Real Estate Booms and Busts: Implications for Monetary and Macroprudential Policy in Europe

Abstract:

Housing is the single largest component of wealth for the majority of households in the Euro area countries with implications for consumer spending, and residential investment is a volatile element of aggregate demand. Real estate collateral plays an important role in bank lending. In advanced countries, financial crises often begin with an overvaluation of asset prices, especially of housing and commercial real estate, preceded by poor quality of lending and excessive credit growth funded by sometimes highly leveraged lenders. Interactions between the credit cycle and real estate have important financial stability implications. This paper examines the empirical evidence on the complex channels of transmission of monetary policy and loan standards to lending interest rates, and via house prices, to residential investment, debt, wealth, consumption and non-performing loans. Though relevant both for monetary and macroprudential policy, most current central bank policy models have an inadequate coverage of these channels.