UK inflation rose last month, and seems to be heading up to 5% on the official CPI measure, more on the traditional RPI. And it's amazing how a few years of inflation can completely confuse people about market signals. Most people, for example, might imagine that house prices have fallen a tiny bit. In fact – as surveyor James Wyatt of estate agents John D Wood told a meeting of the Economic Research Council this week – house prices have fallen 22% in real terms over the last three years. Indeed they have fallen more in many parts of the country.

That is despite a real interest rate that is around -4.5%. But then part of the trouble is that, at these negative rates, the supply of people willing to lend money has dried up. Banks, for their part, see the money supply, M4, also going negative in a big way. They know that this is going to make the housing market even gloomier, and houses are people's main asset. As prices continue to fall, people are going to struggle to repay the loans they already have. No wonder the banks are hoarding cash instead of lending it: and the proposals for tougher capital requirements, both from Basel III and from the recent Vickers report, will simply increase that credit crunch.

And this falling market has a very interesting social effect, says Wyatt. The biggest losers are home owners round retirement age who want to downsize, since the value of larger homes has fallen particularly fast. It is on track to be the largest distribution of wealth between social groups in perhaps fifty years. Maybe it might make up for all those years of the retiring generation expanding its own benefits at the expense of future generations, thanks to the mechanism of public borrowing.

Central London, as usual, is defying the downward trend. That is because a crashing pound has made it much cheaper for foreigners to come in and snap up prime property in prime locations, and planning laws restrict new developments. The trouble is they can afford to hang on to their luxury London bolt-holes for decades, which reduces the supply of such property, and keeps the price high. And stamp duty, which makes it more expensive to move, is prompting people to extend their homes – upwards, outwards and downwards – instead of moving. And that means the rest of the market is pretty thin too. What a tangled web we weave when we mess around with money, interest rates and taxes.