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Housing-related policies matter for economic resilience

By Boris Cournède, Sahra Sakha and Volker Ziemann

Policies that shape the housing market, such as rules concerning mortgage lending, homebuilding and rental regulation as well as taxation, can have a considerable impact on economic crisis risks and the capacity to recover from a crisis. The reason is that housing market developments strongly influence the business cycle and macroeconomic trends. Changes in house prices, rents and mortgage interest rates prompt variations in household wealth, income and expenditure that often have a sizeable impact on aggregate demand and inflation. Furthermore, house price fluctuations affect residential investment, which is a component of GDP. Countries with sharper declines in residential investment in the aftermath of the global financial crisis generally needed more time to recover from the crisis and regain the pre-crisis level of real GDP (Figure 1).

New OECD empirical studies have probed the transmission of housing-related shocks to the real economy and the role that policy plays in (a) mitigating or amplifying shocks and (b) facilitating or hampering a recovery. The aim is to identify which housing policy-related reforms can foster economic resilience. These studies used a range of econometric techniques, including quantile regressions, probit estimation and propensity-score matching.

The main findings are (Table 1):

  • Tighter loan-to-value (LTV) caps are associated with a reduced likelihood of severe downturns but also slower recoveries and lower growth. Overall, the evidence confirms earlier results that LTVs seem to entail a trade-off between growth and crisis risk.
  • More demanding capital requirements also appear to involve the same trade-off, as they are linked with a reduced incidence of downturns but lower median growth. Risk weights that penalise risky mortgages more are tentatively linked with stronger episodes of positive growth, which would be consistent with the hypothesis that they encourage a more efficient allocation of credit.
  • More stringent rental market regulations are associated with severe downturns that are more likely and more protracted, which may be related to bottlenecks in housing supply and lower labour mobility. On the other hand, tighter rental regulations, which aim to protect tenants against adverse economic shocks, appear to be associated with reduced extreme output losses (measured by GDP-at-risk).
  • Higher effective taxation of housing is associated with less severe downturns. Moreover, countries with higher taxation experience more moderate house price fluctuations and smoother residential construction cycles.

Taken together, these results mean that, in the management of macroeconomic risks from housing, policies that shape the housing market itself, such as its regulation and taxation, are at least as important as tools to manage the flow of credit. Well-functioning housing markets are therefore important not only to improve housing affordability but also to enhance macroeconomic resilience.

References:

Cournède, B., S. Sakha and V. Ziemann (2019), “Housing Markets and Economic Resilience”, OECD Economics Department Working Papers, OECD Publishing, Paris, https://doi.org/10.1787/aa029083-en.




Should we worry about high household and corporate debt?

By Catherine L. Mann,  OECD Chief Economist and Head of the Economics Department, and Filippo Gori, Economist, Macroeconomic Policy Division, OECD Economics Department

Household and corporate debt in many advanced and emerging market economies is high in the wake of the financial crisis and following a decade of low global interest rates.  Should we be worried by these developments?

The forthcoming OECD Economic Outlook special chapter on “Resilience in a Time of High Debt” looks at how high debt-to-GDP ratios can increase vulnerability in the short run. While higher indebtedness does not necessarily imply that problems are just around the corner, it does increase vulnerability to shocks and the on-going deterioration of credit quality, changes in the structure of corporate financing, increased forex risk and buoyant asset price dynamics raise concerns.

The impact of high debt on the sustainability of growth in the medium term is often overlooked. While finance is needed to support economic activity and innovation, it can increase risks, lower growth, and raise inequality in the longer term.

The assessment highlights some key features of the post-crisis expansion of private sector debt for risk:

  • There has been a significant shift in corporate finance towards bonds and a substantial decrease in credit quality, including a surge in issuance of non-investment grade bonds, weaker covenants and low bond ratings (Çelik et al., 2015). While deepening of bond markets can be positive, this points to higher credit risk and rollover risk.
  • There has been a substantial expansion of international bond markets and foreign-currency borrowing. This helps to share risk and improves access for countries with limited domestic financial markets. However, it increases the risk of international spillovers. The rise in foreign-currency denominated bond issuance – much of which via foreign subsidiaries – exposes borrowers more to exchange rate risk.
  • On the asset side, more credit risk now lies with bond holders. They also face interest rate risks and the low level of coupon rates and rising maturity means that there are now record levels of duration risk, implying that bond values are very sensitive interest rate changes.
  • Household debt ratios are closely linked to house prices and the credit cycle in mortgages: some OECD countries that have experienced the strongest increases in household debt since the crisis have also the steepest rise in house prices. The housing cycle is an important risk factor as excessive house price developments are predictive signals of future recessions (Caldera Sánchez, et al., 2017). A number of advanced economies have experienced worrying increases in house prices in recent years, while household debt as a share of income in some Asian countries is reaching levels typically seen in advanced economies.

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The efficiency of capital allocation is critical to ensure that corporate debt is sustainable and does weigh on medium-term growth. However, weak investment since the crisis raises concerns that debt is not being used to finance long-term productive capacity. Over-indebted firms tend to lose business dynamism, failing to keep up with the required investment to remain competitive, and become “zombie” firms, not only impairing their own prospects but also reducing performance by competing firms (Adalet McGowan et al., 2017).

An integrated policy approach is needed to enhance the financial resilience of economies to shocks and minimise the risks of sub-par growth in the medium term, balancing risks and the growth impacts. This needs to draw on a familiar menu of policy tools including an appropriate balance of macroeconomic policies and use of macroprudential instruments.

However, the approach needs to go beyond cyclical fixes and address underlying structural features of the economy and policy that can lead to too much corporate and household debt. For corporate finance, a sounder and healthier financial system would reduce the tax bias towards debt, deepen equity markets and improve the design of insolvency regimes. For housing markets, removing tax and other subsidies for housing and making housing supply more fluid would enhance the resilience of household debt.

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References:

Adalet McGowan, M., D. Andrews and V. Millot (2017a), “Insolvency regimes, zombie firms and capital reallocation”, OECD Economics Department Working Papers, No. 1399, OECD Publishing, Paris. DOI: http://dx.doi.org/10.1787/5a16beda-en

Çelik, S., G. Demirtaş and M. Isaksson (2015), “Corporate Bonds, Bondholders and Corporate Governance”, OECD Corporate Governance Working Papers, No. 16, OECD Publishing, Paris.
DOI: http://dx.doi.org/10.1787/5js69lj4hvnw-en

Caldera Sánchez, A., et al.  (2016), “Strengthening economic resilience: Insights from the post-1970 record of severe recessions and financial crises”, OECD Economic Policy Papers, No. 20, OECD Publishing, Paris.

OECD (2017), OECD Economic Outlook, Volume 2017 Issue 2, OECD Publishing, Paris.

 

 




Employment ins and outs in OECD countries

By Paula Garda, OECD Economics Department

Labour markets are in a continual state of flux. Workers get employed, leave a job and become unemployed, join the labour force or leave the labour force. The balance of these flows determines the overall employment rate. Analysing workers’ ins and outs of employment is critical to our understanding of labour market dynamics, especially from a welfare perspective. Transitions into unemployment hurt well-being that can be very strong and persistent, while transitions into employment boost life satisfaction. Not all job losses, however, involve financial loss or substantial hardship for individuals and their families. Indeed, high labour market transition rates could reflect the capacity for constant renewal, career development and productivity-enhancing reallocation of jobs.

The paper Garda (2016) “The Ins and Outs of employment in 25 OECD country” uses household surveys for 25 OECD countries to analyse cross-country differences in the transitions between employment, unemployment and economic inactivity for individuals. Between 2005 and 2012, the annual probability of leaving employment averaged 10% across OECD countries. Jobless people have an average 30% per year probability of finding a job. The variation in these flows across countries underlines the diversity of OECD labour markets (Figure 1). Every year, many workers in countries such as Austria, Finland, Portugal and Spain move from employment to joblessness and vice versa. On the other hand, labour market transitions are relatively infrequent in Belgium, the Czech Republic, France, Luxembourg, Poland, the Slovak Republic and Slovenia.

Employment ins and outs garda

Job-to-job flows are also very important for individual welfare and aggregate productivity. Many workers build their careers through moving to jobs with a higher pay or more generally trying to find better job-skill matches. These job-to-job flows typically translate into enhanced aggregate productivity and earnings gains. The job-to-job transition probability averages 7% across the 25 OECD countries in the sample. This average masks large cross-country differences: countries such as Norway, Sweden and the United Kingdom have high job-to-job flows of more than 12%.

From a welfare perspective it is also important to understand how these labour market flows differ across workers (Figure 2). Several common patterns emerge across countries. Young workers have a twice higher probability of leaving their job than older workers, but they also have a higher probability of finding a job when out of employment. This higher rotation rate is likely to be related to young workers trying to find the best match for their career development but also to a more intensive use of fixed-term contracts.

Female, low educated and low income workers face the highest risk of becoming jobless. Once jobless, these groups of workers experience lower probabilities of moving into a job. This means that labour market insecurity is particularly high for these groups of workers with consequent detrimental effects on individuals’ well-being. The size of the effects implies that lacking education, alone, can increase one’s labour market insecurity several times relative to their highly-educated peers.

National policies and institutions may shape the patterns of worker flows in OECD countries. Knowing more about how policies affect these flows can help us understand channels through which flexibity-enhancing reforms affect workers. This is the subject of other papers: have a look here or here.

Transition problems workers garda

Want to read more?

Cournède, B., O. Denk, P. Garda and P. Hoeller (2016), “Enhancing Economic Flexibility: What is in it for Workers?”, OECD Economic Policy Papers, No. 19, OECD Publishing.

Cournède, B., O. Denk and P. Garda (2016), “Effects of Flexibility-Enhancing Reforms on Employment Transitions”, OECD Economics Department Working Papers, No. 1348, OECD Publishing.

Denk, O. (2016), “How Do Product Market Regulations Affect Workers? Evidence from the Network Industries”, OECD Economics Department Working Papers, No. 1349, OECD Publishing.

Garda, P. (2016), “The Ins and Outs of Employment in 25 OECD Countries”, OECD Economics Department Working Papers, No. 1350, OECD Publishing.

Boeri, T., P. Cahuc and A. Zylberberg (2015), “The Costs of Flexibility-Enhancing Structural Reforms: A Literature Review”, OECD Economics Department Working Papers, No. 1227, OECD Publishing.




Strengthening economic resilience: What lessons to draw from the post-1970s record of severe recessions and financial crises

By Alain de Serres, Filippo Gori and Mikkel Hermansen, OECD Economics Department

Major global crises such as the 2008-09 episode are mercifully rare, but severe recessions have been quite frequent among OECD countries over the past four decades.  Even when they do not inflict long-lasting economic damages, they often entail significant costs in terms of foregone income and high unemployment. It is therefore important that measures be taken to minimise the risk and frequency of such episodes, but also to mitigate their impact once they occur. This raises the question of what can policy makers do to lastingly enhance resilience in the face of economic and financial risks. In looking for answers, they need to be mindful of the potential long-term growth impact of risk-mitigating measures.

More specifically, in considering measures to reduce risks, the benefits need to be balanced against the potential costs in terms of the lower average economic growth rate that some policies could entail. The objective is to reduce financial fragilities and minimise systemic risk, but without undermining entrepreneurial risk-taking, which is the essence of innovation-based economic growth. When risk-mitigating measures involve a trade-off between growth and crisis risk, the most cost-effective actions need to be identified, spanning both macro and structural policies.

Recent OECD research sheds light on possible growth-crisis trade-offs from two angles: i) looking at the extent to which pro-growth policies can make economies more vulnerable to severe recessions and ii) assessing the impact on growth of risk-mitigating (prudential) policies. These issues are explored using an empirical approach that provide insights on both the impact of various policy settings on average GDP growth on the one hand, and either financial crises (i.e. banking, currency and twin crises) or exceptionally low GDP growth rates (i.e. extreme negative tail risk), on the other (see references).

What are the main insights from this research? Considering first policies outside the financial sector, that is product and labour market policies as well as those related to the quality of institutions, there is no evidence that policymakers would face trade-offs between enhancing growth and reducing risks of crises (see figure).

  • The results indicate having in place a sound legal and judicial infrastructure – based on a high quality of institutions – is good for both growth and resilience. It may do so notably by facilitating a greater diversification of funding sources away from the banking sector and towards capital markets.
  • Regarding product and labour market policies, the findings indicate that policy settings conducive to higher productivity (g. through stronger product market competition) and employment generally have little impact on crises risks, i.e. they do not reduce the likelihood of severe recessions, but do not raise it either.

More significant trade-offs between growth and crisis risks arise in the case of financial market policies:

  • Financial market liberalisation often yields stronger growth, but also higher risks of banking crises and hence severe recessions. That said, in the cases where liberalisation essentially leads to the development of private credit – in particular bank credit – as opposed to equity-based financial instruments, the impact on growth diminishes.
  • Greater capital flow openness raises growth, but also increases the risk of banking and currency crises. However, the results indicate that among the different types of capital flows, only debt is associated with higher crisis risk.
  • The risk of crises can be mitigated through prudential policies. Indeed, greater use of prudential policies is associated with fewer occurrences of severe recessions. At the same time, the findings indicate that several of these measures may come at a cost in terms of lower average growth.

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Note: Structural policies should be assessed on the basis of their effect on growth and economic fragility. In this chart, the effect of policies on economic fragility is plotted on the horizontal axis, the effect on growth is shown on the vertical axis. Fragility is defined as a higher likelihood of financial crises (banking, currency or twin crisis) or a higher GDP (negative) tail risk. Different risk-growth patterns emerge for each of policy area considered: pro-growth labour and product market policies improve economic performance without substantially affecting economic fragility. Better quality of institutions both increases growth and reduces economic fragility. However, macro-prudential and financial market polices entail a growth-risk trade-off: the former decrease economic risk to the detriment of a higher growth rate, the latter promote growth but also increase financial risk.
Source: Authors’ calculation based on Caldera Sánchez and Gori (2016) and by Caldera Sánchez and Röhn (2016).

What does this mean for policy? One of the main implications of the analysis is that taking measures in the financial sector to lower the risk of severe recessions is entirely appropriate, but focusing too narrowly on that sector is unlikely to be sufficient and could entail substantial costs in terms of foregone GDP growth.  Policymakers need to consider other potential sources of distortions that can contribute to the build-up of vulnerabilities.

OECD research also shows that among the factors creating an environment prone to severe recessions, the more prominent are rapid growth of private credit, imbalances in the housing market (as proxied by real house prices and the ratios of house prices to income and house prices to rent), and, to a lesser extent, large current account imbalances. This points to the need for looking at how domestic policy distortions – notably in the areas of housing market regulation as well as taxation – contribute to excess leverage, in particular through real estate markets and current account imbalances.

References:

Caldera Sánchez, A., A. de Serres, F. Gori, M. Hermansen and O. Röhn (2016) “Strengthening economic resilience: insights from the post-1970 record of severe recessions and financial crises economic policy paper”, OECD Economic Policy Papers, December 2016 No. 20.

Caldera-Sánchez, A. and O. Röhn (2016), “How Do Policies Influence GDP Tail Risks?”, OECD Economics Department Working Papers, No. 1339, OECD Publishing, Paris.

Caldera-Sánchez , A. and F. Gori (2016), “Can Reforms Promoting Growth Increase Financial Fragility? An Empirical Assessment”, OECD Economics Department Working Papers, No. 1340, OECD Publishing, Paris.