Low interest rates fuel property bubble: International Monetary Fund
The International Monetary Fund has warned that low interest rates and low inflation can fuel a property bubble even in countries with economic tranquillity.
It doesn’t isolate Australia but it has called for stricter bank lending standards to mitigate the threat of a property bubble.
“Where low policy rates are consistent with low inflation, they may still contribute to excessive credit growth and the build-up of asset bubbles and sow the seeds of financial instability,” the IMF wrote in its staff paper titled “Key Aspects of Macroprudential Policy”.
“Country experiences suggest that exposures to tail risks, including sharp changes in interest rates, house prices and exchange rates, tend to increase in the run-up to crises as lending standards fall and the terms of financial contracts change,”
It says there should be a global tightening of lending standards.
"A number of countries have found that the pass-through of an increase in capital requirements on mortgage loans to loan growth can be limited when strong increases in asset prices and credit feed each other,” it says.
"This suggests the use of additional tools that act on the demand for credit and directly increase the resilience of borrowers to shocks."
Tools it advocates include limits on loan to value ratios and debt to income ratios which it says mitigate the effects of low interest rates on financial stability.
“An LTV ratio introduces a cap on the size of a mortgage loan relative to the value of a property, thereby imposing a minimum down payment. A DTI ratio restricts the size of a mortgage loan to a fixed multiple of household income, thereby containing unaffordable and unsustainable increases in household debt,” the report says.
“The available research suggests that these tools can reduce feedback between credit and prices in upswing, as well as improve resilience to shocks, thereby reducing default rates and boosting recovery values when the housing market turns.
“However, they can also be seen as more intrusive and calibration can seek to soften their impact, e.g., by exempting first-time buyers. Moreover, the evidence suggests that LTV ratios can have a relatively strong effect on house prices and aggregate demand, which can justify a gradual approach to tightening of such ratios (as in Canada and the Netherlands).
It also says imposing taxes will help offset the risk of a property bubble.
“Taxes can also affect asset prices. As future tax liabilities are capitalized, in principle, imposing taxes during a boom can make bubbles less likely; or the announcement of future tax relief on asset returns can support asset prices during a bust,” the report says.
“For example, during the crisis countries have used tax measures to bolster house prices by removing stamp duties on housing transactions or extending mortgage interest relief. Stamp duties have more recently also been used in a number of countries to lean against house price appreciation, such as in Singapore and Hong Kong.”