[FINANCE WATCH] What Interest Rates Mean for the Housing Market (November 16, 2006) CHOI Ho-Sang / Research Fellow (Money and Finance Department)
Welcome to our Video Program, I am Ho-Sang Choi. Our discussion today concerns speculation in the real estate market.
Spirited debate exists over escalating prices in the housing market. The average growth rate of housing prices stood at 1.0% during 2004 and 2005, but jumped to 5.2% year on year for the first nine months of 2006.
Apartment prices in Seoul's Kangnam area rose an average of 16.7% in the same period, up from 6.1% growth in 2005. Likewise, average nationwide prices for detached single-family homes and town houses, which declined during 2004 and 2005, also moved upwards.
I think it is necessary to examine the relationship between interest rates and housing prices. I examined data starting in 2001 - before the current low-interest rate regime - to the second half of 2005 when the government implemented anti-speculative measures.
We assessed the potential presence of "asset price bubbles" in the housing market by comparing the fundamental value of real estate with the actual market price. We discovered that low interest rates fed inflated asset prices in Korea's housing market.
For the first half of 2005, the average asset price bubble in the nationwide market for single-family homes was estimated to be 17.0% of the current market price. Of the 17% total, 11.6 percentage points stemmed from low interest rates. In addition, the average asset price bubble for nationwide apartments was estimated at 32.4% of the current market price during the first half of 2005, accounting for 70.9% of the total.
In a word, asset price bubbles are closely linked with interest rates. Therefore, the most effective measure to level off housing prices would be to adjust interest rates. Having this in mind, what is the right direction for interest rates?
In the face of conflicting goals - stimulating the economy and cooling housing prices - an answer depends on the relation between interest rates and housing prices. According to our study, the positive effects of interest rate cuts on consumption and investment are minimal over the last five years. Meanwhile, the price-boosting effect of rate cuts has strong evidence. Now let's take a closer look at the effect of interest rate hikes.
Interest rate hikes are difficult in the current economic environment. A rate hike coupled with high consumer debt levels will likely increase bankruptcies and the non-performing loan burden on banks.
Instead, policy makers should focus on market deregulation and fiscal policy measures to stimulate the economy. In the short run, regulators can adapt administrative measures such as limiting mortgage loans to quell speculation. In addition, the government can curb money supply growth by tightening mortgage loan requirements.
In the long run, monetary authorities must be able to respond swiftly to changes in the business cycles to stabilize the housing market. In an expansionary cycle, the government should be receptive enough to raise the rates as close to the equilibrium rate as possible, helping the housing market find long-term stability.
Thank you for watching. I am Ho-Sang Choi.
Copyright 2006 Samsung Economic Research Institute. All rights reserved.
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