Bank of EnglandHousingInflationPoliticsRegional economies

Housing reflation and housing inflation – Alternative inflation …

As this is being written, in 2012,  squeezed living standards have been the norm in the UK now for a good many years. The lastest news indicates apparently that the global downturn is taking the pressure off food and energy prices.   

Rental prices for housing are still edging upwards although purchase prices are subsiding, and it is only the inflow of Greek and Chinese money into the upper end of the London housing market that is hiding this in national figures.

With our ‘double-dip’ recession the coalition government is now talking about using house purchase and house building to look to return us to some sort of ‘growth’. Whether in the coming years this will ease or increase the inflationary pressures on the population, would be clearer to all if we had an inflation index in this country that properly took housing, and especially owner-occupied housing, properly into account.

New Inflation Indices

House price inflation in this country has always tended to become apparent in one part of the country before going on to become a general phenomenon. And it affects some social strata before going on to affect everyone. That is why we have been calling for regional inflation indices in the UK and indices that follow the fortunes of different types of households. However, none of these indices would be any good unless housing was properly factored into these figures.

The Office for National Statistics (ONS) is currently doing a consultation on these issues. They are consulting on the formula for owner-occupied housing and the regional issue at the same time. You might have heard of the consultation on owner-occupied housing, but you will not have heard about the consultation on regional indices because it takes the form of a few sentences on the last but one page of  the document on the housing issue. And it says – let’s just forget about them.

This is something worthy of Sir Humphrey Appleby, the satirical character from the 1980s BBC comedy, who was endlessly inventive at stopping anything happening that he did not want to happen. Indeed earlier in his career, Appleby might well have helped kill off the idea of regional inflation indices, when in the early 1970s Whitehall decided not to follow the rest of the developed world, and much of the less developed world, in establishing them.

…so that things remain the same.

Sir Humphrey has also been involved in framing what we are being offered as a new national inflation index that will include housing inflation, and owner-occupation inflation especially. Over a year ago they were offering us a choice of 2 indices. But when you looked at them closely there was no significant difference between them. Below you will see a chart which shows these two choices. It is a very busy chart. The green and the purple lines represent the two ways of including owner-occupied housing  that were being considered until early this year.

The green line is the index that the ONS wants to use and is currently asking approval for. It is the line that is closest to the black line that is the current Consumer Prices Index. Indeed for most of the time shown here you will barely be able to tell them apart.  However neither the  green nor the purple index are significantly different to the current black index.

When inflation exceeds 3%,  the Bank of England can no longer deny a problem and must write to the Chancellor to explain it and what they are going to do. None of the indices in the chart above compel any such attention before food and energy prices create pressure during the final years of the noughties. None of these indices would have triggered an alert at 3 % during the UK house price boom which is shown at its most accelerated in 2003 –  indicated by the additional blue line on this chart. Indeed you can see house prices are actually falling (notice the scale on the right) when the indices cross the 3%  letter-writing  point.    Video update on these issues in 2018

However, the Sir Humphrey consultation document does not ask readers whether they think these problems might make these indices unfit for purpose. Instead the consultation asks a whole series of very technical questions that could be guaranteed to provoke the rival camps among statisticians that have variously been championing the green and the purple.

               

 Can you see the bubble ?

Indeed,when you say that the house price bubble should make some significant  presence in these figures for the early 2000s, the ONS says – well it is not a house price index. However, when you look at the US Consumer Price Index over the last decade, their house price boom is visible in that.

Very specifically the impact of the infamous US house price bubble is visible in the weights of the housing components of the US CPI.

This can be seen in the chart shown immediately below. The weight given to what they term ‘Owners equivalent rent of primary residence’  can be seen here  (in the red columns). It rises from 20%  as the US house price boom took off from 2001.  Had the price rise only been in line with either general inflation or popular incomes, this item would not have needed to be enlarged as a factor in US consumer price inflation.

But over the period 2001-2005, US average house prices rose by about a third in relation to median/average US incomes.  So this item came to play a bigger role than before in driving the US inflation indices up to levels that would provoke the US Federal Reserve to take action to address this by increasing interest rates. (It is now down to where it was in 2002 – as can be seen by scrolling down the current weights.)

Not in no UK index

The black columns are the weights that our UK Office for National Statistics wants to use in their new UK Consumer Price Index as they would be felt during the same period of our even bigger house price boom. They only go up from just over 10% to just under 11% of the index during this period.

This failure to properly pick up the housing inflation in the weights is why the ONS chart we have already displayed fails to pick up our even bigger UK house price boom in any significant way. We have previously quantified this boom from the particular standpoint of the West Midlands. Over the period 1997 to 2007, UK house prices doubled in relation to income. But any increase in the weights in the ONS’ proposal is barely visible, even if we charted the figures back to 1996.  That the weights are less than half the weights in the US index is a further flaw, because during all the period shown in our chart, house prices have been far higher in relation to income in the UK then in the US.

What should the ONS do now ?

The best thing is for the ONS to go back to the drawing board and sort out some proper weights for the new index.  To go ahead with this deeply flawed index, even as an interim measure, would be pointless given that it is basically the same as the existing CPI in most important respects. Worse, to go ahead with this index would give the public the impression that housing in the inflation index is a problem that has been solved, when it has not.

It is clear that the index the ONS is proposing, had it been available 10 years ago, would have done nothing to make the UK’s entrapment in house price inflation and huge private debt any less likely to have happened.  The doubling of UK house prices in relation to incomes was only brought to an end because interest rates around the world began to head upwards, when the US Federal Reserve began to push them up as their house price bubble began to be a problem in their index that could not be ignored. UK house price inflation was brought to a halt by the action of the US system –  not our own.

It was as if they put their brakes on, and because we had no proper controls over our system, we went straight into the back of them. How much better it would have been if we had had an index that had prompted us to damp down our house inflation before the Americans. Then we would not have ended up in this transatlantic pile up when they acted on theirs.

Andrew Lydon

LWM Regional Prosperity & Inflation Project

 

Video update on these issues in 2018