The Impact of a Housing Boom on the Economy - Essay Example

Identify the factors that influence the demand for housing in a country of your choice and examine the impact of a housing boom on the economy of your chosen country Introduction This assignment will examine the factors that influence housing in the UK, as well as providing other influences that have impacted a boom within the UK housing market, especially between 2003-2006 and 2011-2014, particularly in London and the south-east. A short summary and conclusion of the arguments will then be provided.

Demand for factors that influence housing in the UK Firstly, migration. There would need to be an increase in the supply of housing, as restrictions in supply can distort the housing market. However, in the London and southern England markets especially, there is under-supply, which has increased price. For example, it is estimated (www.ftcom and www.theguardian.co.uk) that London will need 50-60,000 new homes built every year until 2050, to support the population expanding from 8M to 11m. Additionally, overseas migration of students in higher education provides around £10 billion of demand within the UK economy each year (www.

theguardian.co.uk), with many parents’ purchasing properties for their children and children’s flat mates. This further increases the price of UK housing, especially in University cities, such as London. Figure 1.0 accurately denotes the real vs absolute breakdown in pricing as it currently exists within London; a figure that cannot be ignored if the analyst is to seek to understand some of the more dynamic causal factors that are influencing upon supply and demand for housing within the region in question.

Figure 1.0 (Badarinza & Ramadorai, 2014) Secondly, unemployment. If unemployment is falling (which it has been doing for almost 2 years, since the first quarter of 2013), demand for houses and mortgages, linked to low interest rates, will increase, because there is more disposable income within the economy. For example, C+I+G +(X-M). Thirdly, interest rates. Interest rates are currently extremely low, 0.5% since 2009. The supply of money in the economy has increased, increasing the number of loans, but the available land has not increased, or the supply of houses.

Therefore, money is cheap (‘borrowers ability to access funds at low interest rates’) Price goes up, so many people’s wages are not high enough to afford both the deposits and the repayments on a mortgage, so they rent from these landlords. Therefore, fewer and fewer potential buyers are buying, and more are renting, because the value within the housing market is increasing rapidly in price, due to increasing landlord purchases. According to Fenton (2011), “Even though there is a considerable level of legal constraints that demand that affordable housing alternatives should be represented within the markets, the drive to charge higher prices and find manageable work-arounds for existing real estate offerings is one that has come to define the way in which the London real estate market exists” (Fenton, 2011).

Rather than abiding y existing regulations, the piece illustrates that the desire to sell the product at market prices and avoid the difficulty of government paperwork is still a defining attribute of the London housing market. Fourthly, personal rates of tax. In the April 2014 budget of Chancellor George Osborne, personal income tax for those earning over £150,000 per year, decreased from 50% to 45%. Again, many of those earning over £150,000 live in London, and an increase in disposal income will (cetirus paribus) impact price upwards within the housing market.

This was defined by one scholar as “The scandal and crisis of our generation; effectively creating a dynamic by which workers and the fabric of London society is pressured beyond the scope that is normal or expected” (Councils & Singleton, 2014, p. 22). Finally, stamp duty. Stamp duty is set at between 0-7%, depending upon the purchase price of the property. It can be argued that this tax is a disincentive to purchase, given that even for a property of £250,000, £7,500 stamp duty is equivalent to around 7 months’ rent in the London rental market for a 1 bedroom property.

1 Examine the impact of a housing boom Real wages. Real wages in October 2014 (0.5%) have lagged behind prices (1.5%) and especially house prices in London, increasing by 18% during 2013. Disposable income has therefore decreased for those to buy houses, and will decrease for those with mortgages when interest rates rise, which is predicted in 2015. With real wages having risen lower than prices, this has led to a decrease in disposable income for many wishing to purchase. Many workers suffer ‘money illusion’ that their incomes are not falling in real terms.

The Financial Times defines money illusion as, ‘the idea that a unit of money has a fixed amount of purchasing power and does not change in value. A typical example is in periods of inflation, when salaries rise but the amount of goods a unit of money can buy falls.’ Fractional ownership. Fractional ownership of a house includes a percentage, such as 25% purchase with a mortgage, and reduced rent, rather than 100% ownership of the property, and no rental income. This is due to rising asset prices in the UK, and especially London and the south-east since around 1999.

Fractional ownership persuades lenders to lend, builders to build and owners to buy. Normally, price would decrease if there is an over-supply of houses, and the housing market would experience price corrections downwards, and builders would stop building and leave the market. The difficulty in obtaining fractional ownership, i.e. mortgage financing, has greatly contributed to the recent downturn in approved mortgages within the system; as illustrated in Figure 2.0. This factor, perhaps more than any other, is a contributing element to why the rate of growth and overall level of availability for housing remains constrained within the London area and its immediate environs. Figure 2.0 (Councils & Gavin, 2013) However, financiers and builders come together, builders keep building, financiers lend and effectively increase the length of the loan and the size of the repayments for the borrower.

Stamp duty. However, from the perspective of owner occupiers, it also acts a disincentive to move, as the ‘dead loss’ tax has persuaded potential buyers’ to invest in improving their properties and increasing their future values, rather than ‘donating’ a tax to HM revenue instead. The Labour Government between 1997 and 2010 removed mortgage-interest payments, house depreciation, buildings insurance, estate agent and conveyancing fees, from the RPI (Retail Price Index) inflation target (in 2003) www.ons.uk creating the CPI (Consumer Price Index).

It can be argued that, this lower measure contributed towards a ‘housing bubble’ that has affected the UK economy, and also affected the banking system, budget deficit and the national debt, both of which have increased substantially since 2006. The rate of CPI directly influences the rate of interest, in this case lower rates. As house prices rose, this encouraged owner-occupiers to borrow against the ‘equity’ in their properties. In addition, housing costs have outstripped earnings, lowering real wages since 2008 (Pickford, 2014).

According to Culley (2014), “The single greatest impediment to the growth and affordability of the London real estate market is the underlying CPI and the means by which institutional mandates constrain the degree and extent to which government can seek to impact upon these macro-economic issues” (Culley, 2014, p. 18). Summary and conclusion After 2 periods of exceptionally strong growth in the housing market, and much of the general economy (especially in London and the South-East), this essay has attempted to outline the factors influencing the demand for housing and to examine their impact on the UK economy.

Firstly, although some economists might cite ‘market failure’, the misallocation of resources in a free economy as an ‘externality’ responsible for the exceptionally strong growth in the housing market, it can also be argued that short-term supply of housing has been inelastic, taking time for builders to enter the market to correct the current under-supply, due to a ‘lag effect.’ Secondly, monetary policy, which affects aggregate demand (AD), which in turn affects investment, consumption, interest rates and exchange rates.

Low interest rates have contributed towards strong growth and the factors influencing demand for housing. AD has shifted to the right, as interest rates have fallen, and consumption and investment increased, as the cost of borrowing has decreased. The Governor of the Bank of England (Mark Carney) has argued that there is ‘spare capacity’ in the economy, reflected in the gap between real wages and inflation, and that consequently, the Production Possibility Frontier (PPF), is below maximum output, keeping interest rates low and demand for house purchases high.

According to one anlayst, “The shift from spare capacity to existing glut is something that the London market has not yet experienced. It is likely that many of the factors that influence the demand will behave in dissimilar ways in the coming years; leading to an unstable real estate market that is not anything like the current one which is exhibited (Gentile, 2014, p. 94). Thirdly, the coalition Government has not capped buy-to-let-mortgages (BTLP), and continued the policy of tax rebates for BTL landlords.

This has also increased demand for house purchases. Fourthly, the ‘Help to Buy’ scheme (April 2013 budget) fuelled purchases. Finally, the ‘wealth effect’ is linked to equity release. According to Bracke, “The wealth effect is something that will eventually cool; however, the indirect effect on tens of thousands of individuals that have not been given an opportunity or potential means of market entry during this time will have been irreparable” (Bracke, 2014, p. 4). Owner-occupiers believe that they have more value in their house, and have removed these monies, in some cases to support family members’ deposits and/or purchases, increasing the turnover, volume and prices within the housing market.

Bibliography Badarinza, C & Ramadorai, T 2014, Preferred Habitats and Safe-Haven Effects: Evidence from the London Housing Market. Available at SSRN 2353124. Bracke, P 2014, House Prices and Rents: Microevidence from a Matched Data Set in Central London. Real Estate Economics. Councils, L., & Gavin, M 2013, Response to GLA Housing Strategy. Councils, L., & Singleton, A. (2014). 82 per cent of Londoners say there’sa housing crisis–how do we solve it?. Culley, J Bailey, L & Postila, M 2014, Prime London Housing: Drivers and submarkets (No.

eres2014_81). European Real Estate Society (ERES). Fenton, A. (2011). Housing Benefit reform and the spatial segregation of low-income households in London. Gentile, M. (2014). Jane Zavisca 2012: Housing the New Russia. Ithaca and London: Cornell University Press. Pickford, J 2014, Value of buy-to-let sector approaches £1tn - FT.com. [online] Financial Times. Available at: http://www.ft.com/cms/s/0/275ba66a-6698-11e4-8bf6-00144feabdc0.html?siteedition=uk#axzz3Ia2EwtZV [Accessed 10 Nov. 2014].