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House prices are rising in many major economies. This FT series explores whether these increases are sustainable.
Inflation-obsessed central bankers are growing sympathetic to the plight of millions of buyers squeezed out of property markets by soaring house prices. Taking action, however, is another matter.
Janet Yellen, US Treasury secretary, spoke last month of her concern over “the pressures that higher housing prices will create for families that are first-time homebuyers or have less income”. She followed European Central Bank president Christine Lagarde, who acknowledged in June that “the disconnect between housing prices and broader economic developments during the pandemic entails the risk of price corrections”.
But because house prices are not directly included in the headline inflation measures that shape central banks’ mandate in advanced economies, those institutions are not required to seek to quell prices when they rise.
They have a mandate to maintain financial stability, but most do not see the housing market as a prime source of risk. Economists also cite statistical reasons for keeping house prices out of inflation measures.
Why doesn’t inflation include home ownership costs?
Statisticians have long resisted including house prices in headline inflation measures.
FT Series: Global house prices — raising the roof
House prices are rising in many major economies — but is it sustainable?
Part 1: How the pandemic has triggered the broadest global house price boom for over two decades.
Part 2: Buyers flock to smaller US cities, renewing policymakers’ concerns about affordability and risk.
Part 3: Netherlands grapples with the social consequences of rapidly rising house prices.
Part 4: Why Berlin’s renters want to expropriate their homes from Germany’s publicly listed landlords.
Part 5: Should house prices count in inflation data, and what can central banks do about the economic effects?
“A consumer price index aims to measure consumption, whereas the purchase of a house is the purchase of an asset that is not consumed in the same way as other items,” the UK’s Office for National Statistics said in 2016 when it assessed its coverage of housing costs in inflation.
That view is held by all the world’s leading statistical agencies.
Just as they exclude changes in the value of other investments such as equities, bonds, bitcoin or gold, they do not want to include the investment element of home ownership, particularly the cost of land.
But that leaves the housing services acquired by buying a home — shelter, living space, location and security of tenure — out of many official inflation statistics.
How could it be done?
Statisticians agree there is no perfect solution. Conceptually pure methods proved unmeasurable in practice and practical measures suffered from theoretical defects.
The US statistical authorities estimate the change in the notional rent of homes people own. They argue that rental cost is the best estimate of the consumption of housing services, even though rental trends often differ significantly from house prices.
This “rental equivalence” method was also adopted by the UK in 2017.
The EU has taken a different approach. Eurostat and the ECB prefer a “net acquisitions” method that seeks to measure the changing price of purchasing homes but not the land on which they are built. They are still struggling with how to split house prices into dwelling and land.
By 2007 then-Bank of England governor Mervyn King commented that the project “doesn’t seem to be going anywhere very quickly” — and not much has changed since. Lagarde has conceded that any change will take several years to come into effect.
What effect would it have?
Much less than rapidly rising house prices might suggest.
The UK’s ONS found that a net acquisitions measure would have risen 65 per cent faster than a measure based on rental equivalence between 2005 and 2020. But given the many other parts of the basket of goods and services used to calculate headline inflation, this had only a minimal impact on the overall pace of price growth.
An alternative approach, used in the UK’s out-of-date retail prices index, is to use house prices alongside mortgage interest rates to determine the monthly cash payments associated with home ownership. On that measure, housing would drag inflation down over the past 15 years because interest rate cuts since the financial crisis have pulled mortgage costs to historic lows.
Lagarde has said the impact on overall eurozone inflation of including owner-occupied housing would be “quite minimal”. “There are periods of time when those consumer costs are a bit higher and there are periods when it is a bit lower,” she said.
Richard Barwell, head of macro research at BNP Paribas Asset Management, said: “It’s unlikely to be a game changer for monetary policy, will take a long time for Eurostat to implement and in the meantime, it’s unclear how the ECB will take housing into account in its decisions.”
Should central banks’ mandates change?
Earlier this year New Zealand became the first country to require its central bank to assess the effects of its monetary policy decisions on the government’s objective of supporting more sustainable house prices.
That initially appeared to be a significant change that would require rate rises if prices continued their recent rapid growth.
In practice, however, the Reserve Bank of New Zealand has interpreted its new mandate narrowly: to intervene when house prices are deemed unsustainable. In its May monetary policy statement, it defined sustainability as not being in bubble territory and declared that “structural factors explain high house prices” and low interest rates made higher prices sustainable.
Although it ended its asset purchase programme in July, Francesco Pesole, an analyst at ING bank, said the RBNZ “made no explicit reference to house price inflation”, though house prices “might have played a role”.
Other governments seeking a quick fix to the problem of rising housing costs face the same dilemma: raising interest rates to control house prices risks fuelling unemployment and depressing living standards, thereby undermining financial stability. Lagarde has described it as a “balancing act”.
So governments and central banks will probably continue to fret about affordability — but with only limited ability to tackle it.