QE & inflation/deflation

tomterm8

One thing to note is that an individuals personal rate of 'inflation' can vary significantly from the published figure... the published figure is meant to represent the rise in aggregate prices accross the whole economy. So, it is not unusual for people to experience marked differences between the inflation rate, and the actual increase or decrease in the costs of goods and services they buy.

fc123

The recent house price inflation since the mini-crash isn't really to do with general inflation.
Houses are financial assets rather than goods and services, and so they behave in quite different ways.
The recovery in the price of houses has much more to do with the fact that the BoE base rate was slashed to unprecedentedly low levels, which makes borrowing big sums of money seem cheap and so allows people to indulge their demand for housing more than they otherwise would.

Thanks for that..... I get that too....so...

I still don't get the chicken and egg thing with IR's and Inflation.

Inflation goes too high so IR's go up to dampen it.
If Inflation is 'controlled' and stays at lowish levels, will IR's stay low too?

fc123

tomterm8 wrote: »

One thing to note is that an individuals personal rate of 'inflation' can vary significantly from the published figure... the published figure is meant to represent the rise in aggregate prices accross the whole economy. So, it is not unusual for people to experience marked differences between the inflation rate, and the actual increase or decrease in the costs of goods and services they buy.

My shop used to be surveyed every month by a lovely retired FA (who used to curse the gizmo they had to use) for CPI.
It was a PITA as it couldn't cope with the variatons in fashion....we would have JUMPER; Price, brand and fibre content. When it sold out it had to be replaced with a comparable item...but sometimes we had to 'invent' one as exp trims affect retail pice or shape (loose or fitted...less or more cloth affects end price) and so on.

princeofpounds

I still don't get the chicken and egg thing with IR's and Inflation.

Inflation goes too high so IR's go up to dampen it.
If Inflation is 'controlled' and stays at lowish levels, will IR's stay low too?

It is chicken and egg, that's always the tricky thing with economics. It doesn't start at one point and end at another, it just keeps going round and round.

But to answer your question more specifically, you are basically right. There's lots of details about interest rates over different timescales and the correct measure of inflation and so on, but that's the general idea.

What really matters with interest rates is not the number you hear about on TV. That is the nominal interest rate, but the real interest rate is the important number. The real interest rate is the nominal interest rate minus inflation.

Interest makes paying back money more expensive. Inflation makes it cheaper, because the value of the money you will pay back in future is degrading. So if inflation goes up, interest rates go up because lenders want more compensation for letting you borrow their money.

One caveat on that - in the system we currently use for our money the interest rates are nor purely set by the market but determined by central banks. So those banks can modify the behaviour of this relationship and they do so in an attempt to smooth the economic cycle. There's still plenty of debate about how well this system works, although most economist support it in broad terms.

HAMISH_MCTAVISH

princeofpounds wrote: »

The recent house price inflation since the mini-crash isn't really to do with general inflation. Houses are financial assets rather than goods and services, and so they behave in quite different ways.

True.

The recovery in the price of houses has much more to do with the fact that the BoE base rate was slashed to unprecedentedly low levels, which makes borrowing big sums of money seem cheap and so allows people to indulge their demand for housing more than they otherwise would.

Untrue.

The reality is that the effective rate paid by new borrowers, for new purchase of housing, is little changed from what it was in 2005 to 2007. Therefore borrowing big sums of money seems little cheaper today than it did then.

The unprecedentedly low levels the base rate was slashed to have not really impacted new borrowers as bank margins have risen to compensate, and of course, most existing mortgages, which have been impacted, are in the vast majority of cases not portable. Therefore the impact of low base rates on new purchase is negligible.

The supply and demand argument is far more compelling than the low rates argument for recent price rises.

tomterm8

HAMISH_MCTAVISH wrote: »

True.
Therefore the impact of low base rates on new purchase is negligible.
.

In fact, I would have thought with inflation significantly lower than 2005/6, it may actually be more expensive for new mortgage holders now than it was then.

My feeling is that it is a 'supply' issue rather than a demand issue... that is, the crash wiped out a lot of the housing developers, and prevented new homes being built due to credit issues, and so little new housing is coming onto the market.

But I'm probably the least informed of the people on the site in terms of housing issues, so take my opinions on it with a grain of salt.

princeofpounds

The reality is that the effective rate paid by new borrowers, for new purchase of housing, is little changed from what it was in 2005 to 2007. Therefore borrowing big sums of money seems little cheaper today than it did then.

The unprecedentedly low levels the base rate was slashed to have not really impacted new borrowers as bank margins have risen to compensate, and of course, most existing mortgages, which have been impacted, are not portable. Therefore the impact of low base rates on new purchase is negligible.

Actually, Hamish is right here but there is a detail in here I was trying not to get into in order to avoid overcomplicating things.

Banks need a profit margin on top of the rates at which they lend to the government. This is because mortgages are riskier than lending to a government that controls the money supply. Because banks were in such trouble recently and were not able to lend much they were not competing much at all with each other. So mortgages became very expensive relative to base rates, but at the same time base rates were cut so the net effect on the borrower wasn't that different.

But you shouldn't just consider the apparent pricing of a single unit of credit. You have to look at availability, which collapsed. Although the price of the credit that was made available remained roughly constant, credit as an aggregate commodity was far more expensive (or valuable if you are the one that can extend it) because less was available at the same price. That's actually a matter of the suppy curve rather than simply price, but price is nothing more than a signal of scarcity of supply.

I would also argue that there are a lot of expectations bound up in decisions like house price purchases, so that prices at any given moment in time are much less interesting than people's expectations of the future. So when the crisis hit, people were afraid that house prices would continue to fall, unemployment would rise, the currency would devalue and inflation would set in along with consequent high interest rates. When the policy stimulus came along and got traction, it was evident that some of those expectations were overdone, so the recovery in those expectations also helped.

The supply and demand argument is far more compelling than the low rates argument for recent price rises.

Here I differ (assuming you mean physical supply and demand). I would contend that the availability of credit has always had a much stronger effect on house pricing since it became the primary method of financing property purchases. But that is another argument (which i'm willing to go into in another thread when I get the time, I'm not trying to dismiss it and its a valid viewpoint).

HAMISH_MCTAVISH

tomterm8 wrote: »

My feeling is that it is a 'supply' issue rather than a demand issue... that is, the crash wiped out a lot of the housing developers, and prevented new homes being built due to credit issues, and so little new housing is coming onto the market.
.

Corrrect, and of course you can add to that pressures from reduced output from those that survived, a land bank bought at higher prices and not economically viable to be sold until prices recover, etc.

Furthermore supply of existing stock has been at low levels, for a variety of reasons, people not wanting to move off existing good mortgage deals for one, millions in or close to negative equity so selling at reduced prices is impractical, etc.

And the demand side has also increased,, with mortgage approvals up 100% in the last year.

My gut feeling is that demand is more or less constant, provided mortgage funding is available. It was the lack of mortgage funding and rationing of what was available that caused prices to crash. As funding has increased, so have prices.

We know population is increasing by approximately 400,000 per year, and new additional household formation is around 250,000 per year, but new housebuilding is only at 80,000 this year. There is a certain amount of available stock in the system at any time, (which is neccessary for things to function smoothly in both the rented and sales market) but with such little housing being built, the existing stock is being consumed faster than replacement stock becomes available, and therefore available stock is decreasing, leading to upwards pressure on price.

This is supported by the total number of houses available for sale decreasing from 1.1 million pre-crash to just 640,000 today, and RICS reporting that new rental instructions are also at all time record low levels.

princeofpounds

And actually Tomterm makes a useful point about inflation, which is one of the things I was alluding to when I mentioned the importance of expectations but didn't really think to expand on as it is a key reason why expectations are so important.

Effective nominal interest rates for mortgage payers aren't that different to pre-crisis levels, but don't forget that pre-crisis inflation expectations were much higher than during the crisis. So the likely future *real* cost of the mortgages increased in people's perception - people were even anticipating deflation. As inflation expectations returned with more confidence in the economy and a belief that money supply would be increased that same debt in real terms was perceived to be cheap again.

StevieJ

From the horses mouth, so to speak.

http://www.bankofengland.co.uk/monetarypolicy/assetpurchases_stream.htm

BTW I didn't realise that Stephanies dad was one half of that immortal partnership that produced such classics as:

[FONT=arial, helvetica, homerton]A year ago last thursday, I was strolling in the zoo
When I met a man who thought he knew the lot
He was laying down the law about the habbits of baboons
And the number of quills a porcupine has got
So I asked him "What's that creature's name?" and he answered "That's a helk!"
And I'd have gone on thinking that was true
If the animal in question hadn't put that chap to shame,
And remarked—"I ain't a helk—I'm a gnu! [/FONT]

[FONT=arial, helvetica, homerton] I'm a gnu—I'm a gnu
The g-nicest work of g-nature in the zoo
I'm a gnu—how do you do?
You really oughtta g-know w-who's w-who
I'm a gnu—spelt G - N - U
I'm not a camel or a kangaroo
So let me introduce, I'm neither man nor moose
Oh, g-no, g-no, g-no, I'm a gnu!" [/FONT]