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Central Banks Should Consider Asset Prices

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Banks' rate policies 'risk disastrous crash'

By Philip Thornton, Economics Correspondent

Published: 26 June 2006

Central banks must carry out a wholesale revolution in the way they set interest rates to help avert a disastrous crash in the financial markets, the Bank of International Settlements warned today.

The BIS, known as the central banks' banker, said setting monetary policy to keep inflation low in the short term risked fuelling financial imbalances that could unwind suddenly, leading to a global economic slump. It urged policymakers to give greater weight to asset prices, lengthen their forecast horizon and use other regulatory-based tools to prevent asset price bubbles.

The comments are expected to ignite a vigorous debate on the issue especially among bodies such as the Bank of England that have rejected asset price targeting. In its annual report the BIS said: "The current conventional approach to the pursuit of price stability might need refinement. The Keynesian analytical framework, which remains the workhorse in the stable of most central bankers, needs modification."

It said banks needed a "much richer" set of indicators, particularly indicators of financial imbalances. This included external imbalances such as trade deficits and internal ones such as house price bubbles. "Over long periods of time, such imbalances can pose an even greater threat to price stability than shorter-tern and more conventional inflationary "pressures" such as output gaps," it said.

Central banks must carry out a wholesale revolution in the way they set interest rates to help avert a disastrous crash in the financial markets, the Bank of International Settlements warned today.

The BIS, known as the central banks' banker, said setting monetary policy to keep inflation low in the short term risked fuelling financial imbalances that could unwind suddenly, leading to a global economic slump. It urged policymakers to give greater weight to asset prices, lengthen their forecast horizon and use other regulatory-based tools to prevent asset price bubbles.

The comments are expected to ignite a vigorous debate on the issue especially among bodies such as the Bank of England that have rejected asset price targeting. In its annual report the BIS said: "The current conventional approach to the pursuit of price stability might need refinement. The Keynesian analytical framework, which remains the workhorse in the stable of most central bankers, needs modification."

It said banks needed a "much richer" set of indicators, particularly indicators of financial imbalances. This included external imbalances such as trade deficits and internal ones such as house price bubbles. "Over long periods of time, such imbalances can pose an even greater threat to price stability than shorter-tern and more conventional inflationary "pressures" such as output gaps," it said.

Independent Online

No shi'ite Sherlock!

Sounds far to much like common sense, hence likely to be ignored until its too late (which it probably already is).

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I know this is counter-intuitive, but it is my understanding that no link has been proven in the UK between changes in house prices and changes in interest rates.

If so then they'd be wasting their time trying to target asset prices (house prices).

If anyone has evidence to the country please point me in it's direction!

FF

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Before this drops off the page... anyone care to reply to my last post?

The link is very obvious to anyone who does not buy their house with cash.

For most people:

House = mortgage = debt = compound interest

Base rates are just one factor (allbeit the most important) of overall liquidity which is the main cause of inflation

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Clearly it is completely intuitive that house prices are linked to affordability. Evidence of this is that (according to my own work using quarterly land registry data and national statistics office average wage data) 30% of changes in average real house prices can be explained by changes in real average wages (this correlation is just about significant). (The link is that changes in wages hit the house price figures 6 months later - again, quite intuitive)

BUT.

Can I just emphasize this. BUT, BUT, BUT...

Can anyone show me that changes in interest rates have any link with changes in house prices? ie, can you show me two sets of data, correlated to show a significant causal affect? My work showed practically no correlation (1 or 2% when 30% is only just significant). My lecturer said this was what he expected.

It is completely obvious that the higher the height that you drop a cat from the more hurt they're gonna get. BUT, from low heights they are more likely to get hurt as they have no time to adjust their body positioning or prepare themselves for impact. Just because something is obvious doesn't make it right.

Why should the BoE try to control asset prices (house prices) because intuitively they can and it will be a good thing, when there is PRECISELY NO EVIDENCE that this will have any affect?

FF

ps, I am sure I am as sceptical about what I am typing as anyone else, but in the absence of any research or evidence to the contrary I can only assume what I am typing is right.

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Clearly it is completely intuitive that house prices are linked to affordability. Evidence of this is that (according to my own work using quarterly land registry data and national statistics office average wage data) 30% of changes in average real house prices can be explained by changes in real average wages (this correlation is just about significant). (The link is that changes in wages hit the house price figures 6 months later - again, quite intuitive)

BUT.

Can I just emphasize this. BUT, BUT, BUT...

Can anyone show me that changes in interest rates have any link with changes in house prices? ie, can you show me two sets of data, correlated to show a significant causal affect? My work showed practically no correlation (1 or 2% when 30% is only just significant). My lecturer said this was what he expected.

It is completely obvious that the higher the height that you drop a cat from the more hurt they're gonna get. BUT, from low heights they are more likely to get hurt as they have no time to adjust their body positioning or prepare themselves for impact. Just because something is obvious doesn't make it right.

Why should the BoE try to control asset prices (house prices) because intuitively they can and it will be a good thing, when there is PRECISELY NO EVIDENCE that this will have any affect?

FF

ps, I am sure I am as sceptical about what I am typing as anyone else, but in the absence of any research or evidence to the contrary I can only assume what I am typing is right.

You will not find correlating graphs.

Think about it, if interest rates were set very low say 1% for five years the IR graph would look flat yet a graph recording the real price of commodities or property would have a large upward movement due to this liquidity. If the interest rates were then increased gradually from 1% up to 6 or 7 % the rate graph would start to move upwards but the inflation graph will take time to respond, it would likely continue upwards a first but would eventually run out of momentum as yields begin to disappear.

It would then begin to flatten off or plateau out, capital gains would no longer exist and people counting on capital gains would have to cash out and try something else. People counting on yields would draw smaller profits and could probably find better returns elsewhere. Unemployment correlates more closely with house prices.

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You will not find correlating graphs.

Think about it, if interest rates were set very low say 1% for five years the IR graph would look flat yet a graph recording the real price of commodities or property would have a large upward movement due to this liquidity. If the interest rates were then increased gradually from 1% up to 6 or 7 % the rate graph would start to move upwards but the inflation graph will take time to respond, it would likely continue upwards a first but would eventually run out of momentum as yields begin to disappear.

It would then begin to flatten off or plateau out, capital gains would no longer exist and people counting on capital gains would have to cash out and try something else. People counting on yields would draw smaller profits and could probably find better returns elsewhere. Unemployment correlates more closely with house prices.

(1) So you are saying "low" interest rates raise asset prices (other things being equal), and "high" interest rates lower asset prices (other things being equal)? Makes sense. But there is no direct correlation (ie one month interest rates fall but this does not have a direct affect, it takes time for asset prices to respond)?

(2) You correctly (I think) point out that unemployment has a greater correlation with house prices than interest rates. As interest rates are used to slow the economy (increase unemployment - or the fear of unemployment which has a similar if less pronounced affect) then it would be my guess that any minor correlation betweeen IRs and house prices would be a knock on effect of the link between unemployment and house prices. Are you suggesting that high house prices are a bigger problem than unemployment? House prices are a problem but they are not a bigger problem than unemployment. If you are priced out and in a job you can at least rent somewhere nice... if you're unemployed then you have a low standard of living whether you rent or (temporarily, prior to repossession) own.

(3) Whilst I accept that the Gordon Brown miracle economy is not quite the miracle that he claims is it not possible that targetting inflation at 2% has increased stability and improved the economy? How far from the 2% target would you allow inflation to go whilst you're busy controlling house prices (assuming you can?) 2%, 5%, 10%?

(4) Basically I am saying that if there is no measurable impact (no correlation) then it is vey dangerous to set economic policy based on common sense. The BoE can clearly see the affect of IRs on inflation (if they couldn't they would not be able to keep inflation so close to target). This is working. They could not do this at the same time as targetting asset prices (which assets, what if oil prices started falling but house prices carried on rising, aren't equities assets - are we trying to bring the value of our companies down as well?)

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Using IR to target a particular asset price would fly in the face free trade and supply and demand, I am not suggesting that it should be done at all. After all inflation is a measure of asset price change.

I am saying that the recent housing boom is a side effect, if you will, of prelonged low interest rates, and a period of sustained growth.

I do not believe it will continue indefinately. The plateau is due to the market being on the brink of sustainability. People can just about afford current prices if they stretch themselves to the absolute limits.

i.e. Assuming interest rates will remain below 6% for the next 25 years.

In hindsight this will look like a ridiculous assumption to a lot of people. Most of whom are currently in their 30's and know no different.

The white elephant in all of this is the level of debt held by the UK public. The money that people are spending on houses in the current market is money that they will not spend in the future, as they will be servicing a debt instead of going to the high street. Meaning big job cuts.

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Intuitively there should two relationships:

1) A lagged negative correlation - crank up rates to 15% and you can be quite sure house price inflation will be lower after 2 years or so. Drop rates to 0% and house prices have historically gone up after a few years lag. (except in Japan...)

2) And a long term positive correlation - rates float on inflation separted by the real rate, and house prices are historically a good hedge for inflation. So if inflation (and consequently rates) rise, the price of houses should rise too, in the longer term.

Inflation rose dramactically in 1990, and rate rises forced house prices down, but in the 10 year term, that same (wage) inflation will allow house prices to rise, as people normally spend around 1/3 of their wages on their house.

I don't think you can just look at two time series and see an obvious correlation.

If rates stay low then HPI will remain at current low (close to zero levels)

Think the most stable relationship is the inclination of first time buyers to spend around 1/3 of their wages on their house.

Edited by no accountant

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  • 301 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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