if a 
lot of us think we should not be too picky right now. Any growth will do.

It also matters socially. The boom/bust cycle 
redistributes wealth in a capricious and unfair 
way. It is pretty much pure luck on when people 
reach the stage of buying their first home. Hit 
the market in a dip and you are well ahead for 
life; hit it at peak and you are struggling for a 
decade or more. But the steady rise also 
redistributes wealth, and one of the criticisms 
of these very low interest rates is that by 
boosting house prices they redistribute wealth to 
the already wealthy. They also shift it from the 
young to the old and from renters to owners.

It matters geographically. The surge of prices in 
the South-east and the capital, particularly 
prime London, has the effect of redistributing 
wealth from north to south. The main reason this 
is happening is the stronger job market in the 
south, so the differential movement in house 
prices is principally a reflection of what is 
happening in the economy rather than a cause of 
it. But there is a feedback loop in that the need 
for more homes in the south further increases 
jobs and economic activity there. Three-quarters 
of the cranes in the UK are in London and the Home Counties.

So what's to be done? Well, the first thing is to 
recognise that this is bigger than government. No 
government can control house prices. Sensible 
macroeconomic policies will contain booms and 
reduce the impact of slumps, but the general 
level of prices will be set by supply and demand. 
However at the margin, policy can help – or otherwise.

That leads to an important principle: do no harm. 
Do not artificially stoke up a house price boom. 
Stopping the Funding for Lending scheme for 
mortgages and restricting it to business lending 
removes one source of potential harm. As for Help 
to Buy, the best thing that can be said about it 
is that given the size of the housing market, it 
probably is not big enough to do too much harm.

Nor can governments do much about demand for 
homes. The UK population is rising by about 
400,000 a year, and you don't need to be a wizard 
at maths to figure out that we are likely to have 
to fit in another four million people over the 
next 10 years. Maybe inward migration will fall a 
little but it is just as likely to increase. 
Maybe we could use our existing housing stock 
more efficiently, and one effect of high prices 
is to pressure us to do so. But that is a 
short-term fix. People like space. Cramming them 
together is not a recipe for social harmony at 
either domestic or national level.

So we have to increase supply. A fair bit of the 
Chancellor's Autumn Statement last week was 
devoted to that. In one sense we are lucky in 
that there is some space. We are not Hong Kong, 
even Japan. But building decent, pleasant, 
stylish homes in places where people want or need 
to live is a challenge. We have made huge errors 
in home-building in the 1960s and 1970s, with all 
those tower blocks that are now being pulled 
down. It would be nice to think that we are doing 
better now, but since we seem to be building the 
smallest homes in Europe, I fear we are repeating 
the mistakes of the past, albeit in slightly different form.

Let's assume, though, that we can increase supply 
a bit, and let's assume that the forthcoming rise 
in interest rates is gradual and restrained. What might this mean for prices?

Here we step into a minefield. Anyone saying 
anything about the future of house prices is 
liable to have their predictions blow up in their 
face. They are up 8 per cent over the past year. 
Few predicted that. The Office for Budget 
Responsibility has increased its own projections 
sharply, expecting annual increases of between 3 
and 7 per cent through to 2018. Who knows? What I 
think you can say is that homes will continue to 
bear some relationship to earnings and that there 
seems to be a bottom band of about three times 
earnings and a top band of five times, maybe six. 
We are pretty much at the top of that band now. 
While houses are reasonably "affordable" in the 
sense that low interest rates have cut monthly 
repayment rates, they could quickly become less so when rates rise.

Some have argued that the weight of personal debt 
is so great that the authorities cannot increase 
interest rates by much. That might be wishful 
thinking. However, given this burden of debt, 
quite a small increase of rates would be 
effective in holding down house prices. That 
leads to a common-sense conclusion. It is that 
house prices will not be allowed to go mad again, 
or at least not until the recent bubble becomes a 
distant memory. But they are not going to fall 
much either, for the underlying demand is far too strong.

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