US and UK house prices
There are number of reasons for peculiarity of Housing markets. First, houses take time to build, so when demand rises, supply can only respond with a significant lag. Basically the short-run supply of housing is fixed. Second, houses are a plus point that pays an implicit income, so the value of the house should reflect expectations about future rents. But house-ownership in the UK is so pervasive, a house is most households’ most important asset and since prices can go down as well as up, households are uncovered to a considerable amount of risk.
Unluckily, it is not possible to offset this risk because nobody offers insurance for fall in prices. The housing market is also bound up in a mesh of institutions, like all markets, and these institutions differ noticeably across countries. All over the world, housing markets divide into three main types. Firstly, exemplified by the UK, most mortgages are at variable interest rates, loan-to-value ratios tend to be high and re-mortgaging is easy.
Secondly, exemplified by the USA, most mortgages are at fixed interest rates, loan-to-value ratios tend to be slightly lower, but re-mortgaging is still easy. Thirdly, exemplified by Germany, most mortgages are at fixed rates, but loan to value ratios are low and re-mortgaging is complex. But in countries like Germany and Italy, a much bigger proportion of the population chooses to rent rather than buy.
The difference between housing markets tells the instability and determinants of house prices will be different in different countries. For example, in German markets short-term interest rates are not very important, but more important in UK and US markets. It can seen from the recent work by the Bank for International Settlements which suggests that a 1% point rise in the short-term real interest rate would reduce house prices over a five year period by 2. 6% in the UK, 1. 3% in Germany, and 1. 8% in the US.
Many models of house prices find strong positive effects from recent rises in house prices and that there are negative effects from high levels of house prices. Above effects mean that house price rises lean to build up a impetus of their own until eventually they become simply too high for the customary economic conditions and then they reduce noticeably. Some countries are more vulnerable to these effects than others.
But, over the long-run, household earnings is the key factor for determining of prices. And there is general conformity that the real cost of house will depend on expectations of future house price movements; there is little conformity in which such expectations should be modelled. Basic expectations of future house prices are not offered and thus some approx measure has to be used. The simplest way is to substitute present or past inflation as a proxy for future expectations in the cost.
It is also possible to use predicted values from a waning of present house price inflation on a more extensive lagged records. Hendry (1984) gives this approach and suggests that agents should be supposed to have sensible expectations that are not fully competent rather than rational expectations, since the latter impose extreme records. Meen (1990) argues that both of the approaches in which expectations are approximated by a measure based on past behaviour.
Mostly, the ex-post future rate of house price inflation can be used in place of the ex-ante expectation. According to the Barker Report, a protracted supply response was largely responsible for the brawny upward trend in UK house prices over the longer term. Availability of land is the key of undersupply. In some regions, not enough land is allocated for development and the rate of land release is not responsive to market conditions and rising house prices.
The Barker Report suggested positive changes in the planning processes and structures to help simplicity the problems of land availability. House prices rose for the sixteenth consecutive month in February and the pace of increase moderated with prices up at the slowest pace since last May. Most of the country is experiencing modest house price rises with important increases only evident in South East England, Scotland and Northern Ireland.
Demand is showing further symbols of weakening in light of recent interest rate rises, though supply conditions are rigid due to the underlying potency of the economy. Muellbauer and Murphy make an annual model of UK house prices to explain why booms (rise) and busts (fall) occur. For example, The 1980s boom saw a 40% rise in house prices relative to incomes in 1981-89, and huge investment returns to heavily-borrowed first-time buyers.