Economy no longer as exposed to house price shock, ESRI says

The wider economy is not as exposed to swings in the housing market as it was when the financial crisis hit in 2008, according to a new paper from two Economic and Social Research Institute researchers.The massive swings in the housing market had a wider impact on employment and growth between 2007 and 2012, the researchers find, as the bubble inflated and then burst.

However, their work finds no link between economic activity and housing net worth in recent years, which may reflect new controls put on borrowing after the financial crisis by the Central Bank.

This means that household finances and thus the wider economy would be less exposed if the housing market was to go into reverse over the next few years.

ESRI researchers David Cronin and Kieran McQuinn look at the period leading up to the financial crash in 2008 and its immediate aftermath to 2012. They point out that credit was inflated in the run-up to the crash by loose lending policies. This led to major financial difficulties for many households as house prices collapsed.

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The net housing wealth of households can feed through to the wider economy via its impact on household finance and confidence and the researchers find a link from this to the wider performance of the economy during the period, measured by its impact on employment.

However the paper – House Prices and the Credit-Driven Household Demand Channel: the Case of the Irish Economy – which is published in the Credit and Capital Markets journal, says the link appeared to have been broken in recent years.

Bank lending policies have become more prudent, constrained by Central Bank rules. Household finances are less exposed and the research finds “ no evidence of a link” between economic activity and housing net worth driven by credit in more recent years.

“This may reflect market and regulatory responses to the banking crisis-led recession of the late 2000s and early 2010s,” the paper says.

With new uncertainties created by the pandemic, the researchers point out that Irish household balance sheets do not have the exposure they had heading into the financial crisis.

Also when the Covid crisis hit, they calculate that house prices were not out of line with economic fundamentals. They conclude that, while house prices could be affected by any post-pandemic downturn, the dire economic loop which emerged from the hit to household balance sheets after 2008 would be unlikely to recur.