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International developments in housing markets Philip Davis

International developments in housing markets Philip Davis. Discussion by Peter Englund Sveriges Riksbank , 12 November 2010. The issue. Should central banks care about ( observe , react to) house prices ? ”Key lesson …. avoid housing boom bust cycles ”

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International developments in housing markets Philip Davis

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  1. International developments in housing marketsPhilip Davis Discussion by Peter Englund SverigesRiksbank, 12 November 2010

  2. The issue • Should central banks careabout (observe, react to) house prices? • ”Key lesson…. avoidhousing boom bustcycles” • Housingpricechangespredictfinancialcrises, butdotheycausethem? • Panel logitmodelnicelyidentifieshousing as one of four key indicators of a crisis. • Based on 12 crises (systemic and non-systemic) in a 17-year panel of 14 OECD countries. • Housing market mayhavehelpedpredictbutdid not play a major role in the Nordic crisis of the 90s (commercial real estatedid). • The currentcrisiswastriggered by specific features of the US housingfinance system, but US house pricesdid not growextremely fast relative to the rest of the world.

  3. Whatwould the causalmechanism be? • Directeffect on bankingstabilitydepends on nature of housingfinance • Loans with no versus full recourse to borrower assets. • Floatingversusfixedinterest rates • Indirecteffects via aggregatedemand (consumption and investment) • Marginal propensity to consumeout of housingwealthversusfinancialwealth. • MPC of financialwealth ≥ real interest rate • MPC of housingwealth≈ 0? (Housingwealth is not netwealth?) • Econometricevidence • MPC of financialwealth 1-5% (Poterba, JEP 2000) • MPC of housingwealth • In some studies higherthan MPC of financialwealth (US data; Case, Quigley and Shiller, 2005) • In other studies somewhatsmallerbut still positive (European panel data; Slacalek, 2009). • This suggests that housingcapitalgains release credit constraints. • Financial accelerator. Collateral cycles.

  4. Basics about house prices • Real house prices trend upwards • Urbanization • Land scarcity • Land pricesincreasingfraction of house prices: from 32% in 1984 to 50% in 2004 (Davis and Palumbo, JUE 2008). • Housingprices not anchored by productioncosts. • Trend reverting (sluggishquantityadjustment). • Correlatedacrosscountrie. • Think in terms of two markets • The market for housing services sets the price (implicit rent = usercost) as a function of fundamentals (income, demographics..) • The market for housing assets sets the asset price as a PDV of future rents. • Long-run asset pricetieddown by productioncost (and land prices). • Asset priceeffectsfeed back intousercost via capitalgainsexpectations (Poterba, 1984). • Monetary policy and credit market institutions (like LTV limits) primarily work via the asset market (the discount rate).

  5. Real pricedevelopment per year (BIS data) Sincepeak2001-06 New Zealand + 4.4%( 1990-2008) + 12.3% Spain + 2.6% (1991-2008) + 11.4% Denmark + 3.0% (1988-2008) + 9.1 % UK +2.2% (1989-2008) +8.8% Canada +1.1% (1989-2008) +8.5% Australia + 3.4% (1989-2008) + 8.5% USA + 0.9% (1989-2008) + 8.5% Belgium + 6.2% (1990-2008) + 8.4% Ireland + 6.0% (1990-2008) + 7.7% Sweden + 2.5% (1990-2008) + 7.2 % Italy + 0.9% (1989-2008) + 6.3% Finland - 0.7% (1989-2008) + 5.8% Norway + 1.7% (1987-2008) + 5.5 % Netherlands + 4.6% (1989-2008) + 2.5% Switzerland - 1.2% (1989-2008) + 2.2 % Japan - 3.2% (1991-2008) - 4.2%

  6. House prices and downpaymentconstraints • PDV of housing services (R), growingexponentially at rate g and disconted at rate ρ • PDV of costs of buying a house at price P, putting a fractionθdown and borrowing the remainder at the after-tax rate r(1-t) and paying a fractionm of house value for maintenance • Equatingcosts and benefitsyields

  7. Impact of changing LTV • For unconstrainedhouseholdscost of equity ≈ cost of borrowing. R/P independent of LTV. • In general, the cost of equityρincreases with θ, therebyamplifying the impact of a change in LTV. For severelyconstrainedhouseholdsavailableequity puts a cap on demand. • LTV alsoimpacts on tenurechoice, assuming landlords’ capitalcosts to be unaffected. • Duca, Muellbauer and Murphy (2010) estimate US house prices as a function of fundamentals and LTV for first-timehomebuyers and findeconomically and statisticallysignificanteffects.

  8. Conclusions • Theremay be goodreasons for central banks to want to affecthousingprices to avoidcollateralcycles. • For given fundamentals, house prices are determined by • Financial market institutions and regulations • Real after-taxlong-terminterest rates. • Cost of equity. • Can monetary policy control the real interest rate and the cost of equity?

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