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Kalin Nikolov Bank of England and LSE September 2008

Discussion of ‘On the importance of borrowing constraints for house price dynamics’ by Eerola and M ää t ä nen. 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

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Kalin Nikolov Bank of England and LSE September 2008

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  1. 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

  2. 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?

  3. 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

  4. 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 one-time shocks

  5. 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?

  6. Do lower collateral requirements increase steady state housing demand?

  7. 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

  8. 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

  9. Does housing investment matter for housing prices?

  10. 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?

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