The UK’s housing market is in the doldrums. This week’s figures showed that mortgage approvals have flatlined for five years; the Halifax is likely to say next week that prices are falling in real terms; and the RICS is expected to report that estate agents expect demand and prices to remain weak. Does this matter for the wider economy?
Some say not. Willem Buiter, chief economist at Citigroup, has argued that housing is not net wealth for people in aggregate. Yes, home-owners lose from falling prices – especially those planning on trading down or using home equity release schemes. But those who don’t own a home gain, either by needing to save less for a deposit or because rents will eventually fall.
And, in fact, high housing costs are in many ways an economic menace. They are associated with high household debt, which tends to depress growth and increase instability. They divert spending away from innovative and dynamic sectors towards a low-productivity one. They encourage energetic people into “property development” rather than more innovative forms of entrepreneurship. And they compel workers to commute long distances which increases stress and decreases productivity.
And this is not to mention their cultural and political damage: the loss of bohemian arts scenes and the alienation that young people feel in being unable to afford property.
Nevertheless we should be a little disquieted by the weakness of the housing market.
One reason for this is that housing is collateral. It is used to finance some consumer spending via second mortgage or home equity release schemes as well as many small business start-ups. Through this channel, falling prices do depress spending.
Also even if house prices don’t matter, transactions do. There’s a close link between the number of house purchases and spending on housing-related items such as furniture and carpets. In fact, there’s also a link to spending more generally via a framing effect. If we’ve just spent £500,000 on a house, a few hundred pounds seems a smaller sum than it otherwise would, so we are more likely to spend.
For these reasons, there is a strong correlation, with a lag of a few months, between mortgage approvals and retail sales. Recent weakness in approvals therefore suggests that the recovery in high street spending we saw in the third quarter won’t be sustained. And with no sign of any pick-up in the housing market soon, this is a reason for longer-term caution about consumer spending.
I’m not sure all this is as contradictory as it seems. There’s widespread agreement that a healthy economy requires reform of the housing market – through changes to planning laws or taxation, for example. What we don’t need is long-lasting stagnation.
