Transcript Discussion of `On the importance of borrowing constraints for house

Discussion of
‘On the importance of borrowing
constraints for house price
dynamics’
by Eerola and Määtänen
Kalin Nikolov
Bank of England and LSE
September 2008
Motivation and questions
• Finland had a huge housing boom-bust cycle
during the 1985 - 1995 period
– 50% increase 1985-1990
– 50% fall: 1990-1993
• Two key candidate explanations
– Financial liberalisation in the 1980s: much lower
down-payments for house purchase
– A severe recession in early 1990s – GDP down 20%
• The paper studies this episode. 2 key questions
– How does the down-payment affect housing prices in
a model calibrated to the Finnish economy?
– Can the model replicate the Finnish boom-bust cycle?
Answers
• Lower down-payments increase steady state
housing prices
• Down-payments introduce asymmetric dynamics
following income shocks
• The 1990s boom-bust cycle
– Cannot match the 50% housing price increase by
appealing to lower down-payments
– Can match the 50% fall in prices using permanent
income and interest rate shocks
– But: permanent shocks cannot explain the rapid
subsequent recovery
Modelling framework
• Small-open endowment economy
• OLG households – live for 10 periods
– Enjoy houses and non-durables (and bequests)
– Collateral constraint for house purchase
• Fixed housing supply
• Calibrated to the 2004 Wealth Survey of Finnish
households
• Consider perfect foresight dynamics after onetime shocks
Main comments
• I enjoyed reading this paper
• Focus comments on two aspects
– Should we necessarily expect lower collateral
requirements to increase the steady state
demand for housing?
– Is the fixed housing supply assumption
innocuous?
Do lower collateral requirements
increase steady state housing
demand?
Why lower down-payments lead to
higher steady state housing prices
• Lower down-payment requirements allow
young households to increase expenditure
on both housing and non-durables
• Older households unaffected because
they are unconstrained
• Higher aggregate housing demand – leads
to higher prices due to fixed supply
Importance of rental markets
• When renting is ‘allowed’, poor
households rent so as not to have to save
for a down-payment
• When down-payment requirements are
reduced, the poor households borrow and
purchase their rented houses.
• Not necessarily a large change in steady
state aggregate housing demand
• So housing price largely unaffected
Does housing investment matter
for housing prices?
Housing supply
• The endogenous response of housing
supply matters in a forward-looking model
• The elasticity of housing supply varies
greatly across countries and this matters a
lot for housing prices
– Housing investment: 3-4% of GDP (UK), 6%
(US)
– Volatility of housing prices is higher in the UK
– Average growth of real UK housing prices
higher despite lower GDP growth
• How elastic is supply in Finland?