Why central bankers keep their cool in the face of rising house prices
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House prices are rising in many large economies. This FT series explores whether these increases are sustainable.
Inflation-obsessed central bankers are increasingly sensitive to the plight of millions of buyers squeezed from property markets by soaring house prices. Acting, however, is another matter.
Janet Yellen, US Secretary of the Treasury, expressed concern last month about “the pressures that rising house prices will create for families who become homeowners or have lower incomes.” She followed European Central Bank President Christine Lagarde, who acknowledged in June that “the disconnect between house prices and broader economic developments during the pandemic carries a risk of price correction”.
But since house prices are not directly included in the headline inflation measures that shape the mandate of central banks in advanced economies, these institutions are not required to seek to dampen prices when they rise.
Their mandate is to maintain financial stability, but most do not see the housing market as a primary source of risk. Economists also cite statistical reasons for keeping house prices out of inflation measures.
Why Doesn’t Inflation Include Homeownership Fees?
Statisticians have long resisted the inclusion of house prices in measures of headline inflation.
FT Series: Global Real Estate Prices – Raising the Roof
House prices are rising in many large economies, but is it sustainable?
Part 1: How the pandemic sparked the world’s biggest house price boom in more than two decades.
Part 2: Buyers are flocking to smaller US towns, renewing policy makers’ concerns about affordability and risk.
Part 3: The Netherlands is grappling with the social consequences of rapidly rising house prices.
Part 4: Why Berlin tenants want to expropriate their homes from listed German landlords.
Part 5: Should house prices be factored into inflation data and what can central banks do about the economic effects?
“A consumer price index aims to measure consumption, whereas buying a home is the purchase of an asset that is not consumed in the same way as other items,” said the UK Office for National Statistics in 2016 when it assessed its coverage of inflationary housing costs.
This view is shared by all the major statistical agencies around the world.
Just as they exclude changes in the value of other investments such as stocks, bonds, bitcoin or gold, they don’t want to include the investment element of home ownership, especially the cost of land.
But that leaves the housing services acquired by buying a home – shelter, living space, location and security of tenure – out of many official inflation statistics.
How could we do it?
Statisticians agree that there is no perfect solution. Conceptually pure methods proved immeasurable in practice, and practical measurements suffered from theoretical flaws.
The US statistical authorities estimate the change in the notional rent of the dwellings that people own. They argue that the rental cost is the best estimate of the consumption of housing services, although rental trends often differ significantly from housing prices.
This “rental equivalence” method was also adopted by the United Kingdom in 2017.
The EU has taken a different approach. Eurostat and the ECB prefer a “net acquisitions” method which seeks to measure the evolution of the purchase price of homes but not the land on which they are built. They are still wondering how to divide house prices into housing and land.
Although the ECB asked Eurostat this year to include the costs of owner-occupied housing in its calculation of euro area headline inflation, the central bank has been asking since 2000.
In 2007, then Bank of England Governor Mervyn King said the project “doesn’t seem to be going very fast” – and little has changed since. Lagarde admitted that any change would take several years to take effect.
What effect would that have?
Much less than the rapid rise in house prices might suggest.
The UK ONS found that a measure of net acquisitions would have grown 65% faster than a measure based on rental equivalence between 2005 and 2020. But given the many other parts of the basket of goods and services used for calculating headline inflation had minimal impact on the overall rate of price growth.
An alternative approach, used in the obsolete UK retail price index, is to use house prices along with mortgage interest rates to determine the monthly cash payments associated with home ownership. According to this measure, housing would drive inflation down over the past 15 years, as interest rate cuts since the financial crisis have pulled mortgage costs to historically low levels.
Lagarde said the impact on euro area headline inflation of including owner-occupied housing would be “fairly minimal”. “There are times when these consumption costs are a bit higher and there are times when they are a bit lower,” she said.
Richard Barwell, Head of Macro Research at BNP Paribas Asset Management, said: “This is unlikely to be a game-changer for monetary policy, Eurostat’s implementation will take a long time and in the meantime we won’t not know how the ECB will take housing into consideration. counts in its decisions.
Should central bank mandates change?
Earlier this year, New Zealand became the first country to require its central bank to assess the effects of its monetary policy decisions on the government’s goal of supporting more sustainable house prices.
This initially seemed like a significant change that would require rate hikes if prices continued their recent rapid growth.
In practice, however, the Reserve Bank of New Zealand has interpreted its new mandate narrowly: to intervene when house prices are deemed unsustainable. In his May monetary policy statement, he defined sustainability as not being in bubble territory and said that “structural factors explain high house prices” and low interest rates made prices higher. high sustainable.
Although it ended its asset purchase program in July, Francesco Pesole, analyst at ING bank, said the RBNZ “made no explicit reference to house price inflation” , although house prices “may have played a role”.
Other governments seeking a quick fix to the problem of rising housing costs face the same dilemma: raising interest rates to control house prices risks fueling unemployment and depressing living standards, compromising thus financial stability. Lagarde described it as an “act of balancing”.
Thus, governments and central banks are likely to continue to worry about affordability, but with limited capacity to deal with it.