The International Monetary Fund has called on governments in eurozone countries with overheating property markets to take restrictive fiscal and regulatory action. The alternative, they argue, is a possible asset price collapse and potentially disruptive effects on financial sector soundness and private sector solvency.
Writing in the April edition of their World Economic Outlook, IMF economists analyse the links between asset prices and the business cycle in industrialised countries, and considered the problem of regional asset price bubbles within the eurozone area.
The IMF notes that following the decline in real interest rates in the second half of the 1990s and the elimination of the exchange rate risk premium following the introduction of the euro, property prices have risen sharply in Ireland, Portugal, Spain, the Netherlands and the Scandinavian countries. Using econometric analysis, they suggest that property markets in Ireland, the Netherlands, Portugal and Spain may well be overvalued at current levels.
The report maintains that the potentially significant impact of large asset price corrections on credit growth and bank soundness in such countries where the financial system is dominated by banks poses a particular challenge for the conduct of monetary policy.
The IMF economists make the case for restrictive fiscal policies at times when asset prices rise too fast during cyclical upswings and expansionary fiscal policy during asset price deflation.
They recommend reforms to remove distortions in the tax regime for housing, such as the elimination or reduction of the tax deductibility on mortgage interest payments. Denmark, is noted as a recent example where such a policy slowed private consumption growth, while affecting property prices only slightly.
The report says that fiscal policy needs to play a greater role in helping to reduce regional cyclical divergences than was the case before EMU. It points out that fiscal policy in individual eurozone countries has tended to be pro-cyclical, partly due to the Growth and Stability Pact’s focus on actual rather than structural budget deficits. However, it emphasises that the role of fiscal policy should be symmetrical, that is to say if there is a sharp correction in asset prices like in Japan - fiscal expansion should help to stabilise economic activity.
In addition to fiscal policy, the IMF endorses the use of financial sector supervision and regulation to help avoid asset price booms and busts. It suggests that raising provisioning requirements for consumer and real estate loans, margin requirements, enhanced monitoring of lending standards, and moral persuasion, all have their role to play.
To avoid potential credit problems, the IMF calls for the use of ‘stress testing’, which takes account of business cycle effects and feasible downside scenarios with respect to asset prices, in evaluating credit decisions. They say in some cases that it may be desirable for collateralised property lenders to adopt countercyclical features, like requiring a larger down payment in boom times. The Central Bank of Ireland engaged banks in Ireland in a stress testing exercise in relation to property earlier this year.
The IMF economists also recommend that banks have greater disclosure requirements for their loan risk management practices and internal control policies, thereby helping to avoid some of the weak credit risk management practices and poor quality problems that typically underlie financial-sector fragility. |
