Ireland: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Publication Date:
14 Aug 2000
eISBN:
9781451818789
Language:
English
Keywords:
ISCR; CR; price; Ireland; price inflation; GDP; price collapse; price growth; inflation in Ireland; house price increase; housing demand; Land prices; Mortgages
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The sharp and sustained increase in Ireland's housing prices well in excess of income growth, together with rapidly declining affordability for new house buyers, raises concerns that expectations-led demand may have resulted in housing prices overshooting their sustainable levels. The paper reviews the main factors behind the improvement in Ireland's economic performance, and alternative assessments of the stance of fiscal policy during a period of rapidly accelerating economic growth. The major factors that are likely to influence fiscal policy are also reviewed.

Abstract

The sharp and sustained increase in Ireland's housing prices well in excess of income growth, together with rapidly declining affordability for new house buyers, raises concerns that expectations-led demand may have resulted in housing prices overshooting their sustainable levels. The paper reviews the main factors behind the improvement in Ireland's economic performance, and alternative assessments of the stance of fiscal policy during a period of rapidly accelerating economic growth. The major factors that are likely to influence fiscal policy are also reviewed.

I. Ireland’s Property Boom from an International Perspective1

A. Developments in Ireland’s Property Markets

House price developments

1. Since the early 1990’s Ireland has experienced a dramatic increase in property prices, as rapidly growing demand has outpaced relatively inelastic supply. During 1996–99 the price for the average new house increased at an average rate of 17 percent per year, or a cumulative increase of 90 percent. In real terms, this is equivalent to an annual rate of increase of over 15 percent and a cumulative increase of 77 percent. Price inflation for existing houses has been even higher, with the average price increasing at an annual rate of 22 percent (Figure 1). The boom has been especially pronounced in Dublin, where during the same period prices have more than doubled in real terms. Rising building costs have accounted for only a small part of this growth; since 1994 building cost inflation has averaged one-fifth of house price inflation, with rising land prices accounting for most of the difference. While official data show that average house price inflation slowed to 13–14 percent in the first quarter of 2000, this slowdown may be biased by a sharper slowdown in the high end of the housing market; indeed, the Irish Permanent index, which attempts to control for changes in the composition of house purchases, shows house price inflation continuing in the range of 20 percent in the first quarter.2

Figure 1.
Figure 1.

Ireland: House Prices and Costs

Citation: IMF Staff Country Reports 2000, 099; 10.5089/9781451818789.002.A001

Source: Housing Statistics Bulletin

The commercial property market

2. Along with residential property, commercial property has also experienced rapid price increases. Capital values for commercial property began to rise slowly from the beginning of 1994 before accelerating sharply from 1996 onwards, with the annual rate of increase peaking at 33 percent in 1998 (Figure 2). Increases have been particularly pronounced in the office and retail sectors. Reflecting the current strong demand in the commercial property market, vacancy rates have fallen sharply and rents have risen. International experience demonstrates that unsustainable commercial property booms associated with high levels of debt financing may involve serious macroeconomic risks (for example, the cases of Japan, Sweden, Norway, Finland, and the U.S. Savings and Loan crisis).3 This does not currently appear to be a concern in Ireland, given that overall banking exposure to the commercial property market—while rising rapidly—remains relatively low, at about 10 percent of total bank lending (8 percent of GNP). However, it could become a concern in the future if price inflation and lending growth continue at current rates. Vacancy rates are low at present, but large increases in supply of office space and hotels are planned or currently underway (O’Connell and Quinn, 1998). Historically the commercial property market in Ireland has exhibited many of the characteristics of a cobweb model, where an improvement in business conditions elicits a lagged supply response which then accentuates the downturn when business conditions worsen, projects begin to come on stream, and vacancy rates rise. Given the sensitivity of commercial property to the business cycle, an economic downturn of even modest proportions could have serious consequences for investors in marginal projects.

Figure 2.
Figure 2.

Ireland: Commercial Property Market

Citation: IMF Staff Country Reports 2000, 099; 10.5089/9781451818789.002.A001

Source: Jones Lang LaSalle; Hamilton Osbome King

3. With the factors influencing the residential and commercial property markets similar in many ways, the rest of this paper focuses on the residential property market, which has been a source of much attention in Ireland and where international comparisons are somewhat easier to draw. However, the commercial property market is subject to similar risks, and will need to remain a focus of attention for the authorities and private market lenders alike.

Housing market fundamentals

Housing demand

4. Demand for housing in Ireland has been underpinned by longer-term demographic trends, including population growth, a gradual increase in the share of the population in the main household formation group (aged 25–44), and a tendency for the size of the average household to fall towards the European average. The latter tendency has become more important recently as factors associated with Ireland’s strong economic performance, including a 30 percent increase in employment during 1993–99 and a 7 percent average annual increase in real household disposable incomes, have led to an increase in the rate of household formation (Figure 3). In addition, housing demand has been boosted by a substantial fell in interest rates, with real mortgage rates falling in 1999 to ⅓ of their peak in 1992. Migration has also contributed to demand growth in recent years as net inflows, particularly in household-forming age groups, have increased sharply in response to improved economic conditions. According to ESRI estimates, about ¼ of the increase in housing needs between 1991-96 and 1996-01 is accounted for by changes in migration (Duffy et al, 1999).

Figure 3.
Figure 3.

Ireland: Housing Demand Fundamentals

Citation: IMF Staff Country Reports 2000, 099; 10.5089/9781451818789.002.A001

Source: Central Statistics Office, European Mortgage Federation, and staff estimates.
Housing supply

5. Ireland began the property boom with a relatively low housing stock, with the number of houses per capita only about ⅔ of that in the rest of Europe. But accelerating demand has brought about a rapid increase in the rate of supply. The flow of new house completions has grown at an average annual rate of 11 percent in 1993–99, compared to growth of 2 percent for the period 1991–93. Annual flow supply currently represents about 4 percent of the housing stock, and the number of new house completions per capita now exceeds that in the rest of Europe by a large margin (Figure 4).

Figure 4.
Figure 4.

Ireland: House Supply and Housing Needs

Citation: IMF Staff Country Reports 2000, 099; 10.5089/9781451818789.002.A001

Source: Housing Statistics Bulletin, European Mortgage Federation, Economic and Social Research Institute.

6. Given the initial low housing stock, house construction on this scale is to some extent a natural response to Ireland’s long-run demographic convergence. The rapid increase in new house construction has placed considerable strains on infrastructure and planning. As a result, a number of bottlenecks have emerged, including a shortage of land serviced by water, public transport, and roads, and difficulties in securing required planning consents and in proceeding with the development of large-scale housing projects. Nevertheless, supply on this scale is expected to continue for some time as Ireland’s headship rate, the number of adults per household, continues to fall towards European averages. At current rates of house completion, flow supply may now be broadly adequate to accommodate this convergence. Duffy et al (1999) of the ESRI estimate that if rates of in-migration remain at levels comparable to those experienced in the last several years, and if Ireland’s headship rate falls steadily, reaching U.K. levels by 2011, the underlying rate of household formation over the next 10 years will be on a par with the current rate of new house construction (Figure 4). As discussed in Section C, however, the rate at which the headship ratio declines is not determined by demographics alone, but also depends on how households respond to current and expected future house price inflation.

B. Are Price Developments Justified by Fundamentals?

7. With growth in the housing stock now more or less in line with projected annual household formation, some analysts had been predicting that by now house price inflation would have slowed to single-digit rates.4 Yet prices continue to rise rapidly, with only a modest deceleration now expected in the next couple of years.5 This raises concerns about whether property prices are beginning to overshoot levels that can be sustained.

Affordability

8. One way of assessing whether current prices are sustainable is to ask what they imply about the affordability of housing; if house prices become unreasonably expensive, demand can be expected to dry up at some point, forcing prices back down. Some current measures might be interpreted to suggest that house prices in Ireland have already reached levels which are unsustainably high. The ratio of house price to disposable income has reached its highest level since the 1970’s and is substantially higher than U.K. levels, both at present and during the U.K.’s property boom of the late 1980s (Figure 5). Moreover, house prices now appear to be among the highest in Europe; comparing across countries the cost of accommodation, a measure which attempts to control for differences in quality, housing costs in Dublin are now estimated to exceed costs in Berlin and Paris despite substantially lower income levels in Ireland (although they remain well below those in London) (Figure 5).

Figure 5.
Figure 5.

House Price and Earnings Comparisons

Citation: IMF Staff Country Reports 2000, 099; 10.5089/9781451818789.002.A001

Source: Central Bank of Ireland, Goodbody Stockbrokers, Eurostat, and staff estimates.1/ Estimated for end-1999 based on Eurostat data for June 1999 and relative house price growth for July- December.

9. But price-to-income ratios alone do not adequately capture all aspects of affordability. One reason (discussed below) is that high expected future income growth would ease future mortgage debt service burdens for a given price-to-income ratio today. Another reason is that the fall in mortgage interest rates in recent years has helped to moderate the effect of higher house prices on mortgage debt service. One way of assessing affordability which accounts for changes in interest rates, is to measure the ease with which new entrants to the housing market—or marginal buyers—can service their mortgage. Bacon (2000) calculates one such measure defined as the ratio of net after-tax income of the marginal buyer to mortgage servicing costs, and shows that affordability for the new buyer has deteriorated sharply in recent years, falling to levels comparable to previous lows in the late 1980s (Figure 6). It is worth noting that this measure can deteriorate sharply if interest rates rise; this is particularly relevant for Ireland given that most mortgages carry what are in effect variable rates. Another aspect of affordability is the ease with which potential house buyers can obtain the needed financing. As prices rise, new buyers must either borrow a greater portion of the purchase price or provide more equity at the time of purchase. Since average loan-to-value ratios have remained steady at about 60 percent,6 rising house prices have resulted in a rapid increase in equity provided by the buyer, both in absolute terms and as a share of disposable income (Figure 6). This rising equity burden represents an additional aspect in which affordability has fallen for the marginal buyer.

Figure 6.
Figure 6.

Ireland: Measures of Affordability for New Buyers

Citation: IMF Staff Country Reports 2000, 099; 10.5089/9781451818789.002.A001

Source:Bacon (2000) and staff estimates.

10. It is worth noting that while affordability has been declining rapidly for new house buyers, Ireland began the boom with a relatively low level of indebtedness, and exposure of the household sector as a whole to mortgage financing remains modest by international standards. Falling interest rates have actually reduced the debt service burden for households who owned homes when the boom began, keeping the mortgage debt service burden, when averaged across all households, from rising as rapidly as for marginal households. Despite the sharp deterioration in affordability for new entrants to the housing market, the average mortgage repayment burden measured across all households, at just over 20 percent of disposable income, remains below its previous peak of nearly 30 percent in 1982, and well below ratios of nearly 40 percent in the U.K. during the property boom of the 1980s. Likewise, Ireland’s volume of mortgage debt, given its low starting point, remains below that of many other European countries (Table 1).7

Table 1.

Outstanding Residential Mortgage Debt as a Share of GDP in European Countries

(percent)

article image
Source: European Mortgage Federation and staff estimates

For Denmark 1992 is used.

Ratio for 1999.

11. Moderate overall levels of indebtnedness do not necessarily imply that house price levels are currently appropriate. Given that an increase in house prices improves the net worth of existing home owners by increasing their assets while leaving their mortgage debt unchanged, what may be more relevant for assessing whether house price increases can be sustained is how these increases affect the demand of new house buyers. Nevertheless, the relatively low average indebtedness does suggest that mortgage lending may continue to expand rapidly for some time before overall debt level concerns become a binding constraint.8 If house prices continue to grow at double-digit rates as projected by Bacon (2000), debt-to-GNP ratios would rise to about 42 percent by 2001, high by Irish standards but still well below that in many European countries.

The historical relationship between house prices and fundamentals

12. Another approach to assessing whether the increase in house prices can be justified is to relate historical price developments to a basket of observed fundamentals. In this approach, property prices are estimated as a function of key fundamental variables such as real interest rates and income growth, and in some cases demographic variables and construction costs.9 The unexplained component in this relationship is often interpreted as an indication of price misalignment.

13. Along these lines, a recent background study for the May 2000 World Economic Outlook found that based on a relationship between property prices, GDP growth, real interest rates, and inflation estimated using panel data for industrial countries, property prices in Ireland may be overvalued by a margin similar to those estimated for the U.K. and Sweden during their property booms in the late 1980s (Figure 7; top panel). However, this study did not take explicit account of demographic changes which are driving part of Ireland’s current price growth.

Figure 7.
Figure 7.

Ireland: House Price Deviations from Fundamentals

Citation: IMF Staff Country Reports 2000, 099; 10.5089/9781451818789.002.A001

Source: WEO (2000) and Bacon (2000).

14. Using a similar approach but accounting for factors such as demographics and housing stock, Bacon (2000) estimates a housing demand equation for Ireland over the period 1972–96, and uses the parameters to compare predicted house prices for 1997–1999 with actual price developments. Based on this comparison, demand in the later years has been far above that which would be predicted by growth in personal income, demographics, interest rate developments, and other factors (Figure 7; bottom panel). Bacon interprets these results as suggesting that current demand for housing is exceptionally high, with expectations of future price increases themselves accelerating the rate of household formation; he estimates that in 1999 the volume of this “speculative/transitory” demand was equivalent to one year’s volume of new house completions.

15. While the results of these studies are informative, it is difficult to draw strong conclusions that prices are inappropriately high, particularly in the case of Ireland where the change in the economic environment has been dramatic. It is true that house prices have outpaced growth in personal income, one of the measured fundamentals with the most explanatory power. But in addition to current personal income levels, housing demand is also driven by expected future personal income. If income growth in Ireland is expected to be higher than in the past, which may well be the case given Ireland’s growth prospects, this would justify house prices growing faster than current income. Likewise, what drives demand is not just the current cost of house financing, as proxied by the real interest rate, but the expected future cost. In this regard, joining EMU represents something of a regime shift, with increases in real interest rates in the euro area likely to be less dramatic than those occurring in Ireland in the past.10 Knowing this, households might be expected to take on more mortgage debt than in the past, pushing prices higher than would be explained by current real interest rates alone. These considerations make it difficult to draw any firm conclusions from the fact that house price movements do not appear to be fully explained by movements in observed fundamentals.

C. Expectations-led Overshooting in Housing Markets

16. The above discussion suggests that, while Ireland’s fundamentals are strong, it is unclear whether or not these fundamentals can fully justify the recent high rates of house price inflation. However, even with strong underlying fundamentals, at some point rapid sustained price growth itself becomes a concern. The question here is at what point does rapid price growth sustained over several years lead to expectations of further price growth, giving rise to self-fulfilling expectations-driven demand followed by price overshooting?

17. In basic asset price models, expectations can lead to self-fulfilling price movements and overshooting. The process by which this can take place is well-known (see De Long et al., 1990). A shift in investor sentiment towards a given asset, for example, will increase it’s price. If investors interpret this increase as portending a trend, they will be encouraged to buy, pushing prices up further. In these circumstances, arbitrageurs who would otherwise sell might actually find it advantageous to go along with shifts in sentiment in the short run even if they expect these shifts to be reversed at some point in the future. The result is asset price overshooting and bubble-like booms and busts.

18. The property market may be even more susceptible to overshooting than other asset markets for several reasons. Housing differs from financial investments in that it also confers the service of accommodation, so that for many, the issue is not whether to buy but when. With widespread uncertainty over future price developments, those potential house buyers expecting high house price inflation to continue will want to move forward the date of their purchases, increasing demand now. If enough buyers do this, expected price increases will become self-fulfilling. This process could be self-reinforcing if continued price inflation leads others to revise their expectations in the direction of further increases. Naturally, those who come to see prices as exceeding fundamentals would want to sell short, offsetting higher demand and putting downward pressure on prices. In the case of housing, however, there is no mechanism for these investors to act on their expectations.11

19. Two additional considerations might make Ireland’s housing market prone to overshooting. First, the relatively undeveloped rental market limits the scope for those households expecting prices to fall to act on their expectations by selling now with the intent to buy later when prices have fallen. For those expecting price inflation to continue, the underdeveloped rental market also may imply a greater incentive for future house buyers to buy now based on the fear that otherwise they will be priced out of the housing market altogether and will have few options to rent. Second, Ireland’s low indebtedness might actually fuel expectations-led demand by giving households who might otherwise wait to buy the scope to act on their expectations and buy now; as discussed earlier, falling affordability for the marginal buyer might be less effective in restraining expectations-led demand if mortgage debt is spread out over a relatively low-indebted population through intergenerational transfers.

20. Finally, Ireland’s favorable medium-term outlook may add to the risk of overshooting. Medium-term growth prospects are widely viewed as strong, with equally strong growth prospects for disposable income. In addition, the government is actively promoting inward migration as a means of alleviating labor shortages, and has projected that some 200,000 additional workers may be needed in coming years to sustain bouyant growth. This outlook is likely to give confidence to potential home-buyers that demand will remain strong, and consequently that rapid house price inflation will continue for some time to come. In this case, households might have solid reasons for moving forward their demand.

D. Comparing Ireland’s Property Boom with Other House Price Booms

21. In considering whether rapid house price increases sustained over several years tend to lead to price overshooting, it is useful to look at other booms, and compare price behavior in these episodes with Ireland’s. Many industrial countries experienced major property booms in the 1980s; most notably the Nordic countries, the United Kingdom, Spain, and Japan, and within the United States, California, and the New England states. The experience in the United States, measured at the state level, may be particularly relevant for Ireland for two reasons: (i) the U.S. states offer a variety of regional property market experiences within a common currency area; and (ii) since houses are fixed in location, property markets are in essence regional markets, and the U.S. states may offer a more appropriate comparison to Ireland’s property market than the U.S. or other large countries taken as a whole. All of the episodes of the 1980s, both within the United States and in other countries, ended with price falls, in some cases quite dramatic. In contrast, many euro area countries and western U.S. states are currently experiencing or have experienced significant property price inflation in the 1990s, so far without collapse. If episodes where property prices have grown by an average annual rate of 5 percent or more in real terms for at least 3 years are considered, there have been nearly 40 such episodes of sustained property price inflation among the industrial countries and U.S. states in the last 20 years. A complete list is given in the Appendix Table Al, but the characteristics of these booms are summarized in Table 2.12

Table 2.

Summary of Industrial Country Property Booms of the 1980s and 1990s

article image
Source: Housing Statistics Bulletin, BIS, and staff estimates.

22. It is clear that recent house price inflation in Ireland has been close to the highest among industrial country episodes in the last 20 years (Figure 8). Only Spain during 1986–91 experienced a noticeably higher annual average growth rate, with Ireland’s rate of over 15 percent during the period 1996–99 comparable to rates in Finland and Rhode Island. In terms of cumulative increases, Ireland’s 77 percent is again close to the top, exceeded only by Spain, Massachusetts, New York, and Connecticut.

Figure 8.
Figure 8.

House Price Increases in Industrial Country Property Booms

Citation: IMF Staff Country Reports 2000, 099; 10.5089/9781451818789.002.A001

Source: Housing Statistics Bulletin, BIS, and staff estimates.

23. Have these booms all ended with collapse, or have there been episodes where high inflation is followed by a soft landing? And how does Ireland’s current growth experience fit in with these experiences? Comparing house price inflation during the boom with subsequent growth, it is clear that most high inflation episodes have been followed by price declines. There is a pronounced tendency for these declines to be larger the higher the growth during the boom (Figure 9). This is particularly true when ranking episodes by annual growth rates. Countries and regions experiencing booms comparable to Ireland’s have all suffered sizable price declines; the most extreme case was Finland, where prices declined by 46 percent in four years, but even excluding Finland, episodes characterized by real house price inflation of 14 percent or more suffered on average a loss in the next four years of over 40 percent of the cumulative price increase during the boom.

Figure 9.
Figure 9.

House Price Increases in Industrial Countries During and After Property Booms

Citation: IMF Staff Country Reports 2000, 099; 10.5089/9781451818789.002.A001

Source: Housing Statistics Bulletin, BIS, and staff estimates.

24. The tendency observed in Figure 9 for higher growth to be followed by greater falls is what would be expected if rapid house price inflation gave rise to self-fulfilling expectations- driven demand; the farther prices rise relative to fundamentals as prices overshoot, the farther they must fall later on if they are to return to fundamentals when expectations are reversed. The role of expectations-driven overshooting is also supported by price movements within the United States which suggests that differences in monetary policy across regions cannot account for this tendency. During the 1980s most U.S. regions did not experience property booms, but for those that did, the regions with the highest house price inflation during the boom also suffered the greatest collapses (Figure 10). This tendency appears to hold even after accounting for differences in observed fundamentals such as mortgage rates, construction costs, and per-capita income and employment growth (Higgins and Osier, 1998). While it is possible that unobserved or unmeasured fundamentals were driving these price movements, in order to explain such a phenomenon, those fundamentals would need to have deteriorated most sharply in precisely those regions where they had previously improved most sharply.

Figure 10.
Figure 10.

House Price Increases and Declines in US Regions in the 1980s

Citation: IMF Staff Country Reports 2000, 099; 10.5089/9781451818789.002.A001

Source: Freddie Mac and staff estimates

25. While nearly all the 1980s booms ended badly, those in several euro area countries and Western U.S. states in the 1990s are either still underway or have been followed by soft landings. Price inflation in these episodes is driven by many of the same fundamental factors as in Ireland, including high income growth, and in many cases rapid inward migration. In comparing house price inflation in these episodes to Ireland’s, it is clear that house price increases in Ireland, in terms of both annual and cumulative increases, have been significantly higher than in all other episodes (Figure 11). Based on rates of increase alone, Ireland’s experience looks more like the booms in the 1980s than those of the 1990s.

Figure 11.
Figure 11.

House Price Increases in Industrial Country Property Booms in the 1990s

Citation: IMF Staff Country Reports 2000, 099; 10.5089/9781451818789.002.A001

Source: Housing Statistics Bulletin, BIS, and staff estimates.

26. In addition to the property booms in industrial countries, several newly-industrialized Asian economies experienced dramatic and prolonged property price inflation beginning in the mid-1980s. Price increases were particularly impressive in Hong Kong SAR and Singapore where prices more than tripled over the course of 10 years. Prices subsequently declined, but still remain about twice the level at the start of the boom. Comparing a few selected episodes for which data are available with Ireland suggests that were price inflation to moderate in Ireland in the near future, the cumulative increases would still be in line with the cumulative increases in Hong Kong SAR and Singapore over the span of their boom-bust cycles. (Figure 12) Given that Ireland shares many characteristics with these economies, such as high rates of economic growth and physical constraints on the capacity to expand housing supply in the short run, these episodes may suggest that there could still be room for further increases in house prices in Ireland before the overall increase would approach the Asian experience. On the other hand, the fact that these episodes ended with significant price declines suggests that this experience may not necessarily be a source of comfort regarding the prospects for a soft landing in the Irish housing market.

Figure 12.
Figure 12.

House Price Booms in Ireland and Selected Asian Economies

(Index of real house prices)

Citation: IMF Staff Country Reports 2000, 099; 10.5089/9781451818789.002.A001

E. Interpretation and Implications

27. The sharp and sustained increase in Ireland’s house prices well in excess of income growth, together with rapidly declining affordability for new house buyers, raises concerns that expectations-led demand may have resulted in house prices overshooting their sustainable levels. Taken together, the international experience with property booms suggests that if property prices in Ireland were to level off without a significant fall, it would be an event unprecedented in the last 20 years. Of the nearly 40 episodes of high property price inflation examined here, there has not been a single experience of price inflation on the scale of Ireland’s which did not end in prices falling.

28. It would be wrong to conclude based on this that a price collapse in Ireland is inevitable. While the number of episodes examined is large, Ireland’s experience is really only being compared with two distinct periods—the booms and busts of the 1980s and the booms of the 1990s. Whether Ireland’s impressive economic performance puts its property boom in a separate category from the episodes of these two periods is not clear. Strong fundamentals clearly justify a sizable increase in house prices, but the issue is how much. On the one hand, fundamentals, to the extent that they can be observed and measured, cannot explain the full extent of the rise in house prices, and affordability for the marginal buyer is deteriorating rapidly. At the same time, Ireland’s prospects may have shifted in ways not captured by observed fundamentals. But beyond the influence of fundamentals, the issue is whether price inflation can be sustained for long periods before a speculative element tends to emerge on top of the fundamentals-driven demand. In this regard, the international experience suggests that prolonged property booms on the scale of Ireland’s may lead to self-fulfilling expectations- driven demand followed by price overshooting.

29. If Irish property prices were to fall, the aggregate demand effects would probably be substantial, particularly given Ireland’s high rate of house ownership. Consumer spending, either through wealth effects or indirectly through consumer confidence, would be sensitive to a fall in property prices. Liquidity effects would also be important; some of the recent household spending boom has been fueled by a sharp increase in consumer borrowing, collateralized in part by the increase in the value of real estate. Likewise, the current investment boom has been fueled in part by very rapid lending to the property sector, and a decline in property values would curtail investment demand.

30. Some analysts have taken comfort in Ireland’s relatively low average exposure to the housing market, both for banks and households. Others have noted that with solid prospects for output and disposable income, with the ECB not generally expected to raise interest rates sharply, and with in-migration expected to continue, there does not appear any event on the horizon which would trigger a house price decline in the near future. But these factors may actually heighten the risk of overshooting. If the analysts are correct that strong demand, and consequently high house price inflation, is expected to continue, households would be somewhat justified in moving forward their demand. Ireland’s low indebtedness may also suggest that mortgage lending can continue to expand rapidly to meet this demand before debt level concerns become a binding constraint. Given these considerations, the risks may arise not so much from a price decline now, as from the possibility that rapid price increases may persist, leading to greater overshooting and a sharper future decline.

Table Al.

Industrial Country Property Booms of the 1980s and 1990s

article image
Source: Housing Statistics Bulletin, BIS, and staff estimates.

Note that, for any given price decline, the reduction will be larger when expressed in percent of the previous price increase than when expressed in percent of the peak price level. For example, if prices increase from 100 to 200 during the boom, and subsequently fell to 150, this would represent a decline of 25 percent, but would result in the share of the previous house price increase lost of 50 percent.

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1/

Prepared by Brian Aitken.

2/

The house price data used in this paper are based on official data on the average house price for which loans were approved by mortgage lenders, as published in the Housing Statistics Bulletin. The Irish Permanent index, published together with the Economic and Social Research Institute (ESRI), has methodological advantages but goes back only to 1997. The Irish Permanent index and the official data show the same general pattern of house price inflation, although there are differences at higher frequencies.

5/

Bacon (2000) forecasts real prices for new houses to increase by 17 percent in 2000 and 15 percent in 2001. A similar rate of increase has been projected recently by a number of other analysts, including Irish Permanent, Davy Stockbrokers, and Goodbody Stockbrokers.

6/

Loan-to-value ratios for first time buyers are generally higher than average ratios. Mortgage lender data show that loan-to-value ratios for first-timebuyers are generally in the 70 to 75 percent range, with about ⅓ of first-time buyers receiving loan-to-value ratios of about 90 percent (Goodbody, 1999).

7/

Based on these factors, the European Central Bank (2000) concluded that there appears to be no major systemic threat to the Irish banking system from a decline in real estate prices. A similar conclusion was reached by the recent FSAP mission, on the basis that major banks are well capitalized and have relatively diverse portfolios.

8/

Moreover, low indebtedness might partly explain why housing demand remains strong despite a sharp decline in affordability for the marginal buyer. One apparently common way of increasing affordability for new buyers is for relatively debt-free home-owning parents to take out a mortgage against the capital gains on their own home and apply this to their children’s home purchase, thereby reducing the debt service burden their children face.

10/

Between 1981 and 1987, for example, real mortgage interest rates in Ireland increased by some 14 percentage points (O’Connell and Quinn, 1998).

11/

For a model of land prices with heterogeneous real estate investor perceptions, see Carey (1990).

12/

Price data for the U. S. states are from Freddie Mac’s Conventional Mortgage Home Price Index, deflated by the CPI. Data for other industrial countries are from the BIS’s Real Residential Property Price Index.

Ireland: Summary of Major Tax Measures, 1990-2000

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Statiscal Appendix Tables

Table A1.

Ireland: Summary of Balance of Payments 1/

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Sources: Central Statistics Office; and data provided by Irish authorities.

Owing to changes in the methodology of the compilation of the balance of payments statistics, data from 1998 onward are not comparable with the earlier series.

Not available prior to 1998 under the current classification.

Table A2.

Ireland: Merchandise Trade 1/

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Sources: Central Statistics Office, Statistical Bulletin; and data provided by the Irish authorities.

Data on customs basis; not adjusted for balance of payments purposes.

Table A3.

Ireland: Exports by Sector of Origin 1/

(In percent)

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Sources: Central Statistics Office, Statistical Bulletin; IMF, World Economic Outlook; and data provided by the Irish authorities.

Data on a customs basis.

Including the value of EC intervention stocks sent for storage abroad, which is excluded from merchandise exports for balance of payments purposes.

From 1993, includes Intrastat Survey Estimates which are not classified by main use.

Comprises SITC divisions 09, 54, 75,76, and 87.

Table A4.

Ireland: Foreign Trade Shares

(At current prices)

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Source: IMF, Direction of Trade Statistics.

Data excludes Belgium and Luxembourg until 1999.

Table A5.

Ireland: Imports Classified by End Use

(Percentage distribution)

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Source: Central Statistics Office, Statistical Bulletin.1/ From 1993, includes Litrastat Survey Estimates which are not classified by main use.
Table A6.

Ireland: Consumer, Wholesale, and Tradables Price Indices

(Percentage change fromone year earlier) 1/

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Sources: Central Statistics Office, Statistical Bulletin; and data provided by the Irish authorities.

Annual date are based on period averages.

Wholesale price indices are exclusive of VAT.

Table A7.

Ireland: Population and Employment

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Source: Central Statistics Office, Live Register and Quarterly National Household Survey.

Numbers for 1998 and 1999 are yearly averages of unemployed for a period exceeding one year.

Defined as persons aged 15 years and over either at work or unemployed (including first time job-seekers) expressed as a percentage of the total population aged 15 years and over.

Table A8.

Ireland: Employment by Sector

(In thousands)

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Sources: Central Statistics Office, Labor Force Surveys, Quarterly National Household Surveys and Quarterly Industrial Inquiry.

Labor force survey data up to 1997 and Quarterly National Household Survey data from 1998 onward. Some 20,000 of the observed increase in employment between 1997 and 1998 has been attributed to improvements in the survey questionnaire.

Table A9.

Ireland: Overview of Public Finances

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Sources: Department of Finance, and staff estimates.

Capital spending in excess of the budgetary provision in 1999 is accounted for mainly by the transfer for pre-funding and repayment of future pension liabilities.

Table A10.

Ireland: Central Government Current Expenditure

(In millions of Irish pounds)

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Sources: Department of Finance, Budget; and data provided by Irish authorities.