If this is a guide to the uncertainty firms feel about returns on new investments then, on the basis of the model in Chart 4, you might expect an additional hurdle of 10% points or more, over and above the normal cost of funding. 2  In steady state, the ratio of capital to investment is 1/(g+δ), where g is trend growth and δ is the rate of depreciation. In advanced economies, and recognising that a substantial proportion of capital is the value of land (which doesn’t depreciate) g+δ is unlikely to be more than 7% - so the value of the capital stock is generally more than 15 times the annual rate of investment. In 2015, according to official ONS estimates, the ratio was 23. 3 Financial options are instruments that give the owner the right to buy or sell an underlying security at a fixed, so-called “strike” price. When the security’s spot price rises above the strike an option to buy is said to be “in the money”. But that doesn’t mean it’s rational to exercise the option straightaway, because there’s a chance the spot price could rise further. The more volatile the series, the greater that chance and the more valuable the option. In just the same way, it’s not enough that the option to make an irreversible investment project be expected to cover its financial cost – it has to cover the value of waiting, and that value is higher the more uncertain the resulting stream of income.
However, this is merely a question of fairly marginal adjustments in the timing of our interest rate decisions. Seen in a longer-term perspective, I believe that these considerations benefit stability both in the real economy and inflation. But I wish to point out that neither house prices nor household indebtedness have any independent significance for monetary policy. The important factors here are inflation prospects and developments in the real economy. Concluding remarks Let me summarize. In recent years we have seen prices soar with regard to both commercial property and housing. The rapid price increase has gone hand in hand with a substantial increase in household debts. At present I am not particularly concerned that these prices will lead to problems for financial stability. But this is a development that is not sustainable in the long term. House prices and household indebtedness cannot increase faster than household incomes in the long run. Otherwise there is a risk of imbalances building up, which may be costly for the economy. We at the Riksbank will therefore be closely watching future developments. Thank you! 6  BIS Review 56/2007