Managing Housing Markets Under EMU:

The Case of Ireland

John FitzGerald8th December 11

www.esri.ie

Background

Housing markets are idiosyncratic EMU changed environment for household sector Drivers of housing market Building sector bubble & the economy:

Output effects Price effects and financial sector

Managing housing markets under EMU

Housing markets: idiosyncratic

US housing market First time that there is a general decline

Europe: no general trend – even in 2007 Germany and Italy weak Ireland, Spain, UK exceptional inflation

Was globalisation and financial integration promoting a convergence in housing cycles?

Effects of new financial architecture?

Housing Markets in & out of EMU

Problems in some economies Loose fiscal & monetary policy, still SGP compliant

Ireland, Spain, Estonia Poor banking regulation

Ireland Also problems with wider building sector

Problems of building overinvestment Baltics, Bulgaria, Romania

EMU – Effects ex post

Nearly a decade “shock free” Lulled fears – hubris in Ireland

Reduction in risk premium Not just EMU Expected benefit – effects differ across members Governments affected – e.g. Italy Companies affected – SMEs, less benefit if large Household sector – reduction in Ireland & Spain

Had been constrained?

Housing - Long-Term Drivers

Model of Ireland & Spain: Conefrey & FitzGerald, 2010

Income, cost of building Must be embedded in a model of the economy

User cost Expectations and incorporate subsidies Effects of different expectations regimes

Demographics Natural increase, migration – Ireland & Spain different

Culture, preferences – “headship rates”? Holiday homes – Spain Financing bubble – credit and balance of payments

Dwellings per 1000 Adults, 2001

All Dwellings Occupied

Denmark 620.8 594.6France 633.6 525.6Germany 598.5Ireland 2001 525 464Ireland 2006 574 478Netherlands 534.0 534.0Poland 453.5 421.2Spain 655.1 443.6UK 574.8 550.8

Headship Rates

10

20

30

40

50

60

70

80

20-24

25-29

30-34

35-39

40-44

45-49

50-54

55-59

60-64

65-59

70-74

Age

%

IrelandGermanyUK

Irish Housing Demand - Components

Cost of Capital

EMU and financial liberalisation Fall in risk premium especially for households Benefits economy – if managed correctly

Real cost of capital Companies – inflation in output prices Households – depends on local consumer price

Risk premium: percentage points

1980-98 1985-98

Ireland 2.0 1.6

Spain 1.4 1.9

UK 2.1

Relative to DM

Real Interest Rates

-4

-2

0

2

4

6

8

10

12

1980 1985 1990 1995 2000 2005

Ireland Spain

Household sector financing

Borrow from banks to fund housing investment If big financing requirement under EMU

Banks borrow abroad Reduction in risk premium – real rates

Increased investment - Banks increase credit If credit > domestic resources

Pre EMU – exchange risk premium – ration? Post EMU – “unlimited” Euro area funding Post EMU – even outside EMU cheap finance – Baltics, Poland?

Shows up in balance of payments

Net Foreign Liabilities of Banking System

0

10

20

30

40

50

60

70

1989 1991 1993 1995 1997 1999 2001 2003 2005 2007

% o

f G

DP

Ireland Spain Poland

Role of Building in Economy

Effects of change in share: Wealth effects? Demand – output effects Crowding out of tradable sector

CompetitivenessTrue cost of bubble – kill off tradable sector (Gros)

Crowding in of tradable sector in bust?How long?

Role of the labour marketBuilding labour intensive

Housing, % of GDP, 1970-08

Average Max Min 2007

France 5.4 10.0 4.1 4.0

Germany 6.5 7.8 5.2 5.5

UK 3.6 4.5 2.8 4.0

Ireland 6.1 14.0 3.7 12.3

Spain 5.4 9.4 4.1 9.2

Estonia 1993-08 3.3 6.8 2.0 6.5

Poland 1995-08 2.7 3.2 2.2 2.4

Housing investment share of GNP

0

2

4

6

8

10

12

14

16

% o

f GD

P

Ireland Spain EU 15

Adjustment to dateGDP

Growth Investment share of GDP Unemployment rate

Country Years % Start End change change

Portugal 08-10 -1.2 22.5 19.0 -3.5 3.3

Greece 08-10 -6.4 19.1 14.7 -4.4 0.1

Ireland 07-10 -11.8 26.4 11.3 -15.1 9.1

Spain 07-10 -3.0 30.7 22.5 -8.2 11.8

Hungary 08-10 -5.6 20.6 17.7 -2.9 3.4

Romania 07-10 -1.5 30.2 22.7 -7.5 0.9

Lithuania 07-09 -12.2 28.3 17.1 -11.2 9.4

Estonia 07-09 -18.3 34.4 21.6 -12.9 9.1

Bulgaria 07-10 0.5 28.7 23.5 -5.2 3.3

Latvia 07-09 -21.4 33.7 21.5 -12.2 11.1

Managing Housing Markets

Not just housing – also property market Ireland and Spain v the UK

Housing bubbles do a lot of damage Through effects on real economy Through effects on financial sector

Ireland and US v Estonia EMU changes available instruments

Interest rates – not available Fiscal policy & taxation Financial regulation

Fiscal Policy Fiscal policy to manage domestic demand

Crowding out through domestic inflation Ireland, Spain and Estonia needed surpluses Surpluses need to increase – fiscal stance

Targeted fiscal measures Raise costs of housing for households

Targtind with Fiscal Instruments Eliminate subsidies Stamp duty – e.g. UK and Hong Kong Tax on mortgage interest rates

Banking regulation

Failed to prevent problem in Ireland & Estonia Domestic banks v Foreign banks Domestic Banks: Ireland

Irish banks largest but competitive market Fight for market share Regulator failed to protect Irish financial system Failure especially on property

Banking Regulation Foreign Owned Banks Estonia

Dangers known No domestic banks

Ireland No attempt to regulate Irish or Foreign banks Could Foreign banks have been reigned in? Mortgages v property loans Need for EU wide regulation?

Spain – foreign buyers

Banking regulation

Instruments Capital requirements – e.g. Spain

Foreign banks? Loan to Value ratio (Hong Kong) Other instruments

Share of loans on property? Why were banks stupid?

Conclusions

Ireland and Spain Need more dwellings in long term Mismanagement of housing markets has large

macro-economic costs Crowds out tradable sector - unemployment Costs of financial collapse dominate

Governments can manage housing market (Don’t blame EMU, blame governments!) Fiscal policy AND Financial regulation Need EU banking regulation & EU banking system