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

 John Fitz Gerald and Thomas Conefrey
  The 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
               All Dwellings   Occupied
Denmark              620.8          594.6
France               633.6          525.6
Germany              598.5
Ireland 2001          525            464
Ireland 2006          574            478
Netherlands          534.0          534.0
Poland               453.5          421.2
Spain                655.1          443.6
UK                   574.8          550.8
Headship Rates
    80
    70
    60
    50                                                                     Ireland
%




                                                                           Germany
    40                                                                     UK
    30
    20
    10
         20-   25-   30-   35-   40-   45-   50-   55-   60-   65-   70-
         24    29    34    39    44    49    54    59    64    59    74

                                       Age
Irish Housing Demand - Components


            80
            70
            60
Thousand




            50
            40
            30
            20
            10
             0
           -10
                  1991-96      1997-02    2003-06     2007-11    2012-16       2017-21

           Population Growth   Change in Headship   Migration   Vacant     Obsolescence
Cost of Capital
• EMU and financial liberalisation
Risk premium: percentage points
           Relative to DM

             1980-98        1985-98

Ireland         2.0           1.6

Spain           1.4           1.9

UK              2.1
Net Foreign Liabilities of Banking System

           70

           60

           50
% of GDP




           40

           30

           20

           10

            0
                1989   1991   1993   1995   1997   1999    2001   2003   2005   2007

                                        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
12
10
 8
 6
 4
 2
 0
-2
-4
     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
                  Average   Max    Min   2005
France              5.4     7.9    4.1   4.6
Germany             6.5     8.2    5.2   5.6
UK                  3.6     4.5    2.8   3.9
Ireland             6.1     13.9   3.7   13.9
Spain               5.4     8.9    4.1   8.9
Poland, 1996-05     2.6     3.0    2.2   2.7
Housing Investment
           16
           14
           12
% of GNP




           10
            8
            6
            4
            2
            0
                1980    1985   1990       1995     2000    2005   2010
                                Ireland    Spain   EU 15
Housing Markets Today
• How big a fall in price?
Maximum House Price Falls, %
Denmark              -37
Finland              -50
France               -18
Germany              -15
Ireland              -27
Netherlands          -50
Sweden               -38
United Kingdom       -34
US                   -14
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
100%

 80%

 60%

 40%

 20%

 0%
       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
% of GDP




           2
           0
           -2
           -4
           -6
           -8
                2000   2001   2002   2003   2004   2005   2006   2007    2008

                          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 Bureau
Trend GDP per capita: Sweden




Source: Wim Suyker, Netherlands Central Planning Bureau
GNP per capita

36
35
34
33
32
31
30
29
28
27
     2000   2002   2004   2006   2008   2010   2012   2014
World Recovery Scenario

                              2009         2010      2010-15      2015-20


                             Annual % Growth Rate   Average Annual % Growth

GDP                           -7.2         -0.2        5.6           3.3

GNP                           -10.0        -1.5        5.4           3.2

Year End:                     2009         2010         2015         2020

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

Balance of Payments, % GNP    -2.5         0.5         3.5           4.0
GNP Growth Rates
     8
     6
     4
     2
     0
%




     -2
     -4
     -6
     -8
    -10
    -12
          2009   2010   2010-15   2015-20
The Two Deficits

            8

            4
% of GDP




            0

            -4

            -8

           -12

           -16
                 1980    1985   1990   1995   2000   2005   2010   2015

           Balance of Payments            General Government Balance
Net Acquisition of Financial Assets
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
20
   06




            0
                20
                     40
                          60
                               80
                                                          100
                                                                                                                                                             120

      M
 20 1
   06
      M
 20 3
   06
      M
 20 5
   06
      M
 20 7
   06
20 M9
  06
     M
       1
 20 1
                                    Table C3, line 3




   07
      M
 20 1
   07
      M
 20 3
   07
      M
 20 5
                                    Combined NFLB+CB lending




   07
      M
 20 7
   07
20 M 9
  07
     M
20 11
  08
     M
20 01
  08
     M
20 03
  08
     M
                                                                                                   Net foreign liabilities of the banking system, % of GDP




20 05
  08
     M
20 07
                                    Credit Institutions' borrowing from the Central Bank, % GDP,




  08
     M
20 09
  08
     M
20 11
  09
     M
20 01
  09
     M
20 03
  09
     M
20 05
  09
     M
20 07
  09
     M
       09
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
% of GDP




        -4
             -2
                  0
                      2
                          4
                              6
                                  8
                                      10
                                           12
                                                14
20
   00
20
   01
20
   02
20
   03
20
   04
20
   05
20
   06
20
   07
20
   08
20
   09
20
   10
20
   11
20
   12
20
   13
20
   14
20
                                                     General Government Balance




   15
Budget Measures
                  200 9 Suppleme ntary Budgets                 2010 Budget

                Effects in 2009     Full Y ear          Effec ts in 2010
Tax revenue
  (i ncl PRSI             1,7 99             3,550                    0

Current expe             - 2,6 86            -3,200              -3,090

Capital expe               -5 76                 -576              - 961

Total ex an               5,0 61             7,326                4,051
% G DP                   3 .00%              4.40%              - 2.4 7%
Fiscal Stance
                         Incremental Measure of Fiscal Stance
                    (% of GNP +ve expansionary -ve contractionary)
4.0

3.0

2.0

1.0

0.0

-1.0

-2.0

-3.0

-4.0

-5.0

-6.0
   76

         78

               80

                     82




                                        88

                                              90

                                                    92




                                                                   00

                                                                   02

                                                                   04

                                                                   06
                            4

                                  86




                                                           4

                                                                   96

                                                                   98




                                                                   08

                                                                   10
                             8




                                                            9
 19

        19

              19

                    19




                                 19

                                       19

                                             19

                                                   19




                                                                19

                                                                20

                                                                20

                                                                20

                                                                20
                          19




                                                         19

                                                                19




                                                                20

                                                                20
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

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John Fitz Gerald 12th February 2010

  • 1. Blowing Bubbles and Bursting Them: Housing Markets in Ireland and Spain John Fitz Gerald and Thomas Conefrey The Economic and Social research Institute, Dublin www.esri.ie
  • 2. 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
  • 3. 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
  • 4. 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
  • 5. 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
  • 6. 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?
  • 7. Housing - Long-Term Drivers • Income, user cost, cost of building, credit • Culture, preferences? • Demographics – Natural increase, “headship rates”, migration • Holiday homes
  • 8. Dwellings per 1000 Adults All Dwellings Occupied Denmark 620.8 594.6 France 633.6 525.6 Germany 598.5 Ireland 2001 525 464 Ireland 2006 574 478 Netherlands 534.0 534.0 Poland 453.5 421.2 Spain 655.1 443.6 UK 574.8 550.8
  • 9. Headship Rates 80 70 60 50 Ireland % Germany 40 UK 30 20 10 20- 25- 30- 35- 40- 45- 50- 55- 60- 65- 70- 24 29 34 39 44 49 54 59 64 59 74 Age
  • 10. Irish Housing Demand - Components 80 70 60 Thousand 50 40 30 20 10 0 -10 1991-96 1997-02 2003-06 2007-11 2012-16 2017-21 Population Growth Change in Headship Migration Vacant Obsolescence
  • 11. Cost of Capital • EMU and financial liberalisation
  • 12. Risk premium: percentage points Relative to DM 1980-98 1985-98 Ireland 2.0 1.6 Spain 1.4 1.9 UK 2.1
  • 13. Net Foreign Liabilities of Banking System 70 60 50 % of GDP 40 30 20 10 0 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 Ireland Spain Poland
  • 14. 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
  • 15. Real Interest Rates 12 10 8 6 4 2 0 -2 -4 1980 1985 1990 1995 2000 2005 Ireland Spain
  • 16. 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
  • 17. Housing, % of GDP, 1970-05 Average Max Min 2005 France 5.4 7.9 4.1 4.6 Germany 6.5 8.2 5.2 5.6 UK 3.6 4.5 2.8 3.9 Ireland 6.1 13.9 3.7 13.9 Spain 5.4 8.9 4.1 8.9 Poland, 1996-05 2.6 3.0 2.2 2.7
  • 18. Housing Investment 16 14 12 % of GNP 10 8 6 4 2 0 1980 1985 1990 1995 2000 2005 2010 Ireland Spain EU 15
  • 19. Housing Markets Today • How big a fall in price?
  • 20. Maximum House Price Falls, % Denmark -37 Finland -50 France -18 Germany -15 Ireland -27 Netherlands -50 Sweden -38 United Kingdom -34 US -14
  • 21. Housing Markets Today • How big a fall in price? • Impact on Economy – Demand impact – Ireland – Labour Market
  • 22. Housing Markets Today • How big a fall in price? • Impact on Economy – Demand impact – Ireland – Labour Market • Speed of adjustment • Role of rental sector
  • 23. Private Rental Share of Housing 100% 80% 60% 40% 20% 0% US UK Germany Spain Ireland Owner Occupied Social Private Rental
  • 24. Managing Housing Markets • Housing bubbles can do a lot of damage • EMU changes instruments available to governments – Interest rates – Taxation – Financial regulation
  • 25. General Government Balance 8 6 4 % of GDP 2 0 -2 -4 -6 -8 2000 2001 2002 2003 2004 2005 2006 2007 2008 Finland Denmark Ireland Spain
  • 26. 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
  • 27. 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?
  • 28. 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
  • 29. Trend GDP per capita: Finland Source: Wim Suyker, Netherlands Central Planning Bureau
  • 30. Trend GDP per capita: Sweden Source: Wim Suyker, Netherlands Central Planning Bureau
  • 31. GNP per capita 36 35 34 33 32 31 30 29 28 27 2000 2002 2004 2006 2008 2010 2012 2014
  • 32. World Recovery Scenario 2009 2010 2010-15 2015-20 Annual % Growth Rate Average Annual % Growth GDP -7.2 -0.2 5.6 3.3 GNP -10.0 -1.5 5.4 3.2 Year End: 2009 2010 2015 2020 GGB, % GDP -11.8 -11.3 -3.3 -2.4 Balance of Payments, % GNP -2.5 0.5 3.5 4.0
  • 33. GNP Growth Rates 8 6 4 2 0 % -2 -4 -6 -8 -10 -12 2009 2010 2010-15 2015-20
  • 34. The Two Deficits 8 4 % of GDP 0 -4 -8 -12 -16 1980 1985 1990 1995 2000 2005 2010 2015 Balance of Payments General Government Balance
  • 35. Net Acquisition of Financial Assets 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
  • 36. 20 06 0 20 40 60 80 100 120 M 20 1 06 M 20 3 06 M 20 5 06 M 20 7 06 20 M9 06 M 1 20 1 Table C3, line 3 07 M 20 1 07 M 20 3 07 M 20 5 Combined NFLB+CB lending 07 M 20 7 07 20 M 9 07 M 20 11 08 M 20 01 08 M 20 03 08 M Net foreign liabilities of the banking system, % of GDP 20 05 08 M 20 07 Credit Institutions' borrowing from the Central Bank, % GDP, 08 M 20 09 08 M 20 11 09 M 20 01 09 M 20 03 09 M 20 05 09 M 20 07 09 M 09
  • 37. 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
  • 38. % of GDP -4 -2 0 2 4 6 8 10 12 14 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 General Government Balance 15
  • 39. Budget Measures 200 9 Suppleme ntary Budgets 2010 Budget Effects in 2009 Full Y ear Effec ts in 2010 Tax revenue (i ncl PRSI 1,7 99 3,550 0 Current expe - 2,6 86 -3,200 -3,090 Capital expe -5 76 -576 - 961 Total ex an 5,0 61 7,326 4,051 % G DP 3 .00% 4.40% - 2.4 7%
  • 40. Fiscal Stance Incremental Measure of Fiscal Stance (% of GNP +ve expansionary -ve contractionary) 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 -5.0 -6.0 76 78 80 82 88 90 92 00 02 04 06 4 86 4 96 98 08 10 8 9 19 19 19 19 19 19 19 19 19 20 20 20 20 19 19 19 20 20
  • 41. 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?
  • 42. 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