House Prices in France

According to a new report, "Macroeconomic risks related to a correction in real estate prices appear to be relatively contained. The increase in housing prices (over 100 percent in real terms since the mid 1990s) has been supported by stronger fundaments (higher population growth, relatively low supply of housing, and low household indebtedness) than in other countries with rising real estate prices, but also by tax incentives that have fueled demand without addressing underlying supply constraints. There is a perception of price overvaluation, especially in Paris (by 10-20 percent at end-2011 according to staff estimates). However, there is no housing glut or household debt overhang that could trigger a sudden price adjustment. Moreover, stress tests suggest that banks are well placed to absorb the impact of a possible sizable price adjustment owing to tight underwriting criteria (emphasizing sustainability of the borrower’s income, not collateral value) and the absence of nonrecourse loans. The impact of a possible price correction on private demand would also be contained reflecting weak evidence of wealth effects on consumption."

Macroprudential Policies and Housing Prices

Several countries in Central, Eastern and Southeastern Europe used a rich set of prudential instruments in response to last decade’s credit and housing boom and bust cycles. A new paper collects detailed information on these policy measures in a comprehensive database covering 16 countries at a quarterly frequency. The authors use this database to investigate whether the policy measures had an impact on housing price inflation. Their evidence suggests that some—but not all—measures did have an impact. These measures were changes in the minimum CAR and non-standard liquidity measures (marginal reserve requirements on foreign funding, marginal reserve requirements linked to credit growth).

An assessment of the US jobless recovery through a non-linear Okun’s law

From Econbrowser:

Following the recent financial crisis and its subsequent Great Recession, the issue of a sluggish US employment was raised by economic observers. In a previous post on Econbrowser, Menzie Chinn pointed out the usefulness of the Okun’s law in assessing the potential level of employment after the recession. Especially, Menzie shows that:

• If one does not account for the long-term relationship between GDP and employment (i.e.; if one focuses only on the relationship in differences), then the bounce-back in employment after the 2008-09 recession cannot be captured.
• A standard error-correction model (ECM) is able to reproduce the general evolutions, but misses a large part of the recovery after the end of the recession.
• Accounting for the US business cycle by incorporating a dummy variable that takes the value 1 during recessions and 0 otherwise, according to the NBER Dating Committee dating, enables a better reproduction of stylized facts.

In this work, we reconsider this ECM approach but we do not impose any dummy variable and propose to let the data speak through a non-linear ECM. Read more.

How the IMF and the World Bank contribute to a job-rich global recovery?

See the interview here.

Seven Questions on Turning Points of the Global Business Cycle

The depth and breadth of the worldwide recession that followed the 2007–09 financial crisis have led to intensive discussions about the phases of the global business cycle—global recessions and global recoveries. The fragile nature of the ensuing global recovery has added a new twist to these discussions because of widespread concerns about the possibility of a double-dip global recession. This article provides brief answers to seven commonly asked questions about the global recessions and recoveries. Read more.

A Project in Every Port

 Prakash Loungani profiles Jeffrey Sachs, peripatetic development economist

IT IS HARD to imagine a more accomplished—and more varied—career than that of Jeff Sachs. Harvard University granted him tenure in 1982 when he was only 28. In his early thirties, he helped Bolivia end its hyperinflation and restructure its debt. Only a few years later, he was drafting the Polish government’s blueprint for transition from communism to capitalism. Stints as advisor to the governments of Russia, Estonia, Burkina Faso, and India—among many others—followed. Sachs campaigned for debt relief for poor countries and, as an advisor to UN Secretary General Kofi Annan, developed a plan to achieve the Millennium Development Goals. Since 2002, as director of the Earth Institute at Columbia University, Sachs has set his sights even higher. The Institute, an interdisciplinary group of 850 people, addresses some of the world’s most difficult problems, from eradication of disease to global warming. Read more.

Honoring a Forecasting Giant

Herman Stekler has predicted 10 of the last 6 U.S. recessions. Despite this dismal forecasting performance, he is considered one of the giants of the economic forecasting profession. At the age of 80, he is still going strong, recently finishing his 100th academic paper. 

photo: IMF

A GW-IMF Forecasting Forum held on November 15-16, 2012 honored Stekler’s contributions to the profession. The program features papers by:

• Prakash Loungani on whether forecasters believe in Okun’s Law (they do); 
• Neil Ericsson on uncovering biases in government forecasts of U.S. debt; 
• Ulrich Frtische on whether there is (lack of) herding in foreign exchange rate forecasts; 
• Michael Kumhof on what will happen to the price of oil in ten years (warning: this is not the official IMF view); 
• Natalia Tamirisa on information rigidity in growth forecasts; 
• Massimiliano Marcellino on whether the estimation of large Bayesian VARs can be speeded up by assuming a common stochastic volatility factor. 

The papers can be downloaded from here along with the comments of the stellar group of discussants (Kajal Lahiri, Tara Sinclair, Ed Gamber, Danny Bachman, Robert Fildes, Jonas Dovern, Olivier Coibion, Andy Levin, Fred Joutz, Chris Erceg, Keith Ord and Xuguang Sheng).

The forecasters attending the forum had been asked to predict the outcome of the U.S. Presidential election. Peg Young came the closest, predicting that Obama would win 50.5% of the popular vote (he got 50.6%) and 326 votes in the electoral college (he got 332).

photo: IMF

Okun's Law: Fit at 50?

This paper investigates how well Okun’s Law explains short-run unemployment movements in the United States since 1948 and in a sample of 20 advanced economies since 1980. Our principal conclusion is that Okun’s Law is a strong and stable relationship in most countries. Also, the coefficient in the relationship—the effect of a one percent change in output on the unemployment rate—varies substantially across countries. We take a first look at the sources of these differences; one finding is that they are not explained by differences in employment protection laws. Finally, we find that Okun’s Law held up well during the Great Recession and that recoveries have not become “jobless” in the sense of a breakdown in Okun’s Law. The paper is available here.

United States: Actual and Fitted Unemployment Rate, 1948Q2-2011Q4

Restoring Hope: Policy Options for Jobs & Growth

Sara Eisen of Bloomberg TV moderated a discussion on jobs and growth at the Tokyo annual meetings of the IMF and the World Bank. IMF Deputy Managing Director Zhu said that “in the near term, a growth strategy is the best jobs strategy”. Read his views here.

Are We Headed for Another Food Price Crisis?

My presentation at the Bank of America/Merrill Lynch conference in Tokyo is available here.

The global impact of the ‘food supply crunch’

From the FT:

Which countries will be worst affected by the sharp rise in global grains prices?

The International Monetary Fund, which has an interest in the question because it is usually a source of loans for countries that have run out of money, has studied the vulnerability of different regions to the jump in food prices due to the US drought.

In one section of its World Economic Outlook published on Monday, the fund analyses the effects of the “food supply crunch”.

While commodities traders – who are awaiting the US Department of Agriculture’s monthly forecasts on Thursday – may have already moved on from the US drought, higher prices are still a reality for consumers of wheat, corn and soyabeans. Despite a recent correction, prices for the three staples are still up 20-40 per cent year on year.

The IMF breaks down the issue into three sub-questions: which countries have low food inventories; which countries are most dependent on the global markets for their food supply; and which countries’ populations spend the largest proportion of their income on food.

The countries and regions at the most vulnerable end of the range for each of the categories are the most likely to suffer problems, the fund explains.

While China is a large importer of some foodstuffs (especially oilseeds), it would be able to withstand higher prices better than others because of its large stockpiles. At the other end of the scale, inventories of food commodities in the US have fallen well below historical norms, but food is a relatively small proportion of US consumer expenditure, therefore the country is less exposed.

It may not come as a complete surprise to learn which countries are most at risk. They are: the Caribbean and Central America, which are heavily reliant on corn imports and whose stocks are lower than during the 2007-08 food crisis; the Middle East and sub-Saharan Africa, which have relatively high import reliance and low inventories of wheat; and north Africa, where food accounts for about 40 per cent of final consumption.

Indeed, Morocco, which is forecast to import a record 4.5m tonnes of wheat this year, has already sought a $6.2bn precautionary loan from the IMF.

But the IMF says that the current situation is less severe than in 2007-08 as rice prices remain subdued, oil prices are not so high, and so far, there have not been widespread export restrictions.

Nonetheless, the fund concludes: “Countries should expect rising inflation and balance of payments pressures.”

State of Global Labor Markets

My regular look at the global employment picture is available here.

IMF's latest commodity outlook

The IMF just released this commodity markets review as part of its World Economic Outlook. The review provides the outlook for energy, metals and food markets.

It also discusses:

• the tight link between commodity prices and global demand;
• impact of Chinese growth on base metals;
• the supply-demand balance in oil markets;
• the vulnerabilities of countries to food price shocks.

We hope you find the review useful. The review is a public document and can be cited without prior permission. Questions and comments can be sent to rescommodities@imf.org

Jobs and Growth: Can’t Have One Without the Other?

Emerging market and developing economies have enjoyed robust growth during the past decade and bounced back quickly from the Great Recession, in marked contrast to the more tepid recovery—and even renewed recession—in advanced economies. Similarly, although unemployment in emerging market and developing economies did go up during the Great Recession, by 2011 it was essentially back to precrisis levels.Is the observed correspondence between jobs and growth a surprise, or does it represent a systemic feature of emerging market and developing economies? In a joint work with Davide Furceri, we show that the short-term relationship between labor market developments and output growth has been fairly strong in many of these economies for the past 30 years. This is particularly the case in many emerging markets. Hence, although the emphasis on structural policies to lower long term unemployment and raise labor force participation remains appropriate, cyclical developments deserve adequate consideration as well. The short term relationship between jobs and growth suggests that macroeconomic policies to maintain aggregate demand also likely play an important role in labor market outcomes in many of these economies.

Preliminary work on Okun’s Law in advanced economies is available here.

House Prices in Korea

"Housing prices have peaked in Seoul but are rising in the rest of Korea," according to a new report from the IMF.  The report says that "following a protracted period of rising prices, housing prices in Seoul have remained weak due to a still large, albeit declining, inventory of unsold homes and limited expectation of price appreciation. The steady rise in housing prices outside Seoul (which have moderated recently) has been supported by contracting supply, a rapid increase in rents, and a rise in demand supported by strong non-bank lending. In response to the weakness in the Seoul housing market, the authorities have relaxed regulations in May 2012, including by raising loan-to-value (LTV) and debt-to-income (DTI) ratios applied to some high-house price districts." 

Global House Prices Still Showing Down Trend

• Prices still falling in roughly half of 54 countries tracked around world
• Brazil, Germany among countries seeing house prices rise
• Within United States, housing picture varies considerably

House prices in the United States have started to pick up a little recently, but globally prices are still on a down trend, according to research by the International Monetary Fund (IMF).
Price trends vary widely between countries, with Ireland, Greece, Portugal, and Spain seeing the biggest falls in the past year and Brazil and Germany, substantial increases.

While overall the trend is mixed, there is no sign of an uptick in the global index of house prices, a weighted average of prices in 54 countries, according to our research. The index remained level during the second quarter of 2012—the latest quarter for which consistent data is available for a large group of countries—and the GDP-weighted index continued to decline. Continue reading here.

The Construction Sector: Reeling or Rolling?

The economic outlook for the construction sector is looking optimistic. In 2012, total construction spending is expected to grow by 3 to 9 percent. And the future looks even brighter; total construction is expected to go up by 6 to 10 percent per year in 2013-2017.

On September 6, Ken Simonson, Chief Economist of the Associated General Contractors, gave a presentation on the economic outlook for construction at an event hosted by the National Economist Club.

What explains the rosy scenario for the construction sector? Simonson said that office, retail, and lodging constructions are up due to remodeling. In addition, the production of shale gas (67 percent increase in 2007-10), and the expansion of the Panama Canal are driving new activity. Shale gas has both direct and indirect impacts on construction. For example, the direct impacts include the construction of access road, site preparation, storage pond, support structures, and pipes for each well. The indirect impacts include local spending by drilling firms, workers, royalty holders, among others.

How does the expansion of the Panama Canal affects construction in the United States? The expansion of the Panama Canal will require an upgrade of the ports in the United States to accommodate larger ships.  The upgrade of ports includes investing in dredging, piers, cranes, and access road. The upgrade will also lead to possible bridge, tunnel, and highway improvements, resulting in possible changes in inland distribution and manufacturing. Overall, private nonresidential and residential spending are leading the way forward for the construction sector.

Looking to buy a house or rent an apartment? According to Simonson, apartments and multi-family housing should boom. On the other hand, single family housing is growing, but with an uncertain future. He noted that the apartment vacancy rate is now at a 10-year low and rents are high.

Looking for a job in the construction sector? “Construction added 0 jobs in 2 years, but unemployment is down,” said Simonson. Basically, workers are leaving for other sectors, going back to school, and retiring. Simonson presented a chart that showed the change in construction employment by state in the United States. The map was half or less in green, meaning jobs available, and half or more in red. 

House Prices in Ireland

The new IMF report on Ireland says that "the correction in house prices, one of the largest in recent history, has continued. The decline in nominal residential property prices slowed to 14.4 percent y/y in June 2012. The index has halved since its peak in 2007, eclipsing recent U.K. and U.S. house price declines and comparable to the Japanese and Nordic experiences of the 1990s. As yet, clear signs of stabilization are limited to Dublin house prices (excluding apartments), which, after dropping by 55 percent, have been flat in H1 2012. Rural areas, in contrast, still show signs of oversupply."

Global House Price Watch

This document draws on “Global Housing Cycles”, an IMF Working Paper 12/217 by Deniz Igan and Prakash Loungani (http://www.imf.org/external/pubs/cat/longres.aspx?sk=26229.0). It updates a few of the charts from that paper. As with Working Papers, the views expressed in this document are those of the authors and do not necessarily represent those of the IMF or IMF policy. 

PDF version

The Global House Price Roller Coaster

 Our global index of house prices—a weighted average of price in 52 countries—shows no sign of an uptick. The equally-weighted index moved sideways during the first quarter of 2012 and the GDP-weighted index continued to decline (see Chart 1).

Chart 1. Global House Price Index

Up or Down?

The global index continued to mask very different developments across countries. House prices have fallen over the past year in just over half of the countries and risen in the rest, in Asian countries in particular (see Chart 2).

Chart 2. House Prices around the World

Hold on tight

The ratio of house prices to income and the ratio of house prices to rents are two indicators that give a sense whether prices are likely to decline or rise. The price to income ratio is the basic affordability measure for housing in a given area and the price to rent ratio compares the total costs of homeownership vs. the cost of renting a similar property. If these ratios are above their historical averages, economic theory suggests that the house prices may decline in the future. The latest data shows that both ratios continue to remain above—and in many cases well above—their historical averages, signaling that there may potential for corrections still to come (see Chart 3).

Chart 3. House Prices Relative to Incomes & Rents:

Current Ratios Compared With Historical Averages

Driving factors

An econometric model of the determinants of house prices, used in the working paper by Igan and Loungani explains house price growth based on several short-run factors, such as growth in incomes, asset prices, and population, and long-run-factors, such as the ratio of house prices to incomes. The difference between house prices and those predicted on the basis of these fundamental factors gives another indication of whether prices may have more room to fall.

The results from this exercise show that in many countries the declines in house prices over the past five years (the ‘actual’) are close to, or even exceed, what was predicted by the model. But for many countries, house prices are still resisting the predictions of the model (see Chart 4).

Chart 4. House Prices Changes Compared With Predictions from an Econometric Model

“Location, Location, Location”: A Closer Look within the United States

With house prices falling substantially over the past few years, housing affordability improved in most U.S. states last year. In most U.S. states, a family making the median income for the state could afford the median house (Chart 5). There were still a few states, along the coasts, where the median house still remained out of reach of the median household. A similar picture emerges when looking at price-to-rent ratios by metropolitan areas: house prices remained out of line with rents in some areas along the coasts (see Chart 6).

Chart 5. United States: House Price Affordability by State

Figure 6. United States: Price to Rent Ratios by Metropolitan Areas

Recent IMF staff studies

As part of its regular monitoring of economic conditions in countries (the so-called “Article IV” reports), the IMF staff often provides an assessment of conditions in the housing markets. Readers are encouraged to complement the broad-brush analysis in this document with the country-focused assessment provided in those reports. A list of some of the countries for which housing markets were described in recent reports is given below.

Housing Markets in Recent IMF Staff Reports		Date of Report
Link to:
Discussion of housing markets	Full report (pages on which housing is discussed)
Germany	Staff Report, Article IV   (pg. 8)	Jul-12
Ireland	Staff Report, Article IV   (pg. 6,7)	Mar-12
Lebanon	Staff Report, Article IV   (pg. 8)	Feb-12
Norway	Staff Report, Article IV   (pg. 12 to 14)	Feb-12
Philippines	Staff Report, Article IV   (pg. 28)	Mar-12
Singapore	Staff Report, Article IV   (pg. 41)	Aug-12
Sweden	Staff Report, Article IV   (pg. 27)	Jun-12
United Arab Emirates	Staff Report, Article IV   (pg. 6)	May-12
United States	Staff Report, Article IV   (pg. 51)	Aug-12

House Prices in Singapore

In Singapore, "indicators of housing affordability are mixed. House prices have risen more quickly than median incomes, especially for HDB resale housing. In addition, the tighter LtV ceilings raise the bar on qualifying for a housing loan. On the other hand, all-time low mortgage interest rates (about 70 percent of which are at floating rates, currently between 1⅓ percent and 2 percent) have reduced debt servicing costs," according to a new IMF report on Singapore.

Moreover, it says "Following successive rounds of policy tightening, together with external factors, home prices have remained flat since end˗2011, while the volume of transactions has declined noticeably. In particular, the share of foreign buyers collapsed in Q1:2012 to 5½ percent as a result of new macroprudential measures targeting foreigners and weakening external investment sentiment, with buyers from China falling by nearly 50 percent. The more-than-proportionate decline in purchases by Mainland Chinese may reflect the impact of the economic slowdown in China. Transactions in the luxury market have also fallen. However, the share in total transactions of “shoe box” apartments (with an area of less than 50 square meters) doubled in Q1:2012 to close to 20 percent. While this may reflect the characteristics of new supply coming on-stream, demand for such housing is strong, possibly because of the reduced affordability of standard-size units."

Interview with IMF Fellow Olivier Coibion

Olivier Coibion

Loungani: Congratulations on your selection as an IMF Fellow. Is this your first stint at a policy institution?

Coibion: Thanks, I’m thrilled to be here!  I worked for a year at the CEA [U.S. Council of Economic Advisers] in 2000-01. It gave me an enduring sense of how economic theory and empirical methods can help address policy questions and make a difference in people’s lives. And because I happened to be there during the transition from the Clinton to the Bush administration, it was fascinating to see the change in style and personalities—and in the dress code. The suits got much more sober and I even had to start wearing a tie once the Bush administration was in place.

Loungani: Dress is casual at the IMF over the summer. You see the suits out in full force in the fall. What will you work on during your year here?

Coibion: I’ll continue some of my work on inequality. One project will look at links between inequality and financial crises, which folks at the IMF have also studied. I’ve also been studying the impact of monetary policy on inequality—who gains, who loses when the Fed changes its policy. This gets debated in policy circles a lot but not much in academia. Ron Paul says that expansionary monetary policies, or debasing the currency as he always puts it, raises income inequality; people on the left like Jamie Galbraith say the opposite.

Loungani: What do you find?

Coibion: We find that expansionary monetary policy has typically reduced U.S. inequality in the short run. This suggests that when the central bank can’t cut interest rates any more—when rates hit the so-called ‘zero lower bound’, as is the case at present—inequality will be higher than it would be otherwise. To avoid these additional increases in inequality at a time of crisis, the government should use other tools, such as targeted fiscal policies. I hope to do some more work on this while I’m here. More generally, I’ll be studying how best to sequence fiscal and monetary policies when the multipliers—the impacts of the policies on the economy—associated with each may vary with the state of the economy.

Loungani: Do you think the Fed has done enough to promote recovery?

Coibion: I think the zero lower bound [on interest rates] has certainly limited the size of their response. They would be lowering rates further if they could.  But as the IMF’s latest review of the U.S. economy noted, the Fed still has a few options to further support economic activity, given the weak state of labor markets and given the significant downside risks that still exist.

Loungani: Do you think that to avoid hitting the zero lower bound in the future, central banks should raise the target rate of inflation?

Coibion: No, I don’t. A higher inflation rate also has economic costs. So raising the target inflation rate will confer the benefit that we’ll be less likely to hit the zero lower bound. But such episodes are rare. So the high benefits conferred on rare occasions have to be balanced against the small but frequent costs of having higher inflation. In some work I’ve done, it turns out that the costs consistently outweigh the benefits for inflation rates above 2%. So rather than raise the target rate of inflation to deal with future episodes like the Great Recession, I’d prefer the more aggressive use of temporary policies designed for precisely this kind of episode, such as additional quantitative easing or fiscal policy.

**

Olivier Coibion--Recent Publications:

    

• The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise their Inflation Targets in Light of the ZLB?” (with Yuriy Gorodnichenko and Johannes Wieland), forthcoming in  Review of Economic Studies. 

• “Why are target interest rate changes so persistent?” (with Yuriy Gorodnichenko), forthcoming in American Economic Journal: Macroeconomics. 

•  “What Can Survey Forecasts Tell Us About Informational Rigidities?” (with Yuriy Gorodnichenko), 2012, Journal of Political Economy 120(1), 116-159. 

• “One for Some or One for All? Taylor Rules and Interregional Heterogeneity” (with Daniel Goldstein), 2012, Journal of Money Credit and Banking 44(2:3), 401-432. 

• “Are the Effects of Monetary Policy Shocks Big or Small?” 2012, American Economic Journal: Macroeconomics 4(2), 1-32. 

• “Strategic Complementarity among Heterogeneous Price-Setters in an Estimated DSGE Model” (with Yuriy Gorodnichenko), 2011, The Review of Economics and Statistics 93(3), 920-940. 

• “Monetary Policy, Trend Inflation, and the Great Moderation: An Alternative Interpretation” (with Yuriy Gorodnichenko), 2011, The American Economic Review 101(1), 341-370. 

Is Long-Term Unemployment Pushing Up Structural Unemployment?

A new IMF report on US structural unemployment says that

while high long-term unemployment has not yet morphed into a permanent structural problem, it does pose an upward risk to the structural rate of unemployment. We have found that long-term unemployed are significantly less likely to find a job now than before the crisis, and that the loss in labor market matching efficiency observed since the recession is entirely due to a worsening of the labor matching of the long-term unemployed. Together, these results point to a risk that the structural rate of unemployment might be greater now than before the crisis.

Hence, forceful measures should be introduced that reduce long-term unemployment and address the risks associated with long spells of unemployment, namely skills erosion and a weaker attachment to the labor force. These measures include policies to increase demand for the long-term unemployed in the short run (active labor market policies, ALMP). When appropriately designed, such policies have been shown to be effective in improving employment and earnings prospects of long-term unemployed workers (Card et al, 2010; Card and Levine, 2000; Heinrich et al., 2008; Hotz et al., 2006). In particular, as discussed in the Staff report, a significant increase in ALMP resources is warranted given the persistently large pool of long-term unemployed and the risk that, as duration lengthens, their skills and attachment to the workforce might erode. Indeed, in terms of resources per long-term unemployed, the United States spends relatively little on active labor market policies, both compared to other OECD countries, and relative to its own pre-recession levels.

House Prices in the US

The IMF's 2012 annual report on the US economy says that "house prices have shown some firming recently, with a surprising increase in Q1 2012." It also highlights that

The authorities noted that the series of measures taken since last year to support the housing market were starting to bear fruit. These measures include in particular an expansion of the Home Affordable Refinancing Program (HARP) for loans owned or guaranteed by the GSEs, and a strengthening of the Home Affordable Modification Plan (HAMP), including loosened eligibility criteria through the elimination of debt service-to-income cutoffs, and the tripling of incentives for investors to carry out principal reductions under HAMP’s Principal Reduction Alternative (PRA) (Box 5). Recent data suggests that the October 2011expansion of HARP seems to have led to a significant increase in HARP refinancing. The share of loans that have benefited from a principal reduction under the modification program (Home Affordable Modification program of HAMP) has also been on the rise, and early signs show that the tripling of the incentives for principal reductions is receiving interest from investors, and is likely to spur further principal reductions in the future. The recent State Attorneys General Settlement with the major banks, which resolved claims about improper foreclosures and abuses in servicing the loans, could lead in the medium run to a non-trivial reduction in foreclosures, including through up to $34 billion of principal reduction. Early signs indicate that the settlement has led banks to delay foreclosures and also to increasingly substitute them with “short sales” of underwater properties, which are less costly and count toward the banks’ commitment for principal reduction under the settlement. The authorities highlighted that greater reliance on short sales, as opposed to foreclosures, could support the housing market going forward.

The mission welcomed this progress, but also noted that more aggressive policy action may be warranted to accelerate the resolution of the housing crisis. As noted in the Fed’s November 2011 white paper, housing markets do not self-correct efficiently and, absent forceful policies to support the market, prices could fall below their equilibrium levels due to feedback loops from prices to demand and supply. If house prices are anticipated to decline, potential buyers could stay out of the market even if interest rates are low. Moreover, a decline in prices reduces housing equity, triggering further defaults and foreclosures. Foreclosures, in turn, put renewed downward pressure on prices, not only by adding to the supply of houses for sale, but also because they lead to a destruction of value and impose “deadweight” losses on the economy, hurting consumer wealth and credit availability.

Successful Austerity in the United States, Europe and Japan

According to a new IMF working paper:

The large fiscal legacies of the global financial crisis have reignited the debate around the impact of fiscal policy onto economic activity during fiscal consolidations. The analysis in this paper shows that withdrawing fiscal stimuli too quickly in economies where output is already contracting can prolong their recessions without generating the expected fiscal saving. This is particularly true if the consolidation is centred around cuts to public expenditure—likely reflecting the fact that reductions in public spending have powerful effects on the consumption of financially-constrained agents in the economy—and if the size of the consolidation is large. Large consolidations make recessions more likely even when made at an expansion time. From a policy perspective this is especially relevant for periods of positive, though low growth. Accordingly, frontloading consolidations during a recession seems to aggravate the costs of fiscal adjustment in terms of output loss, while it seems to greatly delay the reduction in the debt-to-GDP ratio—which, in turn, can exacerbate market sentiment in a sovereign at times of low confidence, defying fiscal austerity efforts altogether. Again this is even truer in the case of consolidations based prominently on cuts to public spending. 

Thus, a gradual fiscal adjustment, with a balanced composition of cuts to expenditure and tax increases boosts the chances that the consolidation will successfully (and rapidly) translate into lower debt-to-GDP ratios. Monetary policy can likely help alleviate further the pain of fiscal withdrawal if it is used proactively via reduction in the real interest rate.

IMF Says Global Recovery Weak and Vulnerable; Depends on Resolving Euro Area Crisis

An already sluggish global recovery shows signs of further weakness, mainly because of continuing financial problems in Europe and slower-than-expected growth in emerging economies, the IMF said July 16 in a regular update to its World Economic Outlook.

How Vulnerable Is Sweden’s Housing Market?

According to the latest IMF's annual report on Sweden, the residential real estate cycle may have reached its long-predicted peak in Sweden. Housing starts halved over 2011 while the real prices dropped substantially in the second half of 2011 (-3.5 percent cumulatively) and remained flat in 2012 Q1 (q-o-q). The surge in late 2010 and early 2011, following the decline through 2008, appears to have been due to buyers taking advantage of the low interest rate environment and to the abolition of the real estate tax in 2008 in favor of a municipal tax set at the lower of SEK 6,825 (around 969 euros) or 0.75 percent of the property's assessed value. Indeed, in the two years to 2011 Q2, residential investment (+37 percent) took off again, contrary to more muted developments during the previous recovery, offsetting the sharp drop in new homebuilding experienced during the global crisis.

Going forward, several factors may indicate further downward pressure on house prices. First, price-to-income and price-to-rent ratios remain 1.1 and 1.4 standard deviations respectively above historical averages. Second, staff’s model-based estimates from the Early Warning Exercise (EWE) and Vulnerability Exercise for Advanced Countries (VEA) suggest an overvaluation around 11–12 percent, exceeding the 10 percent threshold. (The EWE real estate model combines these three indicators to create a heat map for house price valuation.) Moreover, the predicted path of house prices based on WEO income projections suggests a decline of almost 5-6 percent through 2017.

These indicators put Sweden among the advanced countries where a house price correction is most likely to take place. Yet, the point estimate for the house price disequilibrium (the difference between actual prices and estimated equilibrium or long-run prices) is not large by historical standards, and Sweden ranks only 9th among 22 advanced economies in the VEA sample in terms of potential overvaluation. Furthermore, other components of residential real estate vulnerability (namely, potential impact on GDP, household balance sheets, and mortgage market characteristics) remain moderate or low in Sweden, compared to other advanced economies. That said, with most mortgages being “rollover” mortgages with terms of at most five years, any future interest rate increases could put additional strains on already highly indebted households.

2011: “Anything but a boring year” in the energy market

The energy market in 2011 was characterized by disruptions and continuity. Political unrest and violence caused outages in oil and gas production in parts of the Arab world. On the other hand, the world economy benefited from an exceptional swing in European weather, the first release of strategic petroleum reserves since 2005 and an increase in OPEC production.

Christof Rühl, Group Chief Economist of BP spoke to the Fund staff on June 14.

Photo: Michael Spilotro/IMF

Last year, the Arab Spring caused significant interruption in the production and supply of oil. For example, the cessation of Libyan oil exports alone removed 1.2 millions of barrels per day of crude oil for the year. Moreover, in April, the earthquake in Japan damaged the Fukushima nuclear reactor which led to closures of nuclear plants in Japan and Europe. This resulted in losses of 43 millions of tons of oil equivalent, which is more than 11 percent of the European oil consumption. In 2011, average annual Brent prices increased by 40% to reach $111 per barrel. On a related note, huge floods in Australia impaired coal production.

So, with all the chaos, how did the energy market remain resilient? There was the first release of strategic petroleum reserves since 2005. There was a petroleum sale of 30 million barrels non emergency to offset disruptions caused by political upheaval in Libya and elsewhere in the Middle East. The amount was matched by IEA countries for a total of 60 million barrels released from stockpiles around the world. Also, there was the largest increase in OPEC production since 2008 and a mild winter in Europe.

In 2011, energy consumption stayed steady in Non-OECD countries, while it declined in OECD countries. Non-OECD energy consumption stayed firm, in contrast, OECD energy consumption fell by 0.8 percent, despite average GDP growth. Energy consumption in OECD countries has declined in three out of the last four years. Why last year? First, the impact of high oil prices everywhere and of high coal and gas prices outside the US. Second, the decline was due to the impact of Fukushima nuclear disaster. And third, Europe experienced a mild winter in 2011 compared to 2010.

What was the impact of high oil prices on oil importers? The overall effect of how high oil prices affect oil importers depends on how oil exporters use the additional income generated by higher prices. This extra income can be recycled in two ways – they can spend it to purchase goods and services from oil importing countries, this will offset the high import bill in oil consuming countries or they can spend it by purchasing foreign assets which increase the global supply of savings leading to low interest rates and low borrowing costs around the world. But, with interest rates close to zero, this option loses its meaning.

Photo: Michael Spilotro/IMF

Photo: Michael Spilotro/IMF

Photo: Michael Spilotro/IMF

Unemployment: Cyclical or Structural?

Eric Swanson reports on the San Francisco Fed macro conference:

“Breaking down changes in output or employment into structural and cyclical components is very difficult, since these elements are not directly observable. Two papers at the conference applied cutting-edge methods to this question, providing estimates of the structural and cyclical components of the 2007–09 recession’s large employment and output declines.

Chen, Kannan, Loungani, and Trehan use differences in stock market returns across industries to help identify the magnitudes of cyclical and structural shocks to the economy … Chen and coauthors collected cross-industry stock return data from 1962 to 2011, which they use to construct an index of stock return dispersion across industries. The authors then estimate the typical response of output and employment to sudden changes in this index, providing an approximation to the effects of structural shifts on the economy. The authors find that such structural shifts account for about 25% of U.S. output and employment fluctuations since 1962. The remaining 75% is due to cyclical factors.”

Read the rest of Swanson’s excellent summary here. The Chen, Kannan, Loungani and Trehan paper is available here.

Five Reasons for Global Resilience to Oil Price Rises

IMF Analyst Sees Global Slowdown Biggest Oil Worry

By John M. Biers

A big drop in oil prices due to a global economic slowdown constitutes a bigger worry than the relatively high price floor for oil that has prevailed recently period, an International Monetary Fund analyst said in an interview this week.

Oil prices have dropped roughly 20% in recent weeks amid weak jobs data and other economic indicators that have renewed fears of a global slowdown, yet remain high by historical standards, lingering around or above $100 a barrel Brent since January 2011.

In remarks that provided a view of how the IMF sees the oil market, Prakash Loungani said the global economy has adapted to a relatively high oil price floor as long as it isn't caused by an unexpected supply disruption. But Mr. Loungani said the agency now fears a big drop in prices because it would likely be accompanied by a major global economic slowdown.

"The worry is that the economies are looking soft, both the U.S. and major emerging economies," said Mr. Loungani, an advisor in the research department of the IMF who handles commodities research.

"We are very worried about the state of the world economy," Mr. Loungani said in a telephone interview.

Thursday, ICE July North Sea Brent crude was 1.2%, or $1.23, higher at $101.87 a barrel. Light, sweet crude oil for July delivery was up 1.6%, or $1.34 higher, at $86.38 a barrel on the New York Mercantile Exchange.

Mr. Loungani said a relatively high oil price isn't in itself a huge concern for the economy. The influential Saudi oil minister, Ali al-Naimi, said recently he wants oil prices around $100 a barrel. Other countries in the Organization of Petroleum Exporting Countries now also look for triple-digit oil prices, leaving the $22-$28 a barrel price band once favored by the cartel as a distant memory.

Mr. Loungani pointed to IMF research that has shown how the world has adapted to relatively high oil prices due to a number of factors. For one, much of the reason for higher oil prices rests on rising demand in emerging economies; in that case, the benefits of strong growth outweigh the negatives of higher oil prices.

Other mitigating factors to high prices include more sophisticated central bank policies that guard against oil-related inflation growth; greater efficiency in the use of energy in the economy; and greater diversification in energy supplies.

"The trends are in the direction of reduced impact" on the economy from higher oil prices, Mr. Loungani said. "The structure of the economy has adjusted."

However, Mr. Loungani said the global economy can still be harmed by sudden price spikes if they are caused by unexpected supply disruptions, because "the economy still doesn't have the means to handle that in the short-term."

Some economists have highlighted the role that higher oil prices played in the global 2007-2008 slowdown related to lower disposable income. At the time, the dominant explanation for the slowdown concerned the bursting of the U.S. housing bubble and the ensuing financial crisis.

Mr. Loungani said he has been persuaded that "oil prices may have played a role" in that slowdown, but he said the current weakness relates more to lingering financial weakness and the ongoing euro zone crisis.

Write to John Biers at john.biers@dowjones.com