Central Bank Quarterly Bulletin 3 2020

Guest post by Stephen Byrne, Central Bank of Ireland

Today the Bank published its third Quarterly Bulletin of the year. The report contains a detailed overview of developments in the economy since the publication of last Bulletin in early April as well as our latest macroeconomic forecasts out to 2022.

Given the scale of uncertainty surrounding the economic impact of Covid-19, two different scenarios for the economic outlook are outlined in the Bulletin (see featured image above).

In the “baseline” scenario, the economy reopens in line with the Government’s phased plan, allowing for a rebound in economic activity in the second half of the year. Some containment measures would remain in place meaning that activity would be constrained in some sectors for a longer period. Beyond the initial rebound, recovery is expected to be gradual, in line with a slow unwinding of precautionary behaviour as the effects of the shock on consumers and businesses lingers. The unemployment rate is set to decline from its second quarter peak of about 25 per cent as the year progresses and is projected be around half that level by the end of this year, before averaging just over 9 per cent next year and 7 per cent in 2022.

The baseline scenario sees output recovering to its pre-crisis level by 2022. However, the level of activity will be significantly below where it would have been had the economy grown in line with expectations before the outbreak of the pandemic.

In the “severe” scenario, the strict lockdown period is assumed to have a more damaging impact on economic activity and is not successful in effectively containing the virus. Stringent containment measures would remain in place, or would be re-instated, albeit not as severe as before, based on an assumption that there would be a resurgence of the virus at some point over the next year. In this scenario, there is a subdued economic recovery with a larger permanent loss of output. Unemployment remains higher for longer in this scenario and would average just below 17 per cent in 2020, while consumer spending is projected to fall by around 14 per cent and GDP by over 13 per cent this year. In this scenario, the projected recovery in growth in 2021 and 2022 would not offset the loss of output this year, leaving the level of GDP in 2022 about 5 per cent below its pre-crisis level.

Both of these scenarios assume that a Free trade agreement in goods between the UK and the EU, with no tariffs and quotas on goods, takes effect in January 2021. If such an agreement is not reached, then the EU and the UK would move to trading on WTO terms from January 2021. Box D of the Bulletin discusses the implications of such an outcome.

The bulletin also contains analysis of the impact of Covid-19 on debt dynamics and sustainability, as well as a detailed examination of the regional labour market impacts of the pandemic.

Finally, an accompanying signed article explores alternative long-term recovery paths for the economy and assesses the impact of fiscal and monetary policy supports. The Article considers how hysteresis – or scarring ­­– effects could influence the pace and nature of the recovery. The paper shows that, as a highly open economy, Ireland benefits from the positive effects of monetary and fiscal policy measures implemented abroad. The assessment of the combined effects of domestic and international policy supports indicates that the actions will help to meaningfully reduce the scale of the output loss in Ireland from the pandemic.

Updates from the CSO

Composition Effects and Loan-to-Value Limits

The Irish Central Bank is scheduled to introduce new macro-prudential risk controls on Irish mortgage lending, with the new regulations taking effect on January 1st or soon thereafter. One of the regulations will limit most new mortgages to an initial loan-to-value ratio of 80% or less. There has been considerable discussion of the effect of loan-to-value limits on potential property purchasers, but the analysis has been very poorly framed.

The budgeting scenario has been described as follows:

“Consider a couple who wish to purchase a €300,000 property. With a LTV limit of 80% this will require that they save €60,000 for the down payment whereas if they were allowed to borrow 85% they would only need savings of €45,000.”

This oft-repeated budgeting scenario misrepresents the nature of market-wide LTV limits imposed by the Central Bank. This budgeting scenario gives the impression that the policy decision is about imposing/not imposing the LTV constraint on only one particular buyer rather than market-wide. It misses the large compositional effects since leveraged property buyers compete with one another for properties. The degree of leverage allowed in the banking system feeds into property prices, and this affects the opportunity set of purchasers.

Doublespeak of the day

According to the Irish Independent, Minister Noonan was worrying in public last night about the shortage of family homes in the Dublin area. But he also apparently said:

“We need to get property prices up another bit.”

To which the only possible response is: “why”?

If you are stuck in a malfunctioning currency union and can’t devalue, then don’t you want to get all costs down as much as possible, especially if they are going to feed into wage demands? Why interfere with the market in this particular case?

House prices: bubbles versus booms

The end of one quarter and the start of another sees the usual slew of economic reports and the start of Q4 is no exception. Today sees the launch of the Q3 Daft.ie Report. In line with other reports in the last week or so, and indeed with the last few Daft.ie Reports, there is evidence of strong price rises in certain Dublin segments. What is new this quarter is the clarity of the divide between Dublin and elsewhere: all six Dublin regions analysed show year-on-year gains in asking prices (from 1.4% in North County Dublin to 12.7% in South County Dublin), while every other region analysed (29 in total) continues to show year-on-year falls (from 3.1% in Galway city to 19.5% in Laois).

The substantial increases in South Dublin over the last 12 months have led to talk of “yet another bubble” emerging, with internet forums awash with sentiment such as “Not again!” and “Will we never learn?”. To me, this is largely misplaced, mistaking a house price boom for a house price bubble. Let me explain.

Firstly, I should state that, unlike “recession” which is taken to mean two consecutive quarters of negative growth, there is no agreement among economists on what exactly constitutes a bubble, in house prices or in other assets, but the general rule is that prices have to detach from “fundamentals”. For example, the Congressional Budget Office defines an asset bubble as an economic development where the price of an asset class “rises to a level that appears to be unsustainable and well above the assets’ value as determined by economic fundamentals”. Charles Kindleberger wrote the book on bubbles and his take on it is that almost always credit is at the heart of bubbles: it’s hard for prices to detach from fundamentals if people only have their current income to squander. If you give them access to their future income also, through credit, that’s when prices can really detach.