Rate cuts cannot curb property boom and bust
Is the global economy slowing down? That is the hot debate among economists and policymakers, as contradictory data emerges from the largest economies (even without that pesky trade war).
In one sector the answer already seems clear: real estate. According to the Dallas Federal Reserve’s global index, house price growth fell to 1 per cent at the start of this year, down from 4 per cent in late 2016 — a swing last seen during the 2008 crash.
Moreover, residential property investment for the largest 18 economies tumbled in this period from a growth rate around 7.5 per cent to minus 1.4 per cent, according to data compiled by Oxford Economics. “The current slowdown in global housing is a cause for concern,” the research group warns, adding that this “could see global growth dip to its lowest pace in a decade.”
That will undoubtedly make policymakers wince. After all, house prices are not just an economic factor, but a highly political issue in most countries. But before any politicians feel tempted to demand intervention, they should consider two lessons from history: cutting interest rates is not usually an effective way to stop house price falls, and the best way to prevent damaging booms and busts is to use macroprudential policies to curb excessive upward swings.
To understand this, it is worth looking at research released earlier this year by the IMF. Examining three decades of real estate trends in 32 countries, the fund draws four important conclusions.
First — and most obviously — house prices swings are not unusual. Measured overall, real estate prices have risen on average by 2 per cent a year in advanced economies since 1990, and 2.6 per cent in developing economies. However, that figure conceals the fact that “a 10.5 per cent decline in real average house prices occurs once every twenty years” in advanced economies, and “negative real growth in house prices occurs in about half the observations in advanced economies and a third of the observations in emerging economies over a one-year horizon.”
Second, the IMF notes that precisely because cycles are so frequent, they can “be a useful early warning signal for financial surveillance”, particularly since “more than two-thirds of the nearly 50 systemic banking crises in recent decades were preceded by boom-bust patterns in house prices.”
The need to track these cycles has become doubly important now because of an important recent twist. House prices used to be relatively unsynchronised, but the markets of major urban centres are now more tightly correlated, seemingly because global capital markets have become integrated.
So the IMF is now monitoring a special “house prices at risk” index and urging policymakers to do the same. This data apparently suggests that the pattern in Canada looks alarming, particularly in cities such as Hamilton, Toronto and Vancouver, but the situation in the US is generally less worrisome.
Third, there is little historical evidence that monetary policy alone can control house price swings. Yes, rate cuts can soften the pace of slumps for a short period in advanced economies, the IMF argues. But the impact does not last — the price of money is only one of several factors that drive prices higher (or lower). Other issues, such as real economic growth, matter deeply. Capital flows also seem increasingly important, particularly in the west’s urban centres.
Fourth, the IMF argues that if policymakers do want to shape the housing cycle, macroprudential tools are a better option, particularly to prevent the type of crazy booms that led to busts (and to financial stability risks). This could involve curbs on, say, loan to value ratios. More surprisingly, the IMF suggests there might even be a case for more capital controls.
This is pretty sensible advice. Sadly, though, it will not be easy to heed. One drawback of macroprudential policy is that it is fiddly and complex. Another is that it tends to be unpopular with voters and business groups. That makes it harder to implement in western democracies than moving interest rates.
But the next time US President Donald Trump (or anyone else) demands that central banks cut rates, somebody should wave that IMF research. Maybe there will be a wider economic case to ease monetary policy in the coming year. Property prices, however, do not provide this; never mind the striking charts.
Letter in response to this column:
Hong Kong supports loan to value ratios v global property market risks / From Paul Serfaty, Hong Kong