constantinos herodotou : recent developments in housing markets and related policy challenges speech by mr constantinos herodotou, governor of the central bank of cyprus, at the hl conference organised by the nbb, nicosia, 18 february 2022. * * * the target of macroprudential policy is to mitigate threats to financial stability, by reducing vulnerabilities and promoting the resilience of the financial system. in order to achieve its goal, the macroprudential toolbox has been designed to include two broad categories of measures. first category, authorities can use borrowed based measures, such as limits on the loan - to - value ratio, which strengthen the resilience of borrowers against potential vulnerabilities and limit demand for credit. the second category are the capital based measures, such as higher risk - weights on specific exposures, which strengthen the resilience of credit institutions, by increasing available buffers that can be released in case of adverse developments1. one of the macroprudential risks authorities face stems from the overheating of the residential market. the fact that not all euro area countries receive relevant warnings and recommendations by the esrb is an indication that the residential market in the euro area is characterised by heterogeneity. in the upper right quartile of the chart, we find a number of countries that registered an accumulated increase in residential property prices of at least 25 % in the last three years. other countries have recorded accumulated growth as low as 5 %. using as a starting point the observed heterogeneity and by analysing the experiences of several countries, we can draw certain broad conclusions on the effectiveness of the macroprudential toolbox. the design of borrower and capital based measures is a decision of authorities. for example, based on information from the esrb, belgium introduced a loan - to - value on both owner - occupied and buy - to - let properties. cyprus, in order to deal with a specific sectoral exposure, further to the loan - to - value cap, recently introduced an even stricter loan - to - value for luxurious properties. however, by observing the real estate cycles registered in a number of countries, it is evident that even the idiosyncratic design of these measures does not always stop real estate cycles from materialising. the netherlands and slovenia are examples of countries that have recorded vulnerabilities despite the implementation of such measures. analysis performed at

##ost. that would surely have been so on this occasion even if our banking systems had proved more resilient. a great challenge for monetary policymakers everywhere is that external and internal imbalances typically grow slowly, and that the timing and manner of their unravelling is highly uncertain. in setting a course for nominal demand, we are usually trying to stabilise inflation in line with our target over a horizon of 2 – 3 years. of course we care about longer horizons. as a number of us have argued over the years, 13 that is nicely captured by approximating our objective with a so - called quadratic loss function that gives weight to deviations of inflation from target and deviations of the level of output from its sustainable course. in that set up, the policymaker cares about future volatility ( or uncertainty ) about the inflation rate and the “ output gap ”. sizeable imbalances create precisely that uncertainty, threaten precisely such volatility. all very useful as an abstract framework for thinking about policy. the trouble is that there is not a policymaker anywhere who has much of a clue about how to operationalise it in actual interest rate decisions. this matters because not all imbalances are associated with credit booms that pose a threat to financial stability. the development of a set of macroprudential tools would not be sufficient to insulate our economies from imbalances. but i do believe that it is necessary. governments as insurers against aggregate instability : the importance of government balance sheets the bank has said before and we shall carry on saying that no set of measures introduced by national and international authorities – whether by way of regulation, resolution, or the structure of the financial system ; whether leaning against the wind ; or all in combination – is certain to prove sufficient to guarantee macroeconomic stability in the decades ahead. the final protection against economic collapse comes from governments – at the expense of their needing to take care about creating incentives for the private sector to take large risks. we have seen that amply demonstrated in this crisis. but, if society wishes, their role as catastrophe insurer can go beyond financial crises ; governments can help smooth the adjustment of the economy in the face of any kind of disaster. they do so essentially by accumulating debt and so spreading the burden to future years, future generations. the extent to which they can do so depends on the starting position of their own balance sheets – in other words, their levels of debt relative