Interest rates on borrowing: Low interest rates are favourable on borrowing. If interest rates were low, borrowing is made more attractive. Mortgages are a form of borrowing, and so low interest rates mean lower mortgage repayments on houses. This increases demand for houses as it lowers the cost, and therefore house prices increase. High interest rates are not favourable, as it would raise household debt substantially, and so many consumers would be discouraged to buy houses, causing demand to decrease, and so house prices to decrease. High interest rates also encourage saving rather than spending (consumption), and so there would be a general decrease in demand for all goods, as well as houses. This would to some extent partake in the decrease in price of houses.
Redistribution of incomes: Other demand factors suggest that the redistribution of incomes towards white-collar workers show that they are most likely to be house buyers rather than those who are blue-collar workers. If the number of white-collar workers (skilled workers) increases, disposable income for households across the country will increase. Therefore more people are more likely to buy a house or move house, causing demand for houses to increase, and in turn, causing the prices of houses to increase. This is linked to the redistribution of incomes because white-collar workers are paid more, and incomes are usually distributed towards white-collar workers. Today, people are becoming better educated and better trained, and their skills award them higher wages. They therefore can afford bigger houses, and perhaps in more prosperous areas. They can afford to move house, and afford the higher interest rate mortgage payments. Therefore the demand for houses increases, and so house prices increase.
Taxes: Taxes play a predominant role on the disposable income a household has. If taxes surge, households will be reluctant to buy houses, as they have less capital for the repayments, and for the consumer durables to furnish the house. With the lack of disposable income, and buying a house, negative consequences may arise, such as financial hardship and struggle and household debt. Higher tax would decrease demand for houses, and thereby decreasing house prices. Alternatively, tax cuts would encourage house buying, because households would be more able to afford them, due to the higher disposable income that they would possess. Therefore demand increases, and in turn so do house prices. Taxes affect house prices in a way, such that disposable income households have, and their purchasing power depends on the level of tax. Tax cuts give household a stronger purchasing power, enabling them to buy more goods, which includes houses. Higher levels of income also encourage capital expenditure. Tax increases limit household income and results to households buying fewer goods, which again includes houses. The laws of demand show that demand invariably affects the price of goods. The higher the demand, the higher the price and vice versa.
Labour Costs: House prices are partly determined by the cost of labour of making the houses. If labour costs are high, they will be taken into account, and will be included in the price. High labour costs may result to higher prices, and vice versa. If there are wage increase in the secondary sector (which includes the housing market), this would result in an increase in house prices. Even though the increase in house price may be marginal, it may mean, that those who are looking to buy a house lower end of the housing market (small and cheap) may find that they cannot afford that additional increase in price on the house(s) they set out to buy. For those looking to invest in the housing market, the increase in labour costs is not an economic indicator of economic growth, (it may be a result of inflation, causing workers to negotiate higher wages). This gain exposes uncertainty to buy houses, causing demand to fall, and therefore causing prices to fall. A decrease in wages may cause the house prices to decrease, however some housing contractors may just decide to retain the extra profit and house prices mat be unchanged.
Location: Some locations such as London, New York, and Mumbai are popular places to live, due to the better facilities, commerce, jobs and way of life. Demand for housing in major cities id high, and so prices are going to be a lot higher in London than for example Swansea. And so house prices are often determined by location. Even within these major, some parts are more desirable to live in, so prices are higher in those more desirable areas. Where demand for houses in another area is lower, house prices will be lower. This is because, in London, many people work in the city centre, and do not wish to commute everyday. And so they live near the city centre of London so that travel costs and inconvenience is minimised. The centre of London is also very aesthetically pleasing, and is associated with the upper class. Therefore many see this as a 'pull' factor to the centre of London. Different counties pose different levels of council tax on the residents. Higher council tax may repel some from one area, and low levels of council tax may attract others to other areas. These factors both affect demand, and hence it is a factor which affects house prices.
Inflation and recession: High inflation reduces the purchasing power of all households, leaving them with lower disposable income. The lower their disposable income, the lower their certainty and financial stability to buy houses, causing demand to decrease rapidly, which results in lower house prices. A recession would cause price decreases, due to the economic contraction. Moreover, output is reduced, and there is less need for workers, and so unemployment begins to rise. Although a decrease in house price would incur an increase in demand, in this case, because unemployment increases, demand for houses decreases causing prices to plummet further. The higher unemployment has a negative effect on aggregate demand altogether, affecting consumption and government spending. As unemployment increases, consumption, household income and demand all decrease, causing house prices to decrease rapidly. Consumers cannot afford the mortgage payments, and take on benefits and council housing, provided by the government. And so supply of houses increase and demand for houses decrease.
Urban or rural: Many people desire to live in urban areas as it usually is the centre of business and commerce. It is so that people do not have to commute from rural areas of residence to urban areas of commerce. There are often public transport problems, traffic etc, which discourages people from commuting and moving to major cities, causing house prices in urban areas to rise dramatically and house prices in rural areas to fall. House prices in urban areas are often very high, and continue rising due to the increasing levels of demand. Many people see this as a good investment, and move to the city centre to live, and eventually to make money out of.
The Wealth Effect: If house prices are high, people acquire the feeling of being more well off, and so they tend to spend more, therefore increasing consumption and also they may also decide to invest their money through buying more properties. This would increase demand, which in turn would increase prices.
Why are changes in house prices significant as economic indicators?
- If demand rises, so does consumption, which is a component of aggregate demand. If consumption rises, aggregate demand rises. This indicates that there is economic growth, through increased aggregate demand.
- High aggregate demand means there is increased output and GDP.
- Higher output is important as an indicator, as to cope with increased levels of output, it shows that more resources need to be employed, and allocated. This either means investment in capital goods (capital expenditure), which increases investment, and firms' spending (increases consumption further). The other is through increased labour forces. This means lower unemployment.
- Lower unemployment means that the government spends less in the form of unemployment benefits, and receives more in the form of tax revenues.
- If house prices are high, due to high demand, then interest rates are going to be higher. A high interest rates increases the cost of mortgage borrowing. This reduces consumer spending in two ways. Firstly, households have to cut back on expenditure to compensate for the loss of disposable income (through higher mortgage payments). Secondly, they can increase working ours or borrow money, however these are unlikely. And so house prices indicate an interest rate increase. Over time people will become less 'well off' and reduce real consumption which will reduce aggregate demand.
- House prices in the housing market may cause some firms to enter the market, motivated by the 'profit motive'. This would increase demand for builders/contractors etc, raising employment. Again, this benefits the government through lower payments (unemployment benefits), and increased revenue (tax). This means the government can increase spending to boost employment in other work areas, thereby increasing consumption, which increases aggregate demand. This enforces economic growth.
- If house prices continue to rise, the government the the problem of inflation to deal with. If inflation becomes too much of a problem, the government would have to increase interest rates to discourage house buying, and demand for houses, however looking at the exchange rate and international investment to keep aggregate demand high, but not so that the consequences of higher interest rates cause economic contraction.
- Higher mortgage payments through higher interest rates induce a lower opportunity cost for not buying a new house. So high house prices are an indication of inflationary pressures. Extremely low house prices, especially in urban areas indicate economic contraction, which is recessionary.
- Steady growth in house prices may show that incomes are rising, therefore making it more viable for consumers to buy a house. steady increases in prices also shows controlled inflation, perhaps economic growth due to higher consumption, restoring certainty amongst consumers, who (as a result of steady increases in house prices) will then better spend their money.
Bibliography
- 'Monetary policy and the housing market'. By Barry McCormick, Economic Review.
- 'Commuters are feeling the strain on the train'. Financial Times
- 'House prices are falling'. Financial Times, FT.com (internet)
- The A-Z of Economics. Nancy Wall, Ian Marcouse, David Lines, and Barry Martin
- Economics in context. Susan Grant and Chris Vidler
- 'Housing markets and the British economy'. John Muellbauer, Economic Review
