Introduction
Housing issues have assumed greater importance recently due to the increasing housing prices in the UK. Residential housing market in the UK has observed dramatic rise in prices between the 1990s and 2007. This led to a large increase in the equity for homeowners, and made homeownership too expensive. However, the recession of 2008 in the UK has had a negative effect on the housing market. The prolonged recession has led to rise of housing prices, as well as increase in household debts (Chamberlin 2009). The upheaval in the UK housing market has resulted due to the strong cycles that have occurred in case of housing and residential construction. Further, there has been a structural change in the housing demand in the UK. Housing prices in the UK faced sustained downfall since the early 1950s however, from the mid 1950s there was a steady rise in the housing prices in the UK. It was in the 1990s that has had been a fluctuation in the rise of housing prices, which fell in some quarters and had very low growth rate. Overall, the 1990s saw a small rate of housing price growth. From 2000 until present, there has been a dramatic rise in the housing prices. Thus, there has been almost a cyclical variation in the housing prices.
Housing markets are supposed to have a sharp relation with overall economy and are susceptible to business cycles (Meen 1996). There has been a number of studies that have studied the correlation between housing and macroeconomic indicators. For example, studies have tried to find the relationship between labour market and housing and consumption (Bover, Muellbauer & Murphy 1989), credit deregulation and housing decision (Miles 1992), and developing macroeconomic models in order to capture the relation to housing decision in UK during 1980s and 1990s (Meen 1996).
Ewinga & Wangb states, “The housing market and the aggregate economic activity are linked.” (2005, p. 187) Economics suggest that changes in real output of the economy may have an effect on housing starts. When the economy is in an expansionary mode, there will be more purchases of new homes while during recession, there will be a decrease in the purchase of normal goods like houses (Ewinga & Wangb 2005). When there is a rise in the aggregate price level, overall prices rise in the economy, making the purchase of goods and services costlier. If furniture, interior fixtures, etc. are considered to be complementary goods, then higher price level will lower the demand for houses also, thus putting downward pressure on residential housing starts.
Monetary policy too may have an effect on housing starts. Unexpected changes in monetary policy may have an effect on housing starts (Ewinga & Wangb 2005). If there is a tightening of the monetary policy will increase the cost of loans and therefore reduce demand for housing. However, theory suggests that the effect of expected monetary policy has a neutral effect on housing starts (Ewinga & Wangb 2005). Therefore, a higher interest rate will not reduce housing starts through Fisher effect as the real cost of acquiring loans may remain unaltered even after a rise in the price level.
Housing starts may have high effect from other macroeconomic indicators like GDP. A study conducted by Ortalo-Magne and Rady (1999) shows that there in the UK and US, housing prices are more volatile than gross domestic product (GDP) and the former is less volatile than the number of transactions in housing markets. However, there is a specific correlation between the three variables. Therefore, it is believed that in the residential housing investments are more affected by the GDP change. Further, a positive relationship between rise of population and housing prices has been established (Jud & Winkler 2002). Further relation between changes in real income and housing demand also exists (Jud & Winkler 2002).
Other macroeconomic factors like mortgage rate, money supply, employment, inflation, etc. have an effect on the housing prices and the construction of new houses. It is believed that when there is a rise in inflation, there will be a downfall in demand for houses. Further, there is a relationship between interest rates and mortgage interest, which ultimately affects housing prices. Further, increased construction raises demand for labour and thus reduces unemployment, while a downfall in real estate activity increases unemployment growth (Apergis & Rezitis 2003).
Mortgage interest rates are important start as they have a direct effect on the buying decision of the buyers. When the mortgage rate increases, people are apprehensive of taking a house loan and therefore decide against buying a house. This in turn reduces demand for houses. Therefore, it is important to understand what can be the expected trend of housing especially in the residential housing sector in UK and how it is affected by the macroeconomic factors during 1990s and after 2007.
Methodology
This aim of the study is to understand the relation, in any, between macroeconomic factors and residential housing starts. Then the study will undertake a comparison of the effect between the two in the 1990s and 2000s. The paper will empirically investigate the relation between different macroeconomic indicators like GDP, gross disposable income, inflation, interest rates, unemployment, and population. These factors will be used to see a relation with housing starts like housing prices, mortgage rate, housing transactions, affordability index, etc. The study will compare the macroeconomic effect on housing starts in the early 1990s and after 2007. The is collected from the website of the UK government’s Office of National Statistics (2010).
Quarterly data from first quarter (Q1) 1990 to fourth quarter (Q4) 2009 is collected for gross domestic product (GDP), Bank of England interest rate (IR), consumer price index (CPI), and unemployment rate. The housing statistics are queried from Office of National Statistics on prices of the houses both seasonally adjusted and non-adjusted prices on quarterly basis.
UK Residential Housing
A key feature of the UK residential housing plan is provided in this section. Dwelling prices rose in UK almost from 2005 and 2006. There has been an increase in owner occupied buildings in the UK since 1981 and 2006, however, there has been a decline in owner occupancy between the year 2006 and 2007. Figure 1, shows that there has been a fall in the housing prices start falling from Q1 1990 through Q4 1996. However, there has been a rise in the housing prices from Q4 2006, after an intermittent fall from Q1 2005 to Q4 2006.
The red line shows the quarterly change in housing prices. The change in the housing prices shows that prices had reduced in 1990 in all four quarters, however, there has been a again a rise in the prices in 1991, and the change in prices has followed a cyclical trend through 1996. After 2007, the percentage change in housing prices fell through Q4 2008, and it started rising again from Q1 2009 through Q4 2009.
The affordability index for the housing sector in UK is derived as mortgage payment as a percentage of take home pay of the individual. Figure 2 shows that the affordability index shows that there has been a fall in the index Q1 1990 through Q4 1995. This followed the same trend as that of the housing prices. Further, after 2007, the index started rising until Q1 2008 after which it started to fall until it became moderately stable in Q1 2009 and thereafter. After 2007, the affordability index has followed a definite trend similar to that of the housing prices.
From the brief understanding of the housing statistics of UK in early 1990s and after 2007, it is clear there has been different trends in the change in the prices of housing as well as the affordability of the people. The question that arises is that why such a change in the trend has occurred and how the effect of the factors two distinct periods comparable.
Macroeconomics and Housing Sector
The brief review of literature and macroeconomic theory has demonstrated that there is a definite relation between macroeconomic factors and housing statistics. Therefore, it is essential to understand what kind of relation exists between the two and how the effects are comparable in early 1990s and post-2007.
A simple correlation analysis between the quarterly housing starts and macroeconomic indicators taken for UK during the period i.e. 1990 to 2009 gives the following table (table 1).
Table 1: Correlation Analysis
Table 1 show that there exists a positive relationship between GDP and housing prices in the UK for the period under study. The correlation is fund to be 0.96, which is a strong correlation as it is close to 1. Further correlation between real housing prices and GDP is 0.99, which shows a very strong positive relation. Therefore, it can be intuitively deduced that as there is an increase in GDP there will be an increase in the housing prices. However, there is a negative relation between GDP growth rate and Housing Prices. The correlation between the two is found to be -0.26, which shows that when the GDP is growing, residential housing prices are falling. Further, the data analysis also shows that with GDP growth increase, affordability index falls, and vice versa as they too have a negative relation of -0.11. However, affordability index has a positive relation with GDP over the period. The relation with GDP is explainable, as people tend to buy more when there is a higher GDP i.e. the overall productivity of the economy increases. Nevertheless, the relation with GDP growth rate is a paradox, as according to the economic theory, when the economy expands, the overall economic situation of the economy better, and people have higher affordability. However, in case of UK, it is demonstrated that with economic expansion, the affordability of individuals falls, and so falls the housing prices.
Housing prices have a negative relation with unemployment rate with correlation being -0.65. This is a strong correlation indicating that when unemployment increases, the prices of the houses fall. Intuitively, when there is a rise in the unemployment rate, the general affordability of the individuals fall (correlation between affordability index and unemployment rate is -0.47), indicating a lower demand for houses as people have less disposable income at hand. When demand for houses fall, there is a rise in prices of the houses, as residential houses are assumed to be normal goods.
Housing prices have a strong positive relation between CPI as well as CPI for housing and related goods. This implies when the price indexes for consumer goods increases, there i.e. inflation increases, housing prices also inflates due to the influence of the inflation. Further, higher prices of other goods also pushes up the prices of the related goods like furniture, construction material, etc., which pushes the price of houses.
Now the effect of the monetary policy is seen on the housing prices. There is a negative relation between bank rate and housing prices (correlation is -0.55). When the central bank increases the bank rate, it tightens the flow of money in the economy through monetary mechanism. Tightening of the economy leads the commercial banks to lend less money to the people, who too try not to take loans as they become dearer. Therefore, due to less incentive to take loans, the demand for housing also rises, therefore pushing down the prices. Similarly, when bank rates are increased, there is greater money flow in the economy, resulting in greater availability of loans at cheaper rates, which induces consumers to buy houses. As demand for houses increases, prices are pushed up.
Another correlation between disposable household incomes is done with the housing prices. Disposable household income is the amount of money that is left of the household income that can be spent by the household. In this case, there this measure is taken for households and not for individuals as the decision to buy a house depends on the household decision and not on the individual. Further, the purchase will affect the household expenditure and income. The correlation analysis shows that there is a strong positive relation (correlation being 0.93) between housing prices and household disposable income. This indicates that as disposable income of the households’ increases, there is a greater demand for houses as people have greater leisure and money to buy houses. An increased demand will increase the prices of the houses.
Comparison between 1990s and Post 2007 Macro Effect on Residential Housing
This section will compare the housing starts with the macroeconomic indicators of the country during two distinct periods. First is early 1990s, which is taken to be from 1990 to 1995 and post 2007 implying from 2007 to 2009. Quarterly results for these periods are analysed to see how similar or dissimilar are the effect of the macroeconomic factors during the periods.
Table 2:
Table 2 shows the correlation between the housing starts and macroeconomics factors under consideration for the two periods. The table shows that in early 1990s the correlation between GDP and housing prices was -0.75 indicating a strong negative relationship. Therefore, when GDP increased there was a decline in the prices of the houses. In addition, a correlation between GDP growth and housing prices gave a positive relation of 0.26 indicating that when the economy expanded the housing prices also rose, although weakly. Real housing prices also fell with a higher GDP growth rate (correlation being -0.45).
In post 2007, GDP shows a weak positive relation with housing prices (correlation is 0.18) and a strong positive relation with GDP growth of 0.75. Therefore, after 2007, when the GDP rose, the housing prices fell and vice versa. Thus, in 2007 when the GDP of the UK rose, with a positive growth rate, there was a rise in the prices of housing from Q1 2007 through Q2 2008. From Q3 2008, the GDP started to fall, and so did the growth rate and therefore there was a fall of housing prices in the period till Q2 2009, after which there were consequent rise in housing prices, GDP, and GDP growth rate until Q4 2009.
In other correlations, in both the periods similar results are observed. However, inconsistency is observed between the correlation analysis of table 1 and that of table 2. First, in case correlation between disposable income and housing prices, table 1 shows a positive correlation (correlation is 0.93) while that for early 1990s is -0.84 and for post 2007 is -0.78. Correlation between CPI and housing prices are found to be positive in case of the overall period from 1990-2009. However, in early 1990s, the correlation of -0.89 and -0.83 for the post 2007 period is found. Similarly bank rate is fund to have a negative relation on housing prices however, in early 1990s and post 2007 period, bank rate have a positive relation to the housing prices. Employment rate had a negative correlation with housing prices in both early 1990s and post 2007. This result is consistent with the overall data correlation found in table 1.
The above analysis brings forth three pertinent questions to the analysis:
- Why there is a difference in correlation between housing prices and GDP in the two periods i.e. early 1990s and post-2007?
- Why differences in the correlation sign for housing prices and CPI, bank rate, and disposable income for the two periods in table 2 and the overall correlation found in table 1?
- Are there any other macroeconomic factors that may have affected residential housing prices during the two periods?
Macroeconomic Effect – Discussion
In the 1990s, the economy was in recession, it continued until 1992, and from 1993, the economy started to recover. Observing figure 3 shows us that the trend of movement of GDP and housing prices are same. In the early 1990s, the UK economy was facing a recessionary face, and there was downfall in GDP growth. It was then that the housing sector saw a fall in housing prices. During this period, there was rise of inflation and a fall in affordability index. This showed that during the period, individuals had less income to pay back the mortgages. In the early 1990s, there was a housing market crash and it was due to house prices boom and a decline in the mortgage arrears (Figueira, Glen & Nellis 2005). This resulted due to a constantly turbulent housing market in the 1980s when the housing prices rose continuously. During the early 1990s, the stagnation in the UK economy led to a downfall in the prices of houses. However, after 1995 the UK economy started growing at a steady pace, with falling unemployment rate. Further, it was then that the GDP growth rate also started increasing. It is believed that the deregulation of the financial market in the second half of the 1980s and the credit rationing were the key drivers of the boom of the 1980s and bust of 1990s housing market (Figueira, Glen & Nellis 2005). Further, there was rising income during the period and increased incentive to provide housing mortgages to compete in the deregularized environment led to the rise in housing prices in the 1980s.
In early 2007, the UK economy started facing higher GDP. However, there was rise in the unemployment rate. Further, the affordability index during the period saw a sharp downfall, indicating that people could afford houses less. The reason could be two fold – recession and phenomenally increasing housing prices. The monetary policy was restricted by the Bank of England in the early 1990s to combat the recession, caused the weakening of the housing markets. Therefore, there were fall in the housing prices in the 1990s and it continued until 1995. Further, the recession also made affordability a problem as households failed to meet the mortgage repayment terms (Figueira, Glen & Nellis 2005). This is represented through the decline in the affordability index.
In 2007, the UK economy again faced a downward spiral in its business cycle (OECD 2009). This resulted in a full-scale financial and banking crisis in the UK and internationally. The financial system of the UK was susceptible to the international financial turmoil. There was rise in the consumer price index indicating an overall increase in the prices of consumer goods. Therefore, inflation was high in most cases. The bran rate was reduced, thus following a tight monetary policy to face the recessionary pressure. The affordability index dropped sharply. The reason was that households did not enough saving to disposable income to afford the mortgages (OECD 2009). The unemployment rate also increased resulting in lower income. With housing market in UK already in boom, and residential house prices skyrocketing, demand for houses reduced. This led to the subsequent fall in the housing prices in the post 2007 period.
Conclusion
The study shows that the macroeconomic factors that affected the housing market substantially are GDP, bank rate, inflation, and unemployment rate. Research has shown that the UK economy is highly susceptible to the volatility of the housing market cycles (Cooper & Britton 2003). This has been observed in the analysis for both the 1990s as well as the 2007. In early 1990s and in 2007, the UK economy went into a recessionary phase. The housing market boom in the country in the late 1980s and in the 2000s was due to the increased credit availability. In the 1980s, the increased credit availability was due to the opening of the financial sector in the country, which led to higher competition and greater availability of mortgage. Whereas in the 2000s, the reason for strengthening of the economy, which led to higher disposable income, and greater availability of loans. Ultimately, in both the phases, there were boom in the housing prices, higher inflation, and unemployment rate and negative growth of the economy. There in both cases, recessionary pressure, leading to lower GDP growth, and increased inflation, led to a downward pressure on the disposable household income, further, the tightening of the monetary policy, was also responsible to make the availability of credit less, which led to a reduced affordability index. Thus, with less income, and credit availability, demand for houses fell, and subsequently prices.
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