Is it time for a house price target?

by Ken Gibb

An interesting development this morning with the RICS, flush from their Commission that reported earlier in the summer (see my post on 25 June: Does the Housing market constitute a wicked problem? ), launching a proposal for a house price cap of 5% and the suggestion that the Bank if England’s new Financial Policy Committee should use its powers to corral house prices. I have only had the briefest chance to read the report so apologies if there are errors of detail.

I should lay my cards on the table in that I have been arguing for some time that the long term goal ought to be real house price stability i.e. a target of house price inflation matching general price inflation over the piece. However, it is quite one thing to say that is what you want to see and quite another to argue that it can be done with a cap, with the instruments available and in the specific context of the contemporary UK housing market.

Tony O’Sullivan and I discussed this practical question yesterday. Before we get on to that, what exactly did the RICS Economic Research piece actually say? They want an explicit house price inflation policy wherein the BoE uses macroprudential tools such that an annual growth rate threshold for national house prices is set [at 5%] and, if exceeded, triggers the use of these ‘tools’. The objective is to ‘anchor private sector house price expectations’ and row back on excessive risk taking and consequent financial imbalances. RICS go on to say that this should be part of a wide package.

Yesterday the Governor of the Bank told a Commons Committee that he had policies to address excessive housing market activity likely to lead to bubbles and singled out 1. placing additional capital requirements on mortgage lenders for that part of their business and 2. asking lenders voluntarily to set upper limits on loan to value and loan to income ratios.

Tony O’Sullivan and I thought the following about the proposal:

  • A long term policy objective of zero real house price inflation at zero is the only non-distortionary policy that can effect stability between housing and the rest of the economy. Achieving this would make a major stride to normalising the dysfunctional housing market. There should not be an arbitrary target. The BBC (Stephanie Flanders) made the point this morning that there are also blunt regional impacts of a national policy – all the more reason to seek out regional measures of general price inflation (but that is another story). RICS do look favourably on regional targets and policy responses.
  • However, suggesting this policy now as a means to correct or limit the impacts of another bad policy (help to buy 2) is not good policy making and likely to have unintended consequences.
  • Critical here is the ability of the banks to overcome and avoid the Bank’s pretty limited tools (as suggested above). To be fair, the RICS report is also sceptical of the Bank’s policy ‘armoury’. However, we are concerned that the prime policy levers of the capping of ratios are precisely the areas that the Governor does not want to pursue on a mandatory basis and this is exactly where lenders may find innovative ways to avoid the limits.
  • There are mixed messages here about whether or not to lend more or indeed to try to micromanage the composition of total lending, which does sound like considerable optimism bias on the part of the policy designer that is 1. desirable and 2. possible in the real world. Demand management of lending in a still generally weak real economy recovery is also fraught with difficulty – the age old balancing act between recovery and unsustainable bubble.
  • Finally, as RICS says, there needs to be a package of complementary policies and we would emphasis long term measures to expand and render more elastic housing supply.

So, the real question is not whether the Bank should care about excessive house price growth but how to intervene safely and swiftly. Key to this is whether capital requirements can be supplemented by measures like lending ratio caps on a mandatory but credible basis – the current tools do not look enough.  Second, there has to be a series of important supply-side measures and other policies that will stabilise the housing market on a long term path and reduce its potential attraction as a speculative asset.