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UK house prices and three decades of decline in the risk-free real interest rate
[‘Demographics and Real Interest Rates: Inspecting the Mechanism’]

Author

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  • David Miles
  • Victoria Monro

Abstract

SUMMARYHouse prices have risen substantially faster than the prices of consumer goods in most G7 countries over the past few decades. This raises major policy issues: such rises affect the distribution of wealth within and between generations, the mobility of labour and financial stability. This paper explores why such rises have happened, and what the policy implications are. The price rises have been greatest in the United Kingdom, where real house prices have risen more than three and a half times since the 1970s, substantially outpacing real income growth. Meanwhile, rental yields have been trending downwards—particularly since the mid-90s. This paper reconciles these observations by analysing the contribution of a number of drivers of house prices. It shows that the rise in house prices relative to incomes between 1985 and 2018 in the United Kingdom can be more than accounted for by the substantial decline in real risk-free interest rates over the period. This is slightly offset by net increases in home-ownership costs from higher rates of tax. Changes in the risk-free real rate are likely to have been a major driver of changes in house prices. We analyse why they have driven house prices up faster in the United Kingdom than in other advanced economies. Our model predicts that a 1% sustained increase in index-linked gilt yields from current rates could ultimately result in a fall in real house prices of around 20%.

Suggested Citation

  • David Miles & Victoria Monro, 2021. "UK house prices and three decades of decline in the risk-free real interest rate [‘Demographics and Real Interest Rates: Inspecting the Mechanism’]," Economic Policy, CEPR, CESifo, Sciences Po;CES;MSH, vol. 36(108), pages 627-684.
  • Handle: RePEc:oup:ecpoli:v:36:y:2021:i:108:p:627-684.
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    File URL: http://hdl.handle.net/10.1093/epolic/eiab006
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    1. James M. Poterba, 1984. "Tax Subsidies to Owner-Occupied Housing: An Asset-Market Approach," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 99(4), pages 729-752.
    2. Matthew Rognlie, 2015. "Deciphering the Fall and Rise in the Net Capital Share," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 50(1 (Spring), pages 1-69.
    3. Matthew Rognlie, 2015. "Deciphering the Fall and Rise in the Net Capital Share: Accumulation or Scarcity?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 46(1 (Spring), pages 1-69.
    4. Harding, John P. & Rosenthal, Stuart S. & Sirmans, C.F., 2007. "Depreciation of housing capital, maintenance, and house price inflation: Estimates from a repeat sales model," Journal of Urban Economics, Elsevier, vol. 61(2), pages 193-217, March.
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    Cited by:

    1. Geoffrey Meen & Alexander Mihailov & Yehui Wang, 2022. "On the long-run solution to aggregate housing systems," Urban Studies, Urban Studies Journal Limited, vol. 59(1), pages 178-196, January.
    2. Miles, David, 2023. "Macroeconomic impacts of changes in life expectancy and fertility," The Journal of the Economics of Ageing, Elsevier, vol. 24(C).
    3. Nobuhiro Kiyotaki & Alexander Michaelides & Kalin Nikolov, 2024. "Housing, Distribution, and Welfare," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 56(5), pages 981-1020, August.
    4. Mikhail Stolbov & Maria Shchepeleva, 2023. "Sentiment-based indicators of real estate market stress and systemic risk: international evidence," Annals of Finance, Springer, vol. 19(3), pages 355-382, September.
    5. S. Belgin Akçay & Mert Akyüz, 2024. "Why Did House Prices Go Up During COVID-19 Pandemic? Policy-Driven or Market-Driven?," International Real Estate Review, Global Social Science Institute, vol. 27(2), pages 303-328.
    6. Dieckelmann, Daniel & Hempell, Hannah S. & Jarmulska, Barbara & Lang, Jan Hannes & Rusnák, Marek, 2023. "House prices and ultra-low interest rates: exploring the non-linear nexus," Working Paper Series 2789, European Central Bank.
    7. zu Ermgassen, Sophus O.S.E. & Drewniok, Michal P. & Bull, Joseph W. & Corlet Walker, Christine M. & Mancini, Mattia & Ryan-Collins, Josh & Cabrera Serrenho, André, 2022. "A home for all within planetary boundaries: Pathways for meeting England's housing needs without transgressing national climate and biodiversity goals," Ecological Economics, Elsevier, vol. 201(C).

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    More about this item

    JEL classification:

    • R21 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis - - - Housing Demand
    • R31 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Housing Supply and Markets

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