A housing recovery would create new losers

All politicians agree that it would be a good thing if house prices start to rise again. This is very odd, since house price inflation does not make the nation as a whole any better off, and it makes a large slice of the nation considerably worse off. Yet it is clearly a political taboo to suggest that it might be better for the economy to prevent house prices from rising.

How do the links between the housing market and the rest of the economy really work? Obviously, a rise in house prices raises the real cost of acquiring extra housing services, so those households likely to increase their commitment to housing are clearly made worse off. Since these losses are offset by a gain for those who intend to reduce their exposure to housing in the future, the overall result is a large redistribution between generations. In simple terms, the old will gain from house price rises, while the young will lose.

Let us more formally split the population into only two age groups. The old are defined as the group likely to reduce its commitment to housing in the future, either by selling out completely, or by moving downmarket. The young are defined as the group which either has no property at present, or which is likely to move upmarket in future. How do both groups react when house prices rise relative to the prices of other goods and services?

First, on the surface, the old seem to have an obvious windfall gain to their immediate net worth, and they are quite likely to increase consumption as a result, relative to their incomes. In other words, they will probably save less. However, there is one question mark over this conclusion. Although the old themselves are better off, their heirs are actually worse off, since they will one day need to pay more for their housing. If the old are equally concerned about the welfare of themselves and their heirs, they will plan to increase the amount they bequeath to future generations, and this will offset the effects of higher house prices on the consumption of the old today.

Meanwhile, the young have the opposite forces operating on them. On the one hand, they need to save more to afford the same level of housing in the future, while on the other hand they expect to receive higher inheritances from their forebears, which will enable them to save less.

Overall, then, the theoretical effect of higher house prices on savings and consumption in the economy is unclear. In fact, if everyone is entirely rational about future inheritances, and if everyone fully cares about the welfare of all future generations, there should in theory be virtually no effect on overall consumption. This is because, in a long-run equilibrium, any gains today for the house-owning population would be exactly offset by losses for future generations.

However, in the real world, rising house prices are usually accompanied by rising consumption. This might happen because people in practice do not care as much about the welfare of future generations as they do about themselves, so they spend part of the windfall gains from higher house prices. Or it might happen because people are able to borrow against the rising value of their homes, thereby attaining access to the capital markets previously unavailable. For whatever reason, it is usually the case that higher house prices are associated with some increase in consumption relative to income.

Surely, this must be a good thing, one might think. Not so. An increase in spending relative to output would create inflation pressures in the system which would need to be offset by higher interest rates, or higher levels of taxation. Either way, a whole new class of losers would be created to offset the gains from higher house prices.

Alternatively - and this possibility raises some more complicated issues - the balance of payments might deteriorate as consumption rises relative to income. This would initially prevent any worsening in the inflation rate, but the key question would be whether this could be a permanent gain for UK living standards, or whether the deterioration in the trade balance would only be temporary. It would almost certainly be the latter.

Consider what would happen. The increase in consumption relative to income would automatically involve an increase in imports relative to exports, or a trade deficit. The offset to this would be a capital inflow from abroad, implying that foreigners would be lending more money to the UK than before. In the first instance, they might be willing to do this because they would accept the collateral implied by the increase in the value of UK housing assets. In other words, the UK would be financing its increased import bill by issuing claims on its housing assets.

But problems would soon arise. Foreigners would notice that the UK was not putting in place any new productive capacity which would enable the economy to service the build-up in foreign debt in the long run. Therefore, they would begin to notice that they were, in effect, providing goods for UK citizens to consume in exchange for claims on the housing stock in Britain. This would be acceptable to foreigners only if they believed that they could one day redeem these housing claims.

But the chances of them being able to do this would, in effect, be nil. Housing services are not capable of being sent overseas for foreigners to use, so the only way foreigners could redeem their claims would be, in effect, to "repossess" UK houses, sell them in the open market and take the money overseas. But this would inevitably depress the value of the housing stock, eliminating part of the "collateral" which foreigners believed they possessed. It would also reverse the initial gain in British consumption as house prices fell back towards their original level. The upshot of this is that any attempt by the UK to consume more as a result of a rise in the value of the housing stock would be quite quickly doomed to failure.

A case in point is what would have happened to the economy if house prices had in fact recovered sharply, as politicians were fervently praying, two years ago. One unequivocally good effect would have been that those families trapped in negative equity would have been freed up, and this would have increased labour mobility. But on top of this, consumers' expenditure would almost certainly have been much stronger, and this would have resulted in considerably greater inflationary pressure. Base rates would probably have risen by more than the 1.5 per cent, which we have actually seen, and this would have pushed the exchange rate higher. As a result, the remarkable improvement which has occurred in the balance of payments would never have happened.

I suppose it is far too much to ask, but I would applaud the first politician who has the nerve to say that a significant recovery in real house prices would be a very bad thing.

PROMOTED VIDEO
News
peopleStella McCartney apologises over controversial Instagram picture
Voices
voices
Arts and Entertainment
Hayley Williams performs with Paramore in New York
musicParamore singer says 'Steal Your Girl' is itself stolen from a New Found Glory hit
Sport
Ronaldinho signs the t-shirt of a pitch invader
footballProof they are getting bolder
News
William Hague
people... when he called Hague the county's greatest
Extras
indybestKeep extra warm this year with our 10 best bedspreads
News
ebooksAn unforgettable anthology of contemporary reportage
News
people
Voices
voicesBy the man who has
News
people... and stop them from attacking people
Arts and Entertainment
Ed Sheeran performs at his Amazon Front Row event on Tuesday 30 September
musicHe spotted PM at private gig
Sport
Arsene Wenger tried to sign Eden Hazard
footballAfter 18 years with Arsenal, here are 18 things he has still never done as the Gunners' manager
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Trainee Recruitment Consultant - Birmingham - Real Staffing

£18000 - £23000 per annum + Commission: SThree: Real Staffing are currently lo...

Trust Accountant - Kent

NEGOTIABLE: Austen Lloyd: TRUST ACCOUNTANT - KENTIf you are a Chartered Accou...

Graduate Recruitment Consultant - 2013/14 Grads - No Exp Needed

£18000 - £20000 per annum + OTE £30000: SThree: SThree are a global FTSE 250 b...

Law Costs

Highly Competitive Salary: Austen Lloyd: CITY - Law Costs Draftsperson - NICHE...

Day In a Page

Ebola outbreak: The children orphaned by the virus – then rejected by surviving relatives over fear of infection

The children orphaned by Ebola...

... then rejected by surviving relatives over fear of infection
Pride: Are censors pandering to homophobia?

Are censors pandering to homophobia?

US film censors have ruled 'Pride' unfit for under-16s, though it contains no sex or violence
The magic of roundabouts

Lords of the rings

Just who are the Roundabout Appreciation Society?
Why do we like making lists?

Notes to self: Why do we like making lists?

Well it was good enough for Ancient Egyptians and Picasso...
Hong Kong protests: A good time to open a new restaurant?

A good time to open a new restaurant in Hong Kong?

As pro-democracy demonstrators hold firm, chef Rowley Leigh, who's in the city to open a new restaurant, says you couldn't hope to meet a nicer bunch
Paris Fashion Week: Karl Lagerfeld leads a feminist riot on 'Boulevard Chanel'

Paris Fashion Week

Lagerfeld leads a feminist riot on 'Boulevard Chanel'
Bruce Chatwin's Wales: One of the finest one-day walks in Britain

Simon Calder discovers Bruce Chatwin's Wales

One of the finest one-day walks you could hope for - in Britain
10 best children's nightwear

10 best children's nightwear

Make sure the kids stay cosy on cooler autumn nights in this selection of pjs, onesies and nighties
Manchester City vs Roma: Five things we learnt from City’s draw at the Etihad

Manchester City vs Roma

Five things we learnt from City’s Champions League draw at the Etihad
Martin Hardy: Mike Ashley must act now and end the Alan Pardew reign

Trouble on the Tyne

Ashley must act now and end Pardew's reign at Newcastle, says Martin Hardy
Isis is an hour from Baghdad, the Iraq army has little chance against it, and air strikes won't help

Isis an hour away from Baghdad -

and with no sign of Iraq army being able to make a successful counter-attack
Turner Prize 2014 is frustratingly timid

Turner Prize 2014 is frustratingly timid

The exhibition nods to rich and potentially brilliant ideas, but steps back
Last chance to see: Half the world’s animals have disappeared over the last 40 years

Last chance to see...

The Earth’s animal wildlife population has halved in 40 years
So here's why teenagers are always grumpy - and it's not what you think

Truth behind teens' grumpiness

Early school hours mess with their biological clocks
Why can no one stop hackers putting celebrities' private photos online?

Hacked photos: the third wave

Why can no one stop hackers putting celebrities' private photos online?