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What to make of the UK? It’s an economy supposedly in the throes of a “cost of living crisis” and yet consumer demand remains resilient enough that the central bank has now raised interest rates 13 times in a row to try to reduce stubbornly high inflation.
It’s not as if no one is struggling. Food bank use has surged. Shop owners have started to add security tags to products such as steaks, butter and cheese amid the highest levels of theft in a decade. But plenty of people still seem willing and able to keep spending money on goods and services in spite of high inflation and tighter monetary policy. Official data last week showed significant increases in the cost of air fares, package holidays and live music events, while retail sales rose 0.3 per cent between April and May, confounding economists’ expectations of a 0.2 per cent fall. What’s going on?
The housing market offers some clues. One of the most direct ways that monetary policy affects demand is through the rates people pay on their mortgages. But unlike in the late 1980s, when about 40 per cent of all households in England had mortgages, by 2021/22 the proportion was just 30 per cent.
Meanwhile, the number of people who own their homes outright has climbed sharply as baby boomers have retired, from about 26 per cent in the late 80s to 35 per cent by 2021/22. In every region of England and Wales except London, there are now more homes owned outright than there are homes of any other type of tenure (such as rented or owned with a mortgage).
That causes two problems. First, the power of monetary policy to cool the economy is blunted somewhat (compounded by the fact that many more people today are on fixed-term than variable mortgages, which slows down how higher rates filter through.) Of course, tighter monetary policy can work in other ways too, such as through the currency and by dissuading companies from investing and hiring.
But that brings us to the second problem — that people may begin to see this tightening cycle as uneven and unfair. The pain of sharply higher mortgage rates is falling on the shoulders of fewer people this time around — and mortgage-holders are overwhelmingly working people, which means they are more exposed to any Bank of England-induced downturn in the labour market too. In contrast, two-thirds of those who own their homes outright are retired.
It is easy to see how this could reignite intergenerational resentments. In the decade of super-loose monetary policy, young people lost out because house prices moved further out of reach, while delivering rising levels of wealth for older homeowners. In this new era of sharply rising rates, younger working people with mortgages may come to feel that they are once again absorbing the pain on behalf of society as a whole.
That complaint is somewhat unfair — but not entirely so. It’s unfair because it ignores the counterfactual: it is likely that the decade after the great recession of 2008-09 would have been even worse for young people’s job prospects without supportive monetary policy. It is also the case that many older people suffered poor annuity rates during the period of low interest rates.
And those who own their houses outright don’t all fit the stereotype of comfortable baby boomers with bountiful pensions. Data from the English Housing Survey suggests the distribution of income among outright owners is quite similar to that of private renters, whereas mortgage holders have more money coming in. As for the current moment, young people who don’t own yet might benefit eventually if house prices fall a lot (though they are suffering now from rising rents).
Nonetheless, there is a kernel of truth to the complaint, especially for a cohort of people — now in their mid-30s — who have probably been pummelled twice by monetary policy over the past decade. Some of them will have seen house prices run away from them in their 20s, then scrimped and stretched to buy with a big mortgage fairly recently. According to the Institute for Fiscal Studies, disposable incomes for people with mortgages are set to fall by 8.3 per cent, with those aged 30 to 39 likely to be hit hardest with an 11 per cent drop.
Given the need to get inflation down, it wouldn’t be wise for the government to help them with handouts. But it could and should consider how to use the tax system to spread the pain of cooling the economy more widely. Otherwise, a generation might conclude that monetary policy really just boils down to this: heads you lose; tails you also lose.
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