Blowing Bubbles and Bursting Them: Housing Markets in Ireland and Spain

John Fitz Gerald and Thomas ConefreyThe Economic and Social research Institute, Dublin

www.esri.ie

Introduction

• EMU, housing and managing economies– EMU changed environment for household sector– Housing markets are idiosyncratic– Drivers of housing– Building in the economy & housing markets today– Managing regional economies under EMU

• What Next?– Dynamics of the Irish economy– Fiscal policy

EMU – Anticipated Effects

• Optimal currency area?– Dangers of shocks– Inappropriate monetary policy?

• Transactions costs and FDI– Small effects

• Risk premium– Lower interest rates for government

EMU – Effects ex post

• Nearly a decade “shock free”– Insulates against financial shocks – 1992, 2008

• Enhanced competition?• Reduction in risk premium

– Governments – yes– Companies – SMEs, less benefit if large– Household sector – major reduction

• EMU permitted more rapid adjustment to optimal housing stock

Household sector financing

• Borrow from banks• If big financing requirement

– Banks borrow abroad– Balance of payments deficit

• 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

Housing markets: idiosyncratic

• US housing market– First time that there is a general decline

• Europe– No general trend – even in 2006– Germany and Italy in doldrums– Ireland, Spain, UK exceptional inflation

• Is globalisation and financial integration promoting a convergence in housing cycles?

Housing - Long-Term Drivers

• Income, user cost, cost of building, credit• Culture, preferences?• Demographics

– Natural increase, “headship rates”, migration• Holiday homes

Dwellings per 1000 Adults

550.8574.8UK443.6655.1Spain421.2453.5Poland534.0534.0Netherlands478574Ireland 2006464525Ireland 2001

598.5Germany525.6633.6France594.6620.8Denmark

OccupiedAll Dwellings

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

-100

1020304050607080

1991-96 1997-02 2003-06 2007-11 2012-16 2017-21

Tho

usan

d

Population Growth Change in Headship Migration Vacant Obsolescence

Cost of Capital

• EMU and financial liberalisation

Risk premium: percentage points

2.1UK

1.91.4Spain

1.62.0Ireland

1985-981980-98

Relative to DM

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 GD

P

Ireland Spain Poland

Cost of Capital

• EMU and financial liberalisation– Fall in risk premium especially for households

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

Real Interest Rates

-4-202468

1012

1980 1985 1990 1995 2000 2005

Ireland Spain

Role of Building in Economy

• Affects of change in share:– Wealth effects, Demand effects

• Size of Housing/Building– Optimal v Actual capital stock

• housing, infrastructure

• Crowding out of tradable sector• Crowding in of tradable sector in bust?• Role of the labour market

Housing, % of GDP, 1970-05

2.72.23.02.6Poland, 1996-05

8.94.18.95.4Spain

13.93.713.96.1Ireland

3.92.84.53.6UK

5.65.28.26.5Germany

4.64.17.95.4France

2005MinMaxAverage

Housing Investment

02468

10121416

1980 1985 1990 1995 2000 2005 2010

% o

f GN

P

Ireland Spain EU 15

Housing Markets Today

• How big a fall in price?

Maximum House Price Falls, %

-34United Kingdom-14US

-38Sweden-50Netherlands-27Ireland -15Germany-18France-50Finland-37Denmark

Housing Markets Today

• How big a fall in price?• Impact on Economy

– Demand impact – Ireland– Labour Market

Housing Markets Today

• How big a fall in price?• Impact on Economy

– Demand impact – Ireland– Labour Market

• Speed of adjustment• Role of rental sector

Private Rental Share of Housing

0%

20%

40%

60%

80%

100%

US UK Germany Spain Ireland

Owner Occupied Social Private Rental

Managing Housing Markets

• Housing bubbles can do a lot of damage• EMU changes instruments available to

governments– Interest rates– Taxation– Financial regulation

General Government Balance

-8-6-4-202468

2000 2001 2002 2003 2004 2005 2006 2007 2008

% o

f GD

P

Finland Denmark Ireland Spain

Summary

• Ireland and Spain– Need more dwellings in long term– Mismanagement of housing markets has macro-

economic costs– Crowds out tradable sector– Costs a function of how far & how fast the fall

• Governments must manage housing market– EU-12 – especially Poland

• Don’t blame EMU – blame unwise governments

Implications• Fiscal policy should

– Prevent bubbles– Manage real exchange rate

• Balance of payments in regional economies– They matter– Private sector liabilities may become public– Indication of competitiveness

• Policy rules– Target a surplus– Needed a growing surplus– SGP the problem?

The Irish Economy

• Economic Background– There is a future!– Potential Growth– Balance of Payments

• Budget 2010– Fiscal Stance– Micro-economics of the Budget– Future Fiscal policy

Trend GDP per capita: Finland

Source: Wim Suyker, Netherlands Central Planning BureauSource: Wim Suyker, Netherlands Central Planning Bureau

Trend GDP per capita: Sweden

Source: Wim Suyker, Netherlands Central Planning BureauSource: Wim Suyker, Netherlands Central Planning Bureau

GNP per capita

27282930313233343536

2000 2002 2004 2006 2008 2010 2012 2014

World Recovery Scenario

4.03.50.5-2.5Balance of Payments, % GNP

-2.4-3.3-11.3-11.8GGB, % GDP

2020201520102009Year End:

3.25.4-1.5-10.0GNP

3.35.6-0.2-7.2GDP

Average Annual % GrowthAnnual % Growth Rate

2015-202010-1520102009

GNP Growth Rates

-12

-10

-8

-6

-4

-2

0

2

4

6

8

2009 2010 2010-15 2015-20

%

The Two Deficits

-16

-12

-8

-4

0

4

8

1980 1985 1990 1995 2000 2005 2010 2015

% o

f GD

P

Balance of Payments General Government Balance

-35000

-30000

-25000

-20000

-15000

-10000

-5000

0

5000

10000

15000

20000

25000

30000

35000

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Company Household Government BOP

Net Acquisition of Financial Assets

0

20

40

60

80

100

120

2006

M120

06M3

2006

M520

06M7

2006

M920

06M11

2007

M120

07M3

2007

M520

07M7

2007

M920

07M11

2008

M0120

08M03

2008

M0520

08M07

2008

M0920

08M11

2009

M0120

09M03

2009

M0520

09M07

2009

M09Net foreign liabilities of the banking system, % of GDP

Credit Institutions' borrowing from the Central Bank, % GDP,Table C3, line 3Combined NFLB+CB lending

Budget 2010

• Major Reduction in Structural Deficit– ESRI estimate c. 4% – EU based estimate 9.4%– How much more to come?

• Fiscal Stance– Deflationary

• Microeconomics• Future Fiscal Policy

General Government Balance

-4-202468

101214

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

% o

f GD

P

Budget Measures

Effects in 2009Tax revenue

(incl PRSI

Current expe -2,686 -3,200 -3,090

Capital expe -576 -576 -961

Total ex an 5,061 7,326 4,051% GDP 3.00% 4.40% -2.47%

1,799 3,550 0

Full Year Effects in 2010

2009 Supplementary Budgets 2010 Budget

Fiscal StanceIncremental Measure of Fiscal Stance

(% of GNP +ve expansionary -ve contractionary)

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

Microeconomics of 2010

• The Budget did the key job – but…• Distributional effects

– Budget 2010– Budgets 2009 + Budget 2010

• More revenue? wasted electricity subsidy!• Make welfare, training and education suitable

– Tax child benefit– Look at the system as a whole (incl. min wage)

• Pay – what is the strategy?

Future Fiscal Policy

• Department of Finance– Further €8.5 billion to reach 3% deficit

• ESRI estimate – Further €2 billion to reach 3% deficit

• To eliminate deficit – Cut a further €5 or €6 billion

• Wont know which is right till 2010– Prudent policy cut €3 billion in 2011