You may have heard that house prices are stalling. August’s house price numbers from the Nationwide Building Society revealed that the average UK house price fell by 0.9% which came on the back of a 0.5% fall in July. The Nationwide talks of an ‘unwinding of the demand-supply imbalance that drove up prices for much of the last year’. It seems that the house price rises last year have, over recent months, induced additional supply by encouraging home-owners to put their property on the market. Unfortunately, there are indications that housing demand has weakened during 2010 though, of course, this gives buyers a greater degree of bargaining power.
But, you might wonder how we can get a handle on the strength of housing demand. Well, one particularly useful piece of information in assessing housing demand is the number of mortgage approvals for purchasing property. After all, there are not many of us that can reach into our back-pocket to find the £166,507 that the Nationwide estimates is needed to buy the average UK property.
If we look at Table A5.4 from August’s edition of Monetary and Financial Statistics, which is published by the Bank of England, we find that the number of mortgage approvals for house purchase in July was 48,722. Now, this was marginally up on the 48,562 in June, but, of more significance is the fact that July’s number was over 8% lower than in July 2009 when approval numbers stood at 53,126. Indeed, this number was to rise further through 2009, hitting 59,117 in November. This indicates a strengthening of housing demand at the time and helps us to appreciate why house prices rebounded last year.
But, the start of 2010 was to see mortgage approval numbers fall away and they have essentially flatlined over recent months at between 48,000 and 50,000. This time the numbers indicate a weakening of housing demand and so help to explain why house price growth has seemingly ceased and gone into reverse.
It remains to be seen how the balance between housing demand and supply will ‘play out’ over the remainder of the year. Will, for instance, some properties be taken off the market in response to this weaker demand? Could housing demand weaken further in response to economic conditions or to economic uncertainty? The answers to these questions will help to determine that all important balance between housing demand and supply. But, by monitoring the mortgage approval numbers we have a ready-made barometer on the strength of housing demand. Feel free to see which way the barometer needle swings in future!
Articles
UK mortgage approval rise but total lending weakest since March Telegraph (31/8/10)
House prices set to slump even further as home loans stay scarce Independent, Sean O’Grady (1/10/10)
Housing market ‘faces double dip’ Press Association (31/8/10)
UK mortgage approvals beat estimates as banks make more funds available Bloomberg, Scott Hamilton (31/8/10)
Data
Mortgage approval numbers and other lending data are available from the Bank of England’s statistics publication, Monetary and Financial Statistics (Bankstats) (See Table A5.4.)
Questions
- What variables do you think are important in affecting the level of housing demand?
- What variables do you think are important in affecting the level of housing supply?
- Using a demand-supply diagram illustrate how shifts in housing demand and/or supply may have affected house prices (i) during 2009 and (ii) during 2010.
- What would you expect to happen to the strength of housing demand in the coming months? How will this impact on house prices?
The prices of grains and other foodstuffs are rising rapidly. Wheat prices rose some 40 per cent in July and have continued to rise rapidly since. In June wheat futures were trading at around 450 US cents/bushel. By early September, they were trading at around 700 US cents/bushel. Global food prices generally rose by 5% over the two months July/August. And it’s not just food. Various other commodity prices, such as copper and oil, have also increased substantially.
At the beginning of September there were three days of food riots in Mozambique in protest against the 30% rise in the price of bread. Seven people were killed and 288 were injured. On 2 September Russia announced that it was extending a ban on wheat exports for another 12 months following a disastrous harvest. In Pakistan, the floods have destroyed a fifth of the country’s crops. Drought in Australia and floods in the Canadian prairies have reduced these countries’ grain production.
In response to the higher prices and fears of food riots spreading, the United Nations has called a special meeting on 24 September to bring food exporters and importers together to consider “appropriate reactions to the current market situation”. And yet, although global cereal production is down by some 5% on last year, it is still predicted to be the third largest harvest on record.
So what is causing the price rises? Is it simply a question of the balance of supply and demand and, if so, what has caused the relevant shifts in supply and/or demand? And what role does speculation play? The following articles look at the issues and at the outlook for commodity prices over the coming months.
Clearly changes in commodity prices affect the rate of inflation. The news item (Bank of England navigates choppy waters) amongst other issues looks at the outlook for inflation and the various factors influencing it.
Articles
Commodity prices soar as spectre of food inflation is back Guardian, Simon Bowers (6/8/10)
Food inflation is a rumble that won’t go away Telegraph, Garry White (8/8/10)
Global wheat supply forecast cut BBC News (12/8/10)
Commodity crisis sparks fear of food inflation on high street Independent, James Thompson and Sean O’Grady (10/8/10)
Should we be concerned about high wheat prices? BBC News, Will Smale (6/8/10)
Commodity prices: Wheat The Economist (12/8/10)
Interactive: What’s driving the wheat price spike? Financial Times, Akanksha Awal, Valentina Romei and Steven Bernard (20/8/10)
Wheat pushes world food prices up BBC News (1/9/10)
UN to hold crisis talks on food prices as riots hit Mozambique Guardian, David Smith (3/9/10)
Grain prices spark global supply fears CBC News, Kevin Sauvé (3/9/10)
GRAINS-US wheat firms after Russian ban extension Forex Yard (3/9/10)
Global food prices reach 20 year high BBC News, John Moylan (3/9/10)
Speculators ‘not to blame for higher food costs’ BBC Today Programme, David Hightower (4/9/10)
Q&A: Rising world food prices BBC News (3/9/10)
Don’t starve thy neighbour The Economist (9/9/10)
Data
Commodity prices Index Mundi
Commodity prices BBC market data
Energy prices U.S. Energy Information Administration
Questions
- Use a supply and demand diagram to illustrate (a) what has been happening to wheat prices (b) what is likely to happen to wheat prices over the coming months?
- How relevant is the price elasticity of demand and supply and the income elasticity of demand to your analysis?
- What factors have caused the shifts in demand and/or supply of wheat and copper?
- What has been the role of speculation in the price rises? Is this role likely to change over the coming months?
- What is likely to happen to food prices in the shops over the coming months? Would you expect bread prices to rise by the same percentage as wheat? If so, why; if not, why not?
- If commodity prices generally rose by 5 per cent over the coming year, would you expect inflation to be 5 per cent? Again, if so, why; if not, why not?
Until the credit crunch and crash of 2008/9, there appeared to be a degree of consensus amongst economists about how economies worked. Agents were generally assumed to be rational and markets generally worked to balance demand and supply at both a micro and a macro level. Although economies were subject to fluctuations associated with the business cycle, these had become relatively mild given the role of central banks in targeting inflation and the general belief that we had seen the end of boom and bust.
True, markets were not perfect. There were problems of monopoly power and externalities. Also information was not perfect. But asymmetries of information were generally felt to be relatively unimportant in the information age with easy access to market data through the internet.
Then it all went wrong. With the exception of a few economists, people were caught unawares by the credit crunch. There was too little understanding of the complexities of securitisation and the leveraged risk in these pyramids of debt built on small foundations. And there was too little regard paid to the potentially destructive power of speculation and herd behaviour.
So how should economists model what has been happening over the past three years? Do we simply need to go back to Keynesian economics, which emphasised the importance of aggregate demand and the ability of economies to settle at a high unemployment equilibrium? Can the persistence of high unemployment in the USA and elsewhere be put down to a lack of demand or is the explanation to be found in hysteresis: the persistence of a problem after the initial cause has disappeared? Can failures of markets be incorporated into standard microeconomics?
Or do we need a new paradigm: one that emphasises the behaviour of economic agents and examines how people act when there are information asymmetries? These are the questions that are examined in the podcast below. It is an interview with Nobel Prize winning economist, Joseph Stiglitz.
Podcast
Joseph Stiglitz: ‘Building blocks’ of a new economics BBC Today Programme (25/8/10)
Articles
Needed: a new economic paradigm Financial Times, Joseph Stiglitz (19/8/10)
Obama should get rid of Geithner, Summers Market Watch, Wall Street Journal, Darrell Delamaide (25/8/10)
This rebel’s heresy is not so earth-shaking Fund Strategy, Daniel Ben-Ami (23/8/10)
Questions
- What are Stiglitz’s criticisms of the economics profession in recent years?
- What, according to Stiglitz, should be the features of a new economic paradigm?
- Is such a paradigm new?
- Provide a critique of Stiglitz’s analysis.
- What do you understand by ‘behavioural economics’? Would a greater understanding of human behaviour by economists have helped avert the credit crunch and subsequent recession?
What will happen to interest rates over the next two or three years? There is considerable disagreement between economists on this question at the moment.
There are those who argue that recovery in the UK, the USA and Europe is faltering. With much tighter fiscal policy being adopted as countries attempt to claw down their deficits, there is a growing fear of a double-dip recession. In these circumstances central banks are likely to keep interest rates at their historically low levels for the foreseeable future and could well embark on a further round of quantitative easing (see Easy money from the Fed?). But what about inflation? With demand still expanding in developing countries and commodity prices rising, won’t cost pressures on inflation continue? Those who forecast that interest rates will stay low, argue that the pressure on commodity prices will ease as global demand slows. Also, in the UK, now that sterling is no longer depreciating, this will remove a key ingredient of higher inflation.
These views are not shared by other economists. They argue that interest rates could soar over the next two years. In fact, one economist, Andrew Lilico, the Chief Economist at Policy Exchange argues that interest rates in the UK will reach 8% by 2012. Central to their argument is the role of the money supply. The monetary base has been expanded enormously through programmes of quantitative easing. And yet, consumer credit has fallen. When the economy does eventually start to recover strongly, Lilico and others argue that there is a danger that consumer credit and broad money will expand rapidly, thereby fuelling inflation. But won’t the spare capacity that has built up during the recession allow the increase in aggregate demand to be met by a corresponding increase in output, thereby keeping inflation low. No, say these economists. A lot of capacity has been lost and output cannot easily expand to meet a rise in demand.
It’s not uncommon for economists to disagree! See, by reading the articles below, if you can unpick the arguments and establish where the disagreements lie and whose case is the strongest.
Articles
America’s century is over, but it will fight on Guardian, Larry Elliott (23/8/10)
Rates to remain low for foreseeable future Interactive Investor, Rhian Nicholson (18/8/10)
BoE gets benefit of doubt on inflation – for now Reuters, Christina Fincher (19/8/10)
BGilts reflect continued uncertainty AXA Elevate, Tomas Hirst (23/8/10)
A bull market in pessimism The Economist (19/8/10)
Interest rates ‘may hit 8%’ by 2012 says think tank BBC News (22/8/10)
Interest rates ‘may hit 8pc’ in two years Telegraph, Philip Aldrick (21/8/10)
Bernanke Must Raise Benchmark Rate 2 Points, Rajan Says Bloomberg, Scott Lanman and Simon Kennedy (23/8/10)
Inflation, not deflation, Mr. Bernanke Market Watch, Andy Xie (22/8/10)
Inflation comes through the door and wisdom flies out of the window Telegraph, Liam Halligan (21/8/10)
Data
British Government Securities, Yields Bank of England
Bankstats: Data on UK money and lending Bank of England
Questions
- Summarise the arguments of those who believe that interest rates will stay low for the foreseeable future.
- Summarise the arguments of those who believe that interest rates will be significantly higher by 2010.
- What factors will be the most significant in determining which of the two positions is correct?
- Why are the yields on long-term bonds a good indicator of people’s expectations about future inflation and monetary policy?
- Why has consumer credit fallen? Why might it rise again?
- Why may unemployment not fall rapidly as the economy recovers? Is this an example of hysteresis?
Letter writing has, in many walks of life, rather gone out of fashion. For instance, many of us of a slightly older disposition remember how putting pen to paper was an important part of courtship and the building of relationships. Well, one modern-day couple who are getting very used to an exchange of letters is the Governor of the Bank of England and the Chancellor of the Exchequer. The latest inflation numbers from the Office for National Statistics show that the annual rate of CPI inflation for July was 3.1%. While the inflation rate is down from the 3.2% recorded in June it remains more than 1 percentage point above the government’s central inflation rate target of 2%. Consequently, Mervyn King will again be writing to the Chancellor to explain why this is the case.
Since the turn of the year, the annual rate of CPI inflation has, with the exception of February, been consistently above 3%. Even February was a narrow escape for the Governor because inflation came in at exactly 3%! Another way of putting the recent inflation record into perspective is to note that over the first seven months of 2010 the average annual rate of CPI inflation has been 3.3%.
The slight fall in July’s annual inflation rate is attributed, in part, to falls during July in the prices of second-hand cars and petrol whereas these prices were rising a year ago. Furthermore, the average price of clothing and footwear fell by some 4.9% between June and July of this year as compared with a fall of 3.2% in the same period a year ago. The result is that the annual rate of price deflation for clothing and footwear went from 1.4% in June to 3.1% in July.
Of course, within the basket of consumer goods price patterns can vary significantly. One significant upward pressure on July’s overall annual inflation rate was the price of food and non-alcoholic beverages, especially vegetables. The average price of food and non-alcoholic beverages rose by 1% between June and July which has seen the annual rate of price inflation for food and non-alcoholic beverages rise from 1.9% in June to 3.4% in July.
The fact that July shows inflation running in excess of 3% will surprise very few. In the latest Inflation Report the Bank of England reports that the Monetary Policy Committee’s view is that ‘the forthcoming increase in VAT was expected to keep CPI inflation above the 2% target until the end of 2011’. The Committee then expects what it describes as a ‘persistent margin of spare capacity’ to force inflation to fall back. But, the Committee also feels that the prospects for inflation are ‘highly uncertain’. Therefore, it is difficult to gauge just how many more letters will be passing across London between the Governor and the Chancellor in the coming months. Nonetheless, it would be probably be advisable for the Governor to make sure that he has a sufficient supply of postage stamps at his disposal, just in case!
Articles
UK inflation rate slows again in July BBC News (17/8/10)
Bank of England’s King forced to write another letter to Osborne as prices stay high Telegraph (17/8/10)
Inflation falls to 3.1% in July Financial Times, Daniel Pimlott (17/8/10)
Dearer food keeps inflation high UK Press Association (17/8/10)
Bank ‘surprised’ at inflation strength Independent, Russell Lynch (17/8/10)
Letters
Letter from the Governor to the Chancellor and the Chancellor’s reply Bank of England (17/8/10)
Data
Latest on inflation Office for National Statistics (17/8/10)
Consumer Price Indices, Statistical Bulletin, July 2010 Office for National Statistics (17/8/10)
Consumer Price Indices, Time Series Data Office for National Statistics
For CPI (Harmonised Index of Consumer Prices) data for EU countries, see:
HICP European Central Bank
Questions
- What does the Bank of England mean by a ‘persistent margin of spare capacity’? By what economic term is this phenomenon more commonly known?
- Why do you think the current rate of inflation is above target despite the spare capacity in the economy?
- Since the annual rate of CPI inflation remains in ‘letter-writing territory’ would you expect the Monetary Policy Committee to be raising interest rates some time soon? Explain your answer.
- What impact might the persistence of above-target inflation have for the public’s expectations of inflation?
- What impact can we expect the increase in the standard rate of VAT next January to have on the annual rate of CPI inflation? Is such an effect on the rate of inflation a permanent one?