Graph of the month: EU and EZ Ratio of a House Price Index to rents (Eurostat)
We didn’t see it coming, the Great Financial Crisis. But since yesterday it has become slightly more difficult to miss such events. Eurostat published (among other things) an EU and EZ ratio house price/rent ratio. Read
all of it the parts on methodology and policy implications. Quote: ” The (national, M.K.) alarm threshold adopted in the context of the MIP is 6 % of annual growth rate in the deflated HPI (House Price Index, M.K.). But even on the European level such increases clearly show in the 2005-2007 period (see the Eurostat publication linked). An average increase which is of course connected to house price bubbles in Spain and Ireland and the Baltic states and the Netherlands and the connected increases in deficits on the current accounts (not in the Netherlands, by the way, see below). At this moment, we should of course not miss out on the present ‘debt deflation’ – in a sense the Eurozone is brought down by piles of bricks.
Graph 1. Ratio of House Price Index to actual rents – Index levels 2010 = 100
The connection between high house prices and consumption is investigated in this report from the Central Bank of Ireland: House equity withdrawal trends in Ireland. When house prices rise people feel rich, despite the fact that this is not caused by increases in income and production. House price illusion instead of money illusion. This makes them consume more, facilitated by bank lending, which adds to an economic boom which often leads to a deterioration of the current account (look at graph 1 and 9 here). The question is of course why this did not happen in a country like the Netherlands, which witnessed entirely comparable developments of equity withdrawal. No, that’s not true – equity withdrawal in the Netherlands was even higher. Part of this can be explained by high pension savings, another part by company savings (i.e.: retained earnings which were not invested). The present Dutch problems: savings are still high – but equity withdrawal and comparable lending has stopped. With a quite severe slump as a consequence. Denmark is in a comparable situation, though this country also suffers from a high exchange rate.