Rising house prices are not necessarily good for the economy

The announcement today by the Royal Institution of Chartered Surveyors that house prices dropped slightly in July, month on month, has been taken by some as bad news for the economy. My view is that it is constantly rising prices that are bad for the economy and were a significant contributor to the present economic mess. Here's my reasoning.

House prices for years have been over valued because there is a significant shortage of housing and because mortgage lenders, until the credit crunch, lent multiples on income that were unrealistic but ended up fuelling house price inflation. Lending multiples of five times a person's income without the need to provide a deposit simply meant there was more cash swishing around in the system. Without significant increases in the supply of new houses, that extra cash was soaked up in house price rises.

House price inflation had the effect of pricing many lower income families out of the housing market. Former social housing was no longer available as much of it had been sold off without being replaced. In some areas of the country, former council housing was reappearing as holiday homes, blocking access to full time occupation for people needing to live and work in the same area.

Mortgage repayment before the credit crunch ate significantly into people's income. For many it was by a long way their biggest outgoing. If people have to spend large sums on mortgage costs, they had less to spend in other sectors of the economy and especially, less to save for the long term.

Some homeowners were drawn into treating the constant rise in house values as additional income and borrowed against house price inflation to pay for consumer expenditure. Whilst this had a short term beneficial effect on the consumer goods sector of the economy (and also sucked in too many imports), the consequence was the runaway borrowing levels that characterised the last decade. That massive private indebtedness is now a millstone around the neck of the economy.

Realistic pricing of housing means they start to become more affordable for young people, first time buyers and those on more modest incomes. There also needs to be a culture change in Britain towards the reasons for homeownership. Too often the ownership of a home is regarded as the best way to save and build up capital. That has diverted capital investment into already existing bricks and mortar that could have been invested in business and industry instead.

The problems surrounding housing in Britain are part of the structural problem of the economy. We need more housing, and especially we need more rented housing, both public and private. That's not a suggestion that the private sector should buy up more existing properties to rent them out. That will do nothing to address the lack of supply. The private sector needs to be building more homes purely for rent.

Softening of house prices will encourage individual investment in unproductive, existing bricks and mortar to go into new businesses instead. It makes the building of private housing for rent a more realistic option. In the long run this is good for the economy.