- Ireland and Spain experienced housing bubbles fueled by excessive credit growth as interest rates fell under EMU, crowding out their tradable sectors. - The mismanagement of housing markets had significant macroeconomic costs as the bubbles burst, including large falls in economic demand and activity. - Governments must better manage their housing markets through fiscal policy, financial regulation, and ensuring balanced growth to prevent unsustainable imbalances from developing.

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