For past few years, macroprudential policy has been the new policy buzzword, and the “go-to” tool for many policymakers around the world. This note describes the experience of Israel and the Netherlands in using of macroprudential policies to deal with house prices, and sheds some light on what works.
Israel and the Netherlands are two economies that have been doing well overall in recent decades. This tends to put upward pressure on house prices because there are strong underlying supply constraints in both countries. Nevertheless, the house price booms in these economies in the period before the global financial crisis occurred for different reasons: in Israel, supply constraints played an important role, in the Netherlands it was easy credit.
When the global financial crisis hit, both countries had to make policy adjustments. In both countries, monetary policies had to be eased to support the economies. With the unavailability of monetary policy, macroprudential policies had to be deployed in Israel to contain still-rising house prices. In the Netherlands, macroprudential policies had to be tightened to deal with the aftermath of easy credit, even though the economy and house prices had collapsed. In Israel, macroprudential policies have been used to reduce financial stability risks.
Developments in Israel
The central bank lowered the monetary policy rate from 3.75 percent at the beginning of 2008 to almost zero (0.25 percent) at end of 2014. As monetary policy rate is lowered, one expects to see an impact on economic activity and asset prices. Indeed, in the case of Israel, house prices have risen sharply. So with the monetary policy rate already lowered to counter a deceleration in GDP and to withstand the effects of the global economic downturn, Israel has had to implement macroprudential policies to deal with house price increases (See Figure 1 for the list of macroprudential policies implemented in Israel).
Israel: Real House Price Index and Macroprudential Policies
Developments in the Netherlands
In the Netherlands, macroprudential policies have been used to reduce existing vulnerabilities in the housing market. Prior to the global financial crisis, households in the Netherlands accumulated substantial mortgage debt at generous LTV ratios, spurred in part by advantageous mortgage interest deductibility (MID). More specifically, during the upswing in housing prices in Netherlands, LTV ratios on new mortgages averaged 114 percent in 2007, and over 120 percent in 2010. It is important to note that there was no formal LTV requirement on mortgage lending. This means that there was no limit on the loan amount that people could borrow compared to the value of the home. Also, the MID regime allowed for unlimited deductions of interest payments on mortgages of primary residences.
However, in 2009, real GDP declined by -3.3 percent. Also, house prices started to fall. To reduce the vulnerabilities in the housing market, the Netherlands implemented several macroprudential policies (See Figure 2 for the full list).
Netherlands: Real House Price Index and Macroprudential Policies
Performance of macroprudential policy in Israel
In Israel, even after implementing several measures of macroprudential policies, real house prices have continued to rise (Figure 1). We can ask three questions to find potential reasons for why house prices have continued to rise. First question: could the government have used monetary policy rate? Raising the monetary policy rate would have lead to a deceleration in activity across all sectors of the economy. So a tool that only targets the housing market was needed and hence the use of macroprudential policies in Israel.
Second question: were macroprudential policies not tightened enough? It was hard to tighten macroprudential policies. For example, construction activity is an important contributor to Israel’s economy. So the government had to be careful to not flatten the housing market. Another example is the difficulty in tightening the LTV ratios for first time home buyers since politically it was difficult to introduce regulations that make it difficult for young couples to buy a home.
Third question: are there any other factors that have been contributing to the rise in house prices? Yes, there is evidence that the rise in house prices are explained largely by supply constraints. In Israel, the state owns 93 percent of the land and there is a long process for obtaining licenses, building permits, and finishing construction. For example, the time between initiating new building initiatives and finishing construction can take between 8 to 21 years. Moreover, there is also a lack of support from local governments for high density projects. Since property tax rates are lower for residential properties and for smaller units, local governments prefer commercial properties and luxury buildings over high density residential buildings. Thus, local authorities are reluctant to support large projects, further delaying construction. So in a presence of a strong housing demand, but with supply constraints, house prices will tend to rise sharply. Recognizing this, the government has introduced measures to increase supply, including facilitating coordination between different housing bodies and initiating urban renewal programs.
Performance of macroprudential policy in the Netherlands
In Netherlands, macroprudential policies have started to reduce the vulnerabilities in the housing market, but challenges remain. In contrast to Israel, as noted earlier, the Netherlands was hit hard by the global financial crisis. So it had to implement macroprudential policies gradually in order not to destabilize the housing market in an environment of weak economic activity and falling house prices. We can see this in the way the Netherlands plans to gradually bring down the LTV ratio and the tax deductibility of interest on mortgage loans. The LTV ratio will be gradually reduced by one percentage point per year until January 2018 when it will reach 100 percent. However, an LTV ratio of 100 percent would still be high compared to international levels. LTV ratios should be in place before household debt problems arise. So further work still remains in terms of LTV ratio limits.
Moreover, the MID is the main subsidy for homebuyers in the Netherlands, which allows households to benefit from full interest deductibility. The plan to scale back this benefit will take nearly 30 years to implement fully, a slow and long process.
Moreover, even though the housing market is characterized by high LTV ratios, there are two specific risk mitigating factors that limit the risk of mortgage defaults in the Netherlands. The first factor is that Dutch banks have full recourse to all the assets and income of borrowers who default on their mortgage loan. Also, the bank’s right of recourse generally does not expire, so borrowers have a strong incentive to meet their obligations. The second factor is substantial savings. The Netherlands has the largest pension assets per capita ratio worldwide. In an international comparison of debt to asset value ratios, Dutch household rate among the lowest when comparing the level of indebtedness to total assets. Homeowners do not depend on the value of their homes for their old-age income thanks to their pension savings. Both of these factors have contributed to very low losses taken on mortgages by Dutch banks. In 2013, the losses taken on mortgages by banks stood at 0.08 percent.
Below are four lessons that can be learned from the case of managing housing markets in Israel and the Netherlands.
- Macroprudential policies work in reducing housing related risks to financial stability. In Israel, the increase in house prices was considered a problem. This was due largely to supply constraints and not only due to easy credit conditions or excessive household debt. So macroprudential policies assisted in managing household leverage, but there were no policies in place to address the housing supply constraints. Moreover, the objective of macroprudential policies is not to fully stop the growth of house prices. Instead, the objective is to reduce housing related risks to financial stability and to avoid a crisis. In the Netherlands, the increase in house prices was due to easy credit conditions and excessive household leverage and that was considered a problem. So in the Netherlands macroprudential policies were aimed at the root cause of the problem.
- Macroprudential policies can be politically and economically hard to implement. In Israel, we learned about the difficulty in setting a lower LTV ratio because of the impact it has on first time home buyers, in particularly for young couples. In the Netherlands, we learned that economically, it was hard to bring down the LTV ratios because it could have a negative impact to an already weak housing market and economy. It was also politically difficult to withdraw existing benefits: the maximum rate for tax deductibility of interest payments will be scaled back slowly from 52 percent to 38 percent only by 2042.
- Macroprudential policies work better as ex-ante rather than ex-post tools. In the Netherlands, there was no cap on LTV ratios during the upswing in house prices. The limits in LTV ratios and the reduction in the interest tax deductibility on mortgage loans came after the house price bust. In other words, we can say that the policies came in too late to address an area of risks. Using macroprudential policies ex-post is bound to be difficult to implement and painful.
- The institutional setting of the market matters. In the Netherlands, substantial savings from the pension system and a strong legal position for lenders have helped in reducing mortgage risks. Other elements have helped as well. These include: a system of job protection and unemployment benefits, a mortgage guarantee scheme, and a solid mortgage application process.
Akerlof, George A.; Olivier Blanchard; David Romer; and Joseph E. Stiglitz, 2014, “What Have We Learned? Macroeconomic Policy after the Crisis,” The MIT Press, 2014
Darbar, Salim; and Xiaoyong Wu, 2015, “Experiences with Macroprudential Policy—Five Case Studies,” IMF Working Paper 15/123, International Monetary Fund, 2015
Dutch Banking Association, 2014, “The Dutch Mortgage Market,” May 26, 2014
Global Property Guide, 2015, “Israeli house prices rising faster and faster,” May 21, 2015
IMF, 2015, “Israel: Article IV Consultation,” IMF Country Report No. 15/261, International Monetary Fund
IMF, 2015, “Housing Recoveries: Cluster Report on Denmark, Ireland, Kingdom of the Netherlands—The Netherlands, and Spain,” IMF Country Report No. 15/1, International Monetary Fund
IMF, 2014, “Netherlands: Selected Issues,” IMF Country Report No. 14/328, International Monetary Fund
IMF, 2013, “Israel: Selected Issues,” IMF Country Report No. 14/48, International Monetary Fund
Ministry of Economics Affairs, 2014, “National Reform Programme 2014 The Netherlands,” Ministry of Economic Affairs