Economics help blog – Page 33

Methods to Control Inflation

21 July 20228 July 2022 by Tejvan Pettinger

Inflation is generally controlled by the Central Bank and/or the government. The main policy used is monetary policy (changing interest rates). However, in theory, there are a variety of tools to control inflation including: Monetary policy – Higher interest rates reduce demand in the economy, leading to lower economic growth and lower inflation. Control of …

To what extent can the US president control inflation?

7 July 2022 by Tejvan Pettinger

The best guide to US elections is the state of the economy. If the economy is doing badly with high unemployment and/or higher inflation. The party of the sitting US president tends to get punished by the voters. But, how much influence does the President have on the economy and the rate of inflation? In …

Problems facing UK economy 2022

13 July 20226 July 2022 by Tejvan Pettinger

In 2022, the UK economy is struggling with very weak economic growth and one of the highest inflation rates in the OECD. Some of these problems can be attributed to global short-term problems, in particular recovery from Covid lockdowns and rising oil prices which have caused the worst cost-push inflation since the 1970s. However, short-term …

Why was inflation higher in the 1970s?

5 July 20225 July 2022 by Tejvan Pettinger

Readers Question: Why was inflation higher in the 1970s? In 2022, inflation has increased in western Europe to the highest levels for many years. With inflation in UK and US approaching 10%. Yet, despite rising oil prices and other inflationary pressures, inflation is still considerably lower than in the 1970s. A big question is whether …

Housing supply in UK

18 February 20231 July 2022 by Tejvan Pettinger

A fundamental problem in the UK housing market is a persistent shortage of housing. The ONS forecast the number of households in the UK will increase by 1.6 million (7.1%) over the next 10 years, from 23.2 million in 2018 to 24.8 million in 2028, and yet the current rate of home construction is struggling …

Why is it so expensive to rent in the UK?

18 July 20221 July 2022 by Tejvan Pettinger

Readers Question: Why is it so expensive to rent a house in the UK?

The average cost of renting a property in the UK is now £1,060 a month (£1,752 in greater London) statista. Between 2005 and 2022, the cost of private renting in England has increased nearly 40% (index from 82 to 114) The high cost of renting is due to the shortage of supply in the UK, the growing number of households and the period of low-interest rates since 2009, making it more attractive to try and buy.

renting-private-england

Between 2005 and 2022, the cost of private renting in England has increased nearly 40% (index from 82 to 114)

This is at a time of stagnant/very low real wage growth

average-mean-wages-uk-77-21-lines

This shows that since the financial crisis of 2009, average disposable income growth has slowed down, falling way behind the increase in rental costs. Therefore, rents have risen despite low real income growth.

Reasons for expensive renting

House prices are even higher

average-house-prices-uk

Real house prices (adjusted for inflation)

Rising house prices and rents are closely linked. Renting is the alternative for buying a house. In the UK, buying a house is considered highly desirable. But, increasingly first time buyers cannot afford the high prices. The housing market is influenced by

Shortage of supply. The UK population is growing relatively fast, and the number of households is forecast to grow sharply (also more single people living alone). Demand is forecast to grow by 250,000 a year. However, supply is constrained by planning permissions and the difficulty of making land available. This is especially true in major cities, such as London. Local planning regulations means it is easier for local communities to block the building of new houses.

Low interest rates have definitely helped increase house prices because mortgages are cheaper. Low interest rates mean that buying a house can give a better rate of return than buying other forms of investment, such as shares. An investor looks at the return on housing (rentable income) vs the cost of buying a house (mortgage interest payments). Very low-interest rates increase the attractiveness of buying a house as an investment. The buy to let market has been buoyant but this has meant more first-time buyers having to rent rather than buy.

Growing number of households

uk-household-projections — 27.3 million in 2017. to 31.6 million in 2039. (4.3 million increase)

The UK population continues to grow (52 million in 1960 to 63.23 million in 2012). The forecast is 71 million by 2033.

Shortage of council housing

dwellings-bytenure-dwelling-stock-estimates-2021 — Source: Dwelling Stock estimages gov.uk 2021

Source: Dwelling Stock estimages gov.uk 2021

In 1981, social housing was approximately 30% of housing stock. By 2001, this had fallen to 20% and 16% by 2021. Private renting has doubled as a share from 10% to 20%.

From the 1980s, council tenants were given the Right to Buy. This led to a large fall in the amount of publically provided social housing. This has not been replaced by new council housing builds and so more households have needed to look in the private sector, where continued shortages have caused higher prices.

Why are rental prices more stable than house prices?

Many tenants have longer-term contracts. Landlords may enter into agreements (either formal or informal) to keep rental prices fairly constant. House prices, by contrast, are driven by supply and demand. If more people enter the market for buying a house, it can push prices higher. If house prices rise 20%, it doesn’t mean homeowners will see a 20% rise in the cost of mortgage payments. Most homeowners will be unaffected in the short term by rising house prices. Renters will be affected directly by any change in the cost of rent. Most renters couldn’t afford more a sharp jump in rents.
Rents not affected by interest rates. If interest rates go up, this doesn’t change the cost of renting. But, it might dissuade people from buying a house. Similarly, if interest rates fall, landlords will not pass the interest rate cut onto tenants.
Supply more elastic. It is likely that rental properties are slightly more elastic than houses. If there is greater demand for renting, and the price of renting goes up, it may encourage more landlords to put houses for rent on the market or it may encourage people to let out a room. However, this point is just an assumption – it would need a bit more investigation.
Demand more price elastic for renting. If rents rise in London, it may encourage workers to move elsewhere to find cheaper rents. Renters are more flexible and more price sensitive. If you want to buy a house in a certain area, your demand is more likely to be price inelastic. If house prices go up, you may be willing to pay the higher price – you don’t notice a price rise straight away. Higher prices are spread over the 30 years of the mortgage term.
Buying houses as investment. Rising house prices have encouraged more people to buy houses as an investment. This pushes up house prices, but consequently leads to an increase in the supply of rented accommodation. Therefore, you could have a situation where a sharp increase in buy to let activity, pushes up house prices, but decreases rental prices. Evidence suggests the % of homes which are owner occupied has declined in recent years; this could imply an increase in the supply of homes put on the rental market.
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Fuel Poverty – Definition and Statistics

18 August 202230 June 2022 by Tejvan Pettinger

Households are considered by the Government to be in ‘fuel poverty’ if they would have to spend more than 10% of their household income on fuel to keep their home in a ‘satisfactory’ condition. It is thus a measure which compares income with what the fuel costs ‘should be’ rather than what they actually are. …

How important is the budget deficit?

26 June 2022 by Tejvan Pettinger

Readers Question: How important is the budget deficit?

The budget deficit is the annual amount the government borrow. The government usually financed the budget deficit by selling bonds to the private sector

To libertarian and free-market economists, budget deficits are liable to cause significant economic problems – crowding out of the private sector, higher interest rates, future tax rises and even potential for inflation. However, Keynesian economists are more sanguine arguing that in an economic downturn, a budget deficit plays an important role in stabilising economic growth and limiting the rise in unemployment.

Budget deficits have potential economic costs, but it depends on the economic climate, the exchange rate system, interest rates and the reason for government borrowing.

OECD – Budget deficits 2012

The most useful way of measuring the size of the budget deficit is as a % of GDP. The graph below shows that in 2012, there was a large variance in the size of budget deficits. The biggest deficits occurred in Ireland, Japan, UK, and US – with budget deficits of over 8% of GDP.

Potential benefits and costs of a budget deficit

Reasons to be concerned about a budget deficit

Need to cut spending in the future. Higher deficits are not sustainable forever. Reducing a budget deficit can be problematic. If a country has a deficit that increases too quickly, the government may be forced to adapt policies aimed at a sharp deficit reduction. These ‘austerity measures’ can cause a fall in aggregate demand. For example, during 2012-16, many countries in the Eurozone sought to reduce their budget deficit to comply with EU rules. This deficit reduction caused lower growth, recession and unemployment.
Increasing national debt. A budget deficit increases the level of public sector debt. Large deficits will cause national debt as a % of GDP to increase.
Opportunity cost of debt interest payments. A higher deficit will also lead to a higher % of national income being spent on debt interest payments.
Crowding out. One way of thinking about a budget deficit is that if the government is borrowing from the private sector, the private sector has lower funds to spend and invest. The government is, therefore ‘crowding out’ the private sector – and some economists will argue government spending is liable to be more inefficient than the private sector.
Potential rise in bond yields. Countries with large deficits may struggle to attract sufficient investors to buy bonds. If this happens, bond yields will rise causing the deficit to be more expensive to finance.
Potential inflation. There is a fear that budget deficits could be inflationary. For example, if a country like the UK was struggling to attract sufficient investors to buy UK bonds, the Central Bank could effectively print money and buy bonds. However, unless the economy is in a liquidity trap, printing money will cause inflation, and reduce the value of savings, including government bonds. It is worth pointing out, that in developed economies – inflation from printing money resulting from a budget deficit is quite rare.
Confidence effects. High levels of government borrowing may adversely affect confidence as consumers and firms fear future tax rises or higher interest rates.

Evaluation

There is no simple answer to whether a budget deficit is helpful or harmful because it depends on quite a few factors.

1. It depends on when the deficit occurs. Basic Keynesian analysis suggests that a rise in the budget deficit during a recession is a good thing. In a recession, private sector spending falls and saving rises – leading to unused resources. Government borrowing is a way of utilising these unused savings and ‘kickstarting’ the economy. The deficit spending can help promote higher growth, which will enable higher tax revenues and the deficit will fall over time. If you try to balance the budget in a recession, you can make the recession deeper. Austerity can be self-defeating.