Saturday, June 30, 2007

Instability in the Eurozone?

Instability of the Eurozone? On Monetary Policy, House Prices and Structural Reforms
by
Ansgar Belke and Daniel Gros

This paper deals with potential instabilities of the eurozone stemming from an insufficient interplay between monetary policy and reform effort on the one hand and the emergence of intra-euro area divergences on the other. As a first step, we assess the effect of EMU on structural reform and investigate this question by an examination of the relationship between fixed exchange rates and reform in two wider samples of countries. We also stress that loose monetary conditions which prevailed until some months ago can also manifest themselves in asset price inflation, notably in the housing market. When these bubbles burst, for example, when housing prices stop rising, this often leads to a prolonged period of economic instability and weakness rather than consumer price inflation.

Understanding asset prices

Below are extracts from:

Understanding asset prices:an overview

2006 Autumn Meeting of Central Bank Economists
Peter Hördahl and Frank Packer

The role of credit



As with other asset prices, rising property prices in many countries have been encouraged by low and falling real interest rates. Lower interest rates can operate to loosen credit constraints: Ellis (2005) at the RBA finds that the reduction in the interest rate burden for households was very important for the rapid rise in property prices in Australia in the late 1990s and early 2000s, when the ratio of housing prices to household disposable income doubled. The contribution from Coleman (Reserve Bank of New Zealand, 2006) develops an overlapping generations model of the housing market in New Zealand, where low interest rates also contributed greatly to the amounts that a typical borrower can borrow. Interestingly, the estimated model finds that the relaxation of mortgage credit constraints does not account for the large increase in housing prices in New Zealand, since older unconstrained households easily offset changes in demand from (younger) constrained households. Rather, the price of rental property has been highly sensitive to the decline in real interest rates. In this case, the transmission from lower real interest rates to higher housing prices appears to have been more through the lower discount rate applied to expected cash flows than through the relaxation of liquidity or cash flow constraints.



Other central bank research has been supportive of an independent role for credit in property price determination, given the importance of external finance and credit constraints in many markets. Using an error correction model, the Bank of Korea’s Jung (2006) finds Korean housing prices to be significantly influenced by private credit growth as well as GDP, with private sector lending actually being the most significant variable in an economic sense. In addition, the wide use of real estate as collateral suggests a possible feedback from real estate valuations to mortgage credit availability. The linkage between property prices and bank credit has been recently confirmed in a wide variety of empirical studies based on VAR analysis (Hofmann (2001), Davis and Zhu (2004), Zhu (2003)). Some of the research described in the meeting contributions documents the significance of credit by controlling separately for interest rates in empirical estimation procedures. In a cross-sectional analysis of land prices in different Japanese prefectures, Kamada (2006) finds bank lending to have a significance apart from lending rates, one which has continued after the end of the bubble era. Lecat and Mesonnier (2005) from the Bank of France use dynamic panel data techniques along the lines of Arellano and Bond (1991) to investigate housing price developments in 18 countries. They find that three financial variables – the short-term rate, the term spread and real credit growth – are highly significant. The paper thus suggests that over the past six years, with varying consequences across countries, monetary policy easing associated with completion of the disinflation process has increased housing prices.


Research has shown that the importance of credit conditions on real estate prices can vary widely across countries. The Égert and Mihaljek study (2006) uses the panel dynamic OLS (DOLS) estimator – separating central and eastern European (CEE) countries from panels of other European economies – and documents that private credit growth is more important in driving real estate prices in the CEE economies. Tsatsaronis and Zhu (2004) show that for a group of countries in which mortgage equity extraction is never used, and banks’ lending practices – as measured by low loan-to-value ratios and the use of historical property valuations – are relatively conservative, the link between bank credit and housing prices is relatively weak, whereas in a group where equity extraction is common and banks’ lending practices are more aggressive, the impact of bank lending on real estate valuation is much greater. Systems moving towards more deregulated housing finance markets often show an increased sensitivity of housing prices to credit conditions. Many countries now exhibit more flexible mortgage financing terms, an increased availability of home equity, high loan-to-value and interest-only loans. In Australia, the increased availability of credit due to financial innovation probably put upward pressure on property prices (RBA (2003b, 2005)). In France, where financial deregulation in the mortgage market also contributed significantly to reducing borrowing constraints on households, property price increases have been accompanied by a marked increase in household indebtedness. New measures which modernised the mortgage market have probably increased household vulnerabilities to income and asset price fluctuations as well (Messonier (2004)).

Some studies look at real estate prices jointly with equity prices to examine the question of whether credit growth – and other variables reflecting liquidity conditions – results in asset price “booms”. Examples of this line of research include Detken and Smets (2004), Borio and McGuire (2004) and the conference contribution of Bruggeman (National Bank of Belgium, 2006). Bruggeman defines excess liquidity in terms of cumulative deviations from trend of growth in money-to-GDP exceeding a specific threshold level. Using this identification scheme, the author finds that, in her data set of 18 industrialised countries since 1970, around one third of the periods of sustained excess liquidity have been followed by an asset price boom. Logit model estimations indicate that an asset price boom is more likely to materialise when the driving factors behind the build-up of liquidity include low interest rates, when credit growth is also strong and when asset price inflation is already well advanced. By contrast, using French data, researchers from the Bank of France (Gouteron and Szpiro (2005)) test for Granger causality in a VAR framework and find no clear signs of causality going from excess liquidity measures (such as the deviation from their long-term trends of money supply over nominal GDP, excess credit to nominal GDP and interest rate relative to natural rate) to asset prices.

Rapid credit growth, in part due to its association with property prices, also tends to result in banking and/or currency crises (eg Borio and Lowe (2002b)). The contribution of Kiss et al (Central Bank of Hungary, 2006) focuses on the characteristics of generally rapid credit growth in CEE countries, to disentangle the extent to which credit growth may be due to equilibrium convergence or to unsustainable credit booms. The authors use an error-correction model to estimate the long-run equilibrium level of credit-to-GDP based on fundamental macro variables, and apply the method to euro area countries in order to obtain a benchmark level against which emerging countries can be compared. With the exception of a few smaller countries, the results suggest that credit-to-GDP growth in CEE countries has been consistent with economic fundamentals or with convergence to the long-run equilibrium.

References

Ellis L (2005): “Disinflation and the dynamics of mortgage debt”, in “Investigating the relationship between the financial and real economy”, BIS Papers, no 22.

Hofmann B (2001):"The determinants of private sector credit in industrialised countries: do property prices matter?” BIS Working Papers, no 108.

Davis P and H Zhu (2004): “Bank lending and commercial property cycles: some cross-country evidence”, BIS Working Papers, no 150.

Zhu H: (2003): “The importance of property markets for monetary policy and financial stability”, presented at the IMF/BIS Conference on Real Estate Indicators and Financial Stability, 27-28 October, Washington DC.

Lecat R and J S Mésonnier (2005): “What role do financial factors play in house price dynamics?”, Banque de France Bulletin Digest, no 134, pp 21-37, February.

FAST CREDIT EXPANSION IN CENTRAL AND EASTERN EUROPE: CATCHING-UP, SUSTAINABLE FINANCIAL DEEPENING OR BUBBLE?

Detken C and F Smets (2004): “Asset price booms and monetary policy”, ECB Working Papers, no 364, May.
Peter Backé, Balázs Égert and Tina Zumer

Wednesday, June 27, 2007

Housing and the Migration Turnaround in Ireland

Housing and the Migration Turnaround in Ireland
Chris Paris

This article examines how changing patterns of migration in Ireland affected housing markets. It identifies a dramatic migration turnaround in the Republic of Ireland as net migration loss was replaced by high levels of net inward migration after 1996. The migration turnaround comprised less outward migration and a strong inflow, including return migrants (first and second generation) and overseas-born non-citizen immigrants. The migration turnaround resulted in greater ethnic diversity and, combined with other economic and demographic changes, boosted already-growing housing demand. Northern Ireland, by way of contrast, had net migration loss during the 1990s and lower growth in housing demand.

On the Likely Extent of Falls in Irish House Prices

On the Likely Extent of Falls in Irish House Prices
Morgan Kelly

Looking at house price cycles across the OECD since 1970, we find a strong relationship between the size of the initial rise in price and its subsequent fall. Were this relationship to hold for Ireland, it would predict falls of real house prices of 40 to 60 per cent over a period of 8 to 9 years. House price falls tend not to have serious macroeconomic consequences, but the unusually large size of the Irish house building industry suggest that any significant house price fall that does occur could impose a difficult adjustment on the economy.

Economic, Demographic & Fiscal Influences on Housing

Economic, Demographic & Fiscal Influences on Housing Market Dynamics
Simon Stevenson


The Irish housing market experienced substantial price increases in the late nineties. This paper aims to examine the fundamental factors at play in the Irish market and to see if a speculative element was present in house price dynamics in this period. Fundamental models of both housing supply and demand are modelled and generally provide an accurate depiction of the market. Tests for evidence of speculative behaviour in the market show that substantial premiums over fundamental value were observable in the late nineties. However, in most cases the markets had returned to equilibrium by 2001. Regional differences are also observed, however, this may in some part be due to data bias and these findings should be viewed with some level of caution.

Three Essays On Euro Area Prices

Three Empirical Essays on House Prices
Herve Ott

House-price fluctuations and the disfuctionality of the Dutch Housing market

House-price fluctuations and the disfuctionality of the Dutch Housing market:exploding house prices versus falling housing production

Peter J. Boelhouwer


Home ownership is on the rise in Western Europe, and the Netherlands is a case in point. The share of this tenure in the Dutch housing market has increased over the past 30 years; from a mere 35% in 1970, it now accounts for 54% of the housing stock (Table 1). This tenure is not evenly distributed by income bracket, however. It is especially predominant among households with an above-modal income (67%). The lower half of the income distribution is mainly found in the rented sector (69%). Various housing-demand surveys document the widespread desire to own a home. Housing policy in the Netherlands is closely tied to this expressed demand. By building new owner-occupancy dwellings and selling off a hefty share of the social-rented stock, the government expects to raise the share of home ownership to 65% by 2010. Whereas the owner-occupancy sector has been growing in many other countries in Western Europe, house prices in the Netherlands have taken a different course.

Unlike other West-European countries, the Netherlands did not experience a recession at the end of the 1980s. In fact, in the 1990s there was an unprecedented price explosion in housing markets throughout the country (Ball and Grilli, 1997; Boelhouwer, 2000). A second key difference is the generous fiscal treatment of home ownership in the Netherlands. Almost all West European countries have either abolished the deduction of mortgage interest from taxable income (as in Germany and the United Kingdom) or severely curtailed it (as in the Scandinavian countries, France and Belgium).

The extremely modest Dutch imputed rent (0.8% of the valuation) in no way offsets the advantages of the unrestricted fiscal deduction of mortgage interest that Dutch owner occupiers enjoy. A third difference is the range of lending options offered by financial services to homebuyers in the Netherlands. A mortgage loan can amount to as much as 125% of a dwelling’s valuation, while financiers in most other European countries are not prepared to lend more than 70% to 80%, or occasionally 100% at the very most.

This generous financing, in combination with the mortgage interest deduction, makes a maximum mortgage an attractive proposition for many Dutch owner-occupiers, allowing them to use part of the loan to meet objectives unrelated to housing (purchase of stocks and shares, consumer goods, etc.). The Dutch Central Plan Bureau calculated that, in the period 1993-1999, a third of the growth in the purchase of consumer goods was financed by other means than through the growth of total available family income, while the Netherlands Bank estimated, on the basis of model calculations, that increases in house prices were responsible in the period 1996-1999 for about 0.4 percentage points of the average economic growth through direct and indirect effects on domestic expenditure. For 1999, this percentage would work out to about 0.6 to 0.7% (De Nederlandse Bank, 2000).

House Prices and Monetary Policy: A Cross-Country Study

House Prices and Monetary Policy: A Cross-Country Study
Alan G. Ahearne, John Ammer, Brian M. Doyle, Linda S. Kole, and Robert F. Martin



This paper examines periods of pronounced rises and falls of real house prices since 1970 in eighteen major industrial countries, with particular focus on the lessons for monetary policy. We find that real house prices are pro-cyclical—co-moving with real GDP, consumption, investment, CPI inflation, budget and current account balances, and output gaps. House price booms are typically preceded by a period of easing monetary policy, but then diminishing slack and rising inflation lead monetary authorities to begin tightening policy before house prices peak. In a careful reading of official reports, speeches, and minutes, we find little evidence that foreign central banks have reacted to past episodes of rising real house prices beyond taking into account their implications for inflation and output growth. However, central bankers have expressed a range of opinions in the more recent policy debate with some willing in certain cases to raise policy rates to try to stem current and future surges in asset prices while others favor moral suasion or a hands-off approach. Finally, we characterize the risks associated with house-price reversals. Although mortgage lenders in some countries have significant exposure to house prices, the balance of evidence suggests that this exposure does not, in and of itself, pose a significant risk to financial stability. Nevertheless, the co-movement of both property prices and default rates with the business cycle means that losses on mortgage lending are likely to be higher when banks’ other lines of business are also performing poorly.

EXPLAINING GROWTH DIVERGENCES IN THE EURO AREA

EXPLAINING GROWTH DIVERGENCES IN THE EURO AREA: THE ROLE OF RESIDENTIAL INVESTMENT
Klaus - Jürgen Gern and Carsten - Patrick Meier
IfW Kiel Institute for the World Economy




Over past years, there have been significant differences in cyclical developments in the euro area. The paper addresses the question to what extent these differences can be explained by the pronounced differences in residential construction activity. In our econometric analysis of housing investment in the euro area we, as a first step, distinguish between Germany and the rest of theeuro area. This distinction is motivated by the fact that German developmentshave been special in several respects over the past 20 years and, given the large size of the Germany as a proportion of the euro area economy, influence the developments on an aggregate euro area level significantly (as opposed to, e.g., Austria where housing investment—and population growth—was rather similar to German patterns). Since swings in housing investment in Germany over therecent two decades have been associated with pronounced changes in population growth, special emphasis is given to the importance of demographic developments in explaining diverging trends in housing investment. Population growth and demographic developments that affect the number of households, such as shifts in the share of population in household formation age and falls in the average size of households, all have potentially important implications for housing demand. We estimate functions for Germany and the rest of the euro area where residential investment depends on the existing level of housing stock, real income, the user cost of capital (proxied by the real interest rate) and population growth. In order to quantify the importance that demographic developments through the channel of residential investment have as an explanation of the growth differential between Germany and the rest of the euro area, we simulate how economic activity in the two regions had evolved under the assumption of identical demographic trends using these equations and a macroeconometric model for Germany and the rest of the euro area. In the literature, the impact of demographic developments on the housing market is usually discussed in the context of house prices. Several studies include demographic variables in their estimated house price equations (e.g. Meen 2002, Ahearne et al. 2005) , but they are omitted in recent VAR-studies (Sutton 2002, Tsatsaronis and Zhu 2004). Girouard and Blöndal (2001) discuss the influence of house prices on residential investment through the price-cost ratio, but do not discuss other determinants of residential investment.

Summary and Conclusions

Differences in growth dynamics within the euro area have been pronounced in recent years with German growth especially sluggish relative to the rest of the euro area. A substantial part of the growth differential between Germany and the rest of the euro area is due to the strong differences in residential investment growth which has been declining in Germany since the end of the 90s while expanding swiftly in the rest of the euro area. In Germany, changes in population growth have been pronounced in the past two decades and demographic developments have differed markedly from those in the rest of the euro area. Estimation of functions explaining housing investment for Germany and the euro are confirm a significant impact of population growth on residential construction in both cases. A simulation exercise based on these equations finds that if population growth in Germany had been the same as in the rest of the euro area the profile of housing investment in Germany would have been significantly altered and much less different from that in the rest of the euro area. However, while the effect of differences in population growth are not negligible, differences in demographic developments are found to account for only 10—20 percent of the growth differential between Germany and the rest of the euro area that has been observed in recent years. Therefore, in order to explain differences in intra-euro area growth dynamics other factors than demographics have to be taken into account.

Hot and Cold Housing Markets

Hot and Cold Housing Markets: International Evidence
Jose Ceron and Javier Suarez

This paper examines the experience of fourteen developed countries for which there are about thirty years of quarterly inflation-adjusted housing price data. Price dynamics is modeled as a combination of a country-specific component and a cyclical component. The cyclical component is a two-state Markov switching process with parameters common to all countries. We find that the latent state variable captures previously undocumented changes in the volatility of real housing price increases. These volatility phases are quite persistent (about six years, on average) and occur with about the same unconditional frequency over time. In line with previous studies, the mean of real housing price increases can be predicted to be larger when lagged values of those increases are large, real GDP growth is high, unemployment falls, and interest rates are low or have declined. Our findings have important implications for risk management in regard to residential property markets.


The estimation yields three set of results. First, the dynamics of real housing prices is characterized by two rather persistent states that mostly differ in the volatility of price increases. Specifically, the variance of the unpredictable part of quarterly price increases in the high volatility state is almost four times as big as in the low volatility state. The low volatility state is associated with phases of higher growth, occurs with an unconditional probability of 47% and has an expected duration of 23 quarters. The high volatility state is associated with phases of lower price growth, occurs with a frequency of 53% and lasts, on average, about 26 quarters. Second, in addition to the latent state variable, a number of lagged macroeconomic variables have significant predictive power for the expected growth rate of real housing prices. Specifically, the prediction of quarterly growth rates depends positively on the lagged quarterly rate of real GDP growth, negatively on the lagged one-year variation in the unemployment rate and also negatively on the lagged long-term nominal interest rate. We find no evidence of the effect of these variables to be state dependent. Third, even after controlling for the effect of the latent state variable and the explanatory variables, the quarterly growth rate of real housing prices exhibits significant positive autocorrelation.



A problem with the multi-country approach is heterogeneity. Geographical, historical and institutional factors may make residential property prices evolve differently in different countries. Perhaps even simple methodological differences in the construction of each country’s price indices may make them show systematic differences in mean or variance. Thus, without properly controlling for the underlying heterogeneity, a regime-switching model estimated with pooled multi-country data, instead of capturing the common structure of the cyclical pattern, might end up associating the latent states with some rather cross-sectional partition of the data.

consumption wealth and business cycles in Germany

Consumption wealth and business cycles in Germany
BRITTA HAMBURG MATHIAS HOFFMANN JOACHIM KELLER
CESIFO WORKING PAPER NO. 1443

This paper studies the long-run relationship between consumption, asset wealth and income in Germany, based on data from 1980 to 2003. While earlier studies — mostly for the Anglo- Saxon economies — have generally documented that departures of these three variables from their common trend signal changes in asset prices, we find that for Germany they predict changes in income. Asset price changes are found to have virtually no effect on consumption — both in the short as well as in the long-run. We offer an explanation of this finding that emphasizes differences between the bank-based German financial system and the rather market-based Anglo-American system: stock ownership by private households is much less widespread in Germany than in the Anglo-Saxon economies and the share of publicly traded equity in household wealth is much smaller in Germany than in the U.S., the UK or Australia.



The fact that pension systems are so fundamentally different in the two countries is also likely to help explain why the share of equity in household portfolios is so much lower in Germany than in the United States. In Germany, both the public as well as most employer-sponsored retirement schemes are financed on a ”pay as you go” (PAYG) basis. Conversely, private mutual funds and pension funds play a much more important role in the Anglo-Saxon economies. In particular the U.S. saw considerable growth in the number of tax-deferrable defined contribution plans such as the 401 (k) throughout the entire 1980s and 90s (Poterba, Venti and Wise (1994, 1998)). As a consequence of the minor role that equity holdings play in Germany, real estate wealth dominates the net wealth position of the German private sector. About two thirds of net asset wealth come under real estate wealth. In the US, by contrast, real housing wealth accounts for only about a third of total net wealth.

It would therefore seem conceivable that temporary fluctuations in cay capture temporary fluctuations in housing wealth. But while residential real estate prices in the US are characterized by long and pronounced swings over our sample period (1980-2003), prices in Germany have remained relatively flat.3 Here too, differences in the financial system, in particular in the profiles of mortgage finance system, may play a major role: e.g., mortgage equity extraction is not used in Germany (as opposed to the US) and according to the BIS study by Tsatsaronis and Zhu (2004), banks’ lending behaviour is more conservative and requires home buyers to provide relatively high levels of collateral for their mortgages. Against this backdrop, it is not surprising that Germany has not seen any pronounced cycles in the residential real estate market and that, therefore, fluctuations of the cay relation can hardly be attributed to real estate wealth.


These facts clearly support the notion that fluctuations in income must be a relatively much more important lever — in fact the only remaining — in explaining fluctuations in the German consumption-wealth ratio. But it would seem that our results suggest that stock market prices do not have a transitory component in German data, even though there are compelling theoretical reasons to believe that stock markets in general should have transitory components that reflect time-varying risk premia. We make the following remarks: first, we do find that the cay residual is statistically significant in predicting excess returns on the German stock market. But in terms of economic significance, the predictive power of cay for asset prices and in particular for equity returns in Germany is negligible relative to what is found in the U.S., UK or Australian data sets. Secondly, this finding is in no way tantamount to saying that stock markets in Germany could not have sizeable transitory components. What we say is that the consumption-wealth ratio of the average German household does not help to identify these transitory components. We report some evidence below that suggests that the U.S. consumption-wealth ratio has considerable forecasting power for German stock returns.


Our finding that household disposable income — largely derived from labour — constitutes the transitory component of the consumption-wealth ratio in German data may seem at odds with the general notion that German labour markets are very rigid and that wages may display only very sluggish adjustment. But note that it is the sum of all household labour incomes that enters the intertemporal budget constraint from which the cay-relationship is derived. This sum is equally determined by temporary fluctuations in the unemployment rate and in hours worked, so that sizeable temporary fluctuations in labour income do not a priori contradict the view that the German labour market is rigid. Indeed, we report below that cay has considerable predictive power for fluctuations in the unemployment rate and other business cycle variables.


In one important respect, our results differ markedly from those reported in the papers by Lettau and Ludvigson for the U.S. and Fernandez-Corugedo et al. and Voss et al. for the UK and Australia: temporary stock market fluctuations have almost no impact on the budget constraint of the average German household, because stocks account for only a minor share of German household net worth. Conversely, the consumption wealth ratio has considerable predictive power for income at business cycle frequencies: in Germany, cay predicts business cycles, not stock market cycles or the prices of other assets.

This paper has studied the link between consumption and wealth in Germany during the period 1980-2003. Very much as earlier studies for other countries, we can identify an empirical approximation of the consumption-wealth ratio as a cointegrating relationship between consumption, asset wealth and income — the cay residual. In keeping with most versions of the permanent income hypothesis, we find that consumption mainly reacts to permanent innovations in asset wealth and income. But whereas earlier studies for the U.S., Australia and the UK have documented that this cointegrating relationship predicts changes in asset prices, in particular risk premia in the stock market, we find that cay mainly predicts income changes in German data. Our explanation for this phenomenon is that stock market wealth accounts for a much smaller share of household net worth in Germany than in the Anglo Saxon economies so that temporary fluctuations in stock markets have only very limited impact on German private household net worth. We have interpreted this observation in the light of well-documented structural differences in the financial and pension systems of continental Europe and the Anglo-Saxon economies.

Recent House Price Developments (2006)

RECENT HOUSE PRICE DEVELOPMENTS: THE ROLE OF FUNDAMENTALS
Nathalie Girouard, Mike Kennedy, Paul van den Noord and Christophe André

In the vast majority of OECD economies, house prices in real terms have been moving up strongly since the mid-1990s. Because of the important role housing wealth has been playing during the current upswing, this paper will look more closely at what is underlying these developments for 18 OECD countries over the period from 1970 to the present, with a view to shedding some light on whether or not prices are in line with fundamentals. The paper begins by putting the most recent housing price run-ups in the context of the experiences of the past 35 years. It then examines current valuations against a range of benchmarks. It concludes with a review of the links between a possible correction of housing prices and real activity. The main highlights from this analysis are as follows:

1) The size and duration of the current real house price increases; the degree to which they have tended to move together across countries; and the extent to which they have disconnected from the business cycle are unprecedented.

2) Overvaluation of real house prices may only apply to a relatively small number of countries. However, the extent to which these prices look to be fairly valued depends largely on longer-term interest rates remaining at or close to their current low levels. 3) If house prices were to adjust downward, the historical record suggests that the drops might be large and that the process could be protracted, given the observed stickiness of nominal house prices and the current low rates of inflation.

Ten New Propositions in UK Housing

Ten New Propositions in UK Housing Macroeconomics: Macroeconomics: An Overview of the First Years of the Century
Geoffrey Meen
Meen (1996) set out a series of ten propositions concerning housing macroeconomics in the UK. These propositions concerned some of the central policy issues of the eighties and early nineties, for example, the effects of mortgage market liberalisation, explanations of house price dynamics and the role of the housing market in Britain’s exit from the Exchange Rate Mechanism. In this paper, ten further propositions are considered, which reflect the new policy agenda and advances in economic knowledge since the earlier paper. Arguably, three of the current central issues in housing economics in the UK are; (i) the growth in real house prices and their volatility – a continuing theme; (ii) the objective of extending home ownership; (iii) the promotion of integrated or mixed income neighbourhoods. The third is considered in Meen et al (2005), whereas the first two are the subject of this paper, which include issues of risk (both for housing markets and the macro economy) and the sustainability of home ownership.


2.1 The Growth in House Prices, Volatility and Risk
(1) The strength of house prices since 1996 is explainable in terms of fundamentals
(2) There is no simple relationship between house prices and rents
(3) There is asymmetric adjustment between upswings and downswings
(4) The coefficients of house price models are stable over time
(5) In general, increases in house prices do not counterbalance falls in stock market prices


2.2 The Sustainability of Home-Ownership

(6) Natural rates of housing repossessions are higher than in the seventies and early eighties
(7) Sustainable levels of home-ownership depend primarily on the expansion of housing
supply rather than on demand.
(8) The Buy-to-Let market will not continue to expand at the same rate as in the last ten years.,
(9) Wealth redistribution by extending ownership can be risky.
(10) New households are not the main beneficiaries of affordability targets.

Tuesday, June 26, 2007

House Prices in Australia

HOUSE PRICES IN AUSTRALIA: 1970 TO 2003, FACTS AND EXPLANATIONS
Peter Abelson, Roselyne Joyeux,George Milunovich and Demi Chung

This paper describes and explains changes in real house prices in Australia from 1970 to 2003. In the first part of the paper, we develop a national index of real house prices. We then discuss the main factors that determine real house prices and some previous attempts to model Australian house prices. We develop and estimate a long-run equilibrium model that shows the real economic determinants of house prices and a short-run asymmetric error correction model to represent house price changes in the short run. Consistent with economic theory, we find that in the long run real house prices are related significantly and positively to real income and to the rate of inflation as represented by the consumer price index. They are also related significantly and negatively to the unemployment rate, mortgage rates, equity prices, and the housing stock. Employing our short-run asymmetric error correction model, we find that there are significant lags in adjustment to equilibrium. When real house prices are rising at more than 2 per cent per annum the housing market adjusts to equilibrium in four quarters. When real house prices are static or falling, the adjustment process takes six quarters.

Ageing and Financial Markets

THE IMPLICATIONS OF AGING FOR THE STRUCTURE AND STABILITY OF FINANCIAL MARKETS
Jane D’Arista

Analysts have become increasingly concerned about how anticipated demographic changes will affect financial markets. There is general agreement that the share of world population over 65 will rise as the current century progresses. Reasoning out of the life cycle theory of saving, it is assumed that saving rates will tend to decline. One study concludes that the expected pattern of dissaving could lead to balance of payments problems in countries where there is a higher percentage of retirees than in others, and that there will be a shift in the pattern of ownership of financial claims from OECD to emerging market economies as the residents of OECD countries age more rapidly over the next several decades (Davis 2006). Meanwhile, some consequences of demographic changes are already evident – in particular, the increased presence of institutional investors such as pension and mutual funds – and the purpose of this paper is to describe how that development has altered the structure and functions of national and international markets in ways that have important implications for financial stability and the conduct of monetary policy.

Housing Markets to Cyclical Resilience

The Contribution of Housing Markets to Cyclical Resilience
Catte, Girouard, Price and Andre
OECD Economic Studies No.38, 2004/1







Housing Statistics in the European Union 2004

Housing Statistics in the European Union 2004



Description

At the fifteenth informal meeting of EU housing ministers in Padua in November 2003, the Czech Republic and Sweden offered to prepare “Housing Statistics in the European Union 2004”. This report is the tenth edition in a series of publications dating back to 1991. The aim of the report is to provide readers with interesting and comparable data on economic, social and demographic aspects of housing. In the series of publications, the 2004 edition is the first to include data on housing in the ten new Member States. Another new feature of the 2004 edition is the chapter describing different government policies in the field of housing.
The report is made up of five chapters covering a wide range of topics related to housing policy.

* Chapter 1 presents a range of general data on the demographic and socio-economic context for housing.
* Chapter 2 deals with the quality of the housing stock, concentrating on the average useful floor area, amenities and age of the housing stock.
* Chapter 3 is devoted to the availability of housing, including the distribution of different types of housing by tenure.
* Chapter 4 looks at the affordability of housing and illustrates the weight of housing in household budgets; the different indices which offer an overview of the changes in the cost of housing; and trends in mortgage lending.
* Chapter 5 focuses on the role of government and of state intervention in the housing market, paying particular attention to public expenditure on housing and to the existence and characteristics of social housing.

Housing in the euro area

Housing in the euro area — Twelve markets, one money
Jenny Osborne

This paper examines developments in the euro area housing market, with particular reference to the last ten years. Since the mid 1990s, the rising trend in euro area house prices has been remarkable both in its duration and strength, persisting during a phase of economic slowdown. However, developments have been far from uniform across the euro area, and there have been considerable differences in the experience of individual countries. This paper endeavours to explain why we observe such a diversity of house prices, in an area with a common currency and common interest rate. While the significant fall in interest rates over the past number of years has been an important determinant of the rise in house prices in many countries, differences in the structure of housing and mortgage markets have also played a big role. As a consequence, housing markets remain strongly national in character.

Fluctuations and Stability in the Danish Housing Market:

Fluctuations and Stability in the Danish Housing Market


Abstract.


The Danish house prices have been through strong boom and bust cycles the last 30 years. The house price changes are into a high degree explained by the changes in interest payments and in taxes. Denmark has more than 100 years tradition for taxation of owner-occupiers’ imputed rent, but the proceed has followed the house prices and been in a range at ½ to 1% of GDP. At three tax reforms the tax rate for deduction of interest expenses has been reduced. After a slow deregulation and liberalisation the last 10 years the Danish mortgage industry through innovations has created several new products, mostly with short-term interest rates. The net interest expenditure/income ratios for the owner-occupiers have been relatively stable since 1994 and as the interest rates have dropped and half of the debtors had re-mortgaged to adjustable-rate mortgages (with “low” interest rates), the owner-occupiers debt had been increasing. The risk for the owner-occupiers is discussed and is especially linked to their debt. However, the debt had not increased more than the house prices, as the net liability/housing wealth ratios have been nearly stable since 1987. Actually a start to a “bubble” in the house prices is identified. The expectation environment believe on higher rates of increase in house prices than in consumer prices. From 1998 on, the former positive correlation between house prices and the private consumption has been changed, and herd behaviour as well as the new mortgage products are among the possible causes.

Housing, consumption and EMU

Housing, consumption and EMU
UK Treasury


This EMU study informs the assessment of the convergence test – the first of the Government’s five economic tests for determining whether adoption of the euro would be in the UK’s economic interest: “Are business cycles and economic structures compatible so that we and others could live comfortably with euro interest rates on a permanent basis?”. It considers in detail a particular, and important, structural aspect of the transmission mechanism of monetary policy: the housing market. The transmission mechanism as a whole is the subject of the EMU study by HM Treasury EMU and the monetary transmission mechanism.

Structure of the Spanish housing market and sources of finance: an overview

Structure of the Spanish housing market and sources of finance: an overview
Mari-Cruz Manzano

In Spain, gross capital investment in construction, particularly that related to residential uses, has made a significant contribution to aggregate economic and financial developments. In nominal terms, in 2004 construction investment represented 16% of GDP and 58% of total gross fixed investment.


Around 50% of the investment in the construction sector was related to residential uses. The involvement of the public sector in the construction sector and, more specifically, in the residential housing segment has been extensive in Spain. Such involvement has taken the form of new regulations, favourable tax treatment of certain operations, direct supply of subsidised housing and subsidies for housing financing.


Although over recent years such involvement has diminished, regulations are still impinging on the structure of the housing market. Over the last decade, residential building activity in Spain has remained strong and relatively stable in comparison with other types of building activity due to a combination of factors. In a context where the ratio o owner-occupied dwellings has been traditionally high (above 80%), regulations and fiscal treatment have boosted housing ownership against rentals. In addition, the declining trend in the level of interest rates and the lengthening maturities of mortgage loans contributed to improving affordability ratios over the 1990s, even against a background of dynamic house prices.

Structural factors in the EU housing markets

Structural factors in the EU housing markets
ECB 2003

This report, prepared by the Task Force on Housing of the Monetary Policy Committee of the European System of Central Banks (ESCB), examines the origins and effects of housing market fluctuations in the European Union (EU) and provides an overview of developments in EU housing markets since 1980. The emphasis is on structural aspects of the housing market that may influence the effects of monetary policy on economic activity and prices, in particular residential property price and rent dynamics, housing taxes and subsidies, and the main inter-linkages between housing markets and mortgage markets that may give rise to financial cycles. The report presents cross-country information on housing markets, often of a non-harmonised nature, and has benefited from contributions of the EU national central banks (NCBs).

Housing markets and economic growth:

Housing markets and economic growth:lessons from the US refinancing boom
Akash Deep and Dietrich Domanski

Household spending remained unexpectedly strong in the OECD area during the 2001 downturn. One explanation is that it was supported by rising real estate values and declining mortgage rates, mainly in the English-speaking countries.2 Such resilience was particularly remarkable for the United States, where overall household wealth declined because of falling equity prices. The US mortgage market appears to have played a significant role in this strength. There was a wave of mortgage refinancing in 2001 that was unique in both its nature and magnitude. This special feature discusses the effect of mortgage refinancing during the 2001 slowdown and the role played by changes in the structure of the market for housing finance.

Procyclicality of the financial system

Procyclicality of the financial system and financial stability: issues and policy options
William R White

The successful pursuit of the objective of low inflation by central banks in recent decades has also delivered low variability of both inflation and output. At the same time, numerous financial and other "imbalances" (defined here as significant and sustained deviations from historical norms) have emerged. Should these imbalances revert to the mean, there could be significant effects on output growth. Although such an adverse outcome remains only a possibility, the question asked in this paper is whether we might still benefit from a new macrofinancial stabilisation framework in which monetary and regulatory policies gave more attention to avoiding the emergence of imbalances in the first place.

Household debt and the macroeconomy

Household debt and the macroeconomy
Guy Debelle

Lower interest rates and an easing of liquidity constraints have led to a substantial rise in household debt over the past two decades. The greater indebtedness has made the
household sector more sensitive to changes in interest rates, income and asset prices.
This enhanced sensitivity is higher where more households have variable instead of
fixed rate mortgages.

Monday, June 25, 2007

Twin Peaks in Equity and Housing Prices

Twin Peaks in Equity and Housing Prices
Claudio Borio and Patrick McGuire


The strength of housing markets around the world has helped to cushion the recent slowdown in global economic activity. How long should we expect this to continue? A sample of industrialised countries covering three decades allows us to explore this question through an analysis of major peaks in equity and housing prices, the associated booms and busts and the underlying credit conditions.

Profiles Of Mortgage Systems

Mortgage Market Characteristics

Housing Price Dynamics BIS

What drives housing price dynamics: cross-country evidence
Kostas Tsatsaronis and Haibin Zhu.


A house is the largest single asset of most households, and assets whose value is linked to residential real estate represent an important component of the aggregate portfolio of financial intermediaries. The behaviour of house prices, therefore, influences not only business cycle dynamics, through their effect on aggregate expenditure, but also the performance of the financial system, through their effect on the profitability and soundness of financial institutions. Understanding this behaviour is thus of key interest to central banks charged with maintaining price and financial stability.

This broad overall picture, however, ignores considerable differences in the experience of individual countries. During this period, housing price growth was particularly strong in Ireland, the Netherlands and the United Kingdom, which experienced average annual growth rates in excess of 11%. This group is followed closely by Australia, Spain and a number of Nordic countries, where the pace of growth has accelerated in more recent years.


At the other end of the spectrum one finds Germany and Switzerland, where prices have remained rather flat recently even though the latter experienced a boom and bust cycle in the late 1980s and early 1990s. Similarly, there has been a downward trend in real house prices in Japan since the bursting of the so-called “bubble economy” in the early 1990s.


A useful distinction in the demand and supply factors that drive real housing prices is between those that have a longer-term influence and those that affect shorter-term dynamics. Factors that influence the demand for housing over longer horizons include growth in household disposable income, gradual shifts in demographics (such as the relative size of older and younger generations), permanent features of the tax system that might encourage home ownership as opposed to other forms of wealth accumulation, and the average level of interest rates (possibly related to the long-run behaviour of inflation). The availability and cost of land, the cost of construction and investments in the improvement of the quality of the existing housing stock are longer-term determinants of housing supply.

Housing markets, however, are intrinsically local in character. As such, the growth of the housing stock can be constrained in the short run as a result of a number of factors that include the length of the planning and construction phases and the inertia of existing land planning schemes. This suggests that idiosyncratic, national factors can lead to significant differences in the dynamics of prices across countries.4 One set of such factors relates to the prevailing conditions in the provision of financing for the purchase of housing. Another factor affecting the liquidity of the housing market is the specific transaction cost framework such as the level of VAT, stamp and registration duties and inheritance taxes. Finally, the uncertainty about future prospects that follows periods of heightened volatility in housing prices tends to lead to a more cautious response of housing construction to shifts in demand because of the inherent irreversibility of this type of investment.

Residential real estate prices are characterised by long swings. Graph 1 plots inflation-adjusted house prices for 17 industrialised economies between 1970 and 2003. Each country experienced about two full cycles over this period of 33 years.


The empirical framework


The model includes five endogenous variables besides house price growth:

(i) the growth rate of GDP, which provides a measure of the state of the business cycle and household income; (ii) the rate of inflation in consumer prices, which is the only nominal variable in the system; (iii) the real short-term interest rate, which is closely linked with the monetary policy stance; (iv) the term spread, defined as the difference in yield between a long-maturity government bond and the short rate; and (v) the growth rate in inflationadjusted bank credit.

French Housing

Paris New Real Estate Risks Index

Constructing a New Real Estate Risks Index for the Paris Residential Market

Abstract

In this paper we investigate the driving factors associated with the Paris apartment market. We explore a database of more than 220 000 transactions for residential properties in the Paris area over the 1973 – 2001 period. We develop a factorial model that may capture the systematic link between residential prices and a set of predefined economic variables or a linear combination of these economic variables. We assume that capital growth rates in real estate are related to the variables we chose. We measure this link which underlines the ‘true path’ of the real estate market in the sense that systematic factors can represent it. The methodology we develop to construct an index, based on a multifactor approach to apartment price movements in the long run, has two main advantages over traditional indices. Firstly, we are able to identify the main driving factors for the Paris residential market. And secondly, the factors thus derived can be used to generate a “factor model” useful in comparison to existing capital growth indices and that may provide valuable intuition for forecasting residential prices.

Test

This is a test.