0115 966 7955 Today's Opening Times 10:00 - 20:00 (GMT)
Place an Order
Instant price

Struggling with your work?

Get it right the first time & learn smarter today

Place an Order
Banner ad for Viper plagiarism checker

Impact of House Prices on the UK Economy

Disclaimer: This work has been submitted by a student. This is not an example of the work written by our professional academic writers. You can view samples of our professional work here.

Any opinions, findings, conclusions or recommendations expressed in this material are those of the authors and do not necessarily reflect the views of UK Essays.

Published: Fri, 26 Jan 2018

What happens to house prices is perceived as being very important for the wider UK economy (at the moment the concern is that they may fall sharply). Consider to what extent house prices are important for the UK economy and how the government (or Bank of England) should respond to a sharp fall in house prices.

Introduction

The health of the residential property market is seen as a very important factor in the UK economy, and house prices have risen dramatically (though unevenly around the country) between 1996 and 2005. Some analysts argued that this was the result of a ‘bubble’ in the housing market, rather than due to purely economic reasons, while others argued that the rise in prices was a rational reaction to high employment, economic stability and low interest rates. The price rises slowed in 2005 and that led some analysts to predict a sharp fall in prices. These fears proved unfounded, as renewed growth since late 2005 has led most analysts to predict modest price rises in the medium term. However, many analysts remain concerned that housing prices may fall sharply in the near future.

This essay will first consider the different ways in which house prices in an economy relate to (and impact on) the performance of that economy more broadly, outlining in particular the specificities of the UK housing market that make its prices especially important to the UK economy. It will then examine the policies the government (or Bank of England) could adopt in response to a sharp fall in house prices, assessing which of these would be the most appropriate. Finally, it will also consider some longer term policies which could reduce house price volatility and the impact of house prices on the wider UK economy.

The relationship between house prices and the wider economy

The most obvious way in which house prices affect the wider economy is through their impact on household consumption (Cameron 2005:4) – a fall in house prices, for example, makes homeowners feel less wealthy so they tend to reduce consumption. Furthermore, a fall in house prices also reduces consumption indirectly by making it harder for people to borrow. Credit constraints are increased through two key channels: (1) reduced house prices means homeowners have reduced collateral against which they can borrow, further reducing consumption; and (2) lending institutions make losses when housing prices fall, and so they reduce their lending or tighten their lending policies.

According to Oswald (1999:2), ‘an economy’s ‘natural rate’ of unemployment depends on the ease with which its citizens can move around to find jobs. Fluid societies have efficient economies.’ High house prices and a relatively small private rental market make it more difficult for people to move around to find jobs, and thus can contribute to unemployment.

House prices can also have an indirect effect on the exchange rate, which is a particular concern because it may lead to a crash in house prices. High house prices contribute to high levels of household indebtedness which can be associated with increasing the current account deficit. This, in turn, may suddenly trigger a correction in the exchange rate. If the exchange rate is weakened, a sharp rise in inflation and interest rates may follow, leading to a sharp fall in house prices.

House prices and the UK economy

According to Cameron (2005:3), the high level of house ownership in the UK means that households are ‘exposed to a considerable amount of risk (almost half a million households had their homes repossessed in the 1990s).’ Not only are house prices more volatile in the UK than elsewhere in the developed world, the impact of house prices on consumer spending is also particularly heavy in the UK – according to the OECD, a 1% fall in UK housing wealth correlates with a 0.07% fall in consumer spending. The nature of the UK housing market (typically high loan to value ratios, few long-term fixed rate mortgages, and easy to re-mortgage) makes house prices particularly volatile and responsive to interest rates. Cameron (2005:3) explains that ‘a one percentage point rise in the short-term real interest rate would reduce house prices over a five year period by 2.6% in the UK, 1.8% in the US, and 1.3% in Germany.’

The UK housing market is characterized not only by a high level of home ownership and typically high loan to value mortgage ratios, but also by an insufficient housing supply. Demand consistently outstrips supply and the market is not sufficiently responsive, primarily due to the limited land available for construction and the difficulties in obtaining planning permission for new buildings. ‘Constrained housing supply leads to increasingly unaffordable housing, frustrating the home ownership aspirations of many individuals and families. It also leads to wealth redistribution from those outside the housing market to those inside it. Low housing supply reduces labour mobility, damaging the flexibility and performance of the UK economy and key public services, and can also translate into wider macroeconomic instability.’ (HM Treasury 2005:9)

Barker (2004:3) explains her view of the importance of the housing market to the UK economy more broadly: ‘Volatility in the housing market, in the UK, combined with the strong association between house prices and private consumption (reflecting in part high levels of owner occupation) is striking. Consequently, the housing market has contributed to macroeconomic volatility, creating a more difficult environment for businesses and for economic policy makers.’

Responding to a sharp fall in house prices

In order to respond to a sharp fall in house prices, the main tool which the government or central bank has at its disposition is monetary policy. If there is a sharp fall in house prices, consumption can be expected to drop (as per the relationship between house prices and consumption outlined in the first section of this essay) and there is a danger that a recession with ensue. In order to prevent this, the Monetary Policy Committee of the Bank of England should respond to any such fall by reducing interest rates, even though this may not be compatible with meeting their inflation target. This should help house prices to grow again, thus building up wealth and promoting consumption. Further, it will make credit more accessible which will also encourage consumption.

Longer term policies

Rather than being forced to respond to a sharp fall in house prices, the British government, or the Bank of England, would be better off developing longer-term strategies to prevent such a sharp fall in the first place – that is to say, they should be proactive rather than reactive. Cameron (2005:4) argues that it may be possible to make the UK housing market behave more like the US housing market (i.e. to make prices less responsive to interest rates and less volatile) ‘if the share of long-term fixed-rate mortgages could be increased (even when UK borrowers do take out fixed-rate mortgages, they tend to only fix the rate for three to five years).’

According to the OECD (2005:3), the risk of a sharp fall in house prices has been significantly reduced, and this has been achieved by longer term monetary strategies. ‘If a relatively “soft landing” in the housing market has indeed been achieved it owes much to the strategy of gradual preemptive monetary tightening, in marked contrast to previous episodes when an abrupt correction in house prices was triggered by sharp interest rate rises. Nevertheless, reforms are needed to make housing supply more elastic to damp future housing market cycles.’ Furthermore, Miles (2004:97) argues that in order for monetary policy to be most effective in stabilizing the currently volatile housing market, the UK mortgage facilities also need to be improved, and borrowers should be better informed.

Conclusion

Because house ownership levels are high in the UK, and because houses represent most households’ biggest asset, house prices are particularly important to the UK economy. As it currently functions, the UK housing market is insufficiently flexible to respond to, and reflect, the needs of the economy as a whole. Fortunately a drastic fall in house prices is unlikely in the near future. To prevent one in the medium to long term, the government should consider increasing the flexibility of the housing market. This could be achieved through relaxing planning regulations and adapting the mortgage market.

References

Barker, K. (2004) ‘Review of Housing Supply: Delivering Stability: Securing our Future Housing Needs’, Final Report – Recommendations (downloaded from http://www.hm-treasury.gov.uk/media/053/C7/barker_review_execsum_91.pdf on 26 February 2007)

Cameron, G. (2005) ‘The UK Housing Market: Economic Review’ (downloaded from http://hicks.nuff.ox.ac.uk/users/cameron/papers/ukhousingmarket.pdf on 22 February 2007)

HM Treasury (2005) ‘Housing Policy: An Overview’ (downloaded from http://www.hm-treasury.gov.uk/media/296/69/housing_policy190705.pdf on 26 February 2007)

Miles, D. (2004) ‘The UK Mortgage Market: Taking a Longer-Term View’, HMSO (downloaded from http://www.hm-treasury.gov.uk/media/80DDF/miles04_470.pdf on 22 February 2007)

Muellbauer, J. & Murphy, A. (1997) ‘Booms and Busts in the UK Housing Market’, The Economic Journal, Vol. 107, No. 445. (Nov., 1997), pp. 1701-1727

OECD (2005) ‘Economic Survey of the United Kingdom, 2005 (downloaded from http://www.oecd.org/dataoecd/18/34/35473312.pdf on 24 February 2007)

Oswald, A. (1999) ‘The Housing Market and Europe’s Unemployment: A Non-Technical Paper’, Warwick University (downloaded from www2.warwick.ac.uk/fac/soc/economics/staff/faculty/oswald/homesnt.pdf on 27 February 2007)

Wadhwani, S. (2002) ‘Household Indebtedness, the Exchange Rate and Risks to the UK Economy’, Bank of England speech delivered to the Macclesfield Chamber of Commerce on Monday, 25 March 2002 (downloaded from https://164.109.43.50/publications/speeches/2002/speech166.pdf on 22 February 2007)


To export a reference to this article please select a referencing stye below:

Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.
Reference Copied to Clipboard.

Request Removal

If you are the original writer of this essay and no longer wish to have the essay published on the UK Essays website then please click on the link below to request removal:


More from UK Essays