Soaring house prices are a problem, but they are also a sign of success

Why does Mervyn King say he is worried the party is getting out of hand, but doesn't take away the drink?
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The Independent Online

The job of a central banker was to "take away the punch bowl just when the party gets going," according to William McChesney Martin, US Federal Reserve chairman, 1951-1970.

The job of a central banker was to "take away the punch bowl just when the party gets going," according to William McChesney Martin, US Federal Reserve chairman, 1951-1970.

Mervyn King, our own head central banker, is arguably a bit late. The Great British House Party has been swinging along for quite a while and our homes - after another year of rising by more than 20 per cent - apparently are now somewhere between 15 and 40 per cent overpriced.

The trouble for central bankers is that there are several parties going on. All are at different stages of the night, but they sup from the same punch bowl of money, the price of which, of course, is the interest rate.

There is the general economy, which is swinging along reasonably well. There is the manufacturing recovery, which has hardly begun to get going. And there is the overall consumption party, which is almost as OTT as the house-price one. Damp down the housing by increasing interest rates and you cast a damper over the manufacturers.

And that explains why the governor warned on Monday about a crash in house prices. He said that prices were "well above the level that most people regard as sustainable in the long term". Why does a central banker use words instead of interest rates - why say that he is worried that the party is getting out of hand but does not take away the drink? Though the Bank's monetary committee has increased interest rates, most recently to 4.5 per cent, these rates are still very low by historical standards.

The answer is that the Bank cannot increase interest rates by very much because that would do too much damage to the rest of the economy, and most particularly to the manufacturing sector. Mervyn King has to use words because he and his colleagues have only limited room for action.

Still, words can have an effect. Headlines that the governor was warning of a house price crash sent the various mortgage lenders, the banks and the building societies, into damage limitation mode. They were saying yesterday that they did not think a crash was that likely. Ed Balls, the economic guru to the Chancellor, gave a somewhat opaque speech in which the main message seemed to be that the Treasury thought that house prices did not seem to be too far out of line. And it should be added that the main forecast of the Bank of England itself is that prices won't go up over the next two years, but there won't be a crash either.

That is probably the most sensible thing to say. Prices clearly cannot whiz up at 20 per cent a year forever. On the other hand, people have to live somewhere, and if strong economic growth continues people are going to want to use their salaries to house themselves as decently as they can. Those parts of the country where there is prosperous growth will always have expensive property.

You can also be sure of something else. If house prices do start falling fast, that would hit consumption and hence economic growth. There would then be immense pressure on the Bank to cut interest rates to check the fall. The punch bowl, so to speak, would have to be handed back.

But high house prices are a problem. They are an obvious problem for first-time buyers. Tomorrow the Joseph Rowntree Foundation (JRF) publishes a survey showing that parents expect to have to give or lend money to their children to get them on to the housing ladder.

From a social point of view, that is a disaster, because parents who do not own homes - who are not on the ladder themselves - are less likely to be able to help their children on to it. And another generation of people is likely to be put at the same disadvantage as council tenants were before they were given the right to buy their own homes. The well-meaning post-war policy of putting people into council housing actually impoverished the very people it was designed to help because it encouraged them not to buy.

So what is to be done? The JRF points out quite rightly that the answer is to build more homes. Indeed that is the only long-term solution, and it must be a big puzzle to anyone who is not steeped in the British tradition of planning, zoning, green belts and so on that we don't get on and just do it.

It would certainly be a much more sensible way of keeping house prices under control than jacking up interest rates to a level where they damage our export industries. In any case, the legal requirement placed on the Bank of England does not mention the price of houses, shares or other assets. The Bank's job is to keep consumer price inflation rising between 1.5 and 2.5 per cent a year, and it has tended to undershoot rather than overshoot.

Building more houses means more suburbia. Planners don't like suburbs. They think it wastes land and want to see high-density housing in cities - ideally on derelict sites in cities. That is the Government's policy, for on this issue it listens to its experts. The trouble is that people don't agree with the planners. Some of us do love living in cities - I happen to love living in London - but in general most people seem to prefer to live in suburbs. They prefer the larger homes, the gardens, the social homogeneity, the fact they can park their cars and so on. This is not an opinion; it is an observed fact. Even in London, now the fastest-growing large city in Europe, there is still a flight to the suburbs.

Professor Ed Glaeser, of Harvard University, made this point at a Leverhulme symposium on resurgent cities at the London School of Economics last month. He pointed out that cities that in the 1970s looked in hopeless decline, such as London, were now booming and that high house prices was one sign of that success. He also noted the importance of immigrants in turning cities round - my own view would be that the key to London's rebirth has been its ability to attract wonderful human capital from abroad.

But he also noted that consumers signal by their actions that they want to live in suburbs: they want sprawl. There are of course environmental objections to low-density housing and most planners hate it. But if people want something, planners and politicians should surely take note.

All this suggests that there is a solution to Mervyn King's dilemma. High house prices are a sign of economic success in the sense that they show there is strong demand for homes and hence a confidence in the future. But they are also a sign of a shortage of supply and that has a lot to do with the planning process. Increasing interest rates may be a necessary short-term tool to stop people over-borrowing. But interest rates have to be set for the whole economy, not just one that has been distorted by a flawed policy on home building.

Professor King once said that he was happiest when he was being a boring central banker and I can see what he means. Financial markets and economies in general function best when they are moving forward rather than thrashing around. But, go on warning about a forthcoming housing crash, Mervyn, and I can assure you one thing. Boring you ain't.

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