The housing market is crucial in any economy, as it provides so many jobs in related industries. It is frequently a good signal of how buoyant the economy is. With recession in the UK, mortgage rationing continuing and many homeowners having to find 20% deposits to buy a house, many would expect the housing market to be showing signs of trouble.
And to some extent this is the case. Studies on house prices have clearly shown how unpredictable this market is and prices remain 0.7% below what they were a year ago. However, in August house prices increased, recording their biggest rise in two and a half years, at 1.3%. For many, this rise was a surprise, but came as a welcome relief following the declines in previous months. Despite this rise, analysts have suggested that this trend is unlikely to continue throughout the rest of the year, as the demand for houses remains weak. Robert Gardner, the Chief Economist at Nationwide said:
“Given the difficult economic backdrop, the extent of the rebound in August is a little surprising. However, we should never read too much into one month’s data, especially since monthly price changes have been impacted by a number of one-off factors this year, such as the ending of the stamp duty holiday for first time buyers’.
So, what is behind this upward trend? Nationwide’s Chief Economist says that it could be explained by a resilient labour market, where employment has risen in recent months, despite the recession. The labour market undoubtedly has a big effect on the housing market, as mortgages do take up so a large percentage of take-home pay.
However, another key factor that affects house prices is the availability of mortgages. The Bank of England and Treasury launched the Funding for Lending Scheme at the beginning of August in a bid to make mortgages cheaper and more easily available. However, analysts suggest that the scheme is yet to have an effect. Furthermore, until deposit requirements are eased, that first step on the property ladder will remain elusive for many people. Mortgage approvals did increase slightly in July, but still remain a major barrier for the housing market to really boom.
The following articles consider this ‘surprising’ rise in house prices and the factors behind it.
Articles
House prices in ‘surprising’ jump, Nationwide says BBC News (31/8/12)
UK house prices record surprise increase Financial Times, Tanya Powley (31/8/12)
Surprise house price rise in August not indicative of market, says Nationwide The Telegraph, Emma Wall (31/8/12)
House prices in surprise rebound Independent, Vicky Shaw (31/8/12)
House prices continue to hold The Economic Voice, Jeff Taylor (31/8/12)
Mortgage approvals still subdued, Bank of England says BBC News (30/8/12)
Banks are pulling back from property – expect prices to fall Money Week, Matthew Partridge (31/8/12)
UK house prices up, as London continues surge Share Cast, Michael Miller (29/8/12)
Data
Lending to Individuals Bank of England 2012
House Price Index Land Registry 2012
UK house prices (links) Economics Network
Questions
- Use a supply and demand diagram to analyse recent trends in the housing market.
- Why is the Bank of England’s lending scheme not having the expected impact on the housing market?
- To what extent do you think the state of the housing market depends on mortgage rationing? Which other factors are likely to affect the housing market?
- In the article from the Economic Voice, the author says that house prices holding as they are is a surprise, because of relatively high inflation and the fact that wages are not keeping pace. Explain the economic thinking behind this view.
- The Chief Economist at Nationwide has said that the future of the housing market depends heavily on what happens to the labour market. Why is this the case?
- Why have mortgages been rationed and minimum deposit requirements been increased?
- Why is the housing market so important for the economy?
In its report A Distorted Debate: the need for clarity on Debt, Deficit and Coalition Aims, the Centre for Policy Studies claims that the public is confused by economic terminology surrounding the government’s finances. We try and understand this confusion and offer a bath-time solution!
In a survey conducted for the Centre for Policy Studies only 10 per cent of Britons knew that despite cuts to parts of the government’s spending plans, the stock of public sector debt (also known as the national debt) is expected to rise by a further £60 billion by 2015. Rather, 47 per cent of respondents thought that debt would have fallen by this amount.
The confusion is not terribly surprising because there are two important core economic concepts that can confuse: stocks and flows. To try to help we will show how reference to a bath tub can hopefully eliminate the confusion. However, first, let us considerthe Coalition government’s principal fiscal objective. Its so-called fiscal mandate is for the cyclically-adjusted current budget to be in balance by 2015/16. In simple terms, the government wants to be able afford its day-to-day expenditures by this date, after taking into account where the economy is in the business cycle. In other words, if the economy’s output was at its sustainable or potential level in 2015-16 the government should be able to raise sufficient taxes to meet what it refers to as current expenditures. This would still allow the government to borrow to fund investment expenditure, e.g. infrastructural projects, which are enjoyed or consumed over a period of time.
An important thing to note about the fiscal mandate is that the government can expect to need to borrow money in order to afford its current expenditures up to 2015/16. Even beyond this date, assuming that the mandate can be met, it is likely to need money to afford capital expenditures. This is where we introduce the bath tub. Think of government spending as water coming through the bath taps while the taxes that government collect are water leaving through the plug hole. Therefore, spending and tax receipts are flows. If the water pouring into the bath (spending) is greater than the water leaving the bath (tax receipts), the level of water in the bath will rise. You can think of the water level in the bath as the stock of national debt. Therefore, if government is spending more than it receives it needs to borrow money. Borrowing is therefore a flow concept too. As it borrows, the stock of debt (the amount of water in our bath tub) rises.
So we know that government will continue to borrow in the near future. What it is hoping to be able to do, year by year, is begin to borrow less. It wants the deficit to fall. Then, if it can meet its target, it will at least be able to afford current expenditure (after adjustment for where the economy is in the cycle) by 2015/16. As the deficit begins to decline then the stock of debt will rise less quickly. But, the bath tub will continue to fill because more is flowing through the taps than is leaving through the plug hole. However, it will fill less quickly.
What our use of the bath tub analogy demonstrates is the confusion that can be caused when economic terminology is misused. It is important that the terms debt and deficit be used carefully and correctly. Therefore, the next time you are sitting in bath see if you can be the next Chancellor by understanding these key economic concepts.
Don’t know your debts from your deficit? You’re not alone Independent, Andrew Johnson (27/8/12)
Government unlikely to meet deficit targets, warns CPS Telegraph (27/8/12)
Coalition ‘most unlikely’ to meet key economic goals by next election Guardian, Andrew Sparrow (27/8/12)
Public ‘don’t know their debt from their deficit’ Public Finance, Vivienne Russell (28/8/12)
George Osborne ‘still failing to stop rising deficit’ Daily Express (28/8/12)
Questions
- Explain the difference between the concepts of government deficits and government debt?
- Explain what will happen to both the size of the government’s deficit and to its stock of debt if borrowing begins to decline.
- Can the stock of government debt fall if the government continues to borrow? Can the ratio of the stock of government debt fall relative to GDP (i.e. Debt/GDP), if government continues to borrow?
- With examples, explain the differences between the government’s current and investment (capital) expenditures.
- What are the economic arguments for trying to cut the deficit quickly or more slowly?
With droughts and poor harvests in both North America and in Russia and the Ukraine, there are worries that food prices are likely to see sharp rises in the coming months. This is clearly bad news for consumers, especially the poor for whom food accounts for a large proportion of expenditure.
But it’s also bad news more generally, as higher food prices are likely to have a dampening effect on the global economy, struggling to recover from five years of low or negative growth. And it’s not just food prices. Oil prices are rising again. Since mid June, they have risen by nearly 25%. This too is likely to have a dampening effect.
Another contributing factor to rising food prices is a response, in part, to rising oil prices. This is the diversion of land from growing food to growing crops for biofuels.
G20 countries held a conference call on 28 August to discuss food prices. Although representatives decided against an emergency meeting, they agreed to reassess the situation in a few weeks when the size of the US harvest would be clearer. If the situation proved as bad as feared, then the G20 would call an emergency meeting of the Rapid Response Forum, to consider what could be done.
But is the sole cause of rising food prices a lack of production? Are there other problems on the supply side, such as poor distribution systems and waste? And what about the role of demand? How is this contributing to long-term increases in food prices? The articles consider these various factors and what can be done to dampen food prices.
Articles
G20 points to ‘worrying’ food prices Financial Times, Javier Blas (28/8/12)
US food prices to surge on drought Gulf News(30/8/12)
Best to get used to high food and energy prices – they’re here to stay The Telegraph, Jeremy Warner (29/8/12)
Feeling a drought The Economist (14/8/12)
Q&A: World food and fuel prices BBC News (14/8/12)
G20 considers global meeting as food prices rise BBC News (28/8/12)
Biofuels and Food Prices (direct link) BBC ‘In the Balance’ programme (25/8/12)
U.N. body urges G20 action on food prices, waste Reuters, Patrick Lannin (27/8/12)
Ethanol industry hits back over food price claims EurActiv (28/8/12)
The era of cheap food may be over Guardian, Larry Elliott (2/9/12)
Data
Food Price Index Index Mundi
Questions
- Why have food prices been rising in recent weeks?
- Use a demand and supply diagram to demonstrate what has been happening to food prices.
- What determines the price elasticity of demand for wheat? What might this elasticity vary over time?
- What is the role of speculation in determining food prices?
- Illustrate on an aggregate demand and supply diagram the effect of a commodity price shock. What is likely to be the policy response from central banks?
- What determines the price elasticity of supply of food in (a) the short term and (b) the long term?
- What determines the cross price elasticity of supply of food to the price of oil? Is the cross price elasticity of supply positive or negative?
- What can governments do to reduce food prices, or at least reduce food price inflation?
- What benefits may come from higher food and fuel prices over the longer term?
Last year, an academic discovered that the only two firms on Amazon selling new copies of a classic biology textbook were charging well over $1 million (plus $3.99 for shipping!). Furthermore, when he checked the next day, prices had risen even further to nearly $2.8 million! Intrigued by this strange pricing behaviour, he started to investigate the prices further.
In oligopoly markets with a small number of players, firms must make strategic decisions taking into account how they expect their rivals will react. One option in today’s online market places is for firms to use computer algorithms which automatically adjust their prices according to the prices their rivals are charging. The results of his investigation suggested that this was exactly what was causing the prices for this textbook to be so high.
One of the firms appeared to adopt a pricing rule which set its price at 0.9983 times the price of the other firm. This seems to make sense – this firm wants to undercut its rival in order to be more likely to sell its copy. However, if both firms operated under this strategy, we would expect to see prices falling over time (see also). In contrast, the strategy of the other firm appeared to be to price 1.270589 above its rival’s price. Why would it want to try to make sure it was always more expensive that its rival? The academic’s plausible explanation was that:
“…they do not actually possess the book. Rather, they noticed that someone else listed a copy for sale, and so they put it up as well – relying on their better feedback record to attract buyers. But, of course, if someone actually orders the book, they have to get it – so they have to set their price significantly higher – say 1.27059 times higher – than the price they’d have to pay to get the book elsewhere.”
Put both of these pricing rules together and prices will continuously rise over time! This was exactly what the academic observed for over a week, until human intervention appears to have returned prices to a more sensible level.
As Tim Harford discusses in his recent blog post, it had been hoped that online market places would result in very low prices because the high degree of price transparency increases competition. Clearly the prices Amazon was initially charging for the textbook didn’t support this theory and even after human intervention prices would seem to be well above marginal production costs. However, as the blog post goes on to explain, we should not necessarily expect price transparency always to lead to low prices. Economic theory shows us that in oligopoly markets, when a small number of players interact repeatedly, they may be able to collude tacitly on high prices. Furthermore, a high degree of price transparency may help such collusive behaviour because it makes it easier for firms to detect cheating by a rival.
Amazon’s $23,698,655.93 Book About Flies (SCREENSHOT) The Huffington Post, Steven Hoffer (26/04/11)
Questions
- What are the key features of competition between book sellers on Amazon?
- What price setting rule would the two firms have to use for prices to continuously fall over time? Provide an illustrative example.
- What are the pros and cons for a firm of relying on a computer algorithm to set its prices?
- How might a firm program its price setting algorithm if it wanted to collude tacitly with its rivals?
- Can you think of any other explanations for the pricing strategies that the two Amazon sellers adopted?
Rail companies will be permitted to raise average regulated rail fares next year by 6.2%. Not surprisingly, this has been met with dismay and anger by rail travellers, especially long-distance commuters, who could see their annual season tickets going up by several hundred pounds.
Some fares, such as advance tickets, are unregulated. Others, such as anytime, off-peak and season tickets, are regulated by the government. The formula for working out permitted price rises for regulated fares is RPI plus 3%, where RPI is the July annual inflation rate based on the retail price index.
The RPI figure was announced by the ONS on 14 August and was a surprisingly high 3.2% – up from 2.8% in June: see Table 21 in the ONS’s CPI And RPI Reference Tables, July 2012. (Click here for a PowerPoint of the chart on the left.) Hence average fares can rise by 3.2% + 3% = 6.2%.
Rail travellers are angry on three counts:
First, the RPI measure of inflation is generally around 0.5% higher than the CPI measure (which is used for working out public-sector pay increases and the uprating of pensions and benefits). The July figure for CPI inflation was 2.6%.
Second, the extra 3% added on top of RPI means that that rail fares are going up more rapidly than other prices, and incomes too. The reason given for this is to shift the burden of funding the railways from the taxpayer to the traveller.
Third, the formula applies to average fares. Rail companies can raise particular regulated fares by up to 5 percentage points more than the formula provided they raise other fares by less than the formula. Thus some fares are set to rise by 11.2% – including some of the most expensive season tickets.
The government justified the increases by arguing that the higher fares will allow more investment by the rail companies, which could result in lower costs in the future. Nevertheless, two thirds of the revenue from the above-inflation increases will go to the government and only one third to the rail companies.
Webcasts
Inflation shock as rail fares set to soar Channel 4 News, Ciaran Jenkins (14/8/12)
Protests as rail fare price rises announced The Telegraph (14/8/12)
How do our rail fares compare with the rest of Europe? BBC News (14/8/12)
Rail fare increase will make life better, says minister BBC News (14/8/12)
Passenger Focus: Train companies ‘using dark arts’ BBC News, David Sidebottom (14/8/12)
Articles
Rail fares set to increase by 6.2% Financial Times, Mark Odell (14/8/12)
Rail fares set to rise by 6.2% in January Guardian, Gwyn Topham (14/8/12)
Rail fare hike of 6.2% sparks angry reaction BBC News (14/8/12)
Soaring rail fares will do nothing for the recovery The Telegraph (14/8/12)
Commuters plead with Osborne to prevent 10 per cent rise in rail fares Independent, Oliver Wright (15/8/12)
Rail fare rises: how to keep your ticket prices as low as possible Guardian, Mark King (14/8/12)
Documents and information
Fares Review Conclusions 2003 Strategic Rail Authority (June 2003)
Fares Office of Rail Regulation
Fares on National Rail Association of Train Operating Companies
Questions
- What are the arguments for and against the general principle of using an RPI+X formula for regulating rail fares?
- What are the arguments for and against allowing train operating companies to raise regulated rail fares by an average of RPI plus 3%, with 2 of the 3 percent above RPI inflation going to the government?
- In what ways are travellers likely to respond to the higher prices?
- Why are some travellers likely to have a much lower price elasticity of demand for rail travel than others? What determines this price elasticity of demand?
- What externalities exist in rail transport? How should this impact on the government’s rail pricing strategy?
- How is infrastructure development funded for (a) rail, (b) roads and (c) airports? Does this lead to an efficient allocation of transport investment?
- How does rail pricing in the UK compare with that in other European countries? Should other European countries follow the UK’s policy of above inflation fare increases to fund rail investment?
The housing market is crucial in any economy, as it provides so many jobs in related industries. It is frequently a good signal of how buoyant the economy is. With recession in the UK, mortgage rationing continuing and many homeowners having to find 20% deposits to buy a house, many would expect the housing market to be showing signs of trouble.
