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The house price disease

I call this a disease because it is bad for the country's social and economic health. As Conservative peer David Willetts has argued, house price inflation tends to funnel wealth from the young - who must pay high rents and mortgages - to older home-owners. This isn't just of dubious equity. It contributes to weak and unstable economic growth.

For one thing, if youngsters spend an ever-growing proportion of their incomes on housing then resources are being transferred towards a sector with low productivity growth and away from more dynamic sectors. That depresses aggregate productivity growth. What's more, if we older people can get rich simply by watching our house price rise, we'll have less incentive to work and save. This too reduces economic growth.

Also, rising house prices encourage banks to believe that mortgage lending is 'safe': one of bankers' very few abilities is their extraordinary talent for forgetfulness. That encourages lending to home-owners rather than to more productive companies: for every pound British banks have lent to manufacturers, they have lent £34.58 to home-buyers (£36.8bn against £1272.7bn). This creates a tendency towards booms and busts in the housing market.

It's probably no accident, therefore, that countries with high home-ownership rates are not noted for their economic success: Romania and Greece have lots of home owners while Germany and South Korea have fewer.

All this seems like a strong case for policy-makers to do something to reduce house price inflation - perhaps targeting it in much the way they target consumer price inflation. This doesn't mean raising interest rates - there's no point hurting hard-pressed businesses to control one mal-performing sector of the economy - but might mean quantitative restrictions on mortgage lending or (of course) encouraging more housebuilding.

Except for one thing. There's a short-term case for letting house prices rise simply because this might be one of the few ways we have of stimulating economic growth. World trade is falling, so there's no hope of export-led growth. Fiscal tightness will restrain domestic demand. And uncertainty about overseas demand, technical change and perhaps the EU referendum might hold back business investment. Rising house prices, therefore, might be one of the few stimulants the economy has.

We should be clear how this stimulus works.

It's not because rising house prices make us wealthier and thus more likely to spend. Yes, this is true for home-owners planning on trading down. But for others, such as those hoping to trade up or to buy a first house, rising prices make them worse off, because they'll have to spend more. On balance, housing might not be net wealth at all.

Instead, rising house prices boost demand because, as Oxford University's John Muellbauer has shown, they give home-owners more collateral thus enabling them to borrow more. This might explain why lending to households has accelerated recently, even though rising real wages and the prospect of tax credit cuts should have encouraged people to borrow less.

Perhaps, therefore, we need rising house prices to achieve even modest economic growth. As Larry Summers famously said two years ago, in a world of secular stagnation the economy needs bubbles if it is to grow. In this sense, house price inflation isn't merely a disease in itself, but also a symptom of a bigger illness.