Economics help blog – Page 166

Are UK house price rises sustainable or are we heading for a crash?

18 November 201715 May 2014 by Tejvan Pettinger

Readers comment on – House prices stats Excuse me for pointing out the obvious, but why are those ratios (House price to incomes) unsustainable if interest rates stay low? It’s the ratio of house-price-multiplied-by-interest-rate to earnings that determines affordability, not ratio of house price to earnings.

If rates fall as prices rise, then the first ratio remains affordable. If earnings rise, the ratio remains affordable.

Interest rates have been on a downward trend for 25 years and inflation has been tamed, there’s no reason for that trend to change..

UK base interest rates

UK base rates have stayed at 0.5% since early 2009. But, how long will they stay at 0.5%

It is true that housing affordability is determined b:

Disposable income
The cost of mortgage payments; (this depends on both the cost of buying a house and interest rates).

The ratio of house price to earnings is not a reliable guide to the actual cost of housing because there are other factors we need to consider.

We can see this by comparing two graphs which show house price to earnings.

ftb-house-price-earnings

These two graphs show that we can have an improvement in affordability (fall in the cost of mortgage payments) even as house prices rise.

I agree that in the long term the sustainable ratio of house price to earnings can increase. There is no law that the ratio of house price to earnings has to stay at (say 3). For example if we see a decade of lower interest rates and / or rising real incomes. Then house price to income ratios could increase.

However, that doesn’t mean we should ignore a rapid increase in house price to earning ratios.

Affordability has been increased by the significant fall in interest rates to 0.5% – Interest rates certainly can’t fall any further and are likely to increase.
House prices are rising much faster than average earnings.
Many first time buyers, struggle to raise the increased deposits required to buy a house.

ONS house price index Nov, 2013 – Deposits are rising as % of income
There is evidence that house prices are being pushed higher by investors rather than young buyers. The ratio of people renting is increasing.

An increasingly small % of the population is able to get a mortgage. The median income of mortgage borrowers has nearly tripled since 1990.

income mortgage borrowers

Long Interest rate prediction

base-rates

House price affordability has increased because interest rates are at record lows. In the long term I cannot see a return to double digit interest rates that we saw in the 1980s and early 1990s. However, I do expect interest rates to increase above 0.5%. When the economy recovery becomes stronger, I would expect interest rates of 4%. Historically, we see real interest rates of 2%. If inflation stays on target of 2%, then the most likely long-term interest rate is around 4%.

It is possible that the UK and Eurozone economies could replicate Japan ‘lost decade’ of deflationary pressures. In this case interest rates could stay at 0.5% for a decade. But, I would hope, this is still a reasonable chance we can escape this threat of prolonged deflation. Recent growth edging towards 2% a year is promising. The balance of probability suggests interest rates will rise by the end of 2014, or definitely in 2015.

What happens when you destroy money?

12 February 202012 May 2014 by Tejvan Pettinger

Readers question: What happens to the underlying money (supply) if someone destroys currency rather than saving it or spending it? The money supply is the total stock of notes, coins and bank deposits in the economy. If money is destroyed (taken out of circulation) and not put back in by the Central Bank, then the …

The economic effects of cheaper solar power

12 February 20208 May 2014 by Tejvan Pettinger

In recent years the cost of producing solar energy has fallen dramatically. Discuss the economic effects of cheaper solar power on the energy industry and wider economic welfare. Solar power is an alternative energy source to coal and natural gas. Solar power also has a significant environmental advantage over traditional fossil fuels. It is renewable. …

Elasticity in the Petrol Market

24 March 20187 May 2014 by Tejvan Pettinger

Readers Question: Discuss the relationship between elasticity and market power’ in terms of the retail petrol market. And then it says ’use common determinant of both’, whatever that means? Demand for petrol is quite inelastic. If you have a car, there are not many alternatives to buying petrol. This is why the increased price of …

Euro revision notes

18 November 20176 May 2014 by Tejvan Pettinger

The Euro is the single European countries adopted by 18 out of 28 EU countries. The UK has not joined. The Euro involves: Common currency Common monetary policy – Eurozone interest rates set by the ECB in Brussels. Some fiscal rules, e.g. The Fiscal Compact (2012) limiting the amount of government borrowing (a balanced budget …

Inflation and the Basket of Goods

16 January 20185 May 2014 by Tejvan Pettinger

The basket of goods reflects the most commonly bought goods in an economy. When calculating inflation, statisticians check these 1,000 most commonly bought goods and multiplier price changes by their respective weighting. There is an interesting interactive graph here at the NYT showing the different components of the US basket of goods, used to calculate …

Solutions for Water Shortages

19 January 20203 May 2014 by Tejvan Pettinger

“Water, water, every where, Nor any drop to drink.”

– Samuel Taylor Coleridge – The Rime of the Ancient Mariner.

The water companies are the least loved out of the privatised utilities, and the lack of rain over the past two winters is making their job much more difficult. For many people, it is hard to understand that you can have the wettest April for years, and yet we still face the prospect of drought as serious as a country like Australia or Spain (which have much lower rainfall)

It seems crazy that a county with rainfall like the UK should still face the potential for a serious drought. Even when it doesn’t rain much in the UK, there is still more rainfall than other semi-arid countries in the Mediterranean. What is the economics of the UK water situation?

Every day half a billion (17,395 million) litres of water goes into the UK mains water supply
average consumption in the UK is 150 litres – one of the highest in the EU

Where Does Our Water Come From?

When we think of water supplies, we tend to think of reservoirs like Thirlmere in the Lake District. But, actually, 70% of drinking water in England comes from underground boreholes. These underground water supplies can be very deep. After recent dry winters, water is taken from up to 40 metres down. This is why the recent April showers haven’t really altered these underlying water reserves. The April rain will not have been able to seep down 40 metres yet. The current rain is good for topping up reservoirs and rivers, but to top up underground reservoirs, we need persistent rain in winter. Winter rain is not taken up by plants or evaporates, it just seeps down. That is why water companies, complain about ‘the wrong kind of rain’

Policies to Deal With Water Shortages

To deal with water shortages, there are two main approaches:

Increasing Supply of Water
Managing Demand

Increasing Supply of Water

1. Build More Reservoirs. Building reservoirs will increase the potential supply of water. They are easier to refill than underground boreholes. However, building more reservoirs:

Is quite expensive. To rely on reservoirs for our water supplies will increase the cost of water.
Typically it takes 25 years from the concept of a new reservoir to bringing it into use.
Land availability is quite limited in the south east to build reservoirs.
It is not always possible. In many areas of the south of England, the soil is very chalky. Reservoirs are not practical because the chalky soil is not good at holding water. Therefore, reservoirs are not an option in some parts of the country. The problem some regions face is that the only real supply of water is these underground boreholes.

How has China affected UK Economy?

18 November 20171 May 2014 by Tejvan Pettinger

Readers Question: How Has China’s Economic Industrialisation affected the UK’s Economy? And What Policies Could The UK Government Implement To Rectify The Problems Created From China’s Growth?

The rapid growth of China’s economy has had various effects on the UK economy – some positive and some which have created challenges and problems for the UK.

1. Lower Goods Inflation. Chinese economic growth has been characterised by low priced manufactured goods. The price of items such as clothes and electronic goods has consistently fallen, helping to maintain low inflation in the UK. This downward pressure on prices is particularly helpful for consumers, who have experienced rising cost-push inflation in areas such as energy and food in recent years. The falling prices of electrical goods and textiles have helped to increase UK living standards and have enabled a higher percentage of income to be spent on other goods and service

2. Higher price of raw materials. As well as contributing to lower goods inflation. You could argue China’s growth is contributing to rising prices of raw materials e.g. oil. The economic growth in China is pushing up demand and therefore price of oil, which is having an impact on Western inflation. China’s growing demand for oil and raw materials was a key factor in creating cost push inflation in the past few years. Therefore, even though the West has been in recession (2009-2013), we have also seen cost-push inflation. This cost-push inflation arguably exacerbated the recent recession. However, the rising price of oil is not just due to China, but also supply disruption in the Middle East and other factors. Also, the rising price of oil may encourage the developments of greater fuel efficiency and alternatives to oil which will benefit in the long run.

3. Relative decline in manufacturing sector. The UK’s manufacturing sector has been in relative decline since early 1980s. Chinese growth has in a way speeded up this process as British firms with higher labour costs become uncompetitive compared to Chinese firms. However, the manufacturing sector may have declined anyway and up to recently job losses in manufacturing sector have been absorbed into the service sector. Arguably, it is not a problem if we do have a relative decline in manufacturing. The theory of comparative advantage states that we should specialise in those industries, which we are best at.