THE Government must not intervene to prevent house prices falling further to more sustainable levels and instead should have acted years ago to dampen house prices, according to a report form the Brussels-based think-tank, Bruegel.
It warns that the slowing housing market will subtract four percentage points from the country’s GDP growth this year and remain a drag on growth for several years.
The organisation, which specialises in international economics, says the housing boom and bust in Ireland and Spain holds lessons for the fast growing economies of new EU member states.
It says that since governments in the euro zone cannot change interest rates in response to overheating housing and credit markets, they must learn to use other mechanisms, such as tax.
Bruegel suggests that mortgage interest relief should have been eliminated and capital gains tax introduced on the sale of primary residences to dampen the boom that began in 1996.
The analysis of the Irish market by Dr Alan Ahearne of NUI Galway for Bruegel shows that mortgage rates in Ireland were zero or negative between 1999 and 2005 because inflation was much higher than in the rest of the euro zone.
This coincided with greater competition between banks offering attractive mortgage packages such as 100% loans and interest only loans. Such competition led to what the report described as “irrational exuberance” in the Irish housing market that saw major investment in housing resulting in a tripling of house prices in Ireland compared to the rest of the euro zone which increased by just 50%.
There were signs of overheating from 2002, claims the report, and the immigration of workers into the country had an impact on demand. Figures show, however, that the prices being paid for houses was not justified by the rents people were being paid. So, the study concludes, people were investing in housing as they expected to sell at a profit due to rising prices.
Now that the housing boom has burst, Ireland is again out of synch with most of Europe, with the drop in house construction depressing growth, while Germany’s economy is growing robustly.
The Government should now support non-housing parts of the economy, such as infrastructure, and provide incentives for insulation of homes to help the construction industry.
It says that some building firms will collapse and warns that the Government should not intervene like in Spain, where the state has ordered big social housing projects.
Other economies, such as those of new EU member states, can expect similar rapid growth as their economies reach EU averages. But the lessons from the Irish experiences are that governments must intervene early with tax measures to cool overheating.
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