Home > Bank of England, Inflation, Monetary Policy > House Prices, Monetary Policy, and Kafka

House Prices, Monetary Policy, and Kafka

We are going to have to watch these guys.  This is MPC member Jon Cunliffe:

The self-reinforcing link between property prices, the financial system and the broader economy that operate within the stress test have been key to dynamics in previous UK downturns. As well as lowering homeowners’ wealth, falls in house prices reduce their collateral and so their access to credit. This tends to drag on consumption. Preliminary Bank analysis suggests the most highly mortgaged households have tended to cut their consumption very materially in times of economic stress.  And investment in the construction of homes and other property has had a tendency to fall sharply in downturns, with this component of spending accounting for around half of the peak to trough variation in GDP growth across the 2008-9 recession. This combination of lower property prices and a fall in spending across the economy, can, through a rise in defaults, damage banks and contribute to a tightening in credit conditions, creating a further drag on economic activity.

It is Kafkaesque, this world of monetary policy.  On Tuesday the Bank of England describes clearly how the Bank of England can, by running a tight monetary policy, cause a recession and falls in nominal asset prices.  On Thursday the Bank of England is worried about how the economy might unavoidably fall into a recession when there is an unexpected fall in nominal asset prices.

I was half-joking when I suggested that we drop the CPI target in favour of a house price target.  But I am half-serious.  If the MPC thinks that stability of house price inflation is a necessary condition for stability of the real economy then they should clearly lay out the model in which that is true.  Then HM Treasury should consider whether the MPC should target the CPIH, or whatever, so that there is an appropriate focus on stabilising nominal house price growth.  Haldane is apparently going to push for a CPIH target.

Here is a really funny thing.  If the UK had applied a 2% CPIH target for the last five years we would have needed an easier monetary policy, because the CPIH rate has been around 0.2-0.3% below the CPI rate.  And an easier monetary policy would mean higher nominal asset prices.  Thus, if the MPC had been targeting house prices, it’s easy to end up with the conclusion that house price inflation has been too low.

(Because the CPI and CPIH and not equivalent this is really an arbitrary counter-factual; maybe a 1.5% CPIH target should replace the 2% CPI target… or maybe we should stop targeting “inflation” altogether.)

  1. SK
    May 2, 2014 at 09:54

    So we are in catch22 economy where in order to keep the 65% of the population happy and spending , we will have to make the 35% of the population (tenants) poorer every month. Nice.
    You might say this is not a responsobility for the monetary side but surely (since the fiscal does not do anything about it) then their house price constant increase is creating an unequal society…
    And the % of tenants will continue increasing since people in their 20s/30s will soon 110% mortgages..

    How accurate is the CPIH? How come it is below 2% when all are reporting the house inflation is much higher (ONS/Registry/banks etc)? And how can you a housing indicator which is dependent on location in order to apply economic policy over a whole country?

    • May 2, 2014 at 12:25

      SK, I strongly believe that there is no catch-22. There is a substitution effect with rising house prices, it means people are renting more. But that does not mean people are getting “poorer”. All the evidence suggests:

      a) Rents are very well contained. http://hopisen.com/2014/second-generation-rent-controls-solving-a-problem-that-doesnt-exist/

      b) Renting is good for labour mobility, home ownership is bad.

      c) If the MPC did to use monetary policy to constrain house price growth it will hurt everybody.

      I am not sure about your last questions, but they are good ones. Of course my position is that the BoE should target nominal GDP or wages, and they should completely ignore house prices.

  2. SK
    May 2, 2014 at 14:17

    Many thanks for your response. Fully appreciate your blog allowing questions and yourself spending time to respond to these.

    It is very difficult to change our mentality for home ownership. The benefits of the ownership are supported/subsidised both from the monetary/fiscal policy and are constantly advertised by media. Suddendly now telling to younger generations (20s/30s) that they cannot enjoy these might not work.
    if in few years, the segment of tenants has increased to 40-45% , then they will be asking more questions on to why BoE is allowing such a house price inflation.

    b) Agree but somehow the government seems to conspire to do the opposite and make renting a bad financially choice.

    c) How long can they keep the rates low when unemployment decreases, PMI is in 60s and GDP is increasing? Surely they must start preparing the economy.
    The last months will push many people to buy houses with high LTV and then we will hear again from BoE that they cant raise rates. If that is the case, then they should not be pushing people to debt (HTB) and should start preparing the public about the next stages of the economic cycle.

    • May 2, 2014 at 16:24

      The Bank of England gets blamed for all the wrong things anyway, nothing new there.

      I think preferences, our “mentality”, are revealed through and reflected in prices. If a rich foreign investor offered to buy any house in Britain for £100m, would our preferences be to remain a nation of homeowners?

      I agree that the government does many stupid things, like HTB. But Keynesians have spent many years insisting that the government does stupid things like HTB, FLS, and the myriad mortgage subsidy schemes under Brown/Darling, because Keynesians think “bank lending” determines aggregate demand and hence jobs.

  3. merijnknibbe
    May 4, 2014 at 08:11

    We do have to target use multiple price indices. ‘GDP-inflation’ should not be estimated using the consumer price index but the broader domestic demand inflation index of the national accounts. Spending is not just about consumer spending but also about investments and government spending, both included in the broader index. One point about this: during the last years government wages have increased less than private sector wages, which means that ‘public consumption’ (i.e. that part of consumption of households which is financed and produced by the government, like education) increased less in price than the consumer price index (which in the UK of course increased quite a bit because of the devaluation of the pound). This means that domestic demand inflation was quite a bit lower than consumer prices, relatively more public bang for the tax buck.

    Asset prices should be considered next to GDP-prices. GDP is about the flows of spending and *new* production, asset prices are about existing stuff, like stocks and existing houses. That’s a different market: reshuffling ownership titles instead of creating new stuff and putting people to work. Different policies are needed to rein asset price inflation in, like land taxes.

    • May 4, 2014 at 20:27

      Merijn, on price indices: yes, I agree with all of that.

      With respect to asset price inflation I don’t see any attempt to think seriously about public policy. I see a lot of assertions, that prices are “too high” or there are “bubbles”, but these are not based around any model which says what prices “should be”.

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