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Housing bubbles are a well-known source of financial instability. In addition, given the importance of this sector to the economy, the collapse of such bubbles tends to be followed by deeper recessions and slower recoveries than other crises, as the recent boom-bust housing cycles in many countries have clearly demonstrated.
In the European Union, the policy instruments available to address this and to prevent future housing bubbles are implemented either at the national level (macroprudential policies) or at the euro-area level (monetary policy). However, recent research suggests that house price developments and bubbles are above all a local phenomenon.
There are significant regional differences in house price developments within EU countries, in particular between capital cities and other regions. Our results suggest that house price fluctuations in capital cities tend to be more volatile and stronger than in the rest of the countries, warranting more targeted measures at the local level.
The authors propose to use differentiated macroprudential policy at the regional level. This could be done with the application of different loan-to-value (LTV) or debt-to-income (DTI) limits for mortgages in capital cities and in the rest of the countries, in order to tighten policy more quickly in areas more prone to overheating. This type of policy has already been successfully applied in Korea. Competent authorities in the EU should consider adding this instrument to their toolkits in order to increase the precision, and therefore the effectiveness, of their policies.