Kiyohiko G Nishimura: Property bubbles and economic policy
Keynote speech by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at the
Special Panel on "Property markets, financial stability, and macroprudential policies", at the
Allied Social Science Associations - American Real Estate & Urban Economic Association
Annual Meeting, San Diego, 4 January 2013.
* * *
Property market bubbles have long been recognized as an important risk to economic
stability. Although not all property bubbles lead to financial crises, there are malign bubbles
that do indeed trigger significant financial stresses and cause economic crises, such as the
US housing bubble of the 2000s.
In this presentation, I argue that demographic trends are one of the key drivers of the
property price movements we have observed over the past few decades. In particular, I
argue that a growing young population increases the likelihood of a property bubble. The
increased demand for property from a growing young population is likely to induce the
institutional change of a loosening of financial laws and regulations that pushes up prices
further, thereby fueling a malign price bubble. (These institutional factors will be discussed in
greater detail by my fellow panelists Frank Warnock and Tim Riddiough.) In contrast, the
negative effects of the bursting of a price bubble are all the more pronounced where there is
an ageing population.
Macroprudential or institutional policies therefore become important in responding to a
malign property bubble. (This will be the subject of the presentation by Ken Kuttner.)
However, I believe that the issue is not limited to questions of the technical effectiveness of
various macroprudential policies, but highlights the very fact of the "procyclicality" of
institutional changes in laws and regulations induced by demographic change. From this
discussion I will draw three policy implications: firstly, the need, to recognize the significant
effects of demographic trends, secondly, to avoid too loose a policy in the demographic
bonus phase, and thirdly, to avoid too strict a policy in the demographic onus phase.
In the final part of this presentation, I will discuss property price indexes, and outline an
attempt to obtain relevant price information in a timely manner. Timely and accurate data on
property prices is of utmost importance in responding to a property bubble, especially in
emerging markets. (Yongheng Deng will discuss this issue in the context of China.)
1. Demographic trends and property markets
Demographic trends and malign property bubbles; cross-country evidence
Let me first explain why demographic trends are important using a series of charts depicting
the recent bubble episode in the advanced countries. In these charts, I juxtapose, first, the
ratio of working-age population to the rest (the inverse dependency ratio), second, the real
property price index, and third, total loans in real terms.1
In the United States (Chart 1.1), we have two peaks in the working-age population ratio. And
the real property price index, which is the real house price index, seems to have two peaks,
roughly coinciding with the demographic change. It is the second peak which triggered the
financial crisis of 2008. The first peak coincided with the S&L problem, which had a far less
severe effect on the economy. The difference between the two lies in the difference in the
total loans. The level of the real total loans in the first peak was high, but far lower than in the
second peak that triggered the financial crisis. A remarkably similar picture is found in Japan,
where the second peak around 1990 is a malign bubble that triggered a long period of
stagnation (Chart 1.2).
In Europe, we have two groups. The first group, including the United Kingdom (Chart 2.1),
Spain (Chart 2.2), and Ireland (Chart 2.3), had a similar experience to that of the United
States and Japan. The second group, including Germany (Chart 3.1) and France (Chart 3.2),
tells a different story: their working population ratio, property prices, and real loans peaked at
different times. And it is the first group, in Chart 2, which suffered property bubbles triggering
financial distress, most severely in Ireland and Spain, and to a lesser extent in the United
Kingdom.
What lessons can we learn from this rather cursory examination of recent history? It shows
that, if a demographic change, a property price bubble, and a steep increase in loans
coincide, then a financial crisis seems more likely.
Malign property bubbles: interplay of demographic trends and institutional factors
Demographic trends have a significant effect on property prices, especially their land
component.2 In the population dividend phase, young baby boomers want to buy more land
and save more real money for their retirement. Since the supply of land is physically limited,
the real price of land will go up. Similarly, if nominal money supply is held constant, the
"price" of real money holdings, which is the inverse of the price level, should also go up,
implying deflation. Being mandated to maintain price stability, the central bank is then likely
to increase nominal money to keep prices stable. The result is an increase in property prices
while general price levels remain stable.3
The story, however, does not end there. Property markets are also influenced heavily by
institutional factors. The supply of land is regulated by the government in many countries,
typically in the form of zoning. Housing finance systems are heavily dependent on financial
laws and regulations.4 Property markets are subject to high transaction costs, which may
change as a result of financial innovation.5 Any change or even prospect of change in these
institutional factors may drastically change the dynamics of property prices, leading to a
considerable deviation from the underlying fundamentals, that is, to a property bubble.
In fact, in the population dividend or bonus phase, when baby boomers' demand for property
is strong, the demand for institutional change is also strong, favoring easier acquisition of
property. The government is likely to come under political pressure to loosen financial laws
and regulations, which in turn fuels expectation of further loosening. These changes, and the
prospect of change, induce credit expansion to finance property acquisition and push up
property prices further and far beyond their fundamental value given the initial institutional
framework. The price hike caused by such institutional changes may even induce overly
optimistic expectations of the "this-time-is-different" type about property markets and prices.
Thus, the demographic condition of population dividend or bonus is fertile ground for malign
property bubbles.
Population ageing and declining long-term per capita growth
So far, I have discussed the formative stage of malign bubbles. Then, what happens when a
malign bubble bursts? Here again, demographic trends are important and likely to influence
the adjustment process significantly.
As is often argued, the economy has to endure a period of lower growth after a malign
bubble bursts. Chart 4 shows the rolling ten-year average of the per capita GDP growth rate
of advanced countries. After the collapse of the bubble, the Japanese per capita rate plunged
from above 3 to around 1. It is remarkable to note that the per capita GDP growth of the
United States and major European countries also fell almost uniformly to around 1 after the
collapse of the their bubbles (except for Italy, where the rate has fallen even further to
become negative).
Debt overhang and resulting deleveraging are often cited as the major culprits of this
substantially lower growth. The next two charts suggest more than that and point to the
possible importance of demographic trends. They juxtapose the working-age population ratio
(inverse dependency ratio) and the long-run per capita growth rate, which is the average per
capita growth rate of the past ten years, for the United States (Chart 5.1), Japan (Chart 5.2),
the United Kingdom (Chart 6.1), Spain (Chart 6.2) and France (Chart 6.3). These figures
suggest a possible link between demographic trends and long-term per capita growth, which
is determined by efficiency in production.
Population ageing, which we observed first in Japan and now in the United States and
European countries, may affect factor productivity and long-term efficiency in the economy
as a whole. For example, population ageing reduces the mobility of workers and
entrepreneurs between regions and industries. Population ageing also changes the
composition of consumer demand, and the vast difference among senior citizens in terms of
wealth and experience reduces the effectiveness of mass-marketing to create demand.6 This
means many advanced economies experiencing a malign bubble and population ageing at
the same time face doubly downward pressure from debt overhang and population onus.
2. Policy implications
Awareness of the significant effects of demographic trends
Let me now turn to the policy implications of what I have examined. The first lesson from the
experience of the advanced economies is to be aware of demographic trends. In particular,
we should take into account that the likelihood of malign property bubble formation is much
greater in the population dividend or demographic bonus phase, while the negative impact of
the collapsing bubble is far severer in the phase of the burden of an ageing population, or
demographic onus.
This is particularly important in some emerging economies. Chart 7 shows the situation in
Brazil (7.1), China (7.2) and Korea (7.3). In Brazil, the peak of the working age population
ratio is a decade away, but house prices and credit expansion are skyrocketing toward it,
indicating the possible risk of a future malign bubble. The possible risk could be seen in
China and Korea, where the working-age population ratio is likely to peak in a few years and
credit expansion continues. Moreover, the size of population dividends is much greater and
the future decline of the working-age population ratio is much more pronounced in these two
countries than in Brazil and the advanced countries in Charts 1 to 3, suggesting demographic
change will have an even greater impact. Of course, the correlation between demographic
factors and property bubbles remains loose, as exemplified by the German experience.
However, considering the imminent grave consequences of a malign property bubble under
the burden of an ageing population, it is advisable for policy makers to take precautions
against the possible danger.
Avoiding excessive loosening of a policy in the demographic bonus phase
The recent bubble episodes have shown us that, in the population dividend or bonus phase,
when demand for property increases substantially, financial laws and regulations tend to
become loose, thereby fueling property price bubbles.7 In other words, financial laws and
regulations and government policies are markedly "procyclical", though here the cycle is
much longer than business cycles. The financial innovation of subprime RMBS is surely one
example. So the second lesson is that we should avoid an excessive loosening of financial
regulations and government policies in the demographic bonus phase.
Here macroprudential policies become important, which rely on measures such as LTV and
DTI requirements.8 Unfortunately however, I find most discussions about macroprudential
policies are concerned only with taming overly optimistic expansion of credit and fund flows,
while they fail to give sufficient attention to the often "procyclical" regulatory changes that
trigger such expansion. Thus, I still have strong reservations over the effectiveness of some
macroprudential measures in a truly malign bubble, since such measures may simply mean
temporary halting of the expansion and thus amount to "kicking the can down the road".9
Avoiding excessive tightening of a policy in the demographic onus phase
Next, what is the lesson for the collapsing stage of a bubble? Adjustment is still under way,
even in Japan after more than two decades since the 1990 bubble burst. However, one thing
is clear: adjustment is long and severe when the economy is under the burden of an ageing
population, or in the demographic onus phase. It is also becoming evident that there is no
quick fix for the problem and no quick return to the "old normal" of the population bonus
phase.
Policy makers now face dual problems: they have to minimize the likelihood of another
malign bubble in the future, and at the same time they have to minimize the current distress
caused by the past bubble. Future bubble prevention usually leads to significant tightening of
once-loose regulations and government policies toward banking and housing finance
systems. The thrust of strict regulations is fueled by popular anger against the beneficiaries
of the past malign bubble.
At the same time, however, we should be aware that we are in a phase of demographic
onus, with lower demand for property than in the demographic bonus phase of decades ago.
This means regulatory measures appropriate in the population bonus phase may be too strict
in the population onus phase. So we must avoid too strict a policy in the population onus
phase, and avoid regulatory and policy "procyclicality" in the downward direction. Moreover,
we should also recognize that a severe balance-sheet adjustment under population ageing
hampers the effectiveness of conventional policy tools.10 In addition, seemingly overly
pessimistic expectations aggravate the problem of policy effectiveness.
Thus, policy makers have to perform a subtle balancing act between long-run crisis
prevention and immediate crisis response.
3. Property price indexes as the foundation of policy
Let me now turn to the issue of data and statistics as the foundation of policy. Unfortunately,
the current state of our knowledge about property markets is still limited, especially in
constructing property price indexes that are reliable (R), accurate (A), timely (T), and easy
(E) to understand - what I call the "RATE" requirement. Thus, property prices were identified
at the November 2009 G20 Meeting as one of the crucial data gap issues. To rectify the
problem, Eurostat is taking the lead in drafting a Handbook on Residential Property Price
Indices under the aegis of the Inter-Secretariat Working Group on Price Statistics.11
With respect to accuracy, the RRPI Handbook (4th draft) recommends hedonic price
indexes, especially in countries where transactions are limited and repeated sales may
involve sampling biases. Most emerging economies, including China, are in this category, as
well as many advanced countries like Japan.12
With respect to timeliness, there has been promising progress. Note that for a policy maker,
timely information is as important as, or in some cases more important than, reliable and
accurate information. According to this criterion, existing transaction-based property price
indexes, though accurate, are not helpful in immediate policy making, since they inevitably
lag far behind market movements. For example in Japan (Chart 8), it typically takes
10 weeks from posting in the market to negotiation, 5.5 weeks from negotiation to actual
transaction, and 15.5 weeks from transaction to being recorded in the government data base.
In addition, extra weeks are needed for data collection and compilation, so that the lag is
likely to amount to almost a year.
First asking price data are timely but not accurate (because they are biased), while
transaction price data are accurate but not timely, posing a dilemma. However, there is an
important way around this dilemma. Using previously-owned condominium prices in Tokyo,
my collaborators and I are able to show that if a hedonic quantile-regression procedure of
quality adjustment is applied to both first asking price data and transaction price data, the
resulting price distribution is almost identical (Chart 9).13 This implies that if hedonic
quantile-regression quality adjustment is appropriate, which is likely, we can use first asking
10
Not only does the conventional policy of controlling the overnight interbank rate turn out to be ineffective
because of the zero lower bound, but the unconventional policy of asset purchases is also becoming less
effective in altering firms' and households' financial conditions as the long rates themselves move down to a
very low level. The Bank of Japan's funding facilities for financing economic growth and the Bank of England's
funding for lending scheme are new types of unconventional policy aimed at coping with this problem. See
Nishimura, K. G., "Funding for Financing Economic Growth - A Schumpeterian Perspective," Remarks at the
Global Interdependence Center Conference on The Global Financial Crisis: Lessons from Japan, Tokyo
December 3, 2012.
11
http://epp.eurostat.ec.europa.eu/portal/page/portal/hicp/methodology/owner_occupied_housing_hpi/
rppi_handbook.
12
Deng, Y., J. Gyourko, and J. Wu, "Land and Housing Price Measurement in China," in Heath, et. al. ibid.,
13-43.
13
Shimizu, C., K. G. Nishimura, and T. Watanabe (2011) "House Prices at Different Stages of the Buying/Selling
Process," Working Paper no. 69, Research Center for Price Dynamics, Institute of Economic Research,
Hitotsubashi University.
price data to construct a reliable proxy of quality-adjusted transaction price distribution. Thus,
we get timely and reliable quality-adjusted price data through this procedure.
I will stop here for the discussions of other panelists.
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