Usually in an economic downturn there are compensations for the negative effects of reduced demand. The reductions in income and rise in unemployment are to a degree offset by a fall in asset prices especially the housing market. The economic strategy of the Bank of England has been to set an artificially low interest rate to maintain ‘economic stability’. The actions of the central bank are based on the assumption that when house prices increase consumer consumption also increases.
This assumption may be true to a certain extent however it is built on a false sense of wealth due to temporarily high house prices created by long term unsustainable borrowing, a bubble that is inevitably going to burst. As soon as house prices start to fall dramatically the false sense of wealth will disappear and the impact low interest rates will have on aggregate prices will go with it.
In the mean time people who have seen a reduction in income have not seen a reduction in the cost of housing. The housing market has been artificially subsidised through low interest rates, which not only make first time buying harder, but also make the cost of renting higher. Greater demand for rented accommodation has been caused by a growing number of people that cannot afford to buy a house as a result of lower wages, which have not been reflected in house prices due to the low interest rate.
The consequences of this are real and severe. In the last year the number of homeless people in England rose by 14%, which could be partly attributed to the rising levels of unemployment. However there has been a 26% increase in the number of homeless people who are not helped by the local authorities into accommodation, which would indicate the cost of housing has been an issue when attempting to re-house people.
If interest rates were higher the price of housing including rented accommodation would fall and provide the compensation that a normal recession would create. This raises the question is the Bank of England’s strategy hindering more people than it helps?