AS Macro: Extended House Price Deflation?

A pessimistic forecast for the UK economy produced by the National Institute for Economic and Social Research (NIESR) suggests that the UK housing market is set to remain in the doldrums for some time to come. The NIESR has predicted a 4.5 per cent average fall in house prices in real terms this year, with further falls averaging 1.5 per cent for the following five years. The background to this forecast of house price deflation is that mortgage finance remains hard to come by (there has been a steep fall in the average mortgage loan to house price deal on offer). And mortgage interest rates are set to rise from their current low levels. Weak demand is thus the main driver of falling prices. The NIESR argues that “(housing) supply constraints were less important than is often argued since supply just about kept pace with household formation.”

The links between changes in activity in the housing market and the wider economy are important to understand as part of your AS macro course. Many industries rely heavily on the housing market for their revenues and profits and hundreds of thousands of jobs might be affected by a prolonged decline in price levels and continued low levels of new housebuilding.

United Kingdom from Timetric

Many people and industries gained from the decade-long housing boom in Britain:

Homeowners who bought early in the cycle
Construction companies
Mortgage lenders
Government and local councils (higher tax take)
Industries supplying the construction sector
Household goods and furnishings
Estate agents, lettings agencies and other service industries linked to property

But many people regarded the property boom as undesirable - ultimately a cause of macroeconomic instability and a miss-allocation of scarce economic resources. Our obsession with property has deep roots but much of the “wealth” that was created was illusory - property downturns have their economic advantages!

Improvement in housing affordability
Reduction in property-fueled consumption and debt
A greater sense of balance in the economy
Fewer estate agents and their like! which releases people into more productive occupations and sectors
A more sober assessment of the risks and returns of home-ownership
Greater focus now on expanding the improving the stock of social housing (extra government spending as a stimulus to the economy)
Cheaper commercial property provides opportunities for entrepreneurs

UK construction output

United Kingdom from Timetric