“Are Swedish House Prices Too High? Why the Price-to-Income Ratio Is a Misleading Indicator,” first version March 2022, revised April 2024. Paper (latest version). CEPR Discussion Paper. NBER Working Paper. VoxEU column.

Abstract

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 and the sample examined, the UCTI and PTI indicators are in fact strongly negatively correlated and have opposite signs (see figure 1.2). If the UCTI indicator is the right one, the PTI indicator is consistently wrong. Taking the average of the two indicators is not a good idea.

Figure 1.2: The preference-adjusted user-cost-to-income ratio and the negative of the preference-adjusted price-to-income ratio (percentage deviation from historical averages)

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.

“Household Debt Overhang Did Hardly Cause a Larger Spending Fall during the Financial Crisis in the UK,” April 2021, paper. CEPR Discussion Paper DP16059. NBER Working Paper 28806.

Abstract

“Household Debt Overhang Did Hardly Cause a Larger Spending Fall during the Financial Crisis in Australia,” April 2021, paper. CEPR Diskussion Paper DP16094. NBER Working Paper 28776

Abstract

“Macroprudential Policy and Household Debt: What is Wrong with Swedish Macroprudential policy?”, Nordic Economic Policy Review 2020, 111–167. Article incl. Online appendix. Online appendix. Slides.

Abstract

Much is right with Swedish macroprudential policy. But regarding risks associated with household debt, the policy does not pass a cost-benefit test. The substantial credit tightening that Finansinspektionen (FI, the Swedish FSA) has achieved – through amortization requirements and more indirect ways – has no demonstrable benefits but substantial costs. The FI, and international organizations, use a flawed theoretical framework for assessing macroeconomic risks from household debt. The tightening was undertaken for mistaken reasons. Several reforms are required for a better-functioning mortgage market. A reform of the governance of macroprudential policy – including a decision-making committee and improved accountability – may reduce risks of policy mistakes.

Update, June 2020: Problems of the amortization requirements confirmed

The paper was written before the onset of the coronavirus pandemic. It emphasizes that the FI’s mandatory amortization requirements substantially increase the mortgagors’ housing payments and reduce their cash-flow margins. Thereby the amortization requirements reduce households’ resilience to shocks – in contradiction to the FI’s objective to increase the resilience.

The paper also notes that the FI is aware of the problem that amortization requirements reduce households’ resilience. Its response to this problem and contradiction is to allow mortgage firms to make exemptions from amortization payments for mortgagors “for a limited period” on “special grounds.” However, the special grounds FI mentions refer to situations when individual mortgagors face individual problems in fulfilling their debt service for reasons such as “unemployment, long periods of absence from work due to illness and the death of a close relative.” There is no suggestion in the FI’s discussion that mortgage firms might consider mortgagors’ consumption or the macroeconomic risk from a reduction in mortgagors’ consumption—the FI’s official rationale for having introduced the amortization requirements. It difficult to believe that mortgage firms would exempt mortgagors from amortization on the ground that certainly they can fulfill their debt service, but they cannot maintain their normal consumption. The mortgage firms will most certainly be focused on any risk to their individual debt service rather than on any macroeconomic consequences. Thus, the FI has not provided any mechanism through which the exemptions to amortization payments would avoid the reduced resilience caused by the amortization requirements.

The problems of the mandatory amortization requirements were confirmed, when the corona pandemic forced the FI in March 2010 to adapt and to make a surprise special recommendation: “Loss of income due to the corona-virus [is] a cause for exemption from amortization.” But borrowers have no right to an exemption; it is still the mortgage firm that decides. And the recommendation did not apply to those that have not yet lost their income. In April, the FI corrected the latter and stated that banks may grant all mortgagors amortization exemption. But the exemption is only in force until the end of June 2021. As Bäckman has argued – and is argued in the paper – it is better to simply abolish the amortization requirements.

“Monetary Policy Strategies for the Federal Reserve,” International Journal of Central Banking 16 (February 2020) 133-193. Paper.

A previous version was prepared for the conference Monetary Policy Strategy, Tools, and Communication Practices—A Fed Listens Event, Federal Reserve Bank of Chicago, June 4–5, 2019. Video (my presentation starts 3 min 5 sec into the session).

Abstract

The paper finds that the general monetary policy strategy of “forecast targeting” is more suitable for fulfilling the Federal Reserve’s dual mandate of maximum employment and price stability than following a Taylor-type rule. Forecast targeting can be used for any of the more specific strategies of annual-inflation targeting, price-level targeting, temporary price-level targeting, average-inflation targeting, and nominal-GDP targeting. The specific strategies are examined and evaluated according to how well they may fulfill the dual mandate, considering the possibilities of a binding effective lower bound for the federal funds rate and a flatter Phillips curve. Nominal-GDP targeting is equivalent to a single mandate and is found to be inconsistent with the dual mandate. Average-inflation targeting is found to have some advantages over the others.

“Amortization Requirements, Distortions, and Household Resilience:  Problems of Macroprudential Policy II,” November 2019, paper.

Abstract

Mortgage lending standards have tightened in Sweden in recent years, in particular through mandatory amortization requirements introduced by the Swedish FSA. The stated purpose is to increase the resilience of mortgagors to shocks, but it is shown that the resilience actually falls and that the tightening causes or worsens many distortions. Households without high income or wealth face higher barriers to entry into owner-occupancy. The mobility within the market for owner-occupied housing is reduced. First-time buyers without high income or wealth are excluded from the owner-occupancy market in Stockholm Municipality and many outsiders have to resort to a high-rent secondary-rental market. To prevent such exclusions, housing prices may have to fall by almost 40%. Less-than-high-income outsiders have higher housing user cost than high-income insiders. A less wealthy outsider has a higher user cost than a high-wealth insider with similar income. Mortgagors are forced to oversave and underconsume relative to their disposable income, and their consumption becomes more sensitive to income shocks. They have to save in illiquid housing equity instead of more liquid and diversified assets. They become less resilient to shocks for many years, for a very small gain in resilience later. Secondary-rental outsiders are forced to overpay, undersave, and underconsume, and their consumption becomes more sensitive to income shocks. They face less resilient to shocks, without any gain in resilience later. By design the amortization requirements make the amortization countercyclical,  which makes consumption more procyclical and sensitive to income shocks. The tightening of lending standards reduces demand for and lowers the prices of housing. This in turn reduces already too-low housing construction and worsens the structural problem of excess demand for housing. The conclusion is that this example of macroprudential policy is counterproductive and harmful to social welfare and equity.

“Housing Prices, Household Debt, and Macroeconomic Risk: Problems of Macroprudential Policy I,” December 2019. Paper.

Abstract

This paper answers three questions about current Swedish housing prices and household debt: (1) Are housing prices too high? (2) Is household debt too high? (3) Does household debt pose an “elevated macroeconomic risk”? Finansinspektionen (the Swedish FSA) has argued that the answers to these questions are all yes  and that this has justified a substantial further tightening of already rather tight lending standards, achieved through mandatory amortization requirements and in other ways. This paper argues that the answers to the questions instead are all no, in the following sense: Regarding questions (1) and (2), there is no evidence that housing prices and household debt are higher than what is consistent with their fundamental determinants. Regarding question (3), the  “macroeconomic risk” refers to the risk of a larger fall in household consumption in a recession or crisis. There is indeed evidence from Denmark, the UK, and the US of a correlation between households’ pre-crisis indebtedness and subsequent negative consumption responses during the financial crisis 2008-2009. But there is no evidence that high household indebtedness caused a subsequent larger negative consumption response. The correlation is instead explained by an underlying common factor that caused both high pre-crisis indebtedness and a large negative consumption response during the crisis. For Denmark and the UK, the evidence is that the common factor is debt-financed household overconsumption relative to income, more precisely overconsumption financed by housing equity withdrawals. There is also evidence of debt-financed overconsumption for the US. But there is no evidence of debt-financed overconsumption of any macroeconomic significance in Sweden. Therefore, there is no evidence of Swedish household debt posing an elevated macroeconomic risk. In summary, Finansinspektionen’s tightening of lending standards lacks scientific support.

“The Future of Monetary Policy and Macroprudential Policy,”  in ECB (2018), The Future of Central Banking, Festschrift in honour of Vitor Constancio, December 2018, European Central Bank, pp. 69-123. Paper. Slides.

“Amortization Requirements Benefit Well-Off and Hurt Liquidity-Constrained Housing Buyers,” February 2018. Paper. Ekonomistas post (Swedish) Continue reading →

“Leaning Against the Wind: The Role of Different Assumptions About the Costs,” August 2017. Continue reading →