Mersch noted that some assets, including real estate, are at “historically high levels,” and that the elevated prices are to some extent “a function of the long-running downward trend of interest rates.”
How to address this issue is however not an easy question, and Mersch noted that he does not think this can come down solely to monetary policy. Two potential solutions mentioned by Mersch include loan to value and loan to income constraints, “which would be more effective since they act directly onto the borrowers,” and as such “could benefit the stability of the banking sector ... and help mitigate the potential contagion from falling house prices to a more general economic downturn.”
However, Mersch also noted that neither of these solutions are without their own risks and negative impacts:
“While loan to value and loan to income limits are relatively effective in slowing housing booms, they also work by crowding out marginal borrowers, who are precisely those most affected by the housing shortage. Loan to value limits crowd out those without a large enough deposit – usually young, or poor households, while loan to income limits exclude low income households directly. The distributional impact of loan to value and loan to income limits can render their use politically controversial, as has been also seen in recent discussions in the Luxembourg parliament on such measures. And as a consequence it may lead to inaction bias, that nothing is done to control housing price explosion.”
Mersch also commented on the supply issue faced by housing in countries such as Luxembourg, noting that “Insufficient house building owing to capacity constraints in the construction sector, but also owing to regulatory restrictions, has exacerbated the shortage of housing in many European countries.”
This, said Mersch, is a burden felt most acutely by the poorest in society. To this end, Mersch also highlighted a flaw in the way inflation is measured - in that occupant-owned property costs are not included in the ‘basket of goods’ used to calculate inflation, and rental costs only carry a weight of around 6%, despite often accounting for around a third of renters’ actual expenses.
