Evidence and the persistence of mistaken ideas: the case of house prices

Another paper, this time from the Bank of England written by former MPC member David Miles and Victoria Monro, shows that the rise in house prices we have experienced since 1985 is mainly the result of lower real interest rates. The other, less important, driver is household income. Those two effects together can account for all the increase in house prices relative to inflation. The increase in house prices is not the result of a shortage of new houses.

Those who remember two earlier posts of mine will know of my own conjecture along similar lines. More recently Ian Mulheirn has championed this theory: here he is commenting on an apparently contrary view from Paul Cheshire. The importance of real interest rates to house prices has been understood for a long time: the first time I came across it was when Steve Nickell wrote a paper when I think he was still on the MPC. Very recently, here is Paul Johnson making the same point.

Secular stagnation is used by most macroeconomists to describe the current era where real interest rates appear to be permanently lower than they were decades before. The uncomfortable conclusion would be that as long as this era lasts, house prices will remain at levels that are unaffordable for many young people. Building more houses on any reasonable scale is not going to change that very much.

The reasoning behind the theory is incredibly simple. Houses are an asset. Like any asset, its price depends on the return from holding them (in the case of housing rents) and the rate of interest. The demand and supply for housing services (i.e. a roof over your head) determines rents rather than house prices. Imagine choosing between investing in housing or in government debt (more specifically a perpetuity, so you never get the money back but the interest pays forever), Interest rates on government debt are 2%, so on every £100 K you invest in government debt, you get 2K a year in interest. Suppose the (net of costs) rent on every £100K of house was 2K a year. Then you are indifferent to whether you own either asset.

Now suppose interest rates fall to 1%, but rents stay the same. Everyone wants to become a landlord, and people with money to invest buy houses to rent, because before interest rates rose you are getting double the return you were getting on debt. With perfect arbitrage this will carry on happening until houses that used to be worth 100K are now worth 200K, so that the return to housing again equals the return to holding debt = 1%. House prices have doubled, but the demand and supply of housing services has remained unchanged. The suggestion is that this is the process behind rising house prices in the UK.

That does not mean building more houses (increasing the supply of housing services) has no effect on house prices. Raising supply pushes down rents, other things being equal, and that reduces the return from owning a house, so it will reduce house prices. But the stock of houses is very large, so even with large house building programmes the impact on rents is small. Here Ian Mulheirn shows what the paper by Miles and Munro says about the small size of that effect.

You might say that any reduction in house prices is welcome, but you are using a great many resources (and a fair bit of land) to produce a modest effect. You might get a similar impact on house prices if the government undertook a serious fiscal stimulus, leading to a rise in short interest rates which would have a modest impact on long interest rates, but a noticeable impact in reducing house prices.

My question is why this point is almost never made in the popular discourse on the house price problem? One answer is that housebuilders have a vested interest in suggesting a dire need for more housebuilding, in part because it adds to pressure on governments to free up greenfield sites. This is exactly what has happened since 2010. There is nearly always a vested interest in perpetuating incorrect economic explanations.

In this case, as in others like the supposed need for austerity, there is something else, and that is an apparently simple piece of economics that perpetuates this misconception. With austerity it is that the government should be like a household, which most economists believed before Keynes showed it was false. With house prices it is that prices reflect demand and supply.

The difference between austerity and failing to distinguish between house prices and the price of housing services is that the former is more difficult to challenge than the latter. The reason is that everyone also talks about housing normally being a good investment. That is seeing housing as an asset, so all you need to do to break the misconception is a bit of asset pricing theory.

With issues like these, there are two spheres of understanding, with precious few links between them. There is what I will call the knowledge sphere, where academics (including academic think tanks) and economists in central banks and elsewhere regularly exchange ideas and evidence within that group. There is a second group comprising most of the print media, the broadcast media, some (mainly right wing) political think tanks and most politicians, where again communication within the group is pretty good. 

Communication between the two spheres is sparse. Most political journalists in the broadcast media spend more time watching each other and reading the print media than they do talking to people in the other sphere. Despite many who work hard to package knowledge in accessible ways, often the best those in the knowledge sphere can hope for is an article in the Guardian, FT or Times. If politicians don’t want to access expertise, there is therefore little requiring them to be knowledgeable. The examples I have highlighted are from economics, but I think it is true for all the social sciences.

As a result, politicians can continue to propagate and pursue bad ideas, like austerity is necessary or house building is the answer to high house prices, with little or no challenge in their own sphere. This is not about experts forcing politicians to do what they suggest, but about the public and even politicians being aware of what the evidence suggests. The fundamental problem is not that those in the knowledge sphere don't communicate well, but that too many politicians and much of the media do not want to be well informed. 

How Broadcasters should handle the Prime Minister lying

This post is about the Brexit Dividend and how broadcasters should treat it. However I want to start with an extreme case: Donald Trump. He is the right place to start because he became POTUS in good part because of how the media treated him and his opponent. He gained publicity by saying outrageous things. That increased his poll rating, so he started getting favourable coverage because his poll ratings were going up. (I explain how this works in more detail here.) Once he was the republican candidate, the media’s obsession with balance meant they spent as much time talking about the trivial issue of Clinton’s emails as Trump’s lies, whether he pays any taxes, bribes officials and assaults women.

One of the most remarkable polls during that campaign was that more people trusted Trump than Hillary Clinton. How can someone who lies all the time, almost every time he says anything, be trusted more than Hillary Clinton, who has had countless Republican inspired investigations into her affairs and has never been convicted of anything. For some time cognitive linguist and philosopher George Lakoff has pioneered the idea that (among many other things - see for example a Guardian article with Gil Duran) lies that are repeated often enough become associations in people’s minds that they find it hard to combat. So the phrase ‘crooked Hillary’ that Trump repeats all the time has a purpose beyond firing up the base. Equally when Republican’s start investigations into her affairs that alone puts an association of guilt in people’s minds. That is a key reason why before the election they trusted Trump more than Clinton.

In the United States Trump played the media big time, and continues to do so. If the media is not careful the same thing could happen here. The phrase ‘Brexit dividend’ is the equivalent of ‘crooked Hillary’. If it is repeated enough, a sufficient number of people will begin to associate Brexit with a ‘dividend’, whether that dividend is real or not. And in case someone reading this does not know by now, the Brexit dividend is a complete fiction.

To see how May’s claim that there is a Brexit dividend should be handled, read this in the FT and this from Sky News. (HT Femi) The FT article does not have ‘Brexit dividend’ in its title, and this is important. As Lakoff argues, the more often people see those two words together the more likely they are to associate them, so do not put it in a headline as many people just read headlines. (Putting it in inverted commas does nothing.) He suggests what he calls the ‘truth sandwich’ approach: begin with a truthful statement, then report the dishonest spin, and then fact check the spin. Leaving out that first stage plays into the hands of whoever promoted the spin.

Who are the heroes and villains in this example of barefaced lying (see my definition of barefaced below). For villains we have to start with Theresa May herself: if this is a sop to the Brexiters in exchange for a soft Brexit that is no mitigation. Boris Johnson of course for suggesting the idea: the court might like to take a large number of previous offences into account. The right wing Brexit press for whom lying is just part of their game.

Heroes include Paul Johnson, who toured the broadcasters on Sunday to emphatically say there was no dividend, and Conservative MP Sarah Wollaston for saying it was complete nonsense, as well as the two references already given in the FT and from Sky News. I hope there were other examples that I did not happen to notice.

What about the BBC? It did have Paul Johnson on, and Laura Kuenssberg did at least ask the existential question, although she felt unable to answer it. (There are not ‘economic’ and ‘political’ truths: arithmetic is arithmetic, lies are lies.) But there are unfortunately other occasions when the Brexit dividend was treated as if it was real and put into headlines (e.g. here), missing out the first layer of the truth sandwich. And of course the Marr interview on Sunday, where he did not even question the concept. All too often (e.g. here) any questioning of the dividend was left to the end of the article and was presented in the standard ‘he said,she said’ format.

Why does this all matter? In terms of Brexit, it is obvious. Another barefaced lie in the Brexit campaign was £350 per week for the NHS. Most Brexiters continue to believe that they will be better off after Brexit, and I suspect most are not aware why this is unlikely to be true. Talk of the Brexit dividend is designed to keep them in their ignorance.

But I think its importance goes well beyond Brexit. Why don’t politicians lie more often to enhance their cause? Some have integrity, but for the others the deterrent is being found out. But being found out depends critically on the media calling out lies when they happen. And when a large section of the media are very selective about how they treat lies depending on who said them or why they were said, or indeed are often the source of these lies, society has a serious problem.

That is the situation in the US with Fox and Trump and in the UK with the right wing press and Brexit or the Conservatives more generally. How the print media in the US and the broadcast media in the UK treats lies has therefore become critical. With lies ‘she said, he said’ type reporting is just not sufficient to defend democracy. Now often it is quite difficult to prove someone is lying, but if I could delineate a barefaced lie as one where it is very easy to establish the truth, then the Brexit dividend is a barefaced lie. OBR documents, accepted by the government as the basis for their tax and spend decisions, show quite clearly that the money has already been spent. You cannot spend the same money twice.

The right wing Brexit press have already supported this lie. As most of their readers also watch broadcasters, it is imperative that these broadcasters inflict some political damage on those who tell the lie. If they do not, the lesson certain politicians will draw is that they too can get away with barefaced lies, encouraging the kind of behaviour we see with Trump. For that reason broadcasters have to speak truth to power, otherwise the non-partisan media becomes complicit in propaganda or just a mouthpiece for politicians.

Economists, Brexit and the Media: Epilogue

In a thoughtful piece, Paul Johnson of the IFS says that economists must take some of the blame for not getting our message across. In fact he says: “But it is always a mistake simply to look at the media as a scapegoat. The real failings were with my profession.”

What were these failings. He identifies four. The first is that we have failed to get basic economic concepts across to the public, like that a depreciation does not make us richer. The second is that we have no means of getting our voice across as a collective, rather than as individual voices. Third, most of us cannot respond quickly to important issues. Fourth, we fail to translate impacts on ‘the economy’ into concepts people can relate to.

All of these things are indeed general problems. I have written about the lack of collective view here, so I completely agree that is something we should act on. I also think collective action is the only way economists have of dealing with the first problem (apart from individually writing non-economist friendly blogs of course). I do not think the third was an issue for Brexit. Of course the fourth is always likely to be true (more media training!).

But having said all that, Paul is basically wrong. Even if you had put all these things right, I do not think it would have made any difference to the result. In this referendum economists did do their collective best to inform the public. Failing to have a collective voice was compensated for on this occasion by letters and polls. The lack of knowledge of economics (and in this case Europe) among many political correspondents is not really something economists are in a position to rectify. And right from the start, the long term costs of Brexit were expressed in term of costs for the average household. (And when that was done in a perfectly reasonable way, the media mistakenly told us we were doing it wrong.)

This really is like blaming scientists for not warning enough about climate change. And the problem is not confined to the EU referendum. We saw the same problem arise during the Scottish referendum, when the term Project Fear was first coined as a way of dismissing difficult economic realities. The result of the referendum permitted a degree of complacency. I personally would argue, along with other economists, that much the same happened in the 2015 general election, when mediamacro turned perhaps the worst economic record since WWII plus the promise of a referendum into ‘economic competence’. But that was seen as partisan and so ignored. I don’t think either of those two events had much to do with a failure of the economics profession either, and I take no pleasure in having used that experience to anticipate how this referendum would go.

There are all kinds of people you can blame for ignoring economics expertise. Voters themselves, the politicians that call such advice Project Fear, the tabloid media that keeps expertise from the eyes of their readers (or trashes it), the broadcast media for an obsession with balance, underlying economic conditions that lead people to think it cannot get any worse (a phrase I have heard a number of times since the result). It is a long list, and in order of importance the failures of economists themselves comes a long way down it.

And before I get the inevitable comments about the failure to foresee the financial crisis and the sins of neoliberal orthodoxy, please note that the medium term costs of Brexit come largely from models of trade, productivity and international investment which are very empirical and hardly ideological. But if a respected Financial Times columnist calls economists’ assessment of what that literature implies “the profession’s intellectual arrogance” what can you do. Let’s get real: what we said was ignored, and the reasons for that have very little to do with economists themselves.

That £170 billion bombshell

Paul Johnson of the IFS has written that under Labour “national debt [could be] around £170 billion higher (in today’s terms) by the end of the 2020s than would be achieved through a balanced budget.” That was all that certain newspapers needed to start talking about a borrowing bombshell under Labour.

£170 billion is a meaningless number, and the end of the 2020s is a meaningless date. First, we should put everything as shares of GDP. £170 billion is about 10% of GDP, and debt is currently around 80% of GDP. However it would be completely wrong to infer that under Labour debt to GDP would be 90% of GDP by 2030. If they achieved current balance by financial year 2017/18, then my excel spreadsheet says that with nominal GDP growth of 4% a year, by 2030 debt to GDP would be around 65% of GDP. (A few points below 65% if investment remained at 1.5% of GDP, a few points above it became 2% of GDP.) If the Conservatives balanced the overall deficit each year debt to GDP would be about 47% of GDP by 2030.

So a £170 billion bombshell actually means debt to GDP would have been reduced from 80% of GDP to around 65% of GDP. So the correct headline should have been “debt to GDP cut by a fifth in 2030 under Labour’s plans”. That is debt, which is much more difficult to reduce than the deficit. To say this is a ‘different interpretation’ is too polite – newspaper reports got it completely wrong. Who should you blame for this: Paul Johnson, innumerate journalists, biased newspapers? I’ll leave that to you.

There remains a real question of how quickly debt to GDP should be reduced. In terms of the analysis I did here and here, Labour’s plans - if it did achieve current balance by 2017/18 - are tougher than the path I described as ‘fast’ debt reduction, although not nearly as tough as Osborne’s plans. (This analysis was done before the Autumn Statement, but to pretend that the analysis needs to be revised on that account gives these numbers spurious precision.) However my ‘fast’ path did not keep to current balance after 2020, but had some further deficit reduction over the next five years. (As a result, debt to GDP was below 60% by 2030 under this fast path.) I have not seen Labour commit to sticking to current balance until the end of the 2020s. So in that sense as well the £170 billion number is meaningless.

What you should conclude from this is simple. First, as Paul Johnson and many others have pointed out, both Labour and Conservatives are aiming for tight fiscal policies (tighter than I and others think sensible given the macroeconomic situation), but the Conservatives’ plans involve substantially more cuts than Labour. Both involve reducing debt to GDP quite rapidly, so there is no question that both plans would not trouble the markets. So the only reason for going for Osborne’s plan, now apparently involving budget surpluses, is if you expect another financial crisis in the 2030s, and want debt to GDP to be something like it was before the last one. [1] Or, as a headline writer might put it (but somehow I doubt many would): “budget surpluses and austerity so we can afford to bail out the banks again soon”.

   

[1] For those who are really into fiscal rules, there is a technical question about whether it is better to have a target for the overall deficit or the current balance. As George Osborne has moved from the latter to the former, it may be best to read his detailed analysis of the issue. Cannot find anything? Well maybe, as I note here, he is simply following the discussion in Portes and Wren-Lewis (2014), which argues for deficit targets but a separate target for the public investment to GDP ratio.