Should Government Prevent House Price Crashes
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House prices in the UK have been rising at phenomenal rates. However many
economist predict in the future house prices could fall. If this were to occur
what would be the economic implications and should the government do anything
Arguments for government intervention to prevent house price falls
1. House prices tend to be volatile, this is because Supply and demand are
inelastic (if price changes people keep buying them). Also the housing market is
subject to speculation, people may buy houses during house price growth to try
and profit, however if house prices fall these speculators will be inclined to
sell, causing a bigger crash in house prices. Therefore any fall in house prices
could have significant consequences for the economy.
2. House prices can adversely affect the rest of the economy. For example if
house prices rise quickly then it can cause inflationary pressures to build up
leading to a boom and bust economic cycle. If there is a house price crash this
will leave many home owners with negative equity. (This means that the house is
worth less than what they bought it for.) Therefore this will significantly
reduce consumer confidence and therefore a reduction in consumer spending
leading to lower growth and possibly a full blown recession.(negative economic
growth for 2 quarters)
3. The housing market has a significant impact on the economy, because over
75% of households are home owners and mortgage repayments are a significant part
of people’s income. Housing is the biggest form of wealth therefore the negative
consequences should not be underestimated. The fall in house prices could also
lead to a negative multiplier effect, where the final fall in GDP is bigger than
the initial because of the bandwagon effect.
4. Preventing a crash in the housing market will help prevent people have
their home’s being repossessed. This is because with negative equity and high
interest payments people would be unable to pay off their debts.
However there are arguments against the government trying to prevent a
1. Firstly it is difficult to predict future house price inflation. For a
long time people have argued house prices are overvalued but house prices
continue to rise. Therefore it is hard to judge whether house price changes are
due to pure speculation or have good fundamental reasons.
2. Housing is a private good, there are alternatives like renting a house.
3. If house prices are overvalued then there are benefits of letting their
prices fall. Because it will help first time buyers be able to afford to buy a
house, at the moment many key public sector workers are unable to buy. Cheaper
house prices would increase efficiency of the economy and increase geographical
immobility e.g. easier to buy houses in London.
4. A fall in house prices would reduce house price speculation therefore in
the future house prices would be more stable.
5. It is difficult for the government to intervene in the housing market.
Interest rates could be cut. But if the MPC cut interest rates it may conflict
with other objectives like the governments inflation target of CPI= 2% +/-1
Conclusion there are significant costs to the economy of falling house
prices. Therefore if possible the government should seek to avoid house price
volatility, however due to the nature of the housing market it is quite
difficult in practise to prevent falling house prices once they occur. This is
because the government only has limited tools to prevent this. The best option
is to try and reduce house price volatility through meeting supply constraints
and making mortgages less sensitive to changes in interest rates. i.e. more
fixed rate mortgages.
About the Author
R.Pettinger is an Economics teacher at Oxford and writes frequently on the UK
economy and mortgages. He edits a site about Mortgages including a guide to
different types of mortgages.
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Article Published/Sorted/Amended on Scopulus 2007-03-25 20:25:08 in Economic Articles