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
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Showing posts with label UK housing Market. Show all posts
Showing posts with label UK housing Market. Show all posts
Thursday, April 26, 2007
The Effect of the Housing Market on the UK Economy
The UK housing market has a significant impact on the UK economy because:
Those who own houses will see an increase in their wealth. This is likely to increase their confidence, thereby causing higher levels of consumer spending.
In addition, if house prices rise, consumers can increase spending by remortgaging. This means they take out a bigger loan, against the value of their house. This means that the difference between, the current price and their buying price, is available for spend. Mortgage equity withdrawal has been a significant determinant of consumer spending in the UK
Higher levels of consumer spending lead to rising Aggregate Demand and therefore higher economic growth. Consumer spending accounts for 66% of AD, therefore, the effect of rising house prices can be quite significant in determining economic growth.
Higher house prices may cause inflation. This is because, if AD increases then the economy may get close to full capacity, and grow faster than the long run trend rate.
However rising house prices no not necessarily cause inflation. Firstly, it depends upon other factors affecting consumers. For example, if real wages are growing very slowly, or taxes have been increased, then consumer spending will be moderated. Since 2001, House prices in the UK have doubled, however, this has not caused inflation; the reason is that other inflationary pressures have low. For example:
Note: in the 1980s, rising house prices did contribute to inflation (inflation reached over 10% in 1990), because it was combined with loose monetary policy, and buoyant levels of consumer confidence.
Rising house prices are likely to cause a current account deficit. This is because rising house prices increase consumption and therefore consumers will spend more on imports from abroad. Equity withdrawal tends to be spent on luxury imported goods. The UK has a marginal propensity to import. The UK current account deficit recently increased to 3.5% of GDP.
Slump in Housing Market effect on Circular Flow
A fall in house prices will have the opposite effect. Falling house prices will reduce consumer wealth, creating a negative effect on consumer spending and consumer confidence. Therefore, there will be a fall in AD and a reduction in injections into the circular flow. This will lead to lower economic growth, unless other factors override this.
1. 78% of households are privately owned. Home ownership rates are amongst the highest in Europe
2. Housing is the biggest form of wealth in the UK.
3. Mortgage debt accounts for the largest section of UK debt. Average mortgage debt is £21,000 per person.
4. House Prices have a significant effect on consumer confidence and expectations. (house prices and house price predictions are often front page news)
Effect of Rising House Prices.
Those who own houses will see an increase in their wealth. This is likely to increase their confidence, thereby causing higher levels of consumer spending.
In addition, if house prices rise, consumers can increase spending by remortgaging. This means they take out a bigger loan, against the value of their house. This means that the difference between, the current price and their buying price, is available for spend. Mortgage equity withdrawal has been a significant determinant of consumer spending in the UK
Higher levels of consumer spending lead to rising Aggregate Demand and therefore higher economic growth. Consumer spending accounts for 66% of AD, therefore, the effect of rising house prices can be quite significant in determining economic growth.
Higher house prices may cause inflation. This is because, if AD increases then the economy may get close to full capacity, and grow faster than the long run trend rate.
However rising house prices no not necessarily cause inflation. Firstly, it depends upon other factors affecting consumers. For example, if real wages are growing very slowly, or taxes have been increased, then consumer spending will be moderated. Since 2001, House prices in the UK have doubled, however, this has not caused inflation; the reason is that other inflationary pressures have low. For example:
- Independent MPC target low inflation, they have raised interest rates to moderate demand where appropriate
- Real wage growth has been low, (especially in public sector.)
- Low global inflation - helped by cheap manufacturing imports from China, and low commodity prices.
- Improved supply side policies increasing competitiveness of the UK economy.
- UK manufacturing sector in recession.
- UK economic growth close to long run trend rate.
Note: in the 1980s, rising house prices did contribute to inflation (inflation reached over 10% in 1990), because it was combined with loose monetary policy, and buoyant levels of consumer confidence.
Rising house prices are likely to cause a current account deficit. This is because rising house prices increase consumption and therefore consumers will spend more on imports from abroad. Equity withdrawal tends to be spent on luxury imported goods. The UK has a marginal propensity to import. The UK current account deficit recently increased to 3.5% of GDP.
Slump in Housing Market effect on Circular Flow
A fall in house prices will have the opposite effect. Falling house prices will reduce consumer wealth, creating a negative effect on consumer spending and consumer confidence. Therefore, there will be a fall in AD and a reduction in injections into the circular flow. This will lead to lower economic growth, unless other factors override this.
Monday, April 23, 2007
Why House Prices in the UK have risen since 1992
Why House Prices in the UK have risen by 165% since 1992.
In the past 15 years, house prices in the UK have risen much faster than general inflation, and real incomes. The rise in house prices have confounded many industry experts, who have been predicting house price falls for several years.
1. Long period of economic expansion.
Economic growth has been close to the long run trend rate of 2.5% for 15 years. This has increased incomes and confidence in the economy. However, it explains only part of the increase; this is because prices have risen much faster than incomes.
2. Low Real Interest Rates.
This is the nominal interest rate minus inflation. Since leaving the ERM in 1992 real interest rates have been very low. Interest rates fell as low as 3.5% in 2005. Since the bank of England was made independent people expect both lower inflation and consequently lower interest rates. Interest rates increase by only 0.25% at a time. This creates more stability for homeowners. Interest rates are much lower than pre 1992. This has been a significant factor in increasing demand for houses, especially in UK where most mortgages have variable interest rates.
3. Increasing number of households.
Demographic factors have increased the number of households (by a faster rate than the population). These include:
4. Increase in Number of People buying second homes.
In London many houses are being bought by foreigners, for example, Russians and Arabs.
5. Increased availability of Mortgages.
The ratio of house prices to incomes has increased. Banks have sought to lend larger amounts than before. They have introduced new types of mortgages such as interest only, 50 year mortgages; banks have also relaxed lending criteria making it easier to borrow higher salary multiples.
6. Buy To Let Market.
This is the sector of the market where people buy a house and rent it out. The buy to let market has been buoyant because of rising rents. Buy to let buyers hope to get both income and capital gains. This sector of the market is more susceptible to speculation. This means people are buying houses in the hope of making capital gains.
7. Fundamental shortage of Supply.
The fundamental reason for rising house prices is the underlying shortage of supply. Demand has been increasing faster than supply. 1960s houses are being knocked down, and the number of new houses being built is at an all time low. There are many restrictions on building new houses. This is unlikely to be solved in the near future.
Related:
In the past 15 years, house prices in the UK have risen much faster than general inflation, and real incomes. The rise in house prices have confounded many industry experts, who have been predicting house price falls for several years.
Economic Reasons for House Price Rises include:
1. Long period of economic expansion.
Economic growth has been close to the long run trend rate of 2.5% for 15 years. This has increased incomes and confidence in the economy. However, it explains only part of the increase; this is because prices have risen much faster than incomes.
2. Low Real Interest Rates.
This is the nominal interest rate minus inflation. Since leaving the ERM in 1992 real interest rates have been very low. Interest rates fell as low as 3.5% in 2005. Since the bank of England was made independent people expect both lower inflation and consequently lower interest rates. Interest rates increase by only 0.25% at a time. This creates more stability for homeowners. Interest rates are much lower than pre 1992. This has been a significant factor in increasing demand for houses, especially in UK where most mortgages have variable interest rates.
3. Increasing number of households.
Demographic factors have increased the number of households (by a faster rate than the population). These include:
- Increase in divorce Rate.
- Marriage rates declining
- Aging population - more single old people.
- Immigration - has helped to boost population, especially in London.
4. Increase in Number of People buying second homes.
In London many houses are being bought by foreigners, for example, Russians and Arabs.
5. Increased availability of Mortgages.
The ratio of house prices to incomes has increased. Banks have sought to lend larger amounts than before. They have introduced new types of mortgages such as interest only, 50 year mortgages; banks have also relaxed lending criteria making it easier to borrow higher salary multiples.
6. Buy To Let Market.
This is the sector of the market where people buy a house and rent it out. The buy to let market has been buoyant because of rising rents. Buy to let buyers hope to get both income and capital gains. This sector of the market is more susceptible to speculation. This means people are buying houses in the hope of making capital gains.
7. Fundamental shortage of Supply.
The fundamental reason for rising house prices is the underlying shortage of supply. Demand has been increasing faster than supply. 1960s houses are being knocked down, and the number of new houses being built is at an all time low. There are many restrictions on building new houses. This is unlikely to be solved in the near future.
Related:
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