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