24 November 2011

Peter Praet: Housing cycles and financial stability – the role of the Policymaker

Speech by Mr Peter Praet, Member of the Executive Board of the European Central Bank, at the European Mortgage Federation's (EMF) Annual Conference 2011. Housing markets have certain characteristics that intrinsically link them to financial stability.

House price collapses can have systemic consequences. We know this from the current crisis and we know this from past crises. This fact raises a number of important questions for policymakers.

• Do asset price bubbles exist?
• If they do, how do we identify them?
• Should we react in the same manner to all asset price bubbles? Should we treat housing price bubbles differently?
• We know the cost of not reacting to house price bubbles, but what is the cost of over-reaction?
• If we react, how do we react and who reacts?

Mr Praet touched on all of these aspects in his speech.

Asset price bubbles do exist and have potentially large costs for the real economy, particularly in the case of house price bubbles. Although their costs are clear, their identification is not. The ex-ante detection of costly house price booms is extremely difficult. However, a number of useful predicators of potentially costly boom/bust cycles have been identified by researchers; these include simple deviations of money and credit aggregates from a trend that exceed a given threshold. Policymakers can use both proactive and reactive measures to combat costly house price booms.

Limiting credit risk exposures from borrowers and/or ensuring the resilience of banks would help limit the potential costs of house price collapses. The establishment of the ESRB – an independent body responsible for the macro-prudential oversight of the EU financial system – along with the new capital and liquidity measures for banks marks a big step in the right direction.

The use of macro-prudential instruments requires a balancing act: on the one hand containing developments judged to contain financial stability risks and on the other hand ensuring that economic growth and financial development is not unnecessarily constrained by an overreaction. As regards the monitoring of asset price cycles and mitigating the risk of credit-fueled booms, the newly formed ESRB, which brings together central bankers, financial supervisors (both national and European) and the European Commission, is best placed to provide warnings and recommendations to policymakers.

Full speech

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