John McTernan had an interesting piece in the FT a couple of days ago, under the headline “A failure of imagination blights Britain’s housing policy”. John’s pieces are almost always worth reading, and this one’s no exception. However, there is one key point in it I’d like to challenge.

John’s article assumes that house price movements in the UK over the past fifteen years or so have been driven by what he sees as a failure to build enough houses to keep pace with household formation. Many British commentators make this same assumption. But it’s just not very plausible. John mentions international evidence from Canada and Australia – hardly countries facing the same kind of constraints on land availability we have in the UK. Perhaps it’s easy to exaggerate how easily vast tracts of land convert into housing availability in Canada and Australia, but we face no such issues in Spain and Ireland. Both these countries had large house prices booms in the 2000s (comparable to and on some definitions larger) than in the UK despite construction booms.

If it wasn’t a shortage of housing or of new construction that drove the house price booms in Ireland and Spain, what was it? And could the same factors have been significant contributors to house price rises in the UK as well?

Short answer: yes. The slightly longer answer notes that house prices, like prices in all markets, depend upon the balance between the willingness to supply and demand at a given price. There does not need to be a lack of the product for prices to rise. There simply needs to be either a reduced willingness or ability to sell or an increased willingness or ability to buy, at any given price.

In the cases of the UK, Spain and Ireland, the overwhelmingly dominant factor in driving house price movements has not been how much new construction there has been. It has been huge increases in the willingness and ability of buyers to pay any given price. Why? Because these economies grew very strongly from the mid-1990s through to the late 2000s, and richer people have more money to spend on their houses, and because credit for mortgages became easier and cheaper to obtain.

In the UK, credit became easier and cheaper to obtain from the 1980s onwards because inflation and inflation volatility fell (reducing real interest rates) from the early 1980s on, because regulation in the 1980s and early 1990s made providing mortgages easier for a wider range of firms, because unemployment fell in the 1990s (reducing the rise of defaulting), because financial innovations made mortgage credit provision more efficient in the 2000s, and because interest rates were held very low (in my opinion too low) in the mid-2000s. Similar stories can be told for Spain and Ireland, with the upshot being that wealthier home-buyers with easier access to mortgage credit will be willing to pay more for their houses, driving house prices up.

That was overwhelmingly the reason they rose in the period up to 2007, and that was the reason house prices fell in the late 2000s in all these three countries. Folk said it couldn’t happen in the UK – supply constraints would mean desperate buyers would bid prices ever-higher even in an economic crash. But that was nonsense. House prices fell more than 22% in nominal terms and around 33% in real terms on the Halifax index from 2007. The real terms drops were almost exactly the same as in the early 1990s and late 1970s crashes – huge changes in alleged “supply constraints” over that period notwithstanding. Why did they fall? Not because of any new housebuilding boom, but because GDP fell, unemployment rose and mortgages became tougher to obtain following the financial crisis and the new tighter lending regulations that followed it.

Commentators frequently talk about the “excessively lax bank lending” and the “house price boom” of the 2000s as if these were independent issues. What do you think the banks were providing lending for? The vast majority of funds loaned are for mortgages. If lending criteria were too lax and lending was excessive, that meant mortgages were too easy to get and hence house prices were too high. That is all one circle.

House prices fell when the economy and finance sectors did badly. They picked up again when the economy picked up and homebuyers with now-securer earning prospects found, post-QE and zero-interest-rate policies, that they could obtain mortgages for below 2% in nominal terms.

Building tens or hundreds of thousands of extra houses in the UK will not stop house price booms any more than it did in Ireland or Spain. It might have its own merits for other reasons – e.g. we might think it’d be rather cool to have some new Garden Cities or to greatly expand Milton Keynes. But the challenges young people and those on lower incomes have in buying their own homes are almost entirely unrelated to supply. It’s not that folk can’t find houses for sale; it’s that the houses that are for sale are extremely expensive. The reason they’re so expensive is that unemployment is low, the economy is doing okay and interest rates are so extraordinarily, artificially and arguably immorally low.

We will not see house prices subside until interest rates rise back closer to levels consistent with a healthy, functioning economy. And if you’re waiting for that, don’t hold your breath.