How The Housing Market effects the rest of the economy
- Housing is the biggest component of most household’s wealth. Therefore it has a big impact on the economy. The UK has one of the highest rates of property ownership in the UK. It is roughly 77% compared to 50% in France.
- Effect on AD.
If there is a “boom” (or increase) in the housing market then there will be a positive wealth effect as people enjoy capital gains. This will lead to an increase in AD, because people are more confident about the economy and some people will re-mortgage their house (equity withdrawal) to spend more money.
- If there is an increase in AD there may be a multiplier effect which causes the increase in AD to be bigger than the initial effect
Effect on Economic Growth (Real GDP)
- An increase in AD is likely to cause an increase in Real GDP, however this depends on the situation of the economy. In the below diagram there is spare capacity in the economy therefore there is an increase in Real GDP
- However if the economy is close to full capacity then the increase may only be small.
- Also the effect on AD depends upon other components of AD.
For example if taxes are rising or exports are falling this will keep AD low despite rising house prices
Effect on Inflation
- An increase in house prices will cause an increase in the cost of mortgages and therefore will lead to an increase in the RPI. Also the increase in AD could cause demand pull inflation, However again it does depend upon the slope of the AS curve and other factors in the economy.
- The MPC is responsible for setting interest rates. It is committed to keeping inflation within its target of RPIX 2.5% +/-1.
- If house prices are rising this may put pressure on inflation therefore they may be more likely to increase interest rates
- However house prices are only one factor affecting monetary policy
- High House prices could cause some workers to be unable to afford to but houses. High property values has caused a shortage of workers in London and the South East.
- Increased Supply of Houses: With High house prices there is a greater incentive to build new houses. Therefore house-building firms will do well.