Transcript Slide 1

What should Central Banks do about
Real Estate Prices?
Franklin Allen
and
Elena Carletti
Asset Prices, Credit and Macroeconomic Policies
March 25-26, 2011
Idep-Greqam, Marseille, France
Real Estate Markets and Financial Stability
• Reinhart and Rogoff (2009) document that many
financial crises are the result of a sharp drop in
property prices
• In the current crisis Ireland, Spain and some regions
of the U.S. had sharp run ups and then collapses in
property prices that have had a severe effect on these
countries’ banking systems and economies
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Figure 1
Nominal housing Prices in Ireland, Spain and the U.S.
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Some other countries
350.00
300.00
House Price Index
250.00
France
Germany
200.00
Greece
Italy
Portugal
150.00
Spain
UK
100.00
USA
50.00
0.00
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
4
What are the causes of these real estate
bubbles?
• It is widely argued there are two important ones
1. Loose monetary policy – low interest rates
2. Global imbalances – easy availability of credit
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Total Reserves in Billions of US $ 1996-2009
10000
9000
8000
7000
Total
6000
Asia
5000
Oil producers
Latin America-oil producing
4000
Central & Eastern Europe
3000
2000
1000
0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
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Residential Mortgages
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Figure 3
Current Account Deficits as % of GDP
2.00%
0.00%
-2.00%
-4.00%
Spain
Ireland
-6.00%
United States
-8.00%
-10.00%
-12.00%
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
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• The debate needs to go beyond Taylor’s
(2008) assertion that low interest rates cause
property bubbles if preventive policies are to
be designed
• We need to model how property bubbles arise
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Theories of bubbles
1. Infinite horizon (Tirole 1985, Caballero and
Krishnamurthy 2006, Kocherlakota (2010), and
Farhi and Tirole 2010)
2. Asymmetric information (Allen, Morris and
Postlewaite 1993, Conlon 2004, and Dobles-Madrid
2010)
3. Agency problems (Allen and Gorton 1993, Allen
and Gale 2000, 2003, Barlevy 2009)
4. Behavioral (De Long et al. 1990, Herring and
Wachter 1999, Abreu and Brunnermeier 2003, and
Scheinkman and Xiong 2003)
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What should a theory of bubbles explain?
• In “normal times” there are not property bubbles (e.g.
Germany for last 20 years)
• In “bubble times” there is a sharp increase in leverage
and run up in property prices, then a collapse
• This distinction suggests there is a threshold where
speculators enter and start a bubble
• We use an agency approach to model this
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Normal times
Willingness to pay
for housing services
P1’ = H(S1’)
P1’’ = H(S1’’)
S1’
Pr. π
S1’’
Pr. 1- π
Supply of housing
services
Risk neutral consumers determine prices
N
0
P
P1  (1  )P1
 H0 
1  C
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Bubble times
• Risk neutral speculators use their own wealth W and
loan with loan-to-value ratio λ to buy x units at price Pt
so Pt x  W  Pt x
• We focus on the case where there is no default when
the price is high but there is when it is low so
speculators enter if
N


 H0 (1  S )  P1  (1  r0 )P0 x  W(1  S ).


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• In this case speculators enter and the price is bid up
so this condition is satisfied with equality and there is
a bubble if
H 0 (1  S )  P1  W(1  S ) /(x)
P 
 P0N
(1  r0 )
B
0
• In the special case ρS = ρC = r0 = r we can simplify the
entry condition by substituting the borrowing
constraint

1  (1  )
P1 ' 

N
H


P
0
0

1  r 
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• In the special case λ = 1, W = 0 and ρS = ρC = r0 = r
P1
P1  (1  )P1
N
P  H0 
 P0  H0 
(1  r)
1 r
B
0
• In this case bubbles always occur
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Policy considerations
• Objective of policy should be to prevent bubbles
occurring in the first place and restoring normal times
if speculators have entered
• Speculators’ entry condition more likely to be
satisfied with low interest rates and easily available
credit
• Monetary policy and credit availability can have a
role to play in controlling bubbles in small
homogeneous countries like Sweden but in large
heterogeneous economies like China, the Eurozone
and the U.S. macro-prudential policies need to be
relied upon
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Macro-Prudential policies
Macro-prudential policies are designed to counter a
whole range of systemic risks
• Countercyclical regulatory policy
• Control of contagion risk
• Discretionary policies
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Macro-Prudential policies for real estate
• Should eliminate speculators’ incentive to enter the
real estate market and create a bubble
1. Mandatory reductions in loan-to-value ratios
2. Increases in annual real estate taxes
3. Increases in taxes on real estate transfers
4. Direct restrictions on real estate lending
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Implementation of macro-prudential
• Borio and Lowe (2002) and other papers from the
BIS suggest difficult but not impossible to identify
property bubbles
• Christensson et al. (2010) look at Financial Stability
Reports of the Netherlands, Norway, Spain, Sweden,
and the U.K. over the period preceding and during the
crisis
• FSRs were successful in identifying risks and
unsustainable trends but many were regarded as low
probability events not worthy of action
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Chinese experience
• The Chinese have tried a number of these measures
– Lower loan-to-value ratios for second, third, and more
houses
– Taxes on resales of certain types of housing
– Restrictions on foreigners buying
– Loan restrictions on commercial property
• They have not worked very well in the major cities
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Beijing Housing Price vs Disposable Annual Income
Normalized, base year=2002
adjusted by CPI, 2002=100
400
350
300
250
200
150
100
50
housing price, RMB/sqm
Apr-10
Dec-09
Aug-09
Apr-09
Dec-08
Aug-08
Apr-08
Dec-07
Aug-07
Apr-07
Dec-06
Aug-06
Apr-06
Dec-05
Aug-05
Apr-05
Dec-04
Aug-04
Apr-04
Dec-03
Aug-03
Apr-03
Dec-02
income
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Apr-10
Dec-09
Aug-09
Apr-09
Dec-08
Aug-08
Apr-08
Dec-07
Aug-07
Apr-07
Dec-06
Aug-06
Apr-06
Dec-05
Aug-05
Apr-05
Dec-04
Aug-04
Apr-04
350
300
250
200
150
100
50
Dec-03
Aug-03
Apr-03
Dec-02
Shanghai Housing Price vs Disposable Annual Income
adjusted by CPI, 2002=100
housing price, RMB/sqm
income
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Shenzhen Housing Price vs Disposable Annual Income
Normalized, base year=2002
adjusted by CPI, 2002=100
400
350
300
250
200
150
100
50
housing price, RMB/sqm
Apr-10
Dec-09
Aug-09
Apr-09
Dec-08
Aug-08
Apr-08
Dec-07
Aug-07
Apr-07
Dec-06
Aug-06
Apr-06
Dec-05
Aug-05
Apr-05
Dec-04
Aug-04
Apr-04
Dec-03
Aug-03
Apr-03
Dec-02
income
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Concluding remarks
• Objective of policy should be to prevent the property
market becoming speculative
• Monetary policy and credit availability can have an
important role in some economies like Sweden
• It is not clear that macro-prudential policies will
prevent or eliminate bubbles but they may help
• Inefficiency of property markets is also important, i.e.
positive serial correlation of returns (e.g. Englund,
Quigley and Redfearn 1998), and needs to be
incorporated in the analysis
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