In London, an additional source of demand has come from foreign investors looking for alternative sources of return amid a global environment of low interest rates. The government’s help to buy scheme may have also played a role though it is early days. Transactions are still quite low. How much pent up demand exists and how quickly it will come through, is of course unknowable. But it is not at all implausible that it could add significantly to pressure on the market for the next few years. Use of the government’s help-to-buy scheme continues to expand. All of this paints a picture of further pressure on transactions that could take us quickly to pre-crisis rates. Despite the dip in March, housing transactions are still up 30% on their level a year earlier. Were transactions to grow at that pace from here on, we would go past the 97–2007 average level of around 120,000 per month before the end of this year; and be back at 2007 levels by the first half of next year. Nor can we look to increased supply to help to quickly relieve some of this pressure. Housing starts, insufficient to meet demand before the crisis, dropped from around 230,000 to an average of a little over 120,000 between 2008–12. They have begun to recover – indeed, dwellings investment has been a major part of the recovery in economic growth over the past 12 months. But the increase in housing starts seen over the past few years has lagged behind growth in transactions.
The current financial turmoil is here to remind us that financial innovation is not a smooth process. An appropriate knowledge of the mechanisms through which monetary policy affects the economy is of crucial importance for central banks. Financial innovation affects these mechanisms by altering the channels through which monetary policy operates. Drawing on some lessons from the current turmoil, I would like to make four points. First, securitisation has created new uncertainties in the transmission channels of monetary policy. It may have weakened some channels and strengthened some others. At least in normal times, financial innovation significantly weakens the bank-lending channel. Securitisation gives firms broader access to capital markets and, as such, makes them less dependent on bank funding. Similarly, banks may be more able to issue debt securities and less dependent on the constraint of funding themselves with secured deposits. At the same time, however, securitisation strengthens the “direct” transmission channel through which interest rates operate, since a great number of financial intermediaries are more dependent on liquidity and on its price. Second, financial innovation – to the extent that it makes it easier to take risks and encourages the “search for yield” – may have increased the impact of monetary policy because, in such an environment, risk premia are highly procyclical and move in tandem with interest rates. Third, this same procyclicality of “risk taking” can lead to booms and busts, when investors’ appetite for risk changes.