Economics help blog – Page 168

Policies to ease pressure on the housing market

18 November 201720 May 2014 by Tejvan Pettinger

Readers Question: What policies could be used to ease pressure on housing market?

Firstly, the main pressure in the UK housing market is the persistent and continued above inflation price increases. Back in 2004, Kate Barker’s report into housing market trends found that the UK would need to build 250,000 houses to reduce the house price inflation rate to 1.1%. But, since 2004, the UK housing market has fallen short of this target. In the middle of the recession, the number of home starts fell to just over 100,000. (Housing supply)

The Home Builders Federation claim to catch up, we would need to increase home building to 320,000 a year – something not seen in the UK since the 1950s.

Policies to ease pressure on housing market

1. New Garden cities The building of new cities, in the mode of Milton Keynes, can enable a significant increase in homes. Currently there are plans for a new city in Ebbsfleet, Kent on the high speed railway line to London.

However, from planning to completion this will take a long time. It also means building on greenbelt land, which is likely to raise objections.

2. Government subsidy / council homes. Additional government spending to subsidise the building of ‘social’ housing could help increase supply. In the past decades, council housing has fallen out of vogue as the government have sought to sell off council housing and cut back on the building of council housing. But, it was council houses which provided a significant boost to the UK’s housing stock in the post war period.

Clement Attlee’s post-war Labour government built more than a million homes, 80% of which were council houses. In recent years, local authority building of new houses has virtually ceased. It is notable that since local authorities ceased to build homes, the UK housing shortage has become more acute. Housing associations have never been able to replace the large numbers built by local authorities.

It would require a change in political commitment and the willingness to spend extra money. Also, since the Thatcher era, the notion of council housing has gained a form of social stigma. However, it could make a big difference to the number of homes built.

3. Greater flexibility in planning. Planning restrictions are quite strict in the UK. Loosening the number of restrictions and making it easier for builders will make supply more elastic. This could involve reducing the amount of protected greenbelt land. It could also involve streamlining the regulations home-builders have to meet.

However, this could lead to significant local objections as people protest about the increased building, congestion and loss of green fields. One other solution would be to provide grants for turning derelict brown field sites into new homes.

4. Incentives for local authorities

Home building is a local issue. Local authorities have to deal with opposition to home building, so there is often local political pressure to stop house building. However greater financial incentives, such as allowing the council to keep council tax receipts from new housing developments, could give them a greater motivation to allow home building.

5. Introduction of a Planning-gain Supplement scheme

At the moment, building new houses tends to give the greatest benefit to landowners. Local residents feel they just lose out – depressed house prices, loss of unique village e.t.c. One solution is to make sure local residents near new housing schemes gain some compensation in return for accepting more houses. For example, a new housing development could be accompanied with a bypass or better public transport links. This is interesting from an economic perspective as it is seeking to provide a pareto improvement (one where everyone benefits).

The difficulty is that in the real world, it can be difficult to ensure people are compensated. Some local residents may feel there is nothing to compensate for the loss of a beautiful view. People may also exaggerate how much they lose from a new housing scheme.

6. Government’s Help to to buy

The government’s help to buy scheme is controversial because it is seeking to ease the problem through helping homeowners borrow more money. Critics argue this merely fuels demand and keeps prices artificially high.

However, to some extent, the Help to Buy scheme has provided some incentive for private builders to increase supply. In particular the first part of the scheme which offers buyers an interest-free loan worth up to 20% of the value of a new-build home. This increased demand for new build homes, encourages house builders because they are more confident there will be demand for the new homes.

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.