Pearson - Always learning

All your resources for Economics

RSS icon Subscribe | Text size

The housing market: feeling the pinch

According to the Halifax house price index, house prices fell in the UK in the three months to April. This is the first quarterly fall since 2012. The Nationwide index (see below), shows that prices in April were 0.4% lower than in March (although the 3-month rate was still slightly positive).

The fall in house prices reflects a cooling in demand. This, in turn, reflects a squeeze on household incomes as price rises begin to overtake wage rises. It also reflects buyers becoming more cautious given the uncertainty over the nature of the Brexit deal and its effects on the economy and people’s incomes.

The fall in demand is also driven by recent Bank of England rules which require mortgage lenders to limit the proportion of mortgages with a mortgage/income ratio of 4.5 or above to no more than 15% of their new mortgages. It is also affected by a rise in stamp duty, especially on buy-to-let properties.

Despite the fall in prices, this may understate the fall in demand relative to supply. House price movements often lag behind changes in demand and supply as people are reluctant to adjust to equilibrium prices. In the case of a falling market, sellers may be unwilling to sell at the lower equilibrium price, believing that a lower price ‘undervalues’ their property. Indeed, they may not even put their houses on the market. This makes prices ‘sticky’ downwards. The result is a fall in sales.

Eventually, such people will reluctantly be prepared to accept a lower price and prices will thus fall more. Once people come to expect price falls, supply may increase further as vendors seek to sell before the price falls even more. So we could well see further falls over the coming months.

Lower house prices and falling sales is a picture repeated in many parts of the UK. It is particularly marked in central London. There, estate agents have begun to offer free gifts to purchasers. As The Guardian puts it:

London estate agents have begun to offer free cars worth £18,000, stamp duty subsidies of £150,000, plus free iPads and Sonos sound systems to kickstart sales in the capital’s increasingly moribund property market. The once super-hot central London market has turned into a ‘burnt-out core’ according to buying agents Garrington Property Finders, prompting developers to offer ever greater incentives to lure buyers.

… Land Registry figures show that in the heart of the city’s financial district, average property prices plummeted from £861,000 at the time of the EU referendum to £773,000 in February, a decline of 15%, although in London’s outer boroughs prices are still up over the year.

But lower property prices are good news for first-time buyers, although some of the biggest falls have been in the top end of the market.

The fall in property prices may continue for a few months. But population is rising, and with it the number of people who would like to buy their own home. Once real incomes begin to rise again, therefore, demand is likely to resume rising faster than supply. When it does, house prices will continue their upward trend.

Articles
UK house prices in first quarterly fall since 2012 BBC News (8/5/17)
UK house prices fall again in April as buyers feel the pinch The Guardian, Angela Monaghan (28/4/17)
Buy a home, get a car free: offers galore as London estate agents struggle to sell The Guardian, Patrick Collinson (3/5/17)
London is now one of the five cities with the lowest house price growth in the UK City A.M., Helen Cahill (28/4/17)
London Housing Market Property Bubble Vulnerable To Crash The Market Oracle, Jan Skoyles (3/5/17)
A key indicator of a healthy housing market is flashing red in London Business Insider, Thomas Colson (29/5/17)

House Price Data
UK House Prices – links to various sites Economic Data freely available online – Economics Network

Questions

  1. Why are UK house prices falling?
  2. What determines the rate at which they are falling? How is the price elasticity of demand and/or supply relevant here?
  3. How does speculation help to explain changes in house prices? How may speculation help to (a) stabilise and (b) destabilise house prices?
  4. Draw a demand and supply diagram to show how house transactions will be lower if the market is not in equailibrium.
  5. Why are house prices falling faster in central London than elsewhere in the UK?
  6. Why are rents falling in central London? How does this relate to the fall in central London property prices?
  7. How has the Help to Buy scheme affected house prices? Has it affected both demand and supply and, if so, why and how?
  8. How do changes in residential property transaction volumes relate to changes in property prices?
  9. What market imperfections exist in the housing market?
Share in top social networks!

Macronomics

The French have elected Emmanuel Macron as their new President. He claims to be from the economic centre. But just what does this imply for his vision of how the French economy should be run? What policies is he likely to put in place? Can these policies rightly be described as ‘centrist’? In practice, some of his policies are advocated by the centre right and some by the centre left.

He wants to institute policies that are pro business and will have the effect of stimulating private investment, increasing productivity and resulting in faster economic growth.

His pro-business policies include: reducing corporation tax from its current 33.3% to 25%, the hope being that firms will invest the money that this will free up; reducing labour taxes on companies for employing low-wage workers; making the current 35-hour working week less rigid by giving firms greater ability to negotiate special arrangements with trade unions.

Other policies drawn from the centre right include reducing the size of the state. Currently, general government spending in France, at 56.5% of GDP, is the highest of the G7 countries. Italy’s is the next highest at 49.6%, followed by Germany at 44.3%, Canada at 40.8%, the UK at 39.4%, Japan at 36.8% and the USA at 35.2%. President Macron wants to reduce the figure for France to 52% over his five-year term. This will be achieved by cutting 120,000 public-sector jobs and reducing state spending by €60bn. He plans, thereby, to reduce the general government deficit from its 2016 level of 3.4% of GDP to 1% by 2022 and reduce the general government debt from 96.0% of GDP to 93.2% over the same period.

Drawing from centre-left policies he plans to increase public investment by €50bn, including €15bn on training, €15bn on green energy and €5bn each on transport, health, agriculture and the modernisation of public administration. But as this additional expenditure is less than the planned savings through greater efficiency and as GDP is projected to grow, this is still consistent with achieving a reduction in the general government deficit as a percentage of GDP. He has also pledged to extend welfare spending. This will include making the self-employed eligibile for unemployment benefits.

M Macron isalso strongly supportive of France’s membership of the EU and the euro. Nevertheless he wants the EU to be reformed to make it more efficient and achieve significant cost savings.

Articles
Macronomy: What are Emmanuel Macron’s economic plans? BBC News, Simon Atkinson (8/5/17)
Factbox: Emmanuel Macron’s presidential election policies Reuters, Brian Love (14/4/17)
What Analysts Are Saying About Macron’s Victory Bloomberg, Chris Anstey (8/5/14)
The Main Points of Emmanuel Macron’s Economic Programme NDTV, India (9/5/14)
Can Emmanuel Macron solve France’s economic riddle? The Guardian, Larry Elliott (30/4/17)
Why Emmanuel Macron’s bid to haul France out of its economic malaise will be harder than he thinks The Telegraph, Szu Ping Chan and Tim Wallace (30/4/17)
Macron’s policies on Europe, trade, immigration and defence Financial Times, Hannah Murphy (7/5/17)
French presidential election: Investors, economists and strategists react to Macron’s victory Independent, Josie Cox (8/5/17)

Questions

  1. Compare the performance of the French, German and UK economies over the past 10 years.
  2. Why does France have much lower levels of inequality and much higher productivity than the UK?
  3. How would (a) a neoliberal and (b) Keynesian economist explain the slow growth performance of France?
  4. Give some other examples of centre-right economic policies that could be pursued by a centrist government.
  5. Give some other examples of centre-left economic policies that could be pursued by a centrist government.
  6. How do M Macron’s policies differ from those of the (a) Conservative, (b) Labour and (c) Liberal Democrat parties in the manifestos for the 2017 General Election in the UK?
  7. What economic difficulties is M Macron likely to find in carrying out his policies?
  8. Would you describe M Macron’s macroeconomic policies as demand-side or supply -side policies? Explain.
  9. What specific economic policies does France want Germany to pursue?
Share in top social networks!

An energy price cap – a sensible response to a market imperfection?

Following concerns about the market power of the Big Six energy suppliers in the UK and high prices for gas and electricity, the industry regulator, Ofgem, referred the industry to the Competition and Markets Authority (CMA) in June 2014. The CMA published its final report in June 2016. This argued that while there was sufficient potential for competition, consumers nevertheless needed further encouragement to switch suppliers. This would strengthen competition in the market.

To encourage switching, the CMA proposed the creation of a database that would include the details of customers who have been on a supplier’s standard variable tariff (SVT) for three or more years. Competitor energy suppliers would have access to this database to offer better deals for these customers.

There had already been calls for price caps to be imposed on suppliers. For example, in the run-up to the 2015 general election, the then Labour leader, Ed Miliband, proposed imposing a price freeze. This was criticised by the Conservatives for being too anti-market, that it would encourage energy companies to raise prices prior to the freeze and that it would be of no benefit in times of falling wholesale energy prices (which was the position in 2015).

Indeed, in its 2016 report, the CMA recommended price caps only for the 16% of people on prepayment meters and these would be variable caps not freezes. This was followed in February 2017, by Ofgem’s announcement that a temporary price cap for such customers would come into effect in April 2017. The level of the cap would vary by meter type and region. It would also be reviewed every six months to reflect changes in costs and remain in place until 2020. There would be no cap on other customers.

But in the run-up to the 2017 election, the Conservatives announced that they would, after all, introduce a price cap on SVTs – 66% of customers are on such tariffs. Before the details were announced, there was much speculation as to what form such a cap would take? It would not be a simple freeze. But there was debate as to whether caps would vary with wholesale costs or whether they would be relative to the company’s lowest tariffs or to those of its rivals.

As it turned out, the proposal was for a cap on standard variable tariffs. It would be set by Ofgem and reviewed every six months. The cap would be based on the cheapest standard variable tariffs in each part of the UK, taking into account the variable costs for transporting energy there. Ofgem will adjust the cap every six months to reflect changes in the wholesale cost of energy.

Articles before details were anniunced
U.K. Energy Industry Faults May’s Election Pledge to Cap Prices Bloomberg, Rakteem Katakey (23/4/17)
Conservatives promise to cap prices in UK energy market Financial Times, Jim Pickard and Nathalie Thomas (23/4/17)
How might an energy price cap work? BBC News, Brian Milligan (24/4/17)
UK government vows strong action to rein in energy companies The Guardian, Adam Vaughan (19/4/17)
Energy bills: what’s the difference between Tory cap and Miliband freeze? The Guardian, Adam Vaughan (23/4/17)
Capping energy prices? Still a bad idea Adam Smith Institute blogs, Sam Dumitriu (25/4/17)
Bulb becomes ‘first’ provider to cut energy prices this year Moneywise (24/4/17)
Experts slam Conservative plans to cap energy bills as ‘clumsy and counterproductive’ The Telegraph, Lauren Davidson (23/4/17)
Capping energy tariffs isn’t a one-way ticket to Venezuelan-style economic ruin Independent, Ben Chu (25/4/17)

Articles after details were anniunced
Conservatives defend plans to cap UK energy bills Financial Times, Jim Pickard and Nathalie Thomas (9/5/17)
What is the energy price cap – and what does it mean for bills? The Telegraph, Jillian Ambrose (9/5/17)
The new energy price cap con? The Telegraph, Jillian Ambrose (9/5/17)
May defends plan to cap ‘rip-off energy bills’ BBC News (9/5/17)
Q&A: The Tory plan to cap energy prices BBC News, Brian Milligan (9/5/17)
Energy prices could still go up under Theresa May’s price cap plans, admits Business Secretary Greg Clark Independent, Rob Merrick (9/5/17)
Tory claims over energy price cap are just hot air The Guardian, Nils Pratley (9/5/17)

Video and audio
UK government energy price cap ‘sheer politics’: Bernstein CNBC, Deepa Venkateswaran and Andrew Sentance (25/4/17)
Energy UK: price cap could backfire Sky News, Lawrence Slade (24/4/17)
Scottish Power: Capping prices ‘damages customers’ BBC News, Keith Anderson (24/4/17)
Tories to pledge energy bill cap BBC News, Michael Fallon (24/4/17)
Tories: Energy cap will protect vulnerable people BBC Today Programme, Business Secretary Greg Clark (9/5/17)
Energy cap: good or bad for consumers? Sky News, Stephen Fitzpatrick and James Kirkup (9/5/17)

Questions

  1. What scope is there for tacit collusion between the Big Six energy suppliers?
  2. What is meant by the RPI–X price cap? How does it differ from proposals being considered by the government?
  3. Why are people often reluctant to switch energy supplier?
  4. How could people be encouraged to switch supplier?
  5. What are the advantages and disadvantages of imposing a price cap for SVTs (a) relative to costs; (b) relative to lower-priced tariffs?
  6. Comment on Centrica’s chief executive officer Iain Conn’s statement that “price regulation will result in reduced competition and choice, and potentially impact customer service”.
  7. Comment on the statement by Lawrence Slade, chief executive officer of Energy UK, that intervention would create “huge uncertainty around government intentions, potentially putting at risk the billions in investment and jobs needed to renew our energy system”.
  8. Would an announcement of the introduction of a price cap in the near future necessarily encourage energy companies to raise their price now?
Share in top social networks!

Return of the political business cycle?

According to the theory of the political business cycle, governments call elections at the point in the business cycle that gives them the greatest likelihood of winning. This is normally near the peak of the cycle, when the economic news is currently good but likely to get worse in the medium term. With fixed-term governments, this makes it harder for governments as, unless they are lucky, they have to use demand management policies to engineer a boom as an election approaches. It is much easier if they can choose when to call an election.

In the UK, under the Fixed-term Parliaments Act of 2011, the next election must be five years after the previous one. This means that the next election in the UK must be the first Thursday in May 2020. The only exception is if at least two-thirds of all MPs vote for a motion ‘That there shall be an early parliamentary general election’ or ‘That this House has no confidence in Her Majesty’s Government.’

The former motion was put in the House of Commons on 19 April and was carried by 522 votes to 13 – considerably more than two-thirds of the 650 seats in Parliament. The next election will therefore take place on the government’s chosen date of 8 June 2017.

Part of the reason for the government calling an election is to give it a stronger mandate for its Brexit negotiations. Part is to take advantage of its currently strong opinion poll ratings, which, if correct, will mean that it will gain a substantially larger majority. But part could be to take advantage of the current state of the business cycle.

Although the economy is currently growing quite strongly (1.9% in 2016) and although forecasts for economic growth this year are around 2%, buoyed partly by a strongly growing world economy, beyond that things look less good. Indeed, there are a number of headwinds facing the economy.

First there are the Brexit negotiations, which are likely to prove long and difficult and could damage confidence in the economy. There may be adverse effects on both inward and domestic investment and possible increased capital outflows. At the press conference to the Bank of England’s February 2017 Inflation Report, the governor stated that “investment is expected to be around a quarter lower in three years’ time than projected prior to the referendum, with material consequences for productivity, wages and incomes”.

Second, the fall in the sterling exchange rate is putting upward pressure on inflation. The Bank of England forecasts that CPI inflation will peak at around 2.8% in early 2018. With nominal real wages lagging behind prices, real wages are falling and will continue to do so. As well as from putting downward pressure on living standards, it will tend to reduce consumption and the rate of economic growth.

Consumer debt has been rising rapidly in recent months, with credit-card debt reaching an 11-year high in February. This has helped to support growth. However, with falling real incomes, a lack of confidence may encourage people to cut back on new borrowing and hence on spending. What is more, concerns about the unsustainability of some consumer debt has encouraged the FCA (the financial sector regulator) to review the whole consumer credit industry. In addition, many banks are tightening up on their criteria for granting credit.

Retail spending, although rising in February itself, fell in the three months to February – the largest fall for nearly seven years. Such falls are likely to continue.

So if the current boom in the economy will soon end, then, according to political business cycle theory, the government is right to have called a snap election.

Articles
Gloomy economic outlook is why Theresa May was forced to call a snap election The Conversation, Richard Murphy (18/4/17)
What does Theresa May’s general election U-turn mean for the economy? Independent, Ben Chu (18/4/17)
It’s not the economy, stupid – is it? BBC News Scotland, Douglas Fraser (18/4/17)
Biggest fall in UK retail sales in seven years BBC News (21/4/17)
Sharp drop in UK retail sales blamed on higher prices Financial Times, Gavin Jackson (21/4/17)
Shoppers cut back as inflation kicks in – and top Bank of England official says it will get worse The Telegraph, Tim Wallace Szu Ping Chan (21/4/17)
Retail sales volumes fall at fastest quarterly rate in seven years Independent, Ben Chu (21/4/17)

Statistical Bulletin
Retail sales in Great Britain: Mar 2017 ONS (21/4/17)

Questions

  1. For what reasons might economic growth in the UK slow over the next two to three years?
  2. For what reasons might economic growth increase over the next two to three years?
  3. Why is forecasting UK economic growth particularly difficult at the present time?
  4. What does political business cycle theory predict about the behaviour of governments (a) with fixed terms between elections; (b) if they can choose when to call an election?
  5. How well timed is the government’s decision to call an election?
  6. If retail sales are falling, what other element(s) of aggregate demand may support economic growth in the coming months?
  7. How does UK productivity compare with that in other developed countries? Explain why.
  8. What possible trading arrangements with the EU could the UK have in a post-Brexit deal? Discuss their likelihood and their impact on economic growth?
Share in top social networks!

Studies show that money can buy happiness (but only if you spend on experiences)

Guest post by Hazel Garcia from InvestmentZen

An oft-repeated quote is that money can’t buy happiness. But according to multiple studies, yes, it can. The key is what you spend that hard earned cash on. When researchers asked individuals to reflect on their recent purchases, those who had made experiential purchases i.e. trips, lessons, events, etc. were much happier compared to those who had made material purchases.

Why is this the case? According to a 20 year study at Cornell, our excitement from new purchases fades quickly over time. That new watch you bought quickly becomes a part of your everyday life. This is what psychologists call the “hedonic treadmill,” which describes the way we return to our normal state of happiness after a momentous occasion. However, buying a new chair will return you much quicker to that state than an adventure across the Rocky Mountains.

Researchers identified several key reasons why this is the case. One reason is that an object is just an object and can never become a part of your identity (at least, not a healthy one), whereas experiences shape us over time. In addition, because by definition unique experiences are only short-lived, we don’t adapt to them the way we might with a new phone or watch. They do not become part of the routine and as such are usually viewed in a special light.

Interestingly, researchers found that even a negative experience could be rated more highly than purchasing a luxury good. In the study, participants were asked to describe a bad experience they had recently and a few weeks later, they were asked again about it. Over the course of just a few weeks, most people’s opinion of that moment had changed.

This is because the human brain has a tendency to reduce the impact of stressful situations. In fact, a significant portion of those polled even stated that in the end, they were happy to have had the negative encounter as it gave them a fresh way to look at things. When similar questions were asked to those who had purchased a high-end item, their levels of happiness were consistently lower as time went on.

So when it comes to the age old question of “Does money buy happiness?” the answer is a resounding yes – provided you spend it on the right things. But of course, you should still aim to make every dollar go as far as possible in pursuit of great experiences. Take a look at the infographic below to see a visual summary of the research on money and how it can buy happiness.

If you want to be happy, spend money on experiences, not things

Blog
If You Want To Be Happy, Spend Money On Experiences, Not Things InvestmentZen news, Hazel Garcia (23/1/17)

References
Why You Should Spend Your Money On Experiences, Not Things Forbes, Travis Bradberry (9/8/16)
The science of why you should spend your money on experiences, not things Fast Company, Jay Cassano (30/3/15)
To feel happier, talk about experiences, not things Cornell Chronicle, Susan Kelley (29/1/13)
The way we shop now: the revolution in British spending habits The Guardian, Katie Allen and Sarah Butler (6/5/16)
Just do it: the experience economy and how we turned our backs on ‘stuff’ The Guardian, Simon Usborne (13/5/17)

Questions (by JS)

  1. Why does buying material goods not buy happiness? Does this apply to all material goods?
  2. What is different, in terms of happiness, about buying experiences? Does this apply to the consumption of all services?
  3. Is the consumption of experiences subject to diminishing marginal utility (a) for specific experiences; (b) for experiences in general? Explain.
  4. Why do we seem not to care as much about the “Jones’” vacation as about their income or possession of material goods?
Share in top social networks!