Housing Market Heterogeneity in a Monetary Union

Housing Market Heterogeneity in a Monetary Union Margarita Rubio Bank of Spain SAE Zaragoza, 28

Introduction Costs and bene ts of monetary unions is a big question Di erence national characteristics and asymmetric shocks can cause tensions Important sources of heterogeneity in EMU housing markets (e.g. Spanish housing market di erent from rest, should UK join EMU?) Should Europe move towards homogenization?

Question Given that... )Housing markets di er across EMU countries: mortgage contracts, LTV s, proportion of borrowers, price movements Questions to answer: )Do shocks to the economy propagate di erently across countries in a monetary union? )Should countries in a MU move towards housing market homogenization? )Does heterogeneity a ect costs and bene ts of MUs?

Motivation Predominant Type of Mortgage Interest Rate Variable Fixed United Kingdom (72%) United States (85%) Spain (75%) Germany (mostly) Greece (8%) France (86%) Australia (mostly) Austria (75%) Netherlands (74%) Source: ECB (23), Debelle (24), Calza et al. (26)

Motivation Source: European Mortgage Federation

Model Overview Two-country, DSGE with housing Heterogeneous households: Savers, variable-rate borrowers, xed-rate borrowers Consumption goods are tradable. Housing is non-tradable. Savers have access to foreign assets Two monetary regimes: Flexible exchange rates and independent monetary policy vs. monetary union Across countries, I allow for di erences in LTV, in the proportion of borrowers and in the structure of mortgage contracts ( xed vs. variable rates). Common and asymmetric shocks.

Consumers Country A Consume Goods from both Countries, Housing in Country A, work Savers are more patient than Borrowers Borrowers are credit constrained Savers have access to foreign assets Country B is symmetric

Savers Country A s.t. X 1 max E ln t Ct u + j t ln Ht u t= (L u t ) C u At + P Bt P At C u Bt + q th u t + R At 1b u t 1 At + e tr Bt 1 D t 1 P At q t H u t 1 + w u t L u t + b u t + e td t P At + F t + S t FOCs

Borrowers Country A e < Need to collateralize their debt A of them borrow at a variable rate, the rest at a xed rate Maximize utility function subject to BC + an extra constraint: E t R c At bat ci k AE t q t+1 Ht ci At+1 where RAt c = R At if the borrower is variable rate and RAt c = R At if xed rate FOCs

Consumers (cont.) Collateral constraint holds with equality)economy is endogenously divided into borrowers and savers Combining EE for foreign and domestic bonds: Law of one price holds: R At = R BtE t e t+1 e t P At = e t P At

Financial Intermediary in Country A Accepts deposits, and extends both xed and variable-rate loans to consumers Optimality condition for setting the xed interest rate implies that at each point in time, the intermediary is indi erent between lending at a variable or at a xed rate OC Financial markets clear)domestic savings=domestic borrowings

Firms in Country A Firms produce consumption goods Sticky prices)phillips Curve Housing supply is xed

Monetary Policy Two di erent monetary policy regimes for comparison: Independent monetary policies and exible exchange rates: r At = A r At 1 + (1 A ) (1 + A ) At + " R;t r Bt = B r Bt 1 + (1 A ) (1 + A ) Bt + " R;t Monetary Union: r t = r t 1 + (1 ) [(1 + ) (n At + (1 n) Bt )] + " R;t

Dynamics Parameter Values in Baseline Model :99 Discount Factor for Savers e :98 Discount Factor for Borrowers j :1 Weight of Housing in Utility Function 1 1 Inverse of labor elasticity k :8 Loan-to-value ratio :7 Labor share for Savers 1 Proportion of variable-rate borrowers X 1:2 Steady-state markup n :9 Size of Country A :75 Probability of not changing prices :8 Interest-Rate-Smoothing Parameter in Taylor Rule :5 In ation Parameter in Taylor Rule

Dynamics: Common Shock in a Heterogeneous MU Consumption decreases by more in the country with high LTV)Shocks ampli ed. Financial accelerator Figure1 Consumption decreases by more in the country with high borrowers share)collateral constraints more pervasive Figure2 Fixed vs. variable rates. Small aggregate di erences Figure3

Dynamics: Asymmetric Shocks Technology shock in Country B. Interest rates react little in a MU. If Country B conducts monetary policy independently, the interest rate in Country B decreases signi cantly, housing prices in Country B increase and therefore consumption increases by more. In the MU, Country A has also lower interest rates and housing prices increase. Wealth e ects make consumption and GDP increase Figure4

Dynamics: Asymmetric Shocks House price shock in Country A Consumption increases in A because of wealth e ects The shock is slightly transmitted to Country B where consumption also increases because the countries are trading Interest rates, especially in the union, decrease and this makes house prices in Country B increase as well. Figure5

Welfare Should countries in a MU move towards institutional homogenization? Should a country join a MU with di erent institutional features?

Welfare De ne individual welfare: V u;t E t 1 X m= m X 1 V ci;t E t e m Social welfare: m= ln C u t+m + j t ln H u t+m ln C ci t+m + j t ln H ci t+m L u t+m L ci t+m!! V t = (1 ) V u;t + 1 e [V cv ;t + (1 ) V cf ;t ] Total welfare ^V t = nv t + (1 n)v t

Welfare Results. Common Technology Shock Symmetric Baseline k A = k B = :2 A = B = :2 A = B = -3.486-3.87-3.28-1.476 Asymmetric k A = :8=k B = :2 A = :7= B = :2 A = = B = 1-3.453-3.865-1.615 Homogenization towards high LTV decreases welfare Heterogeneity delivers the lowest welfare result concerning Homogenization towards xed rate mortgages is welfare improving

Welfare Technology Shock in Country B. Symmetric MU Flex ER -3.229-71.99 Asymmetric k A = :8=k B = :2 A = :7= B = :2 A = = B = 1 MU Flex ER MU Flex ER MU Flex ER -3.188-16.35-3.331 26.91-3.218 2.146 Asymmetry reduces bene ts from monetary union when there are asymmetric shocks

Conclusions Housing market characteristics matter for the transmission of shocks and welfare Variables respond more strongly to common shocks if the country has a high LTV, a high proportion of borrowers or mainly variable-rate mortgages. In a monetary union, housing market homogenization per se is not necessarily bene cial)low LTVs and xed-rate contracts are welfare enhancing Housing market heterogeneity reduces bene ts from monetary union when there are asymmetric shocks

5 Total Consumption -5 Consumption Savers 5-5 Housing Savers 4 2-1 Inflation -2 Country A (high LTV) 1 Interest Rate -1 Consumption Borrowers -5-1 Housing Borrowers -1-2 5 House Prices -5 Country B (low LTV) Figure: Impulse Responses to a Monetary Policy Shock in a Monetary Union. Back

1 Total Consumption -1 Consumption Savers 2-2 Housing Savers 4 2 5 Inflation -5 Country A (low borrowers share) 1 Interest Rate -1 Consumption Borrowers -1-2 Housing Borrowers -1-2 5 House Prices -5 Country B (high borrowers share) Figure: Impulse Responses to a Monetary Policy Shock in a Monetary Union. Back

5 Total Consumption -5 Consumption Savers 2-2 5-1 Housing Savers Inflation -2 Country A (fixed rates) 1 Interest Rate -1 Consumption Borrowers -1-2 Housing Borrowers -1-2 5 House Prices -5 Country B (variable rates) Figure: Impulse Responses to a Monetary Policy Shock in a Monetary Union. Back

% dev. steady state % dev. steady state GDP A.2 -.2 Interest Rate A.5 -.5 % dev. steady state % dev. steady state Inflation A.1 -.1 House Prices A.2 -.2 % dev. steady state % dev. steady state GDP B 1.5 Interest Rate B -.5 -.1 % dev. steady state Inflation B.5 -.5 % dev. steady state House Prices B 1.5 MU Flex. exchange rates Figure: Impulse Responses to a Technology Shock in Country B. Monetary Union versus Flexible Exchange Rate regime. Back

% dev. steady state Consumption A.1 -.1 % dev. steady state % dev. steady state x 1-3 Interest Rate A -2-4 x 1-3 Inflation A -2-4 % dev. steady state House Prices A 2 1 % dev. steady state % dev. steady state % dev. steady state 1 x 1-3 Consumption B 8 6 x 1-3 Interest Rate B -1-2 2 x 1-3 Inflation B -2 % dev. steady state 6 x 1-3 House Prices B 4 2 MU Flex. exchange rates Figure: Impulse Responses to a House Price Shock in Country A. Monetary Union versus Flexible Exchange Rates. Back

1 C u At 1 D t C u At CAt u CBt u np Bt = (1 n)p At = E t R At At+1 C u At+1! = E t R Bt e t+1 At+1 C u At+1 e t ;! ; w u t = (L u t ) 1 C u At n ; j t H u t = n n CAt u q t E t CAt+1 u q t+1 : Back

n C ci At C ci At C ci Bt np Bt = (1 n)p At! = e E t nr c At At+1 C ci At+1 w ci t = L ci t 1 C ci At n ; + ci At Rc At ; j t H ci t = n C ci At q t Et e n CAt+1 ci q t+1 ci At k AE t q t+1 At+1 : Back

E R OPT A = 1P i=+1 1P E i=+1 i ;i R Ai 1 i ;i : R At = R At 1b cf t 1 + ROPT At bt cf b cf t bt cf 1 : Back