House prices: the message is in the level, not the rate of change
I sent this letter to the FT, not necessarily to be published but to provoke some policy thinking about how to report conditions in the housing market. The typical focus on changes in the rate of change in nominal house prices is not a substitute for a compass of long term house price levels stripped of the ‘money illusion’ that distorts all long term UK data. Financial writers should be helping us to see the wood as well as the trees.
“Why does the FT follow the habit of other newspapers and report house prices in terms of rates of change, as if house prices were only an inflation measure? If does not confine its textual and graphical reporting of stock market indices, exchange rates or commodity prices to annual or other arbitrary period rates of change. It refers to and plots levels. When it is really switched on it deflates them by general inflation to reveal what is happening to real levels.
Reporting of market behaviour must influence how participants in markets respond to price changes. Arguably, the way house prices have always been reported has contributed to the nation’s blindspot about what is normal and abnormal in the housing market and so about risks and opportunity costs. It also helps explain some wild assumptions about economic causes and effects.
If readers are unsure what the sustainable trend in house prices has been in real terms and how far we are now from that trend, or would like to know more about the typical profile of extreme deviations from trend, such as timescales and degrees of both deviation and correction, that rather proves my point.”
These rhetorical questions are worth trying out on your friends – but first you might want to check the answers yourself. They can be found in several other items, including an earlier letter published by the FT, in Property Myths".
Knowing the answers, it is interesting to think afresh about the possible reasons, both for the growth trend and for the profile of the typical cycles. Mr Prescott and Mr Brown both have a lot to unlearn.
Finance writers and professionals (and why not analytically-minded individuals) will find the long-run raw data on deflated house prices (calculated in a way that allows for reinvestment in improvements in the standard of the housing stock and so roughly equivalent to an internal rate of return), at Nationwide’s excellent house price website – but not the interpretation. They are after all on the sell side of the business.