Answer to Question #202650 in Microeconomics for Chulumanco

Question

As a response to Covid-19 the SARB cut its benchmark interest rate to a low record. In the last meeting held on the 25th March 2021, the South African reserve bank’s Monetary Policy Committee (MPC) announced that interest rates would remain stable at 3.5 percent and the prime lending rate at 7 percent. This was largely in line with Economists expectations. What would be the effect of the decision on property price. Is there a possibility of a property bubble? 

Answer 1

Solution:

The action by SARB to cut its benchmark interest rate to a low record of 3.5 percent and maintaining it, including having a stable prime lending rate will lower financing costs such as mortgage rates. When the interest rates are reduced, the mortgage rates also go down. Due to low mortgage rates, it becomes cheaper to purchase properties since they will be more affordable. Also, due to the prime lending rate, it will be easy for people to access credit and purchase properties. Therefore, this will result to a demand increase for properties, pushing up the properties prices, resulting to property bubble.

 

Property bubble is a temporary period where a run-up of property prices is ignited by massive demand, speculation, and excessive or extravagant spending to the point of debacle or collapse. Property bubble normally begins with an increase in demand, even with limited supply, which takes a rather longer period to restore and increase. Speculators then invest money into the market, pushing further up the demand. It then reaches a point where the demand stagnates or start dropping sharply, while at the same time supply increases, resulting to a sharp plummet in prices and the bubble blows-up.