Unaffordable housing is not just down to low interest rates (whatever clever economists may claim)

For years supporters of urban containment policies like the green belt and enthusiasts for more "strategic planning" have argued that Britain's high house prices were simply a consequence of low interest rates:

Another paper, this time from the Bank of England written by former MPC member David Miles and Victoria Monro, shows that the rise in house prices we have experienced since 1985 is mainly the result of lower real interest rates. The other, less important, driver is household income. Those two effects together can account for all the increase in house prices relative to inflation. The increase in house prices is not the result of a shortage of new houses.

This is from Simon Wren-Lewis, who is reliably wrong about most things and particulary wrong here but he gets cover from other economists and from this influential work in 1984 which modelled housing as a financial asset. Those of us who are not economists are always hesitant to criticise these wise folk but it did seem to us that, regardless of such clever modelling, the rules of supply and demand must apply to housing just like everything else.

It seems us non-economists might just be right after all - there isn't a straightforward link between house prises and interest rates:

In the decade from 1990 to 2000, UK house prices rose by just 30% while rates more than halved, falling from 11% to 5%. Then from 2000 to the start of the financial crisis in 2008, house prices doubled while rates barely budged. Since the crisis rates have fallen to just above zero and house prices have risen by a further 20%. They have remained flat in real terms on average.

So at the level of the whole nation there's a pretty weak link between interest rates and prices. This link gets weaker when regional variations are considered where the 'interest rates only' model underestimates the changes in prices in London and the South-East while overestimating price changes in the North of England. The real killer, however, is when we look at international comparisons:

We input actual data on average rents and interest rates for each economy and hold all other factors constant over time...for countries like Germany, Italy and the US, the model predicts house prices of more than double the actual level in the latest data.

The research finds that, while other asset classes like equities show remarkable international consistency, this is not true for housing suggesting that the financial model of housing markets (even a modified version of the original interest rates only model) is not reliable. The UK (and other places like Spain) with tightly constrained urban housing markets has a system that responds poorly to rising demand. Put more simply, more blame needs attaching to policies designed to constrain land supply, that require a long and risky approval process, and which place substantial additional costs on development. In short, the planning system.

The article from which these findings comes still wants to model housing as a financial asset but at least the matter of supply has become a real issue rather than being dismissed as "bad ideas, like ...house building is the answer to high house prices". Wherever we look, from the UK and Spain to Auckland or San Francisco, we see that artifically constrained land supply acts to drive up housing costs, in some cases to the point of extreme unaffordability.

In the Demographia Survey, virtually all of the major housing markets that are “severely unaffordable” have urban containment (such as urban growth boundaries and other policies that severely limit or prohibit new development on the urban fringe). Research in Australia, New Zealand, the United Kingdom and the United States has found comparable land values spiking 10 times and more across urban growth boundaries.

It really is time to reform strategic planning, put an end to urban containment as a policy, to scrap the green belt, so as to allow the housing market to function properly.

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