Kommentarer till ESO-rapporten 2022:3, “Samspel för stabilitet – en ESO-rapport om rollfördelningen mellanfinans- och penningpolitiken“. Bilder pdf, powerpoint.
“Are Swedish House Prices Too High? Why the Price-to-Income Ratio Is a Misleading Indicator,” first version March 2022, revised December 2023. Paper (latest version). CEPR Discussion Paper. NBER Working Paper.
Appropriate indicators of housing valuation are important for macroprudential policy and assessments of risks to financial stability. Overvalued housing may result in a correction and a fall in house prices. This would weaken households’ balance sheets, reduce the collateral of mortgages and covered housing bonds, and threaten financial stability.
According to ECB (2023) and European Systemic Risk Board (2022), Swedish owner-occupied housing (OOH) was overvalued by about 55% in 2021q2, the largest overvaluation in the EU and EEA; according to European Commission (2023c), by about 30% in 2022. These assessments affect warnings and recommendations issued for Swedish economic policy and the shocks in EBA stress tests of Swedish banks.
But these large overvaluation assessments are due to the use of misleading indicators: the deviations of price-to-income (PTI) and price-to-rent ratios from their historical averages. It is shown that according to the appropriate indicator, the user- cost-to-income (UCTI) ratio, Swedish owner-occupied houses have since 2010 instead become increasingly undervalued (not overvalued), by about 30% in 2019q4. Due to rising mortgage rates, they are less undervalued in 2023q2, but still about 20%.
For Sweden, the UCTI and PTI indicators are in fact strongly negatively correlated and have opposite signs (see figure 1.2). If the UCTI indicator is right, the PTI indicator is consistently wrong. Taking the average of the two indicators is not a good idea.
The PTI ratio disregards mortgage rates and other housing costs and lacks scientific support. According to a large housing literature, it is not the purchase price but the user cost that is the appropriate measure of the cost of living in OOH, the cost of the housing services that the OOH delivers. New improved estimates of the user cost are constructed, including an adjustment for a preference shift during the coronavirus crisis in favor of larger and better housing.
The valuation assessments of the ECB, the ESRB, the Commission, the OECD, and the IMF are scrutinized and compared. The problem of misleading indicators and overvaluation assessments—and resulting distorted warnings and recommendations—is not restricted to Sweden but concerns several other countries in the European Union.
“Monetary Mystique and the Fed’s Path Toward Increased Transparency,” chapter, in King, Robert G., and Alexander L. Wolman (eds.), Essays in Honor of Marvin Goodfriend: Economist and Central Banker, Federal Reserve Bank of Richmond, 2022, 289-300.
Marvin Goodfriend’s paper “Monetary Mystique: Secrecy and Central Banking” is a masterpiece: It is an extremely well-written, meticulous, and fair analysis and critique of the Federal Reserve’s defense of its practice of secrecy in monetary policy and central banking. His critique was devastating, and he completely demolished the Federal Open Market Committee’s (FOMC) arguments in the most precise and convincing way. Nevertheless, it took the Fed many years to reach the current standards of transparency and accountability in monetary policy.