Encouraging investment in energy efficient homes

(An instrument for national property price control to support the Euro

Article summary
In large currency areas such as the Euro zone a Central Bank sets a single interest rate to control all forms of inflation, including property prices. This crude instrument is only effective if if all parts of the currency zone are at the same stage in their economic cycle.
But buildings cannot (easily) move across national boundaries. We propose a financial instrument that exploits the fixed position of buildings to shift property price control back to national governments, without undermining Central Bank authority.
Predictable long term house prices would reduce the financial risks of investing in home energy improvements.

The energy prize on offer
In the United Kingdom, approximately one third of our CO₂ emissions are produced running our homes. Useful reductions in home energy efficiency can be achieved at relatively low cost by simple measures such as blocking drafts and lagging boilers.
But moving towards carbon neutral homes requires major refurbishments such as installing triple glazing, modern boilers and solar powered water heating units.

Owner-occupiers need to have a high level of confidence in the long term (20 – 25 years) stability of house prices if they are to be persuaded to take out large loans to pay for expensive energy saving improvements. This confidence is currently lacking because after a long period when international house price inflation has exceeded general inflation, the banking crisis has produced a downturn in house prices.

Our proposal aims to stabilise long term house prices. As a bonus, it will stimulate investment in making homes more energy efficient.

 We will refer to the British market but a similar system could be developed for other markets.

 Background: How the Bank of England currently controls inflation

 The Bank of England is responsible for setting the Bank Rate at a level which keeps national inflation within limits set by the government.
It has to use a single Bank Rate to cover the whole of the UK and all types of inflation.
So when a housing price bubble emerges in one part of the country, say the South East of England, it cannot be suppressed by increasing the Bank Rate without threatening the growth of whole of the UK economy

We propose the introduction of a Surcharge Interest Rate (SIR) which is only used to suppress excessive house price inflation.

 How the SIR system would work: Anyone taking out a mortgage to purchase a property would also have to open a Bonded Savings Account.

Money could be paid into this account at any time but unless the account holder fell upon exceptionally hard times, money could not be withdrawn until the mortgage had been re-paid..
If house price inflation showed signs of outpacing general inflation, the Bank of England would have the power to impose a Surcharge Interest Rate on mortgages.
Unlike normal interest payments that are lost forever, the SIR payment would be transferred to the Bonded Savings Account. 
The payment of an effectively higher interest rate would take the heat out of the housing market, suppressing house price inflation.

Minimising the financial burden
Buyers only bring the threat of inflation into the housing market at the time they are negotiating a price, so long standing mortgagees would not have to pay the current SIR.
The system would be backdated by (say) three months, to prevent speculative buying, in anticipation of a pending Surcharge Interest Rate rise.

Once the SIR had returned to a zero rate, the system would start up again, with the most recent batch of SIR payers being freed from future payment obligations.

Focusing on housing inflation hot spots
After the system has been in place for a couple of years it could be refined to operate on a regional basis, eventually being fine tuned to influence house prices at a post code level.

 The SIR could vary at a post code level, because irrespective of where the mortgage is taken out, the location the property remains fixed.

In part, the SIR mechanism is a psychological confidence building measure. Its present will assure the markets that in the long term, house prices will keep in step with general inflation. This will reduce the benefits of speculative buying, consequently reducing the need for regular surcharge interest rate intervention.

The inspiration for this proposal
The original version of this web page was published in June 2003 in response to a an article in the Economist magazine. This warned of a pending world wide crash in house prices. ["Castles in hot air", Special supplement, The Economist, 31 May 2003.] History has shown that the Economist was right, with the collapse of the American sub prime housing market triggering a banking crisis and an international recession.

Easing the Euro crisis
The SIR system would be particularly useful in large single currency territories such as the Euro and US dollar zones, because it would decouple local control of house price inflation from the bank rate set for the whole of the currency zone.
It's too late to solve the American sub-prime market problem but our proposal could boost confidence in Europe's ability to solve its current problems.

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