In the past, financial system crises have often been triggered or accompanied by a protracted marked rise and then abrupt sharp fall in property prices. This had grave consequences for the respective economies and hence for the entire world economy. These real estate bubbles are seen as a key trigger of the recent crisis in the USA and in some European countries, such as Spain or Ireland, which has then spilled over to other countries. In Germany, house prices have likewise shown very dynamic growth in the recent past – at least on a regional basis. Against this backdrop, the Bundesbank, together with the IMF and the "Financial Market Imperfections and Macroeconomic Performance" Priority Programme funded by the German Research Foundation (Deutsche Forschungsgemeinschaft - DFG), devoted the sixteenth Bundesbank Spring Conference to the topic of "Housing Markets and the Macroeconomy: Challenges for Monetary Policy and Financial Stability". Leading global economists, central bank representatives and delegates from international organisations presented and discussed their recent findings at this conference held on 5 and 6 June 2014 in Eltville, Germany.

Real estate bubbles and banking crises

Compared with incomes and rents, housing prices are "well above the historic averages" for a majority of OECD countries, explained Min Zhu, Deputy Managing Director of the IMF. He pointed out that sharp price movements on housing markets and the subsequent crises are not limited to the recent past. "IMF research shows that of the nearly 50 systemic banking crises in recent decades, more than two thirds were preceded by boom-bust patterns in house prices".

These experiences reinforced efforts to gain a better understanding of the underlying causes and correlations, and to discuss possible countermeasures and precautionary measures. In this connection, the President of the Federal Reserve Bank of San Francisco, John Williams, cited the problematic role of expectations on the housing markets, similar to those on the stock markets, "when house prices go up, people expect them to continue to rise. And when they fall, people turn much more pessimistic about future appreciation".

Accordingly, several papers endeavoured to develop models to improve the analysis of whether house prices are justified. It emerges that house prices do not develop evenly within a country and that different regional interactions must be taken into consideration when forming a judgment as to whether price increases are appropriate and sustainable. Other contributions focused on analysing the extent to which banks (by extending overly generous loans) or central banks and government (by pursuing a loose monetary policy, providing government assistance or granting tax concessions when acquiring property) led to exaggerations on real estate markets.  

In this context, there were also discussions about which strategies and instruments central banks can use to counteract unhealthy developments in the real estate markets. As a possible monetary strategy for such problems, Klaus Adam and Michael Woodford suggested a "robustly optimal monetary policy" which is not based on rational expectations of households in terms of house prices.

Targeted policy response

However, there was a broad consensus among the economists that, after the experiences of recent years, central banks should not ignore developments on housing markets. On the other hand, given the complexity and the fact that conditions vary from one country to another, many open questions remain about the right approach. In this regard, Bundesbank President, Jens Weidmann, pointed out that "studies suggest that relying on macroprudential policy rather than monetary policy to counter housing market imbalances yields socially more desirable results. This is because macroprudential instruments allow for a targeted policy response and thus minimise output and inflation volatility".

Overall, the conference showed that, over the past years, academics have made considerable progress in modelling house prices and in understanding the consequences of inappropriate price developments. However, there are still some questions to be answered, not least with regard to determining which instruments central banks can best use to prevent unhealthy developments.