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When the drugs won't work

Posted by: katalysis

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Despite ultra low interest rates and government incentives the number of housing transactions remains in the doldrums. The need for a big deposit to get a good mortgage rate is often cited as the reason for this. However, maybe this does an injustice to the wider and savvy public. Here’s what Jaime Caruana the General Manager of the Bank for International Settlements said in a recent speech:-

It does not matter how attractive the authorities make it to lend and borrow – households and firms focused on balance sheet repair will not add to their debt, nor should they.”

Mervyn King called ultra low interest rates a paradox of policy. An economy addicted to debt funded spending needs the short-term fix of ultra low rates when in the longer term we require more saving and less borrowing. Well, it seems that the effects of the medication are beginning to wear off. Indeed, the patient is now at risk of developing an addiction to the medicine! Which presents another problem. If you want to wean them off the drug gently you need to start raising interest rates early and move these up in small increments over a long period. The alternative is Cold Turkey. Either way the volume of house sales will not improve until interest rates rise and prices become re-aligned with earnings.  

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