IMF Survey : How Best to Manage a Housing Boom
IMF News, June 15, 2015
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- Published: June 15, 2015
Overview
- Publication: IMF Survey interview with Lars E.O. Svensson.
- Author: Hites Ahir.
- Date: June 15, 2015.
- Core message: Monetary policy is not suitable for managing housing booms and rising household debt; other policies (macroprudential, housing, fiscal) should be used and only if a boom is judged to be a problem.
When rising housing prices may not be a problem
- Rising housing prices can reflect benign forces:
- A fall in the neutral interest rate raises equilibrium housing prices because they "reflect the present value of future housing services."
- Rising disposable income.
- Falling equilibrium mortgage rates.
- Reduced effective housing taxes.
- Urbanization increasing demand in congested urban regions with limited space for new housing.
- Key diagnostic questions to determine if a boom is problematic:
- Are rising prices the natural response to rising disposable income, falling equilibrium mortgage rates, and/or reduced effective housing taxes?
- Are they the consequence of urbanization from rural regions with low and stagnant housing prices to congested urban regions where prices are increasing due to high demand and limited space for new housing?
- Is construction limited because of regulation and zoning restrictions?
- Are rising prices the consequence of falling mortgage lending standards or increasing loan-to-value ratios?
- Are rising prices due to buy-to-live or buy-to-rent behavior?
- Are housing costs for owner-occupied housing, including mortgage debt service, rapidly rising above rents and becoming unsustainably high relative to disposable incomes?
- Are rising housing prices due to unrealistic expectations of future housing prices or mortgage rates?
- Are the new higher housing prices sustainable or not?
- Are rising housing prices resulting in mortgage equity withdrawals that finance excessive consumption, revealed by unsustainably low or even negative household saving?
- How are household balance sheets evolving: loan-to-value and net-wealth-to-total-assets ratios, borrowers’ repayment capacity and resilience to shocks (increasing mortgage rates, falling housing prices, income losses due to unemployment)?
Limits of monetary policy for housing booms
- With flexible inflation targeting, monetary policy objectives:
- Stabilize inflation around an inflation target.
- Stabilize resource utilization (e.g., unemployment rate) around its long-run sustainable rate.
- Main instruments: the central bank’s policy rate and communication including forward guidance; unconventional policies when policy rate is constrained by its lower bound (large-scale asset purchases, exchange rate policies).
- Monetary policy cannot:
- Achieve financial stability (requires macro- and microprudential policy, supervision, regulation).
- Solve structural problems (requires appropriate structural policy).
- On "leaning against the wind" (using tighter monetary policy than warranted by inflation/unemployment objectives):
- Leaning means "tighter policy than justified by stabilizing inflation around the inflation target and the unemployment rate around its long-run rate" and "aiming for average inflation somewhat below target."
- If the inflation target is credible, leaning causes average inflation to fall below inflation expectations, producing higher unemployment above its long-run sustainable rate and increasing households’ real debt burden.
- If credibility is lost and inflation expectations adjust downward, costs in unemployment and debt burden may be smaller but future ability to achieve the inflation target is weakened, increasing vulnerability to negative shocks and risk of a liquidity trap.
- Potential benefits: somewhat higher policy/mortgage rates may dampen housing prices and household debt, reducing probability or depth of future crises.
- Conclusion drawn from quantitative assessments Svensson cites: benefits of leaning are often much less than costs—"in many cases even less than 1 percent of the cost"—and "the cost in those cases is more than 100 times the benefit."
- Overall conclusion: "monetary policy is not suitable for handling problems of rising housing prices and household debt" and "leaning against the wind indeed seems inherently flawed."
Quantitative assessment points and channels
- Important empirical considerations:
- Nominal household debt displays considerable inertia; the average length of mortgages is several years, so only a fraction of mortgages turn over each year.
- Tighter monetary policy dampens growth of both the price level and nominal disposable income; thus tighter policy slows down both numerator and denominator of real debt and debt-to-income ratios, making the net effect small.
- Existing estimates often find the policy-rate effect on real debt and debt-to-income is "quite small and often not statistically significant"; some research finds higher policy rates may even increase real debt and/or the debt-to-income ratio.
- Combining estimates of how crisis probability/depth depend on real debt and how policy rate affects unemployment yields a framework to compare benefits and costs of leaning; Svensson reports benefit much less than cost in examined cases.
Assessing household debt and resilience
- Recommended assessment model:
- Finansinspektionen’s annual Mortgage Market Report uses individual data on new borrowers collected from banks to assess lending standards and borrowers’ repayment capacity.
- Stress tests on individual data assess resilience to shocks: increases in mortgage rates, drops in housing prices, reductions in income due to unemployment.
- Finansinspektionen’s recent reports (as described) conclude banks’ lending standards are high and new borrowers’ repayment capacity and resilience to shocks are good.
- Key elements to monitor:
- Banks’ lending standards.
- Borrowers’ repayment capacity and resilience to shocks.
- Individual-level stress testing results.
Policy tools and recommendations when a boom is judged a problem
- First step: Thorough analysis to clarify the nature of the problem; the appropriate policy depends on the precise problem identified.
- Potential policy instruments and measures:
- Loan-to-value caps for new mortgages to ensure sufficient down payment and equity buffers.
- Increase risk weights on mortgages and capital requirements for systemically important banks to enhance bank resilience to credit losses.
- Improve monitoring of banks’ lending standards and borrowers’ repayment capacity and resilience to shocks.
- Ease zoning restrictions and reduce red tape to allow more construction.
- Use a combination of housing policy, macroprudential policy, or fiscal policy tailored to country-specific circumstances.
- Emphasis: "Each country’s macroprudential and other policy actions need to be tailored to the particular problems and issues in that country. The situation varies a lot from country to country. There is no one size that fits all."
IMF Survey interview with Lars E.O. Svensson, Hites Ahir — June 15, 2015.