In the Perils of snow and stamp duty blog here on the Sloman Economics News site we noted two particular influences that may have contributed to February’s reported fall in UK house prices: the end of the stamp duty holiday and the poor winter weather. Here we ponder a little more on the recent relationship between the economic and house prices cycles and, more generally, on the significance and causes of the recent imbalances between housing demand and supply.
What is particularly interesting about February’s house price fall (the Halifax put the fall at 1½% and the Nationwide at 1%) is that it is happening just after the economy reportedly grew by 0.3% in the last quarter of last year. But, then again, the house price fall is a reversal of an upward trend that started back in the summer of 2009 when the economy was still contracting! One’s gut reaction might be that cycles in house prices and economic growth ought to coincide. One reason for this is that the growth in income of the household sector will reflect the phase of the business cycle that the economy is in. For instance, during the slowdown or recessionary phase, like the period during 2008/9, the household sector’s income is likely to be shrinking and this will impact on housing demand. The magnitude of the effect on demand will depend on the sensitivity of housing demand to changing incomes – something that economists refer to as the income elasticity of demand.
We can, despite what might appear to be the recent puzzling behaviour of UK house prices, apply the concepts of demand and supply to gain some insight into what has been driving house prices. One way of thinking about the concepts of housing demand and supply is to relate them respectively to the number of ‘instructions to buy’ and the number of ‘instructions to sell’ on an estate agent’s book. We can then try and think of factors which might influence, in a given period, the number of instructions to buy and sell.
One possible explanation of the house price growth of last year is that despite the household sector’s shrinking income there were in fact a number of relatively cash-rich households out there, partly because the lowering of interest rates meant that the debt-servicing costs on variable rate mortgages fell. This left some households with more discretionary income to spend or to use to increase their housing investment by trading-up between one housing market and another. The key point here is if there is not a similar increase in the number of instructions to sell then the imbalance between the flow of instructions to buy and instructions to sell results in upward pressure in prices. In those markets where the imbalance between demand and supply is greatest price pressures are most acute. This appears to have been especially true last year in particular markets in the south of England.
So what of February’s fall? Well, again we have to think about the balance between instructions to buy and sell. What appears to have happened is that the demand pressures that built up in some markets lessened. And, as we consider elsewhere on this site, it is perhaps even the case that the wonderful British weather ‘played a hand’ by discouraging some households from looking to buy and adding to our estate agents’ lists of instructions to buy.
Articles
UK housing recovery running out of steam CITY A.M., Jessica Mead (5/3/10)
UK house prices ‘lose momentum’, say Nationwide BBC News (26/2/10)
UK house prices see first fall since June, says Halifax BBC News (4/3/10)
Fears grow of double dip for UK housing market The Independent, Sean O’Grady (5/3/10)
Data
Halifax House Price Data Lloyds Banking Group
House Prices: Data Download Nationwide Building Society
Questions
- What do economists mean by the income elasticity of demand? How income elastic do you think owner-occupied housing demand is likely to be?
- How important do you think current house prices are likely to be in affecting the number of instructions to buy and instructions to sell in the current period?
- How important do you think expectations of future house prices are in affecting the number of instructions to buy and sell in the current period?
- What role might financial institutions, like banks and building societies, play in affecting UK house price growth in 2010? How might their influence compare with that in the period 2008/9?
- Rather than economic growth affecting house prices, is it possible that house price growth could affect economic growth?
The winter months traditionally see lower house sales and prices tend to remain steady or fall. However, house prices had continued to increase over Christmas, as the stamp duty holiday came to an end. In a bid to boost the housing market, the stamp duty threshold had been pushed up from £125,000 to £175,000 for just over a year. This seemed to work, as the housing market did rally throughout 2009 and in particular, in the final months of 2009. Mortgage approvals increased, as first-time buyers in particular tried to complete before stamp duty fell back to £125,000.
However, the end of this ‘holiday’, combined with the icy conditions experienced throughout the UK were contributing factors in the first decline in house prices in about 9 months. According to Halifax, house prices in February fell by 1.5%. House prices are still higher that they were 9 months ago, but the upward momentum they did have, has now taken a dive. Mortgage lending was also down in January by about 32%.
Another factor that has contributed to this downturn is the increased number of properties on the market. Throughout 2009, the number of properties for sale was relatively low and as such, ‘Sale agreed’ notices were appearing on properties within days of them being for sale. This imbalance between demand and supply is now beginning to even out. Is this downward trend merely a blip or does it spell further trouble for the UK economy?
Articles
Snow and end of stamp duty holiday leads to first property price decrease in the UK for nine months PropertyWire (1/3/10)
UK house prices see first fall since June, says Halifax BBC News (4/3/10)
Mortage lending slump prediction comes true as stamp duty returns Daily Mail Online (23/2/10)
House price ‘lose momentum’, says Nationwide BBC News (26/2/10)
Snow and tax send house prices down 1.5% (including video) Times Online, Francesca Steele (4/3/10)
UK house prices fall, snapping rally Telegraph (4/3/10)
House prices fall in February Guardian, Hilary Osborne (4/3/10)
Data
For the Halifax data, see
Halifax house Price Index, February 2010
See also Lloyds Banking Group Housing Research home page and in particular the Historical House price Data link
Questions
- What is stamp duty and how did an increase in the threshold aim to stimulate the housing market? Can this be illustrated diagramatically?
- Illustrate how house prices are determined using a demand and supply diagram.
- One factor that had caused house prices to rise was a lack of supply. Show this on your diagram. Are there any factors that make price fluctuations even more severe, following changes in the demand and supply of houses?
- Illustrate how the imbalance of demand and supply has begun to even out.
- Why is the state of the housing market such an important factor in determining the strength of the economy?
- How do interest rates affect the housing market? Think about the impact on mortgages. Why have mortgage approvals fallen?
- To what extent has the weather contributed to falling house prices?
We have all heard about the troubles of Greece, but are things really that bad? It does have huge debts, which is costing about 11.6% of GDP to service; and estimates suggest that government borrowing will need to be €53bn this year to cover budget shortfalls. Furthermore, its situation could spell trouble for the eurozone and in particular for certain countries. However, as the article below discusses, Greece still has some trump cards to play.
Advantage Greece BBC News blogs, Stephanomics, Stephanie Flanders (3/3/10)
Questions
- “The single most important factor propping it (Greek debt) up in the past year has been that it can be swapped for free money at the ECB.” How does this prop up Greek debt?
- If Greek debt does fall in value, how will other members of the Eurozone be affected?
- Why are countries such as France and Germany hostile to a loan to Greece from the IMF?
- If Greece was to collapse, which countries do you think could potentially follow? Which factors have influenced your answer?
From the end of January to the beginning of March, the sterling exchange rate index fell by over 6% – from 81.7 to 76.5. Against the dollar, the fall has been even more dramatic, falling from $1.62 to $1.49 (a fall of 8%). What are the reason for this? And is the depreciation likely to continue? The following clip looks at what has been going on and whether the reasons are political, or whether there are other economic fundamentals that have contributed to sterling’s fall.
Stephanie Flanders on the pound BBC Politics Show, Jo Coburn and Stephanie Flanders (2/3/10)
Articles
One-way bet? BBC News blogs: Stephanomics, Stephanie Flanders (1/3/10)
Euro drops to lowest level in 10 months against dollar BBC News (2/3/10)
Fiscal and political fears hit sterling Financial Times, Peter Garnham (1/3/10)
Sterling’s slide is not just about polls Financial Times (2/3/10)
Sterling rout is more than a wobble over political uncertainty Guardian, Larry Elliott (1/3/10)
The pound is weighed down Guardian, Howard Davies (2/3/10)
Sterling jitters The Economist (1/3/10)
Sterling crisis might break Britain’s political and economic paralysis Telegraph, Jeremy Warner (3/3/10)
Questions
- What are the reasons for the depreciation of sterling between January and March 2010?
- Why was selling sterling a ‘one-way bet’ for speculators?
- Why might there have been ‘overshooting’ of the sterling exchange rate?
- Who gain and who lose from a depreciation of sterling?
- What is the likely effect of a depreciation of sterling on (a) inflation; (b) economic growth; (c) interest rates? Explain your answers.
- How do problems of government debt affect countries’ exchange rates?
There has been much criticism of the European Emissions Trading Scheme, the world’s most significant cap-and-trade (tradable permits) scheme for curbing greenhouse gas emissions. The main criticism is that the scheme has failed to make significant cuts in pollution. The cap was so loose in the first phase (2005–07) that by the end of this period, carbon was trading for as little as €0.02 per tonne. Although the cap on emissions was tightened by 7 per cent for phase 2 (2008–12) (see Economics, 7th ed, Box 12.5), causing the carbon price to rise to about €30.00 per tonne by mid 2009, since then the price has fallen as industry has cut output in response to the recession. By February 2010, the carbon price was around €12.50 per tonne (see the Guardian article Carbon price falls to new low). For carbon price data see the European Climate Change site.
The experience of the ETS has resulted in many people in the USA and elsewhere calling for the use of carbon taxes rather than cap and trade as the best means for reducing greenhouse gas emissions. Others have called for a mix of measures. In the US Senate, three senators are seeking to overturn cap-and-trade proposals and take a sector-by-sector approach to cutting emissions.
But increasingly the evidence, supported by economic argument, is that cap and trade does work – or can be made to work – and that it is a better policy tool than carbon taxes. The following articles look at cap and trade and assess whether it really is the best alternative.
Buying off the big polluters looks bad but it works Sunday Times, Charles Clover (28/2/10)
Economists hail EU emissions trading success BusinessGreen, James Murray (15/2/10)
EU study plumps for cap & trade in ship carbon carbonpositive (17/2/10)
European carbon trading labelled ‘model for the world’ Ecologist (1/3/10)
Cap and Trade vs Carbon Tax – 6 Myths Busted Cleantech Blog (26/2/10)
Senators seen ditching cap and trade in new bill Reuters, Russell Blinch (27/2/10)
Senators to propose abandoning cap-and-trade Washington Post, Juliet Eilperin and Steven Mufson (27/2/10)
U.S. Senate may scrap Cap and Trade in exchange for Cap and Dividend The Energy Collective, Chris Schultz (27/2/10)
See also:
Emissions Trading Wikipedia
Questions
- What determines the price of carbon in the ETS? Why was it higher in 2008/9 than in 2007? Why has it fallen in recent months?
- Does it matter that the carbon price fluctuates with the business cycle?
- Explain whether it is better to allocate carbon credits free of charge or auction them.
- Assess whether or not the EU emissions trading scheme has been a success so far.
- Compare the relative merits of a cap-and-trade scheme with carbon taxes.
- What other alternatives are there to cap and trade and carbon taxes as means of curbing emissions? Compare their relative merits.
- What is the best means of curbing carbon emissions from shipping? Explain.