Construction Economics – Fiscal and Monetary Policies

The government uses two types of policies to evaluate economic activity and set interest rates in balance with inflation and deficiencies. It is a governmental orthodox that housing market play a significant role in the structuring the economic stability and causes inflation consequent of low prices. According to an economic research, rise in construction costs and uncertainty in housing investment is the real cause of two-third decrease in house construction cycles since 1970.

Fiscal policy is used in evaluation of economic activity, to assess the level of taxation requirement, and establishing what fraction of taxation will be spent on public expenditure. There are two types of fiscal policy: expansionary and deflationary fiscal policy. Under the expansionary fiscal policy, the government aim is to encourage greater spending to boost the economy. Conversely, deflationary fiscal policy aim to assist in the reduction of inflation through decease in the level of economic demand.
Fiscal policy is used by government as an instrument to control economics and to support monetary policy. Conversely, fiscal policy aims to preserve the growing of the economy along with the perseverance of low level of unemployment. In the event of excessive debt or deficiency, fiscal policy will face difficulty to operate accurately.

Whereas, monetary police is used for assessing the supply of money and interest rates to achieve desired economic policy objectives. If the economy is in recession, the government would aim to boost economic activity, through expansionary monetary policy by reducing interest rates whereby growth of money supply will increase. Adversely, if there is a need for reduction in economic activity, due to fast growth causing inflation, the government will put in operation deflationary monetary policy to increase interest rates and reduce rate of growth in money supply.

In broad terms, most of the problems adversely effecting the economy of Britain, over the last fifty years, have been led or influenced by housing market. To particular degree, there has been an unacceptable imbalances in the large demand for housing along with the limited supply of housing, consequent to the fluctuating housing market.

In the contrary, the housing market remains strong, as alertness for economic recovery continues to be at the core of alleviation of the housing market, in parallel with the economy. A sudden increase in house prices came to a screaming peak in 19894. Subsequently, the economy halted and the interest rates increased dramatically to 15% to compensate for the rise in inflation and to shield the British currency. Escalation in net savings was triggered by the dramatic stagnation in house prices.

In the event of continuous decline in house prices, the economy inevitably faces growth in recession in parallel with the anticipated decrease in lending. Substantially, this will result in a collapse of the economy, giving rise to increased levels of unemployment and economic diminution. Government is proposing new measures to increase the supply of housing, promote flexibility in the housing market, and streamline and simplify the planning regime.

The interaction between housing and the economy is pervasive. Fluctuation of house prices, contribute significantly on consumers’ expenditure. The responsiveness of new housing construction to demand changes is weak. Fall in house prices attract construction then rise in prices; this is the factor which resulted in recent recession in construction.

National Income is the total annual income of a state, consisting of employee wages and the profits of companies. Conversely, national income equates to the value of the output of all goods and services during the same period8. In wider terms, national income is valued by gross national product (GNP) which is the amount of a country’s total output subtracted by an allowance for replacement of ageing capital stock.

The primary factors effecting the construction industry have been the rise in building materials, profitability of development, interest rates and the economic growth as opposed to land prices which had little effect on the number of new houses being built10. The evidence from a recent research of the house building cycle, have proved that private building activity such as building of offices, warehouses and shops operate relatively different and move in opposite direction to a house building cycles. Hence, this indicates the adverse reflection on new levels of housing caused by other private sector building crowding out house building. Inevitably, depreciation in one sector is inadvertently means withdrawal of supply from the other sector.

Furthermore, the impulsiveness of construction costs renders it more competitive for house builders to challenge with other sectors, in parallel lines. The current situation is that overall national economic fluctuations appear to synchronise with the fluctuations in housing investments. Whereas, in early 1970s, the economy stabilised as the fluctuation in national economy did not coincide with the changes in housing investment.

Adversely, there are other problems facing house building as we are running out of land suitable for new housing12 (Kelvin Hopkins the UK Parliament). Nevertheless, government is planning to tackle this recession in the economy caused by downturn in house building cycle. In effect, increase in housing investment effectively improves national income. Since the housing market is in the era of recession, the government got its hands full as it faces the reality of decline in national income.

National income has faced a large decline as the house prices rise along with interest rates decreasing demand for house building market. According to relevant figures, since 1960, the UK has invested a lower proportion of its national income in housing than any other EU country. On the one hand of the spectrum, the government’s goal to set high interest rates as a means of controlling inflation. On the other hand, this is clearly exposing prospective house investors to high interest rates which contributes to making the UK housing market much more volatile, which itself adds a potential volatility to the wider economy.

In conclusion, it is the time of volatility for the house building market as the government stretch its legs to establish the exact fiscal and monetary policy for the development and stability of our economy. However, it is the house building cycle, which is paying a high price for the increased interest rates in mortgages, as public demand in the housing market is threaten by increased house prices. In Fact, there is no easy solution for this, expect from anticipation of interest cuts and reduction in cost of construction materials.