2. Monetary Policy and Real Estate Bubbles
2.6. Discussion
cannot be rejected at several lags even at the 1% level of significance. Therefore, the empirical results of Greece should be interpreted with caution.
Table 2.8: Decomposition of Property Bubble Variance
Portugal Greece Ireland Spain
Period ∆IR ∆HL IR HL IR HL IR HL
Note: Since differenced data is used in the estimation of the VAR model of Portugal and level data is used in the estimation of the VEC models of Greece, Ireland and Spain above figures of Portugal cannot be compared directly with the other three countries.
2.6. Discussion
The analysis of the real estate market in Greece, Ireland, Portugal and Spain 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. Greece and Portugal exhibited only a weak increase in the bubble in the period from 2001 to 2012 and 1999 to 2012 respectively.
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 in the
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observed period. The empirical analysis provides evidence that there is a significant long- and short-run relationship between ECB’s monetary policy and the formation of real estate bubbles in the Eurozone. The findings show that, in the long-run, the bubble in Greece, Ireland and Spain is positively related to both the Euribor and the lending for house purchase-to GDP ratio. In the short-run, the bubble in Greece responds weakly positive and the bubble in Ireland as well as Spain strongly negative to an increase in the Euribor. The bubble of Greece, Ireland and Spain responds positively to a rise in the lending for house purchase-to GDP ratio. In the case of Portugal, the analysis indicates no long-run cointegration relationship and only a weak positive response to a shock in the two monetary variables in the short-run.
Although all of the four countries have become members of the Eurozone and they are subject to the single monetary policy of the ECB, their real estate market responded differently to monetary policy shifts. These differences can be mainly attributed to the characteristics of the domestic financial system, fiscal- and macroprudential- policies as well as other local structural factors 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). Thereby, 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) point 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) shows 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
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interest rate and credit channel, the monetary policy of the ECB has a varying impact on domestic deposit and lending conditions of banks. Table 2.9 on the interest rates of housing loans and deposits shows the diverging pattern across Greece, Ireland, Portugal and Spain. 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 the highest among the four countries up to the mid-2000s.Table 2.9: Interest Rates on Housing Loans and Deposits
Average interest rate for housing loans Average interest rate on deposits*
Greece Ireland Portugal Spain Greece Ireland Portugal Spain
1999 8.51 4.94 5.02 4.79 8.68 0.13 2.4 2.13
Note: Data is sourced from the Eurostat database (Eurostat, 2013) and the European Central Bank (ECB, 2013b). * Deposits with agreed maturity of up to 1 year. In the case of Ireland there is no data on this rate available. Therefore, the interest rate for overnight deposits is shown.
Second, fiscal policies in the Eurozone vary across countries. 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 structural issues report from the ECB (2009) shows that tax rates in 2008 varied
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strongly across Eurozone member 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 Portugal, the maximum rate is 42%, in Ireland 20% and in Spain 18%. The divergent tax rates directly impact after-tax returns for investors and thus exert a diverging influence on real estate market developments across countries.
Third, in regard to macroprudential policies as LTV ratios, the report also shows large differences amongst the four countries in 2007. Amongst these 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%.
Fourth, besides financial-, fiscal and macroprudential, other structural factors, such as land availability, local planning system, institutional and contractual features also have an major impact on the functioning of and the transmission of monetary policy to local housing markets. It is also important to note that these factors change continuously over time. Details on structural aspects and major housing market reforms between 1980 and the early 2000s can be found in structural issues report of the ECB (2003) on housing markets in the EU. Details on housing finance in the Euro Area can be found in a more recent structural issues report of the ECB (2009).
The combination of these factors might give an indication why Greece, Ireland, Portugal and Spain exhibited diverging bubble formation and why their real estate market responded differently to monetary policy shifts of the ECB. Further research is needed to assess the the impact of these factors on developments in real estate markets.
As this research only covers aggregate data, diverging developments within each country are not captured. Research on property market developments in specific cities
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or regions within each country would provide valuable insights for policymakers and investors in local real estate markets.