Can the UK inflate fast enough to support house prices?

Posted on 13 August 2010 with 1 comment from readers

Devaluing the pound earlier this year was a good start but the UK is going to have to seriously inflate general price levels if the economy is going to avoid the agony of falling house prices with their impact on consumer spending, bank balance sheets and the illusion of wealth.

This is broadly speaking what happened in the 1970s. House prices fell after the Oil Shock of 1973 and then came the inflation of 1975-80. This brought nominal house prices back up to pre-crisis levels by the end of the decade but by then general price levels had doubled.

50% real fall in house prices

In real terms house prices fell by half from their peak in the early part of the 70s but the impact was disguised in nominal terms by inflation. That also helped to get the national economy back on its feet, although it was a bumpy ride in the late 70s and few businesses did well.

We have seen both increase and decrease in the rate of real estate properties. Some years before, there was a fall in prices and now, the flat prices have increased too much. The normal middle class people why not try these out the oppurtunities to buy a new house when the prices fall suddenly. This will help them to live a life as same as rich people

Only a stern dose of deflation from Mrs Thatcher’s government post-1979 and a very nasty long recession and high unemployment brought a recovery that lasted until Mr Brown decided to spend this inheritance to become Prime Minister. So where are we now?

History never quite repeats itself. The new coalition government seems pretty Thatcherite with its commitment to massive cuts and higher taxes. That said support for the pound looks pretty weak, although financial markets generally like governments that wear hair shirts.

Back to the 70s?

The Callaghan Government of the late 70s – actually supported by the Liberals in a parliamentary pact for its last 18 months in a precursor of today’s coalition – pursued an agenda rather like Mr Brown had in mind with less aggressive cutbacks than Mrs Thatcher pushed through. That helped stop house prices falling and turned them around in nominal terms.

Therefore it looks as though the new government is going to depress house prices further to the downside than might have happened under another Brown administration. Austerity for the general economy, with higher unemployment and people worried about losing their jobs, can hardly be supportive of house prices.

If you think historically, what would have happened in the late 1970s if Mrs Thatcher had been in charge then? The recession of the Oil Shock would have been longer and deeper, and the recovery presumably quicker when it came. But UK house prices would have dropped further in nominal value than actually happened.

So the conclusion has to be that the new government is about to preside over a massive fall in UK house prices. Can it hold true to this course with the public outrage that will follow? We will see.