Why Falling House Prices Cause A Recession

Readers Question: Explain why a decrease in the price of houses can lead the economy to experience a
recession.

Lower house prices reduce consumers main form of wealth.

In the boom years, rising house prices:

• Increased confidence to spend / borrow and reduce savings. This led to strong growth in consumer spending and was one of the main factors behind economic growth.
• Enabled consumers to remortgage their house and take equity withdrawal. This enabled more spending
• Encouraged construction

Now house prices are falling rapidly, these factors are reversed. Consumers are spending less and there is a deep recession in the housing market. It is also worth stressing the importance of the housing market to the economy. It is one of the most widely discussed statistics and the sharp drop in prices has symbolised the economic downturn.

The bad news is that house prices are liable to keep falling for the foreseeable future, perhaps bottoming out in 2010. This reduces the effectiveness of expansionary fiscal and monetary policy.

See: When Greenspan was nearly God – and the growing impotence of Monetary policy