Academic journal article National Institute Economic Review

Commentary: The Housing Market and Government Policy

Academic journal article National Institute Economic Review

Commentary: The Housing Market and Government Policy

Article excerpt

The current market situation

The current view is that, at least for the time being, house prices have stabilised; the Government's house price index has moved erratically but showed a rise in November after a fall in October and the general feeling is that sentiment has improved. The stabilisation is widely attributed to the interest rate reduction from 4 3/4 to 4 1/2 per cent per annum last August, with the possibility that it has created an expectation that further interest rate reductions are likely. At the same time five and ten-year interest rates have fallen; for people who take out fixed rate mortgages these are more relevant than the Bank of England's base rate and even for people who have floating rate mortgages they may be a better guide to interest rate expectations. The fall in these rates may explain why, on the face of it, a small interest rate cut has been adequate to stabilise the market.

A period of stable or slightly rising house prices comes, of course, at a time when they are already unusually high. One factor supporting high house prices is low interest rates. Over the past few years nominal interest rates have fluctuated in a range not seen since the 1950s. Long-term real interest rates, as measured by yields on indexed government debt, are the lowest they have been since such debt was introduced. As we note on page 36 these have fallen largely in line with nominal rates and to an extent that commentators have found difficult to explain, except with the argument that bond prices have been inflated by a bubble.

Interest rates influence prices in two ways, both discussed by Nickell (2004). First of all, low interest rates, and in particular low nominal interest rates make mortgages more affordable and thus facilitate house purchase by people who are financially constrained--those who would like to borrow more than they have been able to. Secondly, a house can be seen as a capital asset, with its value being determined by the rental income it generates. If this is discounted at the real interest rate, then a period of low real interest rates results in high capital values and correspondingly low rental yields, both of which are observed. While rental yields have not moved exactly in line with indexed bond yields, this final point has the implication that if bond prices are supported by a bubble, then so too, in all probability, are house prices. Of the three major markets the equity market seems to be the odd one out, with earnings yields on UK equities not much below long-run norms.

Supply conditions

Separately from the question whether house prices are supported by unusually low interest rates there is the question whether prices are, at present, even higher than underlying economic factors would lead one to expect. House prices, like any market price, are determined by the balance between demand and supply. Housing supply has been extremely weak in the past twenty years or so, as compared to the experience of the housing targets era of the 1950s and 1960s; figure 1 shows the number of dwellings completed. Although private sector completions are at a rate similar to those in the 1960s, the overall rate is much lower. The effective end of council house building has not crowded in the private sector. It is the overall rate of housebuilding and not simply the rate of private sector completions which influences the supply/demand balance in the economy.


The rate of housebuilding has important implications for the age of the housing stock. If the 200,000 dwellings built each year were all for replacement purposes then, given that there are 26 million dwellings in total, the average age of the housing stock would settle at 130 years. However, net additions are around 170,000 per year.1 This may imply a lower average age in the short term but, in the long term, implies an average age well above 130 years.

Figure 2 shows the rate of growth of the number of dwellings in the United Kingdom over ten-year periods and also the average rate of growth of real house prices, that is house prices deflated by the consumer expenditure deflator. …

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