Managing Housing Markets Under EMU: The Case of Ireland John FitzGerald 8 th December 11

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 DwellingsOccupied Denmark France Germany Ireland Ireland Netherlands Poland Spain UK

Headship Rates

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 Ireland Spain UK2.1 Relative to DM

Real Interest Rates

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

Role of Building in Economy Effects of change in share: Wealth effects? Demand – output effects Crowding out of tradable sector Competitiveness True cost of bubble – kill off tradable sector (Gros) Crowding in of tradable sector in bust? How long? Role of the labour market Building labour intensive

Housing, % of GDP, AverageMaxMin2007 France Germany UK Ireland Spain Estonia Poland

Housing investment share of GNP

Adjustment to date GDP GrowthInvestment share of GDPUnemployment rate CountryYears%StartEndchange Portugal Greece Ireland Spain Hungary Romania Lithuania Estonia Bulgaria Latvia

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