Thursday, April 26, 2007

Effect of Falling House Prices on UK Economy

Some Economists and housing analysts argue house prices are significantly overvalued and are due to fall in the near future. Some paint a doomsday scenario of falling house prices leading to recession. Should we be concerned about a decline in the housing market?

Effect of Falling House Prices.

If house prices fall, it will lead to a decline in household wealth, and an increase in negative equity. The effect on consumer confidence is likely to be more significant than for rising house prices. People expect rising house prices, therefore, if house prices fell it would be a real shock, and could adversely affect consumer spending.

Many people have taken out expensive mortgage deal, in the hope that they will be able to remortgage after rising house prices. If house prices fall this will not be possible and they could face negative equity.

Therefore, falling house prices will reduce AD and lead to lower economic growth; It could cause a recession - a period of negative economic growth for 2 quarters.

However, if house prices do fall, it will reduce inflationary pressure in the economy. Therefore the Bank of England will be able to cut interest rates; this reduction in interest rates may maintain positive economic growth. However, it may be that falling house prices reduce confidence so much, that lower interest rates will be ineffective in stimulating demand.

It is worth remembering that in 1991, house prices fell 15% and this was a major factor in the recession of 1991-92.

A significant factor will be whether house prices fall gradually or fall sharply. If house prices stagnate there is unlikely to be a recession; however, if they fall dramatically in a short space of time, a recession is much more likely.

More graphs on - Impact of falling house prices on UK economy



Anonymous said...

The housing market in 6 out 10 UK regions has already stagnated. See UK Housing bubble for the numbers.

Anonymous said...

what is AD in the paragraph? please help me

Tejvan Pettinger said...

AD = Aggregate Demand. Total Expenditure