The societal impact of such a relentless gallop forward in asset prices is widely debated, but those focused on the economic impact generally fall within two camps.
Many, such as US economist Dean Baker, say higher house prices ultimately benefit everyone in the economy, including those who are not homeowners, due to the “wealth effect.”
This is the idea that people will spend more of their actual income, because the rise in their perceived wealth (the rise in the value of their house) increases their confidence about their own future prospects, and so encourages more spending and less hoarding of cash.
Nobel Prize winning economist Milton Friedman advanced the theory of permanent income, advocating the view that individuals' spending levels today are a function of what they expect their future wealth to be, that is, in his phrase, the “permanent income” level.
Friedman’s view was that people’s confidence in their spending habits today is influenced by their notions of what their long-term prospects are, rather than their immediate level of disposable income.
House prices have consistently risen in the decade since the global financial crisis, partly as a result of the policy of quantitative easing,His view contrasts with that of John Maynard Keynes, a British economist who argued that consumer spending could be influenced by a boost of shorter-term income gains to consumers from an increase in government spending.
House prices have consistently risen in the decade since the global financial crisis, partly as a result of the policy of quantitative easing, which is rooted in wealth effect theory.
In the first place, QE increases the volume of money in circulation, and pushes interest rates down.
Lower interest paid on cash deposits means individuals are incentivised to look elsewhere for returns, with the cash going potentially into property and stock markets.
The wealth effect would then kick in, according to its advocates, as people noticing the rise in the value of their house would feel wealthier and be more inclined to spend their income, and so generate extra demand in the economy, which boosts the economic prospects for everyone.
Rising house prices may also serve to aid the recovery of an economy from recession, as banks have the value of the house they have issued mortgages against.
A general rise in house prices therefore makes the balance sheets of banks healthier, and enables them to loan more cash into the real economy, without falling foul of banks' regulatory requirements to keep a certain proportion of their assets in cash or other liquid assets.
Silvia Dall’Angelo, senior economist at Federated Hermes, is among those who is sceptical of the ability of QE to generate a wealth effect to create growth.
She says the issue is that as QE is a policy that increases asset prices, asset owners tend to already be wealthier and older, and wealthier and older people tend to spend less of any extra wealth they receive than younger people and those less financially well-off.
She says, in this way, policy decisions that focus on increasing asset prices may actually have hindered growth over the past decade by boosting the wealth of those less likely to spend it.
According to this analysis, the wealth effect does not generate extra growth, as any gains go to those least likely to spend them.
Andy Haldane, chief economist at the Bank of England, says the policy of QE does the opposite of this, as it keeps interest rates low and so rewards those who need to borrow and penalises those who are savers, and as such, diverts resources to the less well-off and away from the wealthier, who have the ability to save.
Reducing borrowing rates may make borrowing more affordable for those who need to borrow, and so boost economic growth.
Bruce Stout, who runs the £1.6bn Murray International investment trust, has countered Haldane’s view with the argument that “while you can take a horse to water, you cannot make it drink"; meaning that while you can reduce interest rates to make borrowing cheaper, you cannot guarantee that individuals or companies will want to borrow.
QE increases the quantity of money in the economy, but may not increase the speed at which that money moves through the economy.
Speed demon
Stout says a hugely significant driver of economic growth since the dawn of time is “household formation”.
This is the process every generation goes through of buying and furnishing a succession of properties to live in. It is not just the purchasing of a home, but the furnishing and extension of the home, and indeed the creation of and expansion of a family unit.
While low interest rates benefit the creation of a household, the increase in house prices hinders the creation.
Put simply, higher house prices mean that people have to save more to buy a property from a person who is older.
This extra saving from the younger person reduces the total level of spending in the economy, while the extra wealth is transferred to the older person; but an older person is much less likely to spend, so the total of economic activity is reduced, even though the total supply of money has increased.
If people are older before they buy their first property, then they will likely purchase fewer houses in their lifetimes, reducing the impact of the household formation effect on the wider economy, as it happens fewer times.
Policymakers over the past decade have responded to the lack of inflation and economic growth by increasing the QE programmes and cutting rates further, which exacerbates the problems Stout sees with the policy.
He has the majority of his global equity fund invested outside of the developed markets where the above policies have been pursued.
David Thorpe is special projects editor at FTAdviser
