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house prices
When they go through the roof it is usually a warning sign that an economy is overheating. House prices often rise after interest rate reductions, which lower mortgage payments and thus give buyers the ability to fund a larger amount of borrowing and so offer a higher price for their new home. Strangely, people often regard house-price inflation as good news, even though it creates as many losers as gainers. They argue that rising house prices help to boost consumer confidence, and are part of the wealth effect: as house prices rise, people feel wealthier and so spend more. However, against this must be set a negative wealth effect. An increase in house prices makes many people worse off, such as first-time buyers and anyone planning to trade up to a better property. As long as people think that their house is a vehicle for speculation, rather than merely accommodation, it seems inevitable that prices will be volatile, prone to a boom-bust cycle. As house prices rise, profits are made, tempting more speculative buyers into the market; eventually, they start to pay too much, interest rates rise, demand falls and prices plunge. People have also invested in housing as a hedge against inflation: house prices generally rise when other prices rise, whereas the real value of mortgage debt is eroded by inflation. However, when mortgage interest rates are variable (as they generally are in the UK) rather than fixed (as in the United States), they may rise painfully during times of high inflation as a result of macroeconomic policy efforts to slow the pace of economic growth. One of the reasons why the United States has long-term fixed mortgage rates is the financing provided by government-sponsored agencies such as the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, nicknamed, respectively, Fannie Mae and Freddie Mac. Economists increasingly debate their role, especially as they have grown into some of the world's largest lenders. Supporters claim that, as well as reducing macroeconomic volatility, they make housing more affordable, particularly for poorer people, and that other governments should play a similar role in the mortgage market. Critics say they have become a huge potential risk in the global financial system by creating a moral hazard through the controversial but widespread belief that if they were to get into difficulties the government would bail them out and, thus, their financial counterparties.
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- Industry/Domain: Economy
- Category: Economics
- Company: The Economist
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