Transcript EF303: Irish Economic Analysis

EF303: Irish Economic
Analysis
Lecture 18
The Housing Market
From last week
• Demographics:
– Familiarise yourselves with main data findings:
Census 2006, and CSO projections
– Be able to talk (in general terms) about
demographic change in Ireland (past, present,
future)
– Be able to make links between demographics and
the economy
– See ESRI MTR and also two papers on Moodle
Today
•
•
•
•
Explaining the bust
Role of the housing boom
Prospects for the housing market
SR prospects for the economy
• … brings us to the final topic for the
course -- the Public Finances
Immediate prospects…
•
Not good!
•
We know we’re in recession right now
– Official figures from CSO (released end Sept) confirmed this
– GDP declined by 0.8% in Q2, following contraction of 1.3% in Q1 (of this year)
– For 2008 as a whole, economy predicted to shrink by 1.5% - 2%
•
For 2009 the outlook remains bleak…
– Officially, government is planning for a further contraction of 1% next year
– But some commentators now predicting a 4% decline in economic activity in
2009
Ireland’s GNP growth
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
2000
-2.0%
-4.0%
-6.0%
2001
2002
2003
2004
2005
2006
2007
2008
2009
Immediate prospects…
• How did it get so bad??…
• From rapid growth as recently as last year
– Economy expanded by 4.1% in 2007 (GNP growth)
• To a severe downturn (a recession likely to last at least 2
years)…
Explaining the bust
• A ‘perfect storm’ of economic forces…
• Declining domestic demand
– Collapse in construction activity (following the bursting of
the housing bubble)
– Economy had become overly-dependent on construction
sector…
• At the peak (in 2006 -- almost 90,000 houses built that year!):
– total construction accounted for 14% of employment in the
State
– Value of construction output was equal to 25% of GNP!
(value of new house building = 16% of GNP)
(new units built per year)
From boom to bust
• From boom… almost 90,000 units built
at the peak of the boom in 2006…
• …to bust… New house completions
next year (2009) now projected to be
around 25,000 units
• A drop of 72% in just 3 years
Housing cycles
• International evidence shows housing boom
and bust cycles are surprisingly common in
industrial countries (44 such episodes
identified since 1970!)
• Growing populations, rising incomes, access
to credit, all fuel demand…
• Fixed supply of land, low productivity of
construction and the low responsiveness of
housing supply in SR all restrict supply…
• D>S causes prices to rise
Irish experience
• Prices surged 300% (!) in decade to 2006
(peak of the boom)
• Since their peak, prices have fallen about
15%-20%
• Some commentators predict prices might
have to fall by as much as 40%-50% from
peak values before the market ‘bottoms out’
Irish house prices
• Driven by ‘fundamentals’?
– Demand and supply factors…
– Rents earned or satisfaction from use
• Average house prices peaked in early 2007 at €311,000
• Price-rent ratio at around 30 during peak of boom (prices 30
times average annual rent)… 2.5 times above 1996 level
• Price to income ratios… say average salary of around
€30,000, then a price to income ratio of around 10 during
peak of boom
Irish house prices
• ‘fundamentals’ undoubtedly did drive Irish house prices
during the boom…
– Population growth
– Income growth
– Low stock of housing per capita etc.
• However, speculative demand also drove prices
– Easy access to credit
– Low interest rates
– Financial deregulation – more competition among providers of
mortgages, innovations such as 100% mortgages etc.
– Some estimates put ‘investor’ demand at anything up to 1/3 of house
purchases during the peak of the boom… based on expectations of
capital appreciation?
– CSO estimate of vacancy rate at last Census (2006) = 15%
Typical boom and bust scenario
Relationship between housing market and interest rates…
• House prices in a boom tend to peak not long after CBs start to raise
rates in response to fears over inflation
– ECB was raising rates through 2006 and 2007 to combat inflation (driven by
higher commodity prices)
– As recently as July ’08 ECB raised interest rates
– Rates have been falling rapidly since October
• After the peak, prices typically fall for up to 5 years, with previous gains
largely reversed -- i.e. the larger the boom, the greater the bust
• Downward correction in house prices usually accompanied by an
economic downturn, rising unemployment, and deteriorating fiscal
balances
Explaining the bust
• Collapse of construction has meant a big fall in investment spending
(-20% this year and next)
• Also, causing big rise in unemployment…
– Live register claimants up by 57.1% (yoy) in October (260,000 people)
– Males accounted for 70% of the increase (losses continue to be mostly in
construction sector)
– Official unemployment rate increased to 6.3% in Q3 ‘08
– Projected to rise to over 8% next year
• As unemployment rises, two effects:
– People spend less (consumption falls -- 50% of annual GDP!)
– Government finances drained by lower revenues (VAT and income tax) and
increasing social welfare payments
Explaining the bust
• As home values decline --> negative wealth effect (further
downward pressure on consumer spending)
• Knock-on effects for other sectors of economy…
• Retail sales figures:
- 0.2% in Q1
- 4.5% in Q2
- 5.7% in Q3
… data for August and September weakest in 25 years!
– Furniture and lighting sales down 20% (Habitat closure was a sign of
things to come)
– Hardware, paint and glass down 14.2%… (year to August)
• Impact on related services: estate agents, auctioneers,
solicitors, banks…
Responding to the bust
• Ideally cut interest rates to stimulate economic
activity
• Lower interest rates and weaker growth should
cause currency to depreciate
• Boost to exporting sector
• Hope is that external demand can compensate for
falling domestic demand
• Allow prices (nominal variables) - interest rates,
exchange rates and house prices - to do the
adjusting, so that quantities (real variables) - output
and employment - don’t have to…
Responding to the bust
• For Ireland interest rates (and exchange rates) determined
by ECB
• Rates were cut sooner and sharper in US and UK
• € appreciated against $ and £
• ‘perfect storm’ of economic forces compounded the housing
bust…
• Rates now falling in Eurozone, should help economy, but
external environment remains weak…
• Fiscal response?… government has little room to
manoeuvre…
• even if they did, fiscal stimulus less effective in a very open
economy…
Explaining the bust
• Negative domestic shock has been compounded by external
environment…
– Global financial crisis
– Banks under pressure -- further burden on government
– Share prices falling -- again, negative wealth effects
– Small firms and individuals struggling to get loans/credit
– Makes rapid recovery in housing market less likely
– Main trading partners (US, UK and Eurozone) all in
recession
– External demand not compensating for domestic
downturn
Outlook for Irish housing market
• SR not good…
– Overhang of unsold property
– SR no demand
– Availability of credit a constraint even if confidence was restored
– Prices likely to ‘undershoot’ as a result
• Medium term recovery likely…
– Interest rates greatly reduced
– Growing population (particularly in home-buyer segment)
– Relatively low stock of housing per capita
– ESRI suggests a need of 45,000 to 50,000 new units per annum over
the next 10 to 15 years
– Should put a ‘floor’ on the housing market in the medium-term