The recent turmoil in the US residential housing markets has had significant international financial, macroeconomic and in particular housing market repercussions. In the latter market, the turmoil has affected mainly the market for owner-occupied housing in various countries. A distinctive characteristic of this market is that most owners have less than a complete equity share in their home, so that they typically obtain a mortgage and borrow against the collateral value of their home. It is generally thought that financial innovations during the last 20–30 years have made it easier for households to borrow against the collateral value of their homes. Such borrowing needs may derive from households trading activity in the housing market per se or from the desire to finance consumption through mortgage equity withdrawals. An implication from the improved borrowing opportunities is an increase in the demand for housing and house prices. Higher house prices will, in turn, boost up the collateral value of houses. Higher consumption demand will consequently be supported by potential wealth effects which will tend to put upward pressure on inflation.
This is the often quoted transmission mechanism of shocks to house prices, and more generally shocks to asset prices, to aggregate inflation that a number of researchers and policy makers have used to motivate closer monitoring of asset price development by central banks in their pursuit of monetary policy aimed at price stability. But how strong are these wealth effects and, maybe more fundamentally, what do we know about the effects of changes in collateral constraints on house prices? Standard theories of residential housing markets do not actually predict significant house price effects from changes in collateral constraints. Moreover, these theories have the more general difficulty in accounting for the observed sustained positive trend in house prices. Consequently, before studying the effects of financial frictions on the housing market, we should ascertain that our theory of the demand and supply in the housing market is able to capture the salient features of observed house price dynamics.
The two components of the market for single family housing – the market for existing and new homes, respectively – affect the aggregate economy in different ways. Moreover, evidence suggests that these markets have in the past behaved very differently. More specifically, the supply of existing homes in mature neighbourhoods is less elastic than that of new homes in new neighbourhoods. Consequently, changes in the demand for housing should mainly show up in the relative price of existing homes and the construction of new homes. Evidence does indeed indicate that the relative price of existing homes has increased significantly over the past years relative to new ones. Increased construction of new homes, on the other hand, has directly contributed to gross domestic product through its contribution to investment in residential structures. Higher relative prices of existing homes affect gross domestic product only indirectly, as indicated above, through wealth redistribution between current owners and potential future owners.
Infrequently observed house price collapses have not shied households away from investing in the housing market. In many countries a large share of households' wealth portfolio is still in the form of housing wealth. The return on housing wealth has been relatively high and stable probably suggesting that housing is an attractive investment opportunity to households. In this respect the housing market can be viewed as shelter against various shocks. The recent turmoil, however, warns against being too confident about the outcomes in the housing market, ie. the turmoil seems to suggest that the housing market can, infrequently, if not otherwise, also be a major source of shocks. The joint conference organized by the Bank of Finland and SUERF on June 4–5 explored these two aspects of the housing market more thoroughly. The summary below indicates not only the various behavioural and structural features of the housing market that impinges upon the market outcomes but also the potential importance of housing market developments to monetary policy and central banking more generally. |