Portugal Ireland Greece Spain
Period ∆IR ∆HL IR HL IR HL IR HL
1 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
2 0.09 0.01 0.15 2.39 8.36 1.98 0.00 0.10
3 0.13 0.04 3.79 3.13 15.42 2.31 0.00 2.17
4 0.15 0.06 4.30 2.47 20.71 2.75 0.08 2.19
5 0.15 0.07 5.68 4.45 24.05 3.01 0.30 1.82
6 0.16 0.07 10.73 8.90 26.22 3.24 1.37 1.59
7 0.16 0.07 18.81 16.38 27.64 3.42 4.04 1.41
8 0.16 0.07 24.76 24.92 28.64 3.57 7.27 1.23
9 0.16 0.07 28.46 33.13 29.37 3.70 11.32 1.19
10 0.16 0.07 30.85 39.54 29.93 3.80 16.22 1.25
11 0.16 0.07 31.77 44.95 30.36 3.88 21.14 1.44
12 0.16 0.07 31.28 49.64 30.71 3.96 25.29 1.75
13 0.16 0.07 30.16 53.44 31.00 4.02 28.76 2.09
14 0.16 0.07 29.16 56.17 31.25 4.07 31.54 2.40
15 0.16 0.07 28.31 58.19 31.45 4.12 33.61 2.67
16 0.16 0.07 27.62 59.78 31.63 4.16 35.13 2.89
17 0.16 0.07 27.12 61.04 31.79 4.19 36.28 3.05
18 0.16 0.07 26.82 62.00 31.92 4.22 37.19 3.18
19 0.16 0.07 26.63 62.78 32.05 4.25 37.95 3.28
20 0.16 0.07 26.45 63.46 32.16 4.28 38.66 3.36
Before moving on to the discussion part, we apply the residual Portmanteu-test for autocorrelations to each model. The null hypothesis of this test is that the residuals exhibit no autocorrelations up to a specified lag. We choose a maximum lag length of 20 and perform the test for the model of each country. At 5% level of significance,
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the null hypothesis in Portugal, Greece and Spain cannot be rejected. In Ireland, the null hypothesis cannot be rejected on 10% level of significance. Thus, we conclude that the estimated models are robust.
6 Discussion
The analysis of the real estate market in the PIGS countries shows that Spain and Ireland experienced the largest positive bubble formation in the period between the implementation of the single monetary policy under the ECB in 1999 and 2012, followed by Portugal with a small bubble formation. In contrast to that, Greece experienced a strong negative bubble trend. This decrease was due to a very strong drop of interest rates up to 2001, which pushed the fundamental value far above the market price, resulting in a decreasing bubble.
The major bubble boom, starting between 2003 and 2005 was followed by the burst at the end of 2008, when interest rates of the ECB reached its second peak. The empirical analysis confirms that there is a significant long- and short-run relationship between monetary policy and the bubble formation. We find strong evidence that the bubble in Ireland, Greece and Spain is positively related to both the Euribor and the lending for house purchase-to GDP in the long run. In Portugal, however, we find no long-term relationship between the variables. As for Portugal, the impulse response analysis shows only a weak positive relationship between the two variables and the bubble. In Greece, the analysis shows a stronger positive relationship between the two variables and the bubble than in Portugal. In contrast to that, we find that the bubble in Ireland and Spain, the countries with the largest bubble, is negatively related with the Euribor in the short-run. Further, the analysis shows that the bubbles in these two countries are positively related to lending for house purchase-to-GDP. Although we find some similarities in the long- and short-run
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relationship between the bubble and the variables, i.e. the monetary policy, there are still differences across the PIGS countries. These differences can be attributed to the characteristics of the financial system, fiscal- and macroprudential- policies in each country.
First, the monetary policy of the ECB is transmitted differently through the interest rate and credit channel to the countries in the Eurozone (ECB, 2009). The interest rate channel describes the process of how key interest rates set by the ECB impact the interest rates at banks at the national level. In this regard, Sorenson and Lichtenberger (2007) pointed out that although the ECB sets the key interest rate for the entire Eurozone, the interest rates on mortgages are heterogeneous across countries. The credit channel describes the process how monetary policy affects the supply of money on the national level. In this regard, Ciccarelli et al. (2010) showed that a monetary policy shock of the ECB has a significant impact on credit availability.
Further, they demonstrate that there are differences between size and timing of the impact across borrowers and economic regions. As a result of the differences in the interest rate and credit channel, the monetary policy of the ECB has a varying impact on domestic deposit and lending conditions of banks. Table 5 on the interest rates of housing loans and deposits shows the diverging interest rates across the PIGS countries. Looking at the interest rates for housing loans, it is noteworthy that the two countries with the largest bubble had, most of the time, up to the burst of the bubble in 2008 the lowest interest rate. Further, the interest rate in Greece decreased rapidly from 1999 and its level remained still the highest among the PIGS countries up to the mid-2000s. The rapid decrease of the interest rate manifested in the initially strongly decreasing bubble in Greece.
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Table 5
Interest Rates on Housing Loans and Deposits
Average interest rate for housing loans Average interest rate on deposits*
Portugal Ireland Greece Spain Portugal Ireland Greece Spain
1999 5.02 4.94 8.51 4.79 2.40 0.13 8.68 2.13
2000 6.03 5.19 7.62 5.79 3.04 0.40 6.12 3.36
2001 6.04 5.59 6.28 5.84 3.35 0.40 3.32 3.22
2002 5.02 4.58 5.01 4.85 2.96 0.12 2.76 2.75
2003 3.71 3.73 4.77 3.54 1.95 0.52 2.41 2.01
2004 3.49 3.40 4.49 3.21 1.82 0.45 2.30 1.97
2005 3.40 3.40 4.11 3.23 1.88 0.52 2.25 2.10
2006 4.08 4.14 4.32 4.14 2.61 0.81 2.96 2.83
2007 4.88 5.00 4.47 5.15 3.76 1.33 4.09 4.01
2008 5.34 5.07 4.85 5.65 4.10 1.41 4.93 4.52
2009 2.56 2.93 3.79 3.03 1.82 0.62 2.50 2.34
2010 2.54 3.16 3.64 2.52 1.84 0.64 3.36 2.51
2011 3.86 3.40 4.28 3.41 3.53 0.64 4.26 2.67
2012 3.78 3.28 3.20 3.21 2.88 0.48 4.80 2.70
* Deposits with agreed maturity of up to 1 year. In the case of Ireland there is no data on this rate available, therefore we show the interest rate for overnight deposits.
Second, fiscal policies in the Eurozone vary from country to country. These policies include, for instance, tax deductibility of interest payments on mortgage loans, capital gains taxes, inheritance tax, wealth tax, real estate property tax and transaction taxes. A report from the ECB (2009) shows that tax rates in 2008 varied strongly throughout the Eurozone and the PIGS countries. To give an example, the maximum tax rate applicable on capital gains in Greece is zero if capital gains have been or will be reinvested in another permanent residence within certain time limits.
In Spain the maximum rate is 18%, in Ireland 20% and in Portugal 42%. The divergent tax systems also lead to different after-tax returns for investors as well as housing bubbles in these countries.
Third, in regard to macroprudential policies as loan-to-value ratios, the report also
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shows large differences among the PIGS countries in 2007. In the group of the PIGS countries, Ireland has the highest average loan-to-value ratio of 83% for first-time house buyers, followed by Greece with 73%, Spain with 72.5% and Portugal with 71%.
The combination of these three factors gives a strong indicator why Portugal experienced a moderate bubble and why Ireland and Spain experienced a strong bubble. In Portugal, relatively high interest rates in the boom period combined with a high tax rate and comparatively low average loan to value ratio discouraged investors and speculators to move into real estate. In contrast, very low interest rates and moderate tax rates as well as relatively high loan-to-value ratios in Ireland and Spain encouraged investors to move into real estate, thus pushing up the market price and the bubble.
As this research only covered aggregate data for the PIGS countries, diverging developments within each country were not captured. Future research could bridge this gap by analyzing property market developments in specific cities or regions within each country. Further, other variables influencing the calculation of the bubble as occupancy rates, maintenance cost and tax were not considered in this paper. The inclusion of these factors would help draw a more detailed picture about the bubble and its drivers. Further, a more detailed analysis of credit expansion, fiscal- and macroprudential- policies on the national level in relation to the bubble could provide valuable insights for investors and policymakers.
7 Conclusion
Overvalued property prices pose a serious risk for economic and financial stability.
This analysis shows that Spain and Ireland experienced the largest positive bubble formation in the period between 1999 and 2012, followed by Portugal with a very
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small bubble formation. In contrast to that, Greece experienced a strong negative bubble trend, which was due to a rapid decrease of interest rates between 1999 and 2001, resulting in a fundamental value far above the market price. The major bubble boom, starting between 2003 and 2005, was followed by the burst at the end of 2008 when the interest rates of the ECB reached its peak.
Results of the empirical analysis on the long- and short-run relationship between the monetary policy of the ECB and the bubble in the PIGS countries indicate a very strong relationship in Ireland and Spain. In the long run, the bubble is positively related to both an increase in the money market interest rate and the lending for house purchase-to-GDP. In the short run, however, we find strong evidence for a negative relationship of the bubble with the Euribor and a strong positive relationship with the lending for house purchase-to-GDP. In the case of Greece, we find a weak positive long- and short-run relationship between the two variables and the bubble. As for Portugal, we find no long-run and only a very weak short-run relationship. The varying extent of the bubble formation and the differing impact of the monetary policy on the bubble across the PIGS countries can be mainly attributed to the characteristics in the domestic financial-, fiscal- and macroprudential- system. This paper provides strong evidence that central bank’s policies are crucial to trigger the boom and burst of property bubbles by manipulating the interest rate and availability of lending for house purchase. The results also imply that real estate investors should observe the change of monetary and fiscal policies for decision making.
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