12 March 2012

Blowing Bubbles (After They've Burst)

The government has a new plan to reinflate the housing bubble. It's a complex scheme involving 95% mortgages, participation by the building industry and a public sector guarantee.

The problem with the scheme is that house prices are still too high. The Nationwide index of house prices to earnings (based on first time buyers) shows that currently house prices are 4.4 times earnings. The chart below is based on their data. I have fitted a trendline on the data from 1983 to 2003 (that is the two decades before the bubble). It shows that house prices fluctuated around 2.9 times earnings.

House prices are likely to fall, or at best stagnate for a long period. Of course lower property prices could depress household demand. Is it responsible policy to keep house prices inflated?

Lower prices would do more to help first time buyers. Building  houses should help to stimulate growth in the economy and make housing more affordable.

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