What Determines the Price Elasticity of House Supply? Real Interest Rate Effects and Cyclical Asymmetries.

This paper offers a theoretical discussion of the price elasticity of supply. While there have been a number of attempts to estimate the responsiveness of UK supply, relatively little has been written on what determines it. A key omission is the effect of long-term real interest rates. Steep falls in both the annual rent to house price ratio and long real interest rates during a period of relatively static real rents in the UK suggest that the stream of future imputed rents became discounted at successively lower interest rates between 1996 and 2007. New supply responded sluggishly to price rises during this period, but then collapsed rapidly as the market turned in 2008. This paper argues that the decline in long-term real interest rates contributed to rising house prices and the inelastic supply response during the long upswing, and that cyclical asymmetries inherent in the supply response have been exacerbated by changes in the financial system and increased government regulation of the planning process. [ABSTRACT FROM AUTHOR]