Examine Reasons Why Women's average wage is Less than Men's average wage.

• In US. The National Committee on Pay Equity used the occasion to announce that among full-time workers, women make only 77 cents for every dollar paid to men. (1)
• In UK the gender pay gap is 12.6% (down from 17% in 1997) (2)
  

Reasons for Wage differentials include:

1. Level of Skills.

Skills and qualifications are an important factor in determining wages. If men had better qualifications, this could explain their higher wages. With regard to A-levels and university degrees, female qualifications are generally as good as men. However, for certain high paying professions, such as, accountancy and law, there are more qualified men than women, although even this gap is now closing.


2. Differences in Productivity.

According to MRP theory, it is a workers productivity (MRP) that determines wages. In heavy manufacturing, male productivity is likely to be higher. However, now that the economy is mostly service sector, this argument is only applicable to a small % of jobs.


3. Discrimination

Lower wages for women could be due to discrimination. Employers may be less willing to promote women; they may be even pay lower wages for same job.

In theory, sex discrimination, in the labour market, is outlawed by Sex Discrimination Act 1976. However, in practice it can be difficult to prove, especially with regard to promotion - if a women isn't promoted, is it really discrimination or something else?

4. Women take Career Breaks to Have Children.

UK Maternity law means a women can be secured of her job, whilst having a child. However, taking a break from work means women are less likely to get promoted. Also, women of childbearing age, may be viewed as a liability. This is because if they become pregnant the firm has to pay maternity leave, and find somebody to fill the temporary gap. For small firms, this can be a significant cost. This reason is quite significant, although, many women are choosing to have children later in life - if at all.

5. Women Choose Lower Paying Jobs.

Traditionally it has been argued women choose lower paid jobs like nursing, childcare. These are lower paid than other careers such as lawyers, and accountants. However, traditional job patterns are changing, women are increasingly choosing to do do "male dominated jobs". This is due to changing social changes, and changing educational standards. But, this remains one of the most significant factor for explaining wage differentials between men and women.

6. Different Types of Jobs

Women more likely to have part time / temporary jobs. in the service sector, these jobs are lower paid because firms often have monopsony power. Women also have lower travel time. In order to look after children, they need jobs closer to the home; this limits the range of jobs available.


Harvard economist Claudia Goldin replied "There are certainly instances of discrimination, she says, but most of the gap is the result of different choices. Other hard-to-measure factors, Goldin thinks, largely account for the remaining gap -- "probably not all, but most of it."

More on: Labour Market Economics

References:

(1) Women's Pay Gap explained
(2) Women and Equality Unit:

(3) Wage Gap amongst Male and female Engineers

Labels: labour markets, wages

See also: How Long Do Recessions last?

A recession is a period of negative economic growth for 2 consecutive quarters. There are fears that the US economy is heading towards recession in either 2007 or 2008. See: US economy Recession?

There are various factors that determine the length of a recession. These include:

• Effectiveness of Monetary and Fiscal Policy
• Effect on Consumer Confidence
• Response of the Government.
• What Causes Recession, is it Demand side shock, supply side shock, or a combination of both.
• How flexible are Labour Markets?
• Will increased Government spending lead to crowding out.

For more information see this essay: Problems of Recovering from Recession

Back in December, 2006, I wrote about the Dollar in this post: "Will the Dollar continue to fall?"

Today the dollar reached another record low against the Euro,

Yesterday, on the foreign exchanges the euro traded at close to $1.37, while sterling pushed back above the $2 barrier after being under pressure on Thursday.

The reasons for the fall in the dollar include:

1. Large Current Account deficit - and evidence the Chinese are starting to diversify away from investing in the US.
2. Falling Growth rates - partly due to slump in housing market see: Is Us Economy heading towards Recession?
3. Rising Inflation, despite falling growth rates, US inflation is remaining persistently high - close to 4%
4. Fall in Confidence in US economy

See also:

• Exchange Rates
• Factors Influencing exchange Rates
  

I have written a short guide to writing Economics Essays

It is primarily aimed at British A Level economics students, but the principles and ideas are relevant for different subjects and standards.

The most important piece of advice for writing essays is:

• Answer the Question asked.
• Write in a clear and focused manner.
• Remember the 3 steps.

1. Identification of argument
2. Explanation
3. Evaluation.

• Evaluation is most difficult concept; it requires critical distance and deeper analysis. I shall write more on evaluation soon.

Essay advice

Labels: economics help, essays

The Benefits of the EU.

1. Reforms

CAP is being reformed, albeit slowly, prices are being brought closer to world levels; the EU is targeting subsidies to those farmers who need. This process is not complete but it shows reforms can be made. This will lead to better trade negotiations in the future.

2. Bureaucracy Costs Relatively Low

Bureaucracy costs represent a very small % of the EU budget. The UK contribution to the EU is also quite small, only 1.5% of GDP. The UK makes a contribution of £14.2 billion (£4.7 billion net after rebates and grants). This comprises payments of £2.2 billion to European institutions, £15 billion for the Common Agricultural Policy, £1 billion for the Common Fisheries Policy.

3. Benefits of Free Movement of Labour

Free Movement of Labour and People has many benefits. The UK has had labour market shortages. Immigrants have filled in various undesirable jobs. It also enables UK residents to travel and work abroad, without restrictions.

4. Increased Trade and Inward Investment

As a result of its EU membership, the UK has benefitted from inward investment and increased trade. 67% of UK trade is with the EU.

In 2003 an EU commission investigated the benefits of the single market and estimated that EU Gross Domestic Product (GDP) in 2002 was 1.8% higher (€164.5 billion) [£110 billion] than it would have been without the Single Market. (1) Although it is difficult for economists to arrive at such statistics.

5. Social Policies.

In the past the UK has benefitted from regional and social policies, these have given grants to depressed areas, such as, Wales and North East England. However in recent years the net inflows have been less.


7. Increased Competition

Through the EU competition policy, the European Union is able to examine cartels and the competitiveness of markets. This is important in an era of globalisation. For example and EU investigation into football replica shirts led to widespread reductions in prices for consumers

8. Lower Transaction costs

Abolition of tariffs and harmonisation of regulations have helped reduce transaction costs.



See also:

• Arguments for Leaving European Union

• Benefits of Euro

• Benefits of EU at DTI

Disadvantages of European Union include:

1. Common Agricultural Policy.

The CAP has been reformed, but arguably it still is an inefficient method of subsidising the declining agricultural sector.
For a long time the EU has maintained target prices for agricultural goods above the market price; this has various disadvantages:

• Higher prices for consumers
• Higher Tariffs on Imports required, this has been a stumbling block to trade
• High prices encouraged oversupply. EU had to buy surplus that was created.
• Expensive for EU Taxpayer. - CAP budget accounts for nearly 50% of total EU budget. It costs UK £14 billion per year.
  

The UK has a relatively small but efficient agricultural sector, therefore it benefits the least from CAP.

2. High levels of Bureaucracy and Administration within the EU.

The Bruges Group, a Eurosceptic think-tank, estimated that the combined direct and indirect costs in 2007 will amount to £100,000 a minute, or £52.4 billion — about £2 billion more than this year. This includes £20 billion in the additional costs to business of regulations emanating from Brussels. (1) However, it is worth bearing in mind the Bruges groups have an anti - EU ideology, so are likely to look for most costly report.


3. Increased Immigration.

A single market requires free movement of labour. This has led to an inflow of immigrants from Eastern europe, this has placed a strain on housing and other amenities in the UK.

4. UK Can maintain some benefits outside EU.

The main benefits of the EU are free trade. However, the UK could retain these benefits, even if it left. For example, Switzerland is not in EU but benefits from EU trade.

5. Labour Market Inflexibility

EU Social Policies like the Social Chapter have increased labour costs and reduced labour market flexibility. Therefore, by leaving the EU, we would be able to abandon restrictive labour market practices, and therefore reduce unemployment and increase competitiveness.

6. With expansion into the East the UK no longer receives regional policy.

Further Reading

• Arguments for Staying in the European Union
  
• European Union
• Disadvantages of EU
• Disadvantages of EURO
  

References

• (1) Cost of EU - Bruges Group
  
• Cost of EU
• EU Membership to cost £837 per year - Daily Telegraph
  

Some Economists and housing analysts argue house prices are significantly overvalued and are due to fall in the near future. Some paint a doomsday scenario of falling house prices leading to recession. Should we be concerned about a decline in the housing market?

Effect of Falling House Prices.

If house prices fall, it will lead to a decline in household wealth, and an increase in negative equity. The effect on consumer confidence is likely to be more significant than for rising house prices. People expect rising house prices, therefore, if house prices fell it would be a real shock, and could adversely affect consumer spending.

Many people have taken out expensive mortgage deal, in the hope that they will be able to remortgage after rising house prices. If house prices fall this will not be possible and they could face negative equity.

Therefore, falling house prices will reduce AD and lead to lower economic growth; It could cause a recession - a period of negative economic growth for 2 quarters.

However, if house prices do fall, it will reduce inflationary pressure in the economy. Therefore the Bank of England will be able to cut interest rates; this reduction in interest rates may maintain positive economic growth. However, it may be that falling house prices reduce confidence so much, that lower interest rates will be ineffective in stimulating demand.

It is worth remembering that in 1991, house prices fell 15% and this was a major factor in the recession of 1991-92.

A significant factor will be whether house prices fall gradually or fall sharply. If house prices stagnate there is unlikely to be a recession; however, if they fall dramatically in a short space of time, a recession is much more likely.


Related

• Effects of Falling US House Prices
• Boom and Bust in US housing Market
• Effects of Rising UK house Prices
  

Labels: Housing Market, UK housing Market

The UK housing market has a significant impact on the UK economy because:

1. 78% of households are privately owned. Home ownership rates are amongst the highest in Europe
2. Housing is the biggest form of wealth in the UK.
3. Mortgage debt accounts for the largest section of UK debt. Average mortgage debt is £21,000 per person.
4. House Prices have a significant effect on consumer confidence and expectations. (house prices and house price predictions are often front page news)

Effect of Rising House Prices.

Those who own houses will see an increase in their wealth. This is likely to increase their confidence, thereby causing higher levels of consumer spending.

In addition, if house prices rise, consumers can increase spending by remortgaging. This means they take out a bigger loan, against the value of their house. This means that the difference between, the current price and their buying price, is available for spend. Mortgage equity withdrawal has been a significant determinant of consumer spending in the UK

Higher levels of consumer spending lead to rising Aggregate Demand and therefore higher economic growth. Consumer spending accounts for 66% of AD, therefore, the effect of rising house prices can be quite significant in determining economic growth.

Higher house prices may cause inflation. This is because, if AD increases then the economy may get close to full capacity, and grow faster than the long run trend rate.

However rising house prices no not necessarily cause inflation. Firstly, it depends upon other factors affecting consumers. For example, if real wages are growing very slowly, or taxes have been increased, then consumer spending will be moderated. Since 2001, House prices in the UK have doubled, however, this has not caused inflation; the reason is that other inflationary pressures have low. For example:

• Independent MPC target low inflation, they have raised interest rates to moderate demand where appropriate
• Real wage growth has been low, (especially in public sector.)
• Low global inflation - helped by cheap manufacturing imports from China, and low commodity prices.
• Improved supply side policies increasing competitiveness of the UK economy.
• UK manufacturing sector in recession.
• UK economic growth close to long run trend rate.

Note: in the 1980s, rising house prices did contribute to inflation (inflation reached over 10% in 1990), because it was combined with loose monetary policy, and buoyant levels of consumer confidence.


Rising house prices are likely to cause a current account deficit. This is because rising house prices increase consumption and therefore consumers will spend more on imports from abroad. Equity withdrawal tends to be spent on luxury imported goods. The UK has a marginal propensity to import. The UK current account deficit recently increased to 3.5% of GDP.

Slump in Housing Market effect on Circular Flow

A fall in house prices will have the opposite effect. Falling house prices will reduce consumer wealth, creating a negative effect on consumer spending and consumer confidence. Therefore, there will be a fall in AD and a reduction in injections into the circular flow. This will lead to lower economic growth, unless other factors override this.

1. Why House prices may continue to rise?
2. How do House Prices effect Consumption
   

Labels: UK economy, UK housing Market

1. Subsidised Childcare provision.

This reduces the cost of childcare and therefore makes it easier for women to return to the labour Market. This is increases flexibility because; firstly there is a greater supply of labour; secondly, women are more likely to take flexible, part time jobs.

However, it is very expensive to subsidise childcare. Also, there is no guarantee that cheaper childcare will actually encourage women back into the labour market.

2. Increases spending on training and education.

If workers have a greater range of skills and training, then they will be able to take a variety of jobs. This is important for labour market flexibility because if people are made unemployed they can find work quicker.

However, this will cost money and require higher taxes. Also there is no guarantee the government will be able to increase labour productivity.

3. Reduce Minimum Wages.

This enables firms to set wages according to the dictates of the markets, rather than through government legislation. It will mean, in some labour markets, wages can fall closer to the equilibrium. This is important for flexibility. However reducing minimum wages may enable greater exploitation of workers, especially by monopsonies. Also, in the UK, minimum wages have been increased without causing unemployment.

Other policies to increase labour market flexibility could include:

• Better information about job availability.
• Reduce Power of Trades Unions.
• Abolish maximum working week legislation (part of social chapter)

• Advantages and disadvantages of Flexible Labour Markets

• Imperfections in Labour Markets
• Increasing Labour Market Flexibility
  

Labels: labour markets

Flexible labour markets involve a minimum of government intervention, they are labour markets which work efficiently and are competitive. Many supply side economists argue flexible labour markets are of great importance in reducing unemployment and improving the competitiveness of the economy. However, although they have some benefits the advantages of flexible labour markets are not equally shared. In particular, there are concerns over the negative impact on job insecurity.

This is a short answer to an exam essay question. "Examine the Benefits of Flexible Labour Markets"



1. Reduce Classical (Real Wage) Unemployment

Real wage unemployment occurs when wages are set above the equilibrium, for example, through trades unions or minimum wages. Flexible labour markets help to keep wages close to the equilibrium and therefore avoid creating unemployment.

However it is worth noting that minimum wages and trades unions don't always cause unemployment. For example, if firms have monopsonistic power, wages can be kept below the equilibrium. A true flexible labour market would require both workers and firms to lose their market power.

2. Increased Investment.

Flexible labour markets help to reduce costs for firms; for example, workers can be employed when they are needed. It is not necessary to pay for workers who are not productive. This will help attract inward investment. It is argued one reason, for higher unemployment in France is that there are costs in hiring and firing workers, this reduces the incentive for firms to expand.

However if labour markets are very flexible workers may have greater job insecurity, and this can lead to lower productivity.

3. Reduces Wage Price Spirals

If workers have too much market power they can bargain for higher wages, this can lead to inflation.

4. Increases Labour Participation Rates

Flexible labour markets can be beneficial for workers. This is because it gives them more options of, when and where to work. This is particularly helpful for women with young children, for example, they can work part time and still look after their children.

However, although flexible labour markets have created work in the part-time, service sector, there has been less success in creating permanent, full time jobs.

Labels: labour markets, supply side economics

Why House Prices in the UK have risen by 165% since 1992.

In the past 15 years, house prices in the UK have risen much faster than general inflation, and real incomes. The rise in house prices have confounded many industry experts, who have been predicting house price falls for several years.

Economic Reasons for House Price Rises include:

1. Long period of economic expansion.

Economic growth has been close to the long run trend rate of 2.5% for 15 years. This has increased incomes and confidence in the economy. However, it explains only part of the increase; this is because prices have risen much faster than incomes.

2. Low Real Interest Rates.

This is the nominal interest rate minus inflation. Since leaving the ERM in 1992 real interest rates have been very low. Interest rates fell as low as 3.5% in 2005. Since the bank of England was made independent people expect both lower inflation and consequently lower interest rates. Interest rates increase by only 0.25% at a time. This creates more stability for homeowners. Interest rates are much lower than pre 1992. This has been a significant factor in increasing demand for houses, especially in UK where most mortgages have variable interest rates.

3. Increasing number of households.

Demographic factors have increased the number of households (by a faster rate than the population). These include:

• Increase in divorce Rate.
• Marriage rates declining
• Aging population - more single old people.
• Immigration - has helped to boost population, especially in London.

4. Increase in Number of People buying second homes.

In London many houses are being bought by foreigners, for example, Russians and Arabs.

5. Increased availability of Mortgages.

The ratio of house prices to incomes has increased. Banks have sought to lend larger amounts than before. They have introduced new types of mortgages such as interest only, 50 year mortgages; banks have also relaxed lending criteria making it easier to borrow higher salary multiples.

6. Buy To Let Market.

This is the sector of the market where people buy a house and rent it out. The buy to let market has been buoyant because of rising rents. Buy to let buyers hope to get both income and capital gains. This sector of the market is more susceptible to speculation. This means people are buying houses in the hope of making capital gains.

7. Fundamental shortage of Supply.

The fundamental reason for rising house prices is the underlying shortage of supply. Demand has been increasing faster than supply. 1960s houses are being knocked down, and the number of new houses being built is at an all time low. There are many restrictions on building new houses. This is unlikely to be solved in the near future.

Related:

• House Price Rise fastest in 4 years
• UK Housing Market
• Why House Prices have risen in UK
• Effects of Falling US House Prices
• House Price Crash - are UK house prices doomed?

Labels: UK housing Market

When Mrs Thatcher came to power in 1979, her stated aim was to reduce the power of unions. She felt that unions were a major contributor to the declining competitiveness of the UK economy. To a large extent Mrs Thatcher was successful in reducing the power of unions. However, it is worth considering whether unions are necessarily the demonic forces that some commentators have made them out to be.


Advantages of Trades Unions.

1. Increase wages for its members.

Industries with trade unions tend to have higher wages than non-unionised industries.

2. Counterbalance Monopsonies.

In the face of Monopsony employers, Trades Unions can increase wages and increase employment. Monopsony employers are those who have market power in setting wages and employing workers. Traditionally, monopsonies occur when there is only 1 firm in a town, or type of employment. However, in modern economies, many employers have a degree of market power (monopsony).

3. Represent Workers

Trades Unions can also protect workers from exploitation, and help to uphold health and safety legislation. Trades unions can give representation to workers facing legal action.

4. Productivity deals.

Trades Unions can help to negotiate productivity deals. This means they help the firm to increase output; this enables the firm to be able to afford higher wages. Trades unions can be important for implementing new working practices which improve productivity.

5. Important for Service Sector.

Modern economies have seen a fall in trade union power. This is because of a decline in manufacturing and rise in service sector employment. Service sector jobs tend to more likely to be part time and temporary; unions are needed to protect workers in these kind of jobs.


Problems of Trades Unions.

1. Create Unemployment.

If labour markets are competitive, higher wages will cause unemployment. Trades unions can cause wages to go above equilibrium through the threat of strikes e.t.c. However when the wage is above the equilibrium it will cause a fall in employment.

2. Ignore non Members

Trades unions only consider the needs of its members, they often ignore the plight of those excluded from the labour markets, e.g. the unemployed.

3. Lost Productivity.

If unions go on strike and work unproductively (work to rule) it can lead to lost sales and output. Therefore their company may go out of business and be unable to employ workers at all.

4. Wage Inflation.

If unions become too powerful they can bargain for higher wages, above the rate of inflation. If this occurs it may contribute to general inflation. Powerful trades unions were a significant cause of the UK's inflation rate of 27% in 1979.


The benefits of trades unions depends on their circumstances. If they face a monopsony employer they can help counterbalance the employers market power. They can increase wages without causing unemployment.

If unions become too powerful and they force wages to be too high, then they may cause unemployment and inflation

It also depends on whether they cooperate with firm or not on increasing productivity.

see also:

• The UK economy under Mrs Thatcher 1979-1984
• Supply Side Policies

Labels: labour markets, Mrs Thatcher, trades unions

Ernst & Young ITEM Club, a leading economics Think tank, has suggested that the UK economy is close to full capacity and is "skating on this ice, due to the high levels of debt in the economy.

There are a couple of structural problems within the economy.

Firstly the UK current account deficit continues to grow. It now stands at 3.5% of GDP which is getting to the level where it could be unsustainable. It has not been helped by a strong pound. see Balance of Payments

Secondly the level of consumer debt is reaching an all time high. Recent rises in interest rates have not succeeded in reducing demand. Total consumer debt now stands at £1.3 trillion. There are fears that if interest rates rise to 6% (as is likely given recent inflation figures) then some consumers will struggle to finance their debt interest payments.

Thirdly the government debt continues to rise, despite strong economic growth. The government is forecast to borrow £34 billion in the financial year 07-08. This suggests a structural deficit because of the strength of cyclical tax revenues. If the economy was to slow down the government debt would further increase, leaving little room for expansionary fiscal policy.

UK Economy

UK economy skating on thin ice

The latest economic growth statistics show the Chinese economy is growing at an unprecedented rate of over 11%. There are also increasingly signs of over heating as Chinese inflation increases to 3.3%. There are concerns that this level of economic growth is unsustainable and will lead to a potential boom and bust economic cycle.
In response the Chinese government may be forced to:

• Increase interest rates
• Allow an appreciation in the exchange rate.

Both of these will help to slowdown the economy.

However despite growth rates in double figures there are concerns that there are still significant problems with the Chinese economy.

1. Growing levels of inequality between south (manufacturing, urban) and the north (agricultural sector - rural)

2. Continuing levels of unemployment created by the privatisation of previously inefficient state owned enterprises

• China economy at Independent
• China economic review
  

Recent evidence from the UK Housing Market suggest that despite recent rises in interest rates, house prices continue to rise above expectations.

According to the website Rightmove the average asking price of a UK home rose by 3.6 per cent - or £8,307 - in the month of March. This is the largest monthly increase since April 2002. This means the average asking price was £236,490. a yearly increase of 15%.

Miles Shipside of Rightmove, said: "Sellers' asking prices provide one of the earliest indicators of which way the market is headed, and while a boost is to be expected around Easter, £8,000 in a month is the largest amount we have ever recorded. Every region saw large increases, with the minimum jump being £3,000."


Why House Prices in UK don't Fall but continue to Rise



1. Fundamental shortage of Supply.

The Demand for houses continues to grow at a faster rate than supply. The government has a target to build 200,000 homes per year, however this target is not being met. In the UK the planning process for building new houses is quite slow. There are many obstacles, especially in the South East; there is a lack of available land and many potential areas are protected by green belt land. Furthermore existing homeowners and councils usually have a vested interest in preventing new houses being built. An increase in supply of houses leads to lower house prices, increased congestion and increased pollution. The shortage of supply in the UK is unlikely to be solved in the short term or even medium term. Whilst this shortage of supply continues house prices will continue to remain high.

2. Low Real Interest Rates.

Although interest rates have risen 3 times since August 2006, real interest rates are still quite low by historical standards. Real interest rate is nominal (base rate) - Inflation. Thus with interest rates at 5.25% and inflation at 2.7% real interest rates are 2.55%. This makes borrowing still relatively attractive. Buy to let is also still giving relatively good gains.


3. Strong Economic Growth

High levels of economic growth and low unemployment continue to create a feel good factor within UK workers. This is increasing willingness to borrow and spend more on houses. In the South East and London demand is being increased by city workers who are getting higher bonuses.

4. Wealth Effect.

The rise of house prices in the UK has created a generational gap between those who bought a house 20 years ago and those who are struggling to get on the property ladder. However many parents are using their increased wealth to help their children get on the property ladder, through giving a suitable deposit.

5. Increased Availability of Mortgage Finance

Mortgage lenders are increasingly willing to lend higher income multiples. They are also willing to promote riskier mortgage products like interest only mortgages and self certification mortgages. This means that although house prices have increased faster than earnings people are still able to get a mortgage.


See also:

Why House Prices may fall in UK soon


Will House prices drop ?

House Prices set to drop

Labels: UK housing Market

Reader's Question


If the UK were to enter the EMU at this stage, interest rates would fall and this could cause inflation?"


Current interest rates for the Eurozone are 3.75%.

The interest rate for the whole Eurozone is set by the ECB European Central Bank in Frankfurt. (1)

UK interest rates are currently 5.25% (2)

If the UK were to join the Euro we would have the same interest rate as the Eurozone area. Monetary Union involves a Common Monetary policy - interest rates set by ECB. Therefore interest rates would fall by 1.5%. This would be good news for those with mortgage payments. However if interest rates were to fall by 1.5% it would increase consumer spending and therefore could cause inflation.

Lower interest rates would have a big impact on the UK because we have high levels of debt. It would also have a big impact on the UK housing market. Lower interest rates are likely to increase the housing boom, which is not desirable given the already high levels of high prices.

See also:

Why UK will never join EURO

Costs of Joining Euro

Labels: economics help, Euro

In recent months the US housing market has seen significant falls in house prices, combined with record levels of mortgage defaults. Many economists and housing experts have suggested it is a bust that was inevitable to occur. This short article looks at why the US Housing Market has gone from boom to bust.

Why US Housing Market has Declined

1. House Prices Rose at Unprecedented Levels.

Historically US House prices have increased at a similar rate to rents, however in the last period of the housing boom the ratio of House prices to rents had grew at a rate of 78%. (1)
The ratio of House Prices to Income has also increased significantly from the long term average. In 1952 house prices relative to income was 100% in 2002 the ratio was 190%. (2) This increased to over 200% by the end of the housing boom.

The effect of rising house prices was that it was increasingly difficult for first time buyers and those on low incomes to buy a house. It also means that those with mortgages pay a higher % of their income in mortgage payments. This means they are more vulnerable to any changes in the housing market.

2. Aggressive sale of Sub Prime Mortgages.

Usually when house prices rise, demand moderates. However in the case of the US housing market, mortgage lenders were desperate to maintain sales. Therefore they just found new ways to sell the more expensive houses.
In particular mortgage lenders did several things to maintain sales amongst those with poor credit, low income and higher risk see example of inappropriate selling of mortgages (3)

3. Increased Promotion of Discounted mortgages.

Basically this means for the first year or two the home owner gets an introductory interest rate, making mortgage payments cheaper and more affordable. However after 2 years the interest rates jumps to the standard variable rate. Unfortunately because of the way mortgages were sold, these facts were not always made clear; meaning many households on low incomes took out mortgages they would later struggled to pay. This will become an increasing problem throughout 2007 as more mortgages end their introductory period.

4. Increased use of Variable Adjustable Mortgages.

In 2002 interest rates were very low (1%) This made adjustable mortgages very attractive. Therefore more people could afford to get a mortgage. However interest rates have since risen considerably since their historical low, significantly increasing the cost of mortgage payments. The rise in Adjustable mortgages is most prominent amongst low income families. Fixed rate mortgages would have been safer, but mortgage companies have not been pushing these since they tend to look for best short term chance of selling a mortgage. (The growth in ARMs between 2000and 2004 accounted for about two-thirds of the relative increase in variable interest debt.) (4)


5. Rising Interest Rates.

In 2002 because of weakness in other areas of the economy monetary policy was loosened. This was perhaps a good strategy regarding economic growth and inflation, however it ignored the micro implications for the housing market. Low interest rates were a real stimulus for those on low income and bad credit records to buy a house for the first time. However as interest rates have increased from 1% to 5% it has significantly increased the cost of mortgage payments for homeowners. A 2% rise in interest rates can increase the cost of mortgage interest payments by 40% (5)


6. Speculation

Rising house prices did encourage an element of speculation into the US Housing Market. Estimates suggest 25% of house purchases in 2005 were influenced by speculation (5) The Housing market was providing greater returns than the stock market, therefore this encourages buy to let investors. As house prices start to fall this section of the market changes completely.

7. Excess Supply

The boom years encouraged an excess of new houses being built. The supply of housing now exceeds the demand, therefore the price of housing is likely to continue to fall (6)


Footnotes


(1) (2) End of US Housing Boom

(3) House Prices tied to sham mortgages

(4) US Housing Market

(5) House Crash Continues

(6) Excess Supply in US Housing Market


Related links on US Housing Market

• US Housing Market
• Dangers of Sub Prime Mortgages
• Will US crash occur in UK

Next blog post: Effect of Falling House Prices on the Economy. Will it cause Recession?

See also:

• Is US recession likely to occur?

Labels: US economy, US housing Market

"Mankiw's 10 principles of economics, translated for the uninitiated", by Yoram Bauman,

see also: Top 10 reasons for studying economics

and funny economics

Labels: funny

If you would like help or advice for an Economics essay or economic dissertation you are welcome to leave a question as a comment on this post.

I shall try to answer the economics question and / or point to other resources but please bear in mind.

1. The replies will be guidance and not for duplication. Your essays should always be your own work.
2. My specialty is economics for British A Level standard. My university economics is rusty in parts, because generally I don't use it in teaching A level economics.
3. I can't guarantee to always give full answers it also depends on my time schedule.
4. The answers will not necessarily be complete. I know several of my essays on this site could be improved.
5. Please Write the Questions clearly and with proper spelling. Some questions I have not answered because they were not clear what was meant.
6. I will not answer on this blog, but the one here
   

I studied PPE at Oxford University and currently work as an Economics A Level teacher. I have also examined several different economic units for Edexcel AS and A2.

Labels: economics help, readers questions

This is an interesting question asked by a reader, (thanks Bhavin.)

With regard to the recession of 1981 I think that the cause of the recession cannot be entirely attributed to Monetary policy.

Reasons for Recession in 1981

1. Structural problems in economy late 1970s.

In 1979 inflation was a significant problem in the UK economy. The inflation was primarily cost push inflation. This was a combination of wage push inflation, caused by powerful trades unions and rising oil prices. To reduce this inflation was arguably necessary for the long term benefit of the economy; to reduce inflation of 20% inevitably leads to some slow down in economic growth.

2. Strength of Sterling.

Normally the increased production of oil would be beneficial for an economy. However in the case of the UK it came at an unfortunate time. The discovery of oil combined with high interest rates caused a significant appreciation in the £. This caused real problems for exporters. It was in the manufacturing export sector where the recession was felt most keenly.

3. Monetary Policy

However, despite the above 2 being contributing factors, monetary policy played an important role in the recession of 1981. The government had a Monetarist zeal to try and control the money supply. Arguably this caused real interest rates to be higher than necessary. Therefore monetary policy caused the recession to be deeper and more lasting than necessary. This is a good example of the limitation of using monetary targets, rather than targeting inflation directly.



Causes of Recession 1991.

In my view the recession of 1991 can be attributed almost entirely to a failure of government macro economy policy. By 1987 the economy was in a good position. Supply side policies were beginning to increase competitiveness and structural inflation had been brought under control. The essential problem was that the government allowed itself to get carried away by the perceived success of its supply side policies. Therefore it allowed the economy to grow much faster than the long term trend rate of economic growth. Therefore inflation was almost inevitable. In response to inflation of 10% the government then overreacted by increasing interest rates to 15%. The failure of macro economic policy was highlighted by using the ERM as a tool for reducing inflation, rather than direct inflation targeting. Again the recession was deeper than necessary because they tried to maintain a value of the exchange rate that was higher than necessary.

In short the government made 2 elementary mistakes.

1. Allowed the economy to grow too fast - Boom and Bust

2. By targeting a high value of the exchange rate, they caused interest rates to be much higher than necessary to reduce the inflationary pressures they had created.


related posts

• Causes of Recession
• UK economy under Mrs Thatcher

Labels: recession, UK economy

How accurate are economic forecasts?


The “joke” goes put 12 economists in a room and you’ll get 13 different answers. I think it was President Truman who, exasperated at the economic profession, yearned for a “one armed economist” What Truman meant is he wanted an economist who wouldn’t invariable go onto the other point of view. It is the same with economic forecasts ask economists predictions for future house price inflation in the UK and you could get answers ranging from -7% to +10%


Economic forecasting is important. For example it is the basis of the UK’s pre emptive monetary policy. Because there is a time lag in interest rates having a deflationary effect, it is important to be able to predict future inflation. If inflation is forecast to rise then the MPC knows it needs to increase interest rates now to avoid inflation in the future. However if forecasts turned out to be wrong then they could easily increase interest rates too much, causing a slowdown in the economy.

In recent years it has been relatively easy to forecast inflation because it is has been low and has fluctuated by little. However this is not always the case and economists have a bad track record of being able to predict unexpected economic shocks. To give a few examples

* 1929 wall St Crash and great Depression.
* 1990s deflation and low growth in Japan.
* 1997 -01 dot com boom and Bust.

On the other hand there have been economists predicting a major recession in America and with defaults in the sub prime mortgage sector it appears they may soon be vindicated. I have a good friend in America who has been predicting the imminent collapse of the US economy for the past 7 years. I guess at some stage there will be a recession and he will feel vindicated. However this kind of economic forecasting reminds you of the boy who cried wolf. If you predict a recession every year, by the time it comes most people no longer take you seriously.

See also:

• Limitations of UK Monetary Policy
  
• Forecasting Recessions
• Forecasts for UK Economy
  

Labels: economic forecasts, recession

* In the Olympic games, Greeks ran races, jumped, hurled the biscuits, and threw the java.

* Julius Caesar extinguished himself on the battlefields of Gaul. The Ides of March murdered him because they thought he was going to be made king. Dying, he gasped out: "Tee hee, Brutus."

* Joan of Arc was burn to a steak and was canonised by Bernard Shaw. Finally, Magna Carta provided that no man should be hanged twice for the same offence


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Her vocabulary was as bad as, like, whatever.

He was as tall as a 6'3" tree.

The revelation that his marriage of 30 years had disintegrated because of his wife's infidelity came as a rude shock, like a surcharge at a formerly surcharge-free ATM.

The little boat gently drifted across the pond exactly the way a bowling ball wouldn't.

McBride fell 12 stories, hitting the pavement like a Hefty bag filled with vegetable soup.

From the attic came an unearthly howl. The whole scene had an eerie, surreal quality, like when you're on vacation in another city and Jeopardy comes on at 7:00 p.m. instead of 7:30.

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