The Centre for Macroeconomics (CFM) – an ESRC-funded research centre including the University of Cambridge, the London School of Economics (LSE), University College London (UCL) and the National Institute of Economic and Social Research (NIESR) – is today publishing the results of its fourth monthly survey.1 The surveys are designed to inform the public about the views held by leading UK-based macroeconomists on important questions about macroeconomics and public policy.
This month’s survey focuses on UK housing market dynamics and on the appropriate policy response to large and persistent changes in house prices that are deemed to pose a threat to financial stability. The responses suggest that the UK macroeconomics community is broadly supportive of the use of so-called ‘macroprudential’ policies to counter this threat.
Coincidentally, while our survey was open the Bank of England’s Financial Policy Committee (FPC) announced its first macroprudential interventions to prevent the build-up of housing related imbalances.2 The FPC recommended that no more than 15% of a lender’s total number of new mortgages should be at or greater than four and a half times borrowers’ income and that an affordability test should assess whether borrowers can afford their mortgages if Bank Rate was three percentage points higher.
How bad is the threat from the housing market?
The Office for National Statistics estimates that UK house prices have increased by 9.9% in the year to April 2014, as compared with the CPI (consumer price index) inflation rate of 1.5%. Many observers have identified these large increases as posing an emergent threat to the sustainability of the current UK recovery. For the International Monetary Fund, ‘a steady increase in the size of new mortgages compared with borrower incomes suggests that households are gradually becoming more vulnerable to income and interest rate shocks’ and as a result, ‘more policy action is warranted.’3
Several members of the Bank of England’s Monetary Policy Committee have publicly voiced similar concerns. Other observers, however, emphasise the uneven geographical distribution of the price rises (the increase in prices was 6.3% outside London and the southeast) and the fact that the growth in household debt remains quite low compared with pre-crisis levels (lending to individuals rose 1.6% in the year to April). This month’s first question asked respondents if developments in the housing market have already reached the stage where policy action is justified.
Q1: Do you agree it is time for more robust policy action to prevent a build-up of excessive housing-related risk?
Summary of responses
A clear majority of our survey respondents agree with the question. 32 of the 46 experts on our panel provided responses. 72% of them said that they agree or strongly agree (82% when weighted by self-reported confidence), while 22% say that they disagree or strongly disagree (6% neither agree nor disagree).
As usual, the respondents provided a wealth of stimulating commentary to accompany their responses. Several of the respondents who agree cite the need to avoid a repeat of 2008. For example, Michael Wickens (York) cites the risk of ‘creating the conditions of the US sub-prime crisis by encouraging borrowing on the cheap that is not sustainable when, as expected, interest rates are raised before long’; and Luis Garicano (LSE) lists ‘multiple signs that the housing market is, yet again, overheating, including the extremely high level of price increases; the low levels of affordability; and the proliferation of very high loan-to-value mortgages’.
Respondents who disagree counter that ‘rather than on house price inflation,… the focus needs to be on the level of house prices’, which in most areas of the UK is still depressed compared with 2007 (Michael McMahon, Warwick). Similarly, ‘net mortgage lending has been close to zero and the stock of lending to the UK real estate sector is still well below pre-crisis levels’. This is an argument against action because ‘the main conventional and macroprudential instruments … would target lending and leverage, which do not seem to be the main cause of the rise in housing prices’ (Ethan Ilzetzki, LSE).
Both those who agree and those who disagree often cite the need to remove structural bottlenecks on the supply side (such as some features of building regulation), as well as the need to phase out policies that artificially boost the demand for housing (such as Help to Buy). But those who agree think that as long as such distortions persist, ‘it is sensible for the Bank of England to take action to limit people from taking excessive exposure’ (John Driffill, Birkbeck).
Macroprudential policies versus Bank Rate
Whether or not one agrees that action is currently needed to cool the housing market, a separate question is what should be done if and when developments in the housing market are judged to constitute a threat to financial stability. The UK policy framework has recently been enriched with the creation of an FPC endowed with a macroprudential responsibility to make directions and recommendations to the PRA (Prudential Regulatory Authority).
Among its various tools, the FPC has the power to set bank capital requirements and it can force banks to tighten underwriting standards. Some view such macroprudential tools as substituting for the traditional monetary policy tool for the purposes of financial stability, allowing for a ‘targeted’ response to specific financial risks while interest rate policy can continue to focus on the inflation target and the needs of the broader economy.
Others feel that the FPC and its powers are untested and ultimately there is little or no substitute for interest rate increases to nip asset price-debt spirals in the bud. The second question asked our experts for their views on this debate.
Q2: When housing-related risk is deemed excessive from the viewpoint of financial stability, do you agree that the correct response is to deploy macroprudential tools, leaving interest rates focused on the needs of inflation and aggregate real activity?
Summary of responses
A smaller majority of respondents agree with this question. 34 of the experts provided responses, with 53% (both weighted and unweighted) agreeing or strongly agreeing, 27% disagreeing or strongly disagreeing (29% when weighted) and 21% (17% when weighted) neither agreeing nor disagreeing.
Among the experts who agree, Chris Pissarides (LSE) points out that ‘interest rate changes have large impacts on the prices of other assets, many more productive than the housing stock … and they are read as giving signals of future macro policy. A single market, even one as important as the housing market, should not be allowed to dictate policy vis-à-vis this important policy tool’, while Simon Wren-Lewis (Oxford) exhorts us to ‘look at Sweden and Norway for examples of costly, and not obviously effective, attempts to use interest rates to restrain house prices. It seems crazy to use an instrument designed to manage the excess demand for goods to try and manage asset prices in one particular market’.
In general, many of our experts concur that ‘when there are two objectives … it is better to use [two] policy tools’ (Gianluca Benigno, LSE). But Wendy Carlin (UCL), who neither agrees nor disagrees, says that ‘such a neat division of tools for targeting the housing market and the business cycle is unlikely to be possible.’ Sushil Wadhwani (Wadhwani Asset Management), who disagrees, notes ‘that, in general, using a combination of tools to hit multiple targets is preferable to purely assigning a single instrument to a single target. In this particular case, … the impact of using interest rates AND macroprudential tools on the all-important house price expectations is likely to be much greater than just relying on the macropru tools’.
On a similar note, Michael Wickens (York), who strongly disagrees, points out that ‘The demand for housing is affected by the cost of borrowing and the availability of credit. The former can be affected by interest rates and the latter by macroprudential policy. Therefore both financial tools are relevant. Moreover, housing is a major channel through which conventional monetary policy works.’
Irrespective of whether they agree or disagree, many experts stress the lack of previous track record of macroprudential regulation, so that ‘interest rates … should be kept as a backstop to act against asset price rises if the macroprudential tools turn out not to work well’ (David Cobham, Heriot-Watt).
1 Results are available at http://cfmsurvey.org/surveys/uk-house-prices-and-macro-prudential-policy.
3 From the 6 June 2014 ‘Concluding Statement’ on the 2014 Article IV Consultation.