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Why house prices are a problem for governments, not central banks

Why house prices are a problem for governments, not central banks

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House prices in the UK are once again on the rise. Over the country the average price in March stood at £169,124, some 5.6 percent higher than a year earlier. In London the gains were even more marked with the average property price rising to £459,000 – over 10 times average household income.

Those figures are certainly noteworthy and have lead many commentators to warn of a housing bubble. With the memory of the 2008 crash still firmly in the nation’s memory it is understandable that many are now wary of taking too sanguine a view and repeating past mistakes.


Are housing “bubbles” a central bank problem?

Concerns over rising prices have begun to put pressure on Bank of England’s Governor Mark Carney. In his opening remarks ahead of the release of this month’s Inflation Report he moved to reassure critics that the Bank could rely on its untested macro prudential toolkit to monitor the housing market rather than risking a rate rise saying:

“The MPC’s [Monetary Policy Committee’s] flexibility to maintain extraordinary stimulus for as long as necessary is supported by close coordination with the Financial Policy Committee (FPC), which remains vigilant to any resulting risks to financial stability, including those associated with housing. Having taken initial steps in November, the FPC retains considerable flexibility over a graduated range of tools to manage those risks.”

Not everyone is convinced, however. Andrew Sentance, a business economist at PwC and former MPC member, warned on his blog that the strength of the housing market boom required firm action from the Bank in the form of rate rises. Using macro prudential tools to restrict lending through imposing tighter mortgage conditions, he warned, would amount to a “retrograde step [that] will deny many first-time buyers their first step on the housing ladder”.

So is Sentance right to suggest that Carney is taking a big risk by not moving now to cool house prices against a backdrop of strong economic tailwinds?

I’m not convinced. It is certainly the case that prices are rising at a far more rapid rate than we have seen in recent years but that may reflect pent-up demand from buyers who have been locked out of the market. If so we might expect prices to rally sharply but then begin to ease off as this catch-up effect drops off.

Moreover, there have been reports from estate agents that recent geopolitical uncertainty (for example the crisis in Ukraine) may have increased foreign capital flows into the country looking for safe haven assets like prime property. This too may prove to be a temporary effect subject to reversal if the situation improves.

Yet none of this answers the question of whether property price rises should really be the concern of central banks. After all, the systemic risk of a runaway housing market is posed by lax lending that lead to either large scale defaults or debt deflation, not by the prices themselves. That is, although worsening housing affordability can have significant social costs if the market is being driven by, for example, domestic or foreign cash buyers then it is unlikely to become a financial stability problem.

Here we have to go back to the data to see the full story. As the chart below shows, although it is undoubtedly true that monthly net lending in the UK is creeping upwards it is still far below the levels we saw before the crash:

Giving macro-prudential oversight some teeth

That does not suggest the Bank can afford to be blasé about the risk of rising house prices fuelling a cycle of lower quality lending as more and more people look to cash in on the boom. However, it does indicate that it would likely be premature for the MPC to use a blunt tool such as raising the base rate when it also risks making borrowing more expensive for small businesses and increases the interest burden on already indebted households.

Furthermore though their effectiveness is untested, the macro-prudential tools at the FPC’s disposal can be directly targeted at riskier lending (such as high loan-to-value mortgages or repayments that account for a large percentage of the borrower’s income). If the committee is to have any meaningful role in promoting financial stability then these should surely be used first before more traditional monetary policy levers are pulled.

Were the FPC to become increasingly worried about tight housing supply and rising prices they might also decide to ask the Coalition government to scrap their Help to Buy scheme. Under it the government has taken a 20 percent stake in 19,394 house purchases with high loan-to-value mortgages as at the end of March, with current plans for a further 25,000 purchases a year supported by the scheme until 2020.

Seen by some as a way of providing a quick boost to household morale heading into the General Election next year it could become a key test of the effectiveness of the new responsibilities handed to the Bank in the wake of the crisis. It might also be seen as a test of its independence under Carney, the man brought in personally by Chancellor George Osborne – author and champion of the Help to Buy scheme as well as the UK’s controversial austerity programme.

Propping up the housing market by using the state’s balance sheet to massage affordability is hardly likely to be a long term solution. A combination of increasing housing supply in high-demand areas like London and a coherent policy for regenerating regions outside of the capital to ensure that existing housing stock is fully exploited will ultimately be required. Delay here is only likely to increase the social and economic cost over the medium term.

Given the fragility of Britain’s nascent economic recovery managing the exit from extraordinary monetary policy was always going to be a challenge. The nature of that recovery may make it even more of one that policymakers imagined – but central bankers should be wary of calls to correct yesterday’s imbalances.


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I was at the talk by Charlie Bean at the LSE this week where he spoke about the possibility of monetary policy and macroprudence working in opposite directions. This would be the ideal situation for the current UK economy with a still fragile economic recovery (low interest rates) and the housing boom (some limits on mortgage lending). But the Bank of England might be slow to take advantage of these newly acquired capabilities. As can be the case, sometimes a statement of intent is all that is needed. Doing something, anything, can be just as important as the action itself. Otherwise, the Bank of England will be stuck with a limited range of policies and a much diminished reputation which is an outcome that noone wants. For more on the limits to using just interest rates, see http://yourneighbourhoodeconomist.blogspot.co.uk/2014/05/central-banks-false-illusion-of-power.html

Tomas Hirst

Hi Ciaran,

Thanks for your comment.

I agree that rate rises are a blunt tool to address a housing boom - in my opinion, rate rises should be treated as a last resort.

However, I don't think that (in the UK at least) this is a problem of money creation. As you can see in the second chart above lending in the UK is growing but remains far below the levels seen before the crash. Overall debt stock may be a concern in terms of household finances, but a debt-fuelled boom that poses systemic risk requires a sharp pick-up in flow that we're just not seeing yet.

I do agree that if the government is worried about the social cost of rising prices and worsening affordability then it should act and certainly taxation is one route it could go down. The idea that monetary policy alone can/should be responsible for problems in the housing market seems to me to be misguided.

I had this piece recently published in the media in New Zealand - it is just as relevant to the UK

The Reserve Bank and property prices

The Governor of the Reserve Bank is threatening to raise interest rates to control house price inflation in Auckland and Christchurch. History has shown that the increase in interest rates have little effect on property prices but there is plenty of evidence that high interest rates and an over-valued currency erode our economy and increase household poverty while providing super-profits to the banks and foreign lenders. Interest rate manipulation of this sort is not simply illogical it is the root cause of the persistent performance failures of our economy over the past several decades. Every time there is the least spark of dynamism in our economy it is snuffed out by the Reserve Bank hiking interest rates. The consequence is an increase in the operating costs for businesses, an erosion of the profitability of our export sector and the living cost for every household in the country goes up. It does this whether you live in Bluff with deflating property prices or in Auckland where the market is out of control. It does it whether you already have a mortgage and have no intention of buying or selling a home or borrowing more money. The interest rate rise is imposed simply as an attempt to limit price rises in response to artificial housing shortages and speculative investment in two localised parts of the property market that is fuelled by predatory lending activity on the part of the Australian owned banks who dominate the economy.
Because the Reserve Bank Act obliges debtors to pay over the market price for debt, it also guarantees lenders greater than normal market returns on investments. The result is that foreign cash looking for high and secure returns has flooded into the New Zealand property market. The more the Reserve Bank increases interest rates above the natural rate for the marketplace the more money that flows into the property market. The Governor of the Reserve bank raising interest rates to decrease inflation is about as sensible as fireman pouring petrol on a fire to put it out.
The more sensible action would be to address the cause of the problem rather than the effects. There are several causes of property price inflation. Most of these causes are the result of ill-considered government policy decisions. Giving banks the uncontrolled power to create money is at the root of the problem. Banks are only there to make money for their shareholders and the more debt they can pump into our economy the more profit they make. The banks are further incentivised by the Reserve Bank Act to inflate our property market. While this is great for the Australian banks it is awful for much of our economy. It is more awful for the young and the less well-off but is advantageous to those who have spare cash to speculate.
The end result is that we are as a nation carrying vastly more debt than is necessary for the economy to function effectively, we have a ruinously over valued property market, we have a grossly overvalued exchange rate, we are bleeding our scarce foreign earnings on interest payments on all the unnecessary debt and meanwhile our productive sector is crippled by both the cost of borrowing and by the over-valued and highly unstable exchange rate.
Instead of suppressing inflation, the Reserve Bank act causes inflation and stimulates indebtedness.
The Reserve Bank Act is singularly the most unwise element of the reforms of the 1980’s. It is utterly illogical in that it confounds the law of supply and demand, the most basic precept of economics by causing the cost of borrowing to be over-priced.
The answer to the problem of debt fuelled inflation is simple. If a government wishes to increase the cost to the consumer of any element of the economy without increasing the supply of that element it imposes a tax – alcohol and tobacco are excellent examples of this concept in action. The activity the government needs to constrain is the creation of new money by the banks. There are number of ways this could be achieved but one simple way would be by monthly tendering of the right to create new debt. This would increase the cost of new borrowing by individuals but would not increase the profit on lending by banks. The government would generate revenue from increasing the cost of borrowing that would then be returned to the taxpayer through reductions in other taxes and this is far more constructive for the economy than giving our hard earned cash to the banks’ and investors as a windfall profit.

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