Macroeconomic effects of reducing household debtarchive.riksbank.se/Documents/Rapporter/POV/2016/... · Daria Finocchiaro, Magnus Jonsson, Christian Nilsson and Ingvar Strid* The

S v e r i g e S r i k S b a n k e c o n o m i c r e v i e w 2016:2 57

* WethankClaesBerg,JensIversen,GoranKatinic,JessicaRadeschnig,CarolineRichardsandAndersVredinfortheirvaluablediscussionsandinput.TheviewsexpressedinthispaperrepresentourownperceptionandcannotbeassumedtoexpresstheRiksbank’sview.

MacroeconomiceffectsofreducinghouseholddebtDariaFinocchiaro,MagnusJonsson,ChristianNilssonandIngvarStrid*TheauthorsworkintheMonetaryPolicyDepartmentoftheRiksbank

The Riksbank has for a long time emphasised that rising household debt is a concern for financial stability that needs to be addressed. Tighter macroprudential measures or tighter mortgage interest deduction are two alternative ways of tackling this problem. In this article, we study how these two approaches would affect different households using a macroeconomic model. We show that, contrary to what is often argued in the public debate, a tightening of the loan-to-value cap, the loan-to-income cap and the amortisation requirements would lead to a redistribution of resources from lenders to borrowers in the long-run. Moreover, tighter mortgage interest deduction affects households in different ways, depending on how the Government chooses to use the released budgetary resources. If borrowers are compensated, this policy could have positive effects for their consumption other than housing. We also analyse the implications for monetary policy of different measures to dampen household debt and show that the extent of mobility on the housing market plays an important role. In some cases, monetary policy might need to be more expansionary, and in other cases more contractionary. Finally, we study how household debt affects the transmission mechanism of monetary policy on inflation. The higher the indebtedness, the greater the effects of a rate hike on the interest expense and disposable income of borrowers. The effects of a rate hike on demand – and hence on inflation – are therefore greater today than when the inflation target was introduced in the mid-1990s.

58 M a c r o e c o n o M i c e f f e c t s o f r e d u c i n g h o u s e h o l d d e b t

1Whyisitimportanttodampenhouseholddebt?Inthepast20years,householddebthasrapidlyincreasedinSweden.Overtheperiod1995-2015,householddebtinrelationtodisposableincome–theloan-to-incomeratio–increasedfromaround90percenttocloseto180percent,seeFigure1a.Whenonlytakingintoaccounthouseholdswithmortgages,theloan-to-incomeratioiscurrentlyevenhigher,ataround320percent.Swedishhouseholddebtisnotjusthighinahistoricalperspective,butalsoinaninternationalcomparison.Theloan-to-incomeratioofSwedishhouseholdsisamongthehighestintheOECDcountries,seeFigure1b.

Theincreaseinindebtednesshasbeencoupledwithincreasinghouseprices,seeFigure2a.Inthepast20years,priceshavealmostquadrupled.Severalfactorscouldexplainsuchanincrease.Forexample,relativelyfewhomeshavebeenbuiltinthepastfewdecades;moreover,thehomesthatdoexistareperhapsnotbeingusedefficientlyduetorentalmarketregulations.1Butthepricesmightalsohavebeenpushedupbytheincreaseinhouseholds’disposableincome,whileinterestrateshavebeenlowatthesametime.Theinterest-to-incomeratioofhouseholds–theirinterestexpenseinrelationtotheirdisposableincome–iscurrentlyatitslowestlevelinaround40years,seeFigure2b.

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Therearenumerouscross-countryexamplesshowingthatifhouseholddebtincreasesrapidlytogetherwithrisesinhouseprices,vulnerabilityinthefinancialsystem,i.e.theriskofafinancialcrisis,increases.Inmanyofthecountrieshithardestbytheglobalfinancialcrisisof2008-2009,thecrisiswasprecededbyrapidlyincreasingdebtsandhouseprices.Moreover,thepost-crisisslumpriskstobedeeperandmoreprotractedifdebtshavebeenrisingrapidlypriortothecrisis.2

Themostrecentglobalfinancialcrisishasalsotaughtusthattomonitorindividualfinancialinstitutions,i.e.microprudentialpolicy,isnotenough;thefunctionalcapacityofthefinancialsystemasawhole,i.e.itsexposuretosystemicrisk,mustalsobetakenintoaccount.Thisso-calledmacroprudentialpolicyisarelativelynewpolicyareathatcameintofocusafterthefinancialcrisistoaddresssystemicriskconcerns.Thepurposeofmacroprudentialpolicyisbothtomaintaintheresilienceofthefinancialsystem,andtocounteractrisks.

TheEuropeanSystemicRiskBoard,ESRB,issuesrecommendationsregardingmacroprudentialtargetsandspecificmeasuresinSwedenandotherEUcountries.AccordingtoESRB,anintermediatetargetofmacroprudentialpolicyistoavoidexcessivelyrapidcreditexpansionandhighloan-to-incomeratios.3Inline

2 SeeEmanuelssonetal.(2015)foranoverviewofempiricalstudiesoffinancialriskslinkedtohouseholdindebtedness.3 Theothertargetspertaintodifferencesinmaturitiesbetweenliabilitiesandassets,concentratedexposuresandmisguidedincentivesforlargeinstitutionslinkedtotheimplicitorexplicitpublicguarantees.


withthis,theRiksbankhaslongbeenemphasisingthatrisinghouseholddebtisproblematic,andthattheassociatedrisksneedtobeaddressed.Potentialmeasuresmentionedinthepolicydebatetodealwiththeserisksincludetighteningtheloan-to-valuecap,introducingaloan-to-incomecap,introducinganamortisationrequirement,ortighteningthemortgageinterestdeduction,i.e.reducingthetaxreliefonmortgageinterest.4

Thefirstthreemeasuresareexamplesofmacroprudentialtoolsthatmightbeexpectedtodampenhouseholddemandforcredit.Theloan-to-valuecaplimitsthesizeofthemortgagethatmaybegrantedtoahouseholdinrelationtohowmuchthehomeisworth.Itthereforehasadirectimpactonhowmuchdebtahouseholdmaytake.Aloan-to-incomecapalsolimitsthesizeoftheloan,butinrelationtotheborrower’sincomeratherthanthevalueofthehome.Theamortisationrequirementpotentiallyrestrictsthepossibilitiesofhouseholdstotakeoutloans.Inparticular,itposesalimitationforhouseholdsthatmeetthedownpaymentrequirements,butwhichmighthavedifficultyinsavingfurtheramountsinthefirstcoupleofyearsofthedurationoftheloan.

Thetaxreliefonmortgageinterestisafiscalpolicymeasure.Indebtedhouseholdscancurrentlydeduct30percentoftheirinterestexpensefromtheirtotaltax,uptoSEK100,000.Thismortgagesubsidyincentiviseshouseholdstotakeoutlargermortgagesthantheywouldhavedonewithoutthetaxrelief.Ifthetaxreliefonmortgageinterestwerereduced,itisthereforeprobablethathouseholds’demandformortgageswoulddecrease,anditwouldthusbeaneffectivemeasureforcurbingthebuild-upofdebt.

2SummaryofourfindingsInthisarticlewestudyhowdifferenthouseholdsareaffectedandwhatthemacroeconomicconsequenceswouldbefromtighteningtheloan-to-valuecap,theloan-to-incomecapandtheamortisationrequirements,andreducingthetaxreliefonmortgageinterest.Inourpolicyexperiments,weuseamacroeconomicmodelfittedtoSwedishdata.

Wefindthatallthemacroprudentialmeasuresconsideredinourstudycurtailindebtednessintheeconomyovertime;thisinturnbringsaboutareductioninboththeinterestexpenseofborrowersandtheinterestincomeoflenders.Thesemeasuresleadtoaredistributionofresourcesfromdebt-freetoindebtedhouseholds,i.e.fromlenderstoborrowers.Lenderswillreducetheirconsumptionofgoods,housingservicesandleisure,sincetheirinterestincomewillbelower.Ontheotherhand,borrowerscanincreaseconsumptionofgoodsandleisure.

4 Seee.g.SverigesRiksbank(2014,2015and2016).


Whetherornottheyalsoincreasetheirconsumptionofhousingservicesdependsonwhichmeasureisundertaken.Atighterloan-to-valuecapwillforceborrowerstocutbackontheirconsumptionofhousingservices.While,iftheamortisationrequirementandloan-to-incomecaparetightened,borrowerswillalsoconsumemorehousingservices.

Areductioninthetaxreliefonmortgageinterestleadsinthelong-runtoaredistributionoftheconsumptionofhousingservicesfromborrowerstolenders.However,iftheGovernmentusesthereleasedbudgetaryresourcestocompensateborrowers,theycanincreasetheirconsumptionofgoodsandleisure.

Thetighteningofvariousmacroprudentialmeasuresandthereductionofthetaxreliefonmortgageinterestcanalsohaveshort-termeffectsondemandandinflation.Thecentralbankmayneedtoconsiderthiswhensettingthepolicyrate.Howmonetarypolicyreactstolowerhouseholddebtdependsbothonthemeasureunderlyingthereduction,andonresidentialmobility.Ifmobilityinthehousingmarketisrelativelylow,householdswillcutbackonnon-durablesconsumption,therebydampeningdemandandhenceinflation.Insuchascenario,monetarypolicymayneedtobemoreexpansionary.If,however,themobilityinthehousingmarketisrelativelyhigh,monetarypolicymayinsteadneedtobetighter.

Wealsostudyhowthelevelofhouseholddebtaffectstheimpactofmonetarypolicyoninflationandhouseholdconsumption.Ahighdegreeofindebtednessmakesborrowersmoresensitivetochangesininterestrates.Thehighertheindebtedness,thegreatertheeffectof,forinstance,aratehikeonborrowers’interestexpenseanddisposableincome,whichinturnreducestheirscopeforconsumption.Thismeansthattheeffectondemand,andhenceoninflation,fromanincreasetothepolicyratewouldbehighertodaythanpreviously.Specifically,aratehikeatthecurrentlevelofindebtednessreducesborrowers’consumptionmuchmorethanitwouldhavedonehadindebtednessbeenatthesamelevelaswhentheinflationtargetwasintroducedinthemid-1990s.Theeffectoninflationfromthisratehikeisthusalsogreatertodaythaninthemid-1990s.

Thepaperisstructuredasfollows.Inthenextsection,wepresentthemacro-economicmodelusedinourpolicyexperiments,andinthesectionafterthatwedescribehowthemodelhasbeenfittedtoSwedishdata.Followingthatisasectionshowingthelong-termmacroeconomiceffectsofthealternativemeasures.Wethendiscusstheshort-termeffectsofdeleveragingoninflationandthepolicyrate,andhowthepotencyofmonetarypolicyisaffectedbythelevelofhouseholddebt.Finally,wecompareourfindingswithotherstudiesonhouseholddebt.


3TheeconomicenvironmentThissectionpresentsthemacroeconomicmodelweuseinourpolicyexperiments.5Figure3illustratesthestructureofthemodel.Theeconomyispopulatedbyhouseholds,corporations,banks,acentralbankandafiscalauthority.Forthesakeofsimplicity,wedisregardforeigntradeandcross-borderfinancialflowsintheanalysis.

Thehousingmarketisanimportantpartofthemodelsincethemeasureswestudyhaveadirecteffectonthehouseholds'demandforhousing.Asimplifyingassumptionisthathousingisinfixedsupply.Householdsbuyandsellhousingservicestoamarketdeterminedprice.6Furthermore,itisassumedthatthereareonlytwocategoriesofhouseholds–“lenders”and“borrowers”,whodifferinthewaytheydiscountfutureconsumption.Lenderssaveinbankaccountsandfinancetheirhousinginvestmentswithoutamortgage.Ontheotherhand,borrowersfinanceprimarilytheirhousinginvestmentswithbankloans.Inadditiontothesetwocategoriesofhouseholds,therearealso“entrepreneurs”whotakeoutbankloanstofinancetheirinvestments.

Bankshavetwosourcesoffunding,equityandhouseholds’depositandcanuseadepositfacilityatthecentralbank.Theinterbankrateisthusaffectedbythepolicyratesetbythecentralbank.Itisassumedthatdifferentbankscanofferslightlydifferentiatedfinancialproduct,i.e.theyoperateunder“monopolisticcompetition”.Thedegreeoftheirmonopolypowerdeterminesovertimethespreadsbetweenthecentralbank’spolicyrateandthebanks’ratesforhouseholdsandcorporations.Intheshort-term,thesespreadswillalsobeaffectedbythefactthatbanksaresubjecttoadjustmentcostswhenchangingtheinterestrates.Householdpreferencesaredescribedbyautilityfunction,whichdependsontheirconsumptionofgoods,housingservicesandleisure.Bothcategoriesofhouseholdsareforward-looking,buttheyattachdifferentweightstotheirexpectedfutureutility.Thelendersareassumedtobemore“patient”andcaremoreaboutfutureconsumptionthanborrowersdo;thisleadsthelenderstosavemore.

5 ThemodelisbasedonGeralietal.(2010),whichprovidesamoredetaileddescription.However,wehavemodifiedtheirmodelonsomekeypoints,inordertostudytheeffectsofamortisationrequirements,aloan-to-incomecapandreducedtaxreliefonmortgageinterest.SeeFinocchiaroetal.(2016).6 Therearethereforenorentedhomesinthismodel.“Goods”referstoanaggregateofnon-durableconsumergoodsandservicesotherthanhousingservices.


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Thelenderschoosehowmuchtheywillwork,spendonconsumergoodsandhousinginvestments,andhowmuchtheywilldepositinthebanktomaximiseutility.Theirdisposableincomeconsistsofwageincome,interestontheirsavingsandtransfersortaxesfromthepublicsector,aswellasdividendsfromcompanies.Borrowersaresubjecttosimilarbudgetrestrictionsbuttheycanalsofinancetheirhousingwithmortgages.Inouranalysis,weareparticularlyinterestedinwhichtermsandconditions,besidesthelendingratelevel,applyforhouseholdstobegrantedtheseloans.

Householdscanincreaseorreducetheirhousingholdingsbybuyingorsellingonthehousingmarket.ThehousesdepreciateovertimeatarateofδH so the household’shousingholdingatacertainpointintimet, Ht ,isdeterminedbyundepreciatedhousing(1−δH) Ht−1andnewhousinginvestmentsIt ,

(1) Ht = (1−δH) Ht−1+ It.

Notethatwecanbreakdownthehousinginvestmentsofthehouseholdintodepreciationsoftheexistinghomesandchangesinthehousingstock.Inthelong-run,totalhousinginvestmentsconsistofreplacementinvestments,δH H̅ ,whereH̅istheconstantvolumeofhouses.7Thetotalvolumeofhousesisinfixedsupply.Thisimpliesthatif,forexample,theborrowersbuymorehousingservicesthelendersmustconsumeless.

Themodelcanbeusedtostudytheeffectsofchangesinboththeloan-to-valuecapandintheloan-to-incomecap.Theloanrestrictionfortheborrowinghouseholdsdiffersinthesetwocases.Whenborrowingisconstrainedbyaloan-

7 Adashoveravariabledenotesthatitisalong-termvalue.


to-valuecap,newloansofhouseholds,N,maynotbegreaterthantheshareμofthenominalvalueofhousinginvestments,

(2) Nt≤μQtIt,

whereQisthenominalhouseprice.8Aggregatehouseholddebt,B,isaffectedbyhouseholds’amortisationoftheexistingdebtρBwheretheparameterρ istherateofamortisation.9Hence,indebtednessprogressesaccordingtothefollowingrelationshipovertime,

(3) Bt =(1−ρ)Bt−1+ Nt =(1−ρ)Bt−1+ μQtIt.

Inthesecondcase,borrowingislimitedbyaloan-to-incomecap.Inthatcase,newloansmayatmostbeashareσofwageincome,

(4) Nt≤σWt Lt,

whereWisthenominalhourlywagerateandLarethehoursworkedbytheborrowinghousehold.10Inthiscasetoo,thehouseholdsareassumedtoamortisetheloansattherateofρ.Householddebtthusprogressesaccordingto

(5) Bt =(1−ρ)Bt−1+ Nt =(1−ρ)Bt−1+ σWt Lt.

Thebudgetconstraintoftheborrowersisasfollows:

(6) Pt Ct + Qt It+(ρ + RHt−1)Bt−1 + Tt + At = Wt Lt + Nt + ωRH RH

t−1Bt−1.

Thelefthandsideshowsexpenditure,whichbesidespurchasesofconsumergoodsCatthepricePandhousinginvestmentsQIalsoconsistofamortisationρB andinterestpayments,RHBonthemortgage.11Thehouseholdsalsopaylump-sum

8 Theloanrestrictioninequation(2)thuslimitsthehousehold’snewloansinrelationtothevalueofhousinginvestments,whichisanapproachproposedbyKydlandetal.(2016).Analternativeformulationoftheloanrestrictionisthattheloanstockofhouseholdsislimitedby(theexpected)valueofthehousingstockasine.g.Iacoviello(2005).Thisentailshoweverthatallloansareshort(oneperiod)andthattheaggregateloanstockofhouseholdsisdirectlyaffectedbythedevelopmentofhouseprices.9 The“impatience”oftheborrowersisconsideredtobesogreatthattheyalwaysborrowuptothelimit,i.e.therestrictioninequation(2)isalwaysbinding.Thesameassumptionismadefortherestrictioninequation(4).10 ThefactthatthenewloansNarelimitedbyincomefromsalaryalsoimpliesthattotalloans,B,arelimited.Inthemodelcalibration,theparameterσissetsothatthetotaldebtsoftheborrowinghouseholdsinrelationtoannualincome,σ / 4ρ,hasareasonablevalue,seemorebelow.11 Allinterestratesinthemodelarefloating(oneperiod),sothehouseholdspaythesameinterestrateirrespectiveofwhentheloanwasgranted.


taxesTandadjustmentcostsAthatarisewhenhouseholdschangetheirhousinginvestments.12Thesecostsaimatcapturing,inasimplifiedway,theeffectsofvariousfactorsthataffectmobilityonthehousingmarket.Therighthandsideofthebudgetconstraintshowstheresourcesavailabletofinanceexpenditures.BesideslabourincomeWLtheresourcesconsistofnewbankloansN(whicharelimitedbyequation(2)orequation(4))andofgovernmentsubsidiesofthehouseholds’mortgageexpensesωRH RH B.ThedegreeofthesubsidyisgivenbyωRH.Anotherwayofreducinghouseholddebt–besideslimitingtheloan-to-valueratioμand/ortheloan-to-incomeratioσorimposingdemandsforahigheramortisationrateρ–isthustoreducethissubsidy.

Inordertofinancepublicconsumptionandmortgageinterestsubsidies,thepublicsectorbalancesitsbudgetbylevyinglump-sumtaxesfromthehouseholds,andataxonthedividendsthatthelendersreceivefromthecorporatesector.GovernmentconsumptionisassumedtomakeupaconstantshareofGDP,whilethelump-sumtaxisdistributedbetweenthelendersandtheborrowersinrelationtotheirsharesofthetotalwagesum.

TheobjectiveofmonetarypolicyinSwedenistomaintainpricestability,whileatthesametimemonetarypolicyshallcontributetosustainablegrowthandahighlevelofemployment.Inthemodel,itisassumedthatthecentralbankcanadjustitspolicyrateRtostabilisebothinflationπandGDPgrowthΔYintheeconomy. InflationisdefinedastheannualpercentagechangeinthepriceoftheconsumergoodsP.Morespecifically,thepolicyrateevolvesaccordingto,

(7) Rt=φRRt−1+(1−φR)[R̅+φπ(πt−π̅ )+φY ∆Yt ] + εt,

whereR̅isthelong-termlevelofthepolicyrate,π̅isthelong-termleveloftheinflationrate(whichcoincideswiththecentralbank’sinflationtarget)andε adisturbancetermthatweusetocapturethenon-systematic(unexpected)componentofmonetarypolicy.TheparameterφRisameasureoftheinertiainsettingtheinterestrate,whileφπandφYmeasurehowmuchthecentralbank’schoiceofpolicyratelevelisaffectedbyinflationandgrowthfluctuations,respectively.Inthelong-run,monetarypolicydoesnotaffecttherestoftheeconomy.Intheshortterm,however,themacroprudentialandfiscalmeasuresinourstudymayhaveanimpactondemandandinflation,towhichmonetarypolicymayneedtoreact.

Lowerloan-to-valueorloan-to-incomecaps,stricteramortisationrequirementsandreducedtaxreliefonmortgageinterestareallexamplesof

12 Lump-sumtaxesmeansthatthehouseholdspayafixedamountintax.Thehouseholds’behaviourthereforedoesnotaffectthesizeofthetaxpayment.


alternativemeasuresthathaveemergedintheSwedishdebateaspotentialsolutionsforcounteractingtherisksassociatedtohighindebtedness.Inthemodel,changestotheparametersμ(loan-to-valuecap),σ(loan-to-incomecap),ρ(amortisationrequirement)andωRH(taxreliefonmortgageinterest)correspondtothesemeasures.

4FittingthemodeltoSwedishdataInordertostudythemacroeconomiceffectsofreducingSwedishhouseholddebt,themodelmustbefittedtoSwedishdata.Inotherwords,themodelparametersmuchbeassignedvaluessothatthecharacteristicsofthemodelreflecttheSwedisheconomy.Theparameterscanbedividedintotwocategories.

Thefirstcategoryconsistsofparametersthatprimarilyaffectthemodel’slong-termcharacteristics.Forthoseparameters,thereisoftenanobservableequivalentindata.Anexampleistheparameterthatdeterminesthedegreeofcompetitiononthemortgagemarket,whichinturndeterminesthebanks’averagemarginsonmortgages.Thisparametercanbedeterminedbasedontheaveragedifferencebetweenmortgageratesandthereporate.InTable1wedescribelong-termlevelsforcertainvariablesinthemodelthatareofparticularimportance.Theaimisnottoexactlymatchthelong-termvalueswithdata,butrathertoverifythattheconsistencyissufficientlygoodforthemodeltobeusedtostudytheeffectsofreducinghouseholddebtinSweden.

Theothercategoryconsistsofparametersthatprimarilyaffecttheshort-termdynamics.Anexampleofonesuchparameteristhatwhichdetermineswhatimpactachangetothereporatewillhaveonthemortgagerate.Fortheseparameters,thereistypicallynoobservableequivalentindata,soothermethodsareneededtoestimatethem.WehaveusedBayesianeconometricstoestimatethem,entailingthatwehavecombinedinformationindatawithjudgementsbasedoneconomictheoryandempirics.

4.1Householddebt,loan-to-valueratioandamortisationAswenotedinthebeginningofthisarticle,thedebtratiooftheSwedishhouseholdshasincreasedfromaround90percentin1995tocloseto180percentin2015.Around75percentofthosedebtsconsistofloanscollateralisedbyhomes.Mortgagesthusmadeuparound130percentofhouseholds’disposableincomein2015.Thefactthatthisratiohasincreasedoverthepast20yearsmakesitdifficulttocalibratethedebtratio,becauseinthemodelitisconstantinthelongterm.Wehavesetthelong-termratioofmortgagestohouseholds’disposableincometo124percent,i.e.somewhatlowerthanthecurrentlevel.


Thisratioismainlydeterminedbyhowthehouseholdsfinancepurchasingtheirhomes,andhowfasttheypaydowntheloans.Whenthesizeoftheloanislimitedbyhowmuchthehomeisworth,thefollowingrelationshipgivestheloan-to-valueratioforthemortgagestockinthelongterm:

(8) μB = μδHρ ,

where μB is the loan-to-value ratio in the mortgage stock, μ is the loan-to-valueratiofornewloans,δHistherateofdepreciationofthehousingstock,andρistheamortisationrate.Inthemodel,theloan-to-valueratiofornewloanscoincideswiththeloan-to-valuecap,becausetheloanrestrictionisassumedtobebindingandtheborrowinghouseholdsareidentical.Inreality,theloan-to-valueratiovariesbetweenhouseholds, andmost households borrow below the loan-to-value cap.With thepresentleveloftheloan-to-valuecap,thesizeofaloancollateralisedbythehomemayamounttonomorethan85percentofthevalueofthehome.Theaverageloan-to-valueratiofornewloanswas72percent in2014,whilethe loan-to-valueratiofortheentiremortgagestock inthesameyearwas63percent.13Usingmicrodataregardinghouseholddebtsfor2013-2014,wecancalculatetheannualamortisationrateataround2percentannually,moreorlessequallinganamortisationperiodof50years.Basedthereon,wesetμB =65percent,μ=75percent,andρ=0.7percent(quarterly).14TherelationshipabovethengivesarateofdepreciationofδH=0.6percent(quarterly).

Inorderfortheloan-to-incomeratiointhemodeltobeconsistentwithdata,theborrowinghouseholds’shareofthetotalwagesumissetto40percent.Borrowers’mortgagesinrelationtodisposableincomewillthenbe456percent,whichisinlinewithdata.Theaverageloan-to-incomeratiofornewloanswas387percentin2014and406percentin2015.15Thevolume-weightedaverageloan-to-incomeratiowascloseto500percentin2014.

Theloan-to-incomecaplimitshowmuchhouseholdsmayborrowinrelationtotheirwageincome(seeequation(4)).16Inthemodel,σ / 4 ρcorrespondstotheratioofmortgagedebttotheborrowinghouseholds’wageincome,andissetat251percent.Whichevermeasureofincomeweuse,atighteningoftheloan-to-incomecapwillaffectdebtsasashareofboththewageincomeandthedisposableincome.Inourcalculationsbelow,wewilldescribehowtheyareaffectedinrelationtowageincome.

13 Fornewloans,thevolume-weightedaverageinFinansinspektionen’ssampleisused.SeeFinansinspektionen(2015).14 Withthisamortisationrate,aroundhalfthevalueofahomewillbeamortisedafter25years.15 SeeFinansinspektionen(2016).16 Theborrowinghouseholds’disposableincomeconsistsofwageincome,lessinterestexpensesandtaxes.


4.2InterestratesThebanksoperate,toacertaindegree,asmonopolists.Thiscreatesapositivespreadbetweentheirlendingratesandtherisk-freerate,whiledepositratesarelower.Thevariousspreadsinthemodelarecalibratedbasedonaveragedeviationsfromthereporatefortheperiod1995-2015.Theaveragereporateforthatperiodwas2.7percent.Theshortmortgageratewas4.0percentonaverage,theshortcorporatelendingratewas4.7percent,andthedepositrate1.4percent.

4.3ThebankingsectorThemodeldescribesaclosedeconomy.Thebanks’assetsandliabilitiesthusrelatetodomesticmortgagesandcorporatelendinginthebanks’balancesheets.Swedishmortgagesmakeuparound15percentofthebanks’assets,andlendingtonon-financialcorporationsmakesuparound10percentoftheassets.Hence,aroundonequarteroftheSwedishbanks’assetsarecoveredbythemodel.TheassetsofthefourlargeSwedishbanksasashareofGDParearound400percent,andtheyaccountforaroundthreequartersofalldepositsandlendinginSweden.Wehavethereforecalibratedthebanks’assetsasashareofGDPtoavaluesomewhatabove100percent.Inthemodel,thebanks’lendingisonlyfundedbyhouseholddepositsandequity.Inthedata,depositsandborrowingsfromthegeneralpublicmakeuparound35percentofthefourlargebanks’funding.

Thefourlargebanks'equityinrelationtotheirassets(leverage)variesintherangeof4to6percent.Inthemodel,theleverageratioofthebankingsectoriscalibratedat4.6percent.Wealsoassumethattheresourcesneededtorunthebanks,suchassalariesforemployees,dependonthesizeofthebanks’capital.Thebankingsector’sshareofGDPissetat3.6percent.

4.4TaxreliefonmortgageinterestThe30percenttaxreliefonmortgageinterestequals2.5percentofpublicexpenditureinthemodel.Inthemodel,theindebtedhouseholdsspendaround7.4percentoftheirgrossincomeoninterestpayments.Thisisarelativelyhighpercentagecomparedwithrecentdataonthehosueholds'interest-to-incomeratioandthedifferencemay,atleastpartially,beexplainedbythefactthattheinterestrateinrecentyearshasbeenmuchlowerthanitsnormallevel.


Table 1. Calibration of long-term values in the model Percent

GDP components and tax relief on mortgage interest Value

Consumption,percentageofGDP 49

Investments,percentageofGDP 22

Publicexpenditure,percentageofGDP 29

Taxreliefonmortgageinterest,percentageofpublicexpenditure 2.5

Interest rates

Reporate 2.7

Mortgage rate, short 4.0

Corporatelendingrate,short 4.7

Depositrate,short 1.4

Debts, loan-to-value ratios and amortisation

Mortgagedebt,percentageofGDP 55

Mortgagedebt,percentageofdisposableincome,allhouseholds 124

Mortgagedebt,percentageofdisposableincome,indebtedhouseholds 456

Mortgagedebt,percentageofwageincome,indebtedhouseholds 251

Loan-to-valueratio,newloans 75

Loan-to-valueratio,mortgagestock 65

Amortisation,percentageofloanstock,byquarter 0.7

5Long-termeffectsofreducinghouseholddebtAsdiscussedabove,thereareseveraldifferentmeasureswhichSwedishauthoritiesmayundertaketodampentheincreasinghouseholddebt.Inthissectionweexamine,fromamacroeconomicperspective,whatthelong-termeffectswouldbeoffourdifferentmeasures:

• Tighteningtheloan-to-valuecap

• Tighteningtheamortisationrequirement

• Introducingaloan-to-incomecap

• Reducingthetaxreliefonmortgageinterest


Wecalculatehowthedifferentmeasureswouldaffecthouseholdsbyapplyingeachmeasuresuchthattheborrowinghouseholds’loan-to-incomeratio(thepercentageofmortgagedebtofincomefromsalary)declinesby10percent.Thisimpliesthatmortgagedebtasashareofdisposableincomedeclinesbyaround12percentagepoints.Suchastandardisationwillfacilitatethecomparisonoftheeffectsofthedifferentmeasures.17Wethencalculatewhatthemacroeconomiceffectswouldbeforthehouseholds.Theleveloftheloan-to-incomeratiocanbeseenasameasureofpotentialrisksinhouseholddebt,becausemanyhouseholdsusetheircurrentincometopaytheirloanexpenses.

5.1Effectsoftighteningtheloan-to-valuecapAloan-to-valuecapmeansthatthesizeofamortgageislimitedwithrespecttohowmuchthehomeisworth.Ifthecapistightened,householdscanthusfinanceasmallerproportionoftheirhomepurchaseswithloans.InSwedishdataregardingloan-to-valueratiosfornewloans,thereisawidespreadacrosshouseholds.Between20and30percentofhouseholdsarelimitedbytheloan-to-valuecap.Inthemodelweassumethatallborrowershavethesameloan-to-valueratiofornewloans μ.Wealsoassumethattheloan-to-valueratioofthehouseholdsdecreasesiftheloan-to-valuecapistightened.Theloanrestrictionfortheborrowinghouse-holds(equation2)can,inlong-termequilibrium,bewrittenas,

(9) N̅ Q̅ I ̅

= μ.

Similarly,thedebtequation(equation3)canbewrittenas

(10) N̅ = ρ B̅,

wheretheparameterρdenotestheborrowers’amortisationrateandBtheirindebtedness.Hence,thenewborrowingofhouseholdsNequalstheirloanamortisationinthelongrun.

Inthemodel,themortgagerateovertimeisdeterminedbytwofactors:thestateofcompetitiononthemortgagemarket,andhouseholds’preferencesforconsumptiontodayinrelationtoconsumptioninthefuture.Changestotheloan-to-valuecapthereforedonotaffectthemortgagerate,andneitherdoanyoftheothermeasures.Thatmeans,forexample,thatiftheloan-to-valuecapistightened,theinterestexpenseofborrowerswilldecrease–indebtednesswilldeclinewhiletheinterestrateremainsthesame.

17 Themeasurethusleadstotheborrowinghouseholds’mortgagedebtsasapercentageofwageincomedecreasingfrom251to226percent.


Figure4showshownewborrowing,amortisation(ρB)andindebtednesschangeovertimeiftheloan-to-valuecapistightened.Theloan-to-valuecapisreducedatthepointintimet.Wecanseethatnewborrowingsdropimmediately,whileamortisationandindebtednessslowlyadapttonew,lowerlevels.Intime,indebtednessdecreasesinthesameproportionasnewborrowing,becauseatightenedloan-to-valuecapdoesnotchangetheamortisationrate.

New borrowings Amortisation Indebtedness

t t

Figure 4. Adjustments of new borrowings, amortisation and indebtedness following a tightened loan-to-value capSEK


InTable2thelong-termeffectsforhouseholdsfromtighteningtheloan-to-valuecapsuchthattheloan-to-incomeratiodecreasesby10percentareshown.Theaverageloan-to-valueratiofornewloansthendeclinesfrom75to70percent.Theborrowersusethefundsreleasedbythelowerinterestexpensetoincreaseconsumptionofgoods(around2percent)andleisure(around1percent).Butthetighterloan-to-valuecapalsobringsaboutareductionintheconsumptionofhousingservicesofaround1.5percent.

Inthemodel,thesupplyofhomesisassumedtobeconstant,soonlyaredistributionofthehousingstockbetweenborrowersandlendersoccurs.Becausetheborrowerscutdownontheirconsumptionofhousingservices,thelenderswillincreasetheirconsumptiontothesameextent.Inthiscase,thelenders’consumptionofhousingservicesincreasesbyaround1percent.

Forthelendersthelowerloan-to-valuecapleadstoanincreaseintheconsumptionofhousingservices,whileatthesametimetheirsavingsdecline


andhencetheirinterestincometoo.Consequently,theyincreaselaboursupplysomewhatandreducetheirconsumptionofgoods.Thelowerindebtednessintheeconomythusbringsaboutashiftinresourcesfromlenderstoborrowers.

5.2EffectsofincreasingtheamortisationrateThepurposeofanamortisationrequirementistomakehouseholdsamortisetheirdebtsfaster.Anincreasedamortisationratewill,likealowerloan-to-valuecap,leadtodebtsdecreasingandbeinglowerinthenewlong-termequilibrium.However,themeasuresaffectnewborrowingsindifferentways,sotheeffectsonhouseholds’consumptionofgoodsandhousingserviceswillalsobedifferentwithanincreasedamortisationrateρcomparedtowithalowerloan-to-valuecap.Assumethattheamortisationrequirementistightened,leadingtoanincreaseintheamortisationrate.Inthatcase,newborrowingsandindebtednesswillnotchangeproportionallytoeachother,seeequation(10).Inthemodel,afasteramortisationrateleadstoadeclineinindebtedness,whilenewborrowingsarelargelyunchangedbothintheshortandlongterm.Theeffectthusdiffersfromalowerloan-to-valuecap,whichleadstonewborrowingsdecliningrapidlyandbeinglowerovertime,becausetheloan-to-valuecapdirectlylimitsnewborrowings.Anamortisationrequirementdoesnothavethesamedirecteffectonnewborrowings,andwillthereforehavelessofanimpactonthehousingmarket.Figure5illustratestheeffectsafteratighteningoftheamortisationrequirementatthepointintimet.Theincreasedamortisationrateleadstoamortisationsrisinginitiallyandbeinggreaterthannewborrowings,tothenfallbackasindebtednessdeclinestoalowerlong-termlevel.Inthelongrun,thesizeofamortisationsρBismoreorlessunchanged.TheshareofdebtthatisamortisedeachyearρhasincreasedbutatthesametimethedebtBhasdecreased.Becausenewborrowingsintimeareaffectedinthesamewayasamortisations,thisalsomeansthatnewborrowingsarelargelyunaffectedovertime.

Thisillustratesanimportantdifferencebetweentighteningtheamortisationrequirement,andtighteningtheloan-to-valuecap.Bothmeasuresleadtolowerindebtednessovertime,butahigheramortisationratehaslittleimpactonnewborrowings,whilealowerloan-to-valuecapleadstoadropinnewborrowingsinproportiontoindebtedness.Thisisimportantbecauseitisnewborrowings,andnotindebtedness,thataffectthepossibilitiesofborrowerstoconsumehousingservices.


t t

Figure 5. Adjustments of new borrowings, amortisation and indebtedness following a tightened amortisation requirement SEK

New borrowings Amortisation Indebtedness


Table2showsthequantitativeeffectsofatighteningoftheamortisationrequirement.Inorderfortheloan-to-incomeratiotofall10percent,theamortisationperiodmustshortenfrom50to45years.Newborrowingswillbeslightlylowerinthelong-termwiththismeasure.Theborrowinghouseholdsusethemoneytheyhaveleftoverfromreducedinterestexpensetoconsumegoodsandleisure,besidesconsumingslightlymorehousingservices.Theinterestincomeofthelendersdeclines,becausesavingintheeconomyfalls.Therefore,theycutdownontheconsumptionofgoods,housingservicesandleisure.

5.3Effectsofintroducingaloan-to-incomecapTheloan-to-incomecapisamacroprudentialmeasurethatresemblestheloan-to-valuecap.Thedifferenceisthathouseholds’loansarenotlimitedbythevalueofthehome,butratherbythehouseholds’incomefromsalary.Hence,theintroductionofaloan-to-incomecapleadstoachangeinhouseholds’newborrowingsinrelationtotheirindebtedness,justlikeafteratighteningoftheloan-to-valuecap.However,unlikeatighteningoftheloan-to-valuecap,areductioninnewborrowingsduetoaloan-to-incomecapdoesnotnecessarilyreduceborrowers’possibilitiestoconsumemorehousingservices,becausenewborrowingsinthiscasearenotlinkedtothevalueofthehome.18

18 Formally,thismeansthattherestrictioninequation(2)isnotbinding.Evenifnewborrowingsdecline,theborrowinghouseholds’consumptionofhousingservicescanbeunchangedorevenincreasebecausetheirinterestexpensedecreases,aslongastheymeetthebudgetrestriction(6).


Inordertoreducetheloan-to-incomeratioby10percent,aloan-to-incomecapmustbeintroducedthatreducesborrowers’loan-to-incomeratio,i.e.theirdebtsinrelationtotheirwageincome,by25percentagepointsfrom251to226percent.ThecolumnatthefarrightinTable2showsthelong-termeffectsthiswouldhave.Wheretheborrowersareconcerned,thismeansthatconsumptionofbothgoodsandleisureincreases.Thefactthatconsumptionofhousingservicesincreasesisalsonoteworthy.Thisshowsthatatighteningoftheloan-to-incomecapneednotinitselfdampenborrowers’housingconsumption.Thelenders,fortheirpart,cutdownontheirconsumptionofgoods,housingservicesandleisureduetolowerinterestincome.Inpurelyqualitativeterms,atighteningoftheloan-to-incomecap,oratighteningoftheamortisationrequirement,affectshouseholdsinasimilarway,althoughthequantitativeeffectsdiffer.

Table 2. Long-term effects of tightened macroprudential measuresPercent,excepttheamortisationrequirement,whichisinyears

Loan-to-value cap

Amortisation requirement

Loan-to-income cap

Initialvalue 75.0 50.0years 251.2

Endvalue 69.5 44.9years 226.1

Loan-to-incomeratio,change −10.0 −10.0 −10.0

Borrowers

Consumptiongoods,change 2.0 1.5 1.2

Consumptionhousingservices,change −1.7 0.2 1.2

Leisure,change 1.2 0.9 1.0

Lenders

Consumptiongoods,change −0.6 −0.5 −0.5

Consumptionhousingservices,change 1.0 −0.1 −0.5

Leisure,change −0.1 −0.1 −0.1


5.4EffectsofreducingthetaxreliefonmortgageinterestPeoplewhoborrowmoneytopurchaseahomecan,intheirtaxreturns,deductfromtheirtaxedamount30percentofpaidinterestexpense.Thiscanbeviewedasagovernmentsubsidyofloanfinancingtopurchaseahome.19Ifthetaxreliefonmortgageinterestdecreases,thesubsidywillbeless,andhencesotootheGovernment’sexpenditureforit.TheeffectofreducingtaxreliefonmortgageinterestthereforedependsonwhattheGovernmentusesthemoneyforinstead.Inpractice,itcouldbeusedtoincreasetransfers,reducetaxes,increasepublicexpenditureortopaybackthesovereigndebt.Inourmodel,whichhasarelativelysimplisticdescriptionofthepublicsector,thefundsreleasedcanonlybeusedtoincreasetransferstolendersandborrowers,ortoincreasepublicconsumption.20,21

5.4.1 Decreasing the tax relief on mortgage interest lowers the borrower's consumption of housing services Wewillstudythreedifferentscenariostoillustratewhattheeffectswillbefromreducingthetaxreliefonmortgageinterest,andhowthoseeffectsdependonwhattheGovernmentusesthereleasedbudgetfundsfor.Inthefirstscenario,theGovernmenttransfersthemoneytoborrowersandlendersinproportiontothewagesumforeachcategoryofhousehold.Inthesecondscenario,theGovernmenttransfersthemoneyentirelybacktotheborrowers.Thismeansthatthedistortingeffectsofthetaxreliefonmortgageinterestareweededout.Thisscenariothusgivesanindicationoftheextenttowhichtheloansubsidyaddstoexcessiveindebtednessandhenceloanfinancingofhomepurchasing.Inthethirdscenario,theGovernmentinsteadusesthemoneyentirelytoboostpublicconsumption.

Inallthreescenarios,thetaxreliefonmortgageinterestdeclinestothelevelrequiredtobringtheloan-to-incomeratiodownby10percent.Inthefirstcase,whenthereleasedbudgetfundsaretransferredtoallhouseholds,thetaxreliefonmortgageinterestmustbereducedfromthecurrentlevelof30percenttoaround3percent,asshowninTable3.Theborrowersareaffectedmainlythroughtwochannels.First,thedistortingincentivestotakeondebtwillbelower.Second,theyaresubjecttoanegativeeffectonincomebecauselessthanhalfofthereleasedbudgetfundsfromthetaxreliefonmortgageinterestaretransferredbacktothem.Onthewhole,thisleadstoborrowers’consumptionofhousing

19 ReferstointerestexpensesuptoSEK100,000annually.20 Inthemodel,therearenodistortingeffectsfromtaxes,withtheexceptionofthetaxreliefonmortgageinterest,sothereisnodifferencebetweenincreasingtransfersandreducingtaxes.21 SeealsoEnglund(2016)forastudyoftheeffectsofreducingtaxreliefonmortgageinterest.


servicesdecliningbyaround7percent,whileatthesametimetheirconsumptionofgoodsandleisureismoreorlessunchanged.Wherethelendersareconcerned,thereductioninthetaxreliefonmortgageinterestgivesapositiveeffectonincome,becausemorethanhalfofthemoneyistransferredtothem.Therefore,consumptionofbothgoodsandhousingservicesincreases.

Inthesecondscenario,themoneyfromthetaxreliefonmortgageinterestistransferredentirelybacktotheborrowers.Inorderfortheloan-to-incomeratiotodecline10percent,thetaxreliefonmortgageinterestmustbereducedtoaround−6percentinthiscase.Thetaxreliefonmortgageinterestbeingnegativemeansthatitisataxonloanfinancingforhomes.So,a6percenttaxonloansforhomesisneededfortheloan-to-incomeratiotodecreaseby10percent.Inthatcase,borrowers’consumptionofhousingservicesdeclinesbymorethan6percent,whileconsumptionofgoodsincreasesbyover3percent,andleisurebyaround2percent.Thesecalculationsillustratethedistortingeffectsofthetaxreliefonmortgageinterest,becausetheGovernmentfullytransfersbackthemoneyfromthetaxreliefonmortgageinteresttotheborrowers.Thetaxreliefonmortgageinterestthusleadstotheborrowersconsuming“toomuch”ofhousingservices,butalsotothemconsuming“toolittle”ofothergoods.Thelenders,fortheirpart,cutdownontheirconsumptionofgoodsandleisureduetolowerinterestincome.However,theirconsumptionofhousingservicesincreasesbecausethetotalhousingstockisunchanged.

Inthethirdscenario,theGovernmentusesthemoneyfromthetaxreliefonmortgageinterestentirelytoboostpublicconsumption.Inorderfortheloan-to-incomeratiotodecline10percent,inthiscaseitsufficestoreducethetaxreliefonmortgageinteresttoaround6percent.Itisthereforethemostappropriatealternativeiftheaimofreducingthetaxreliefonmortgageinterestissolelytoreducehouseholddebt.Wheretheborrowersareconcerned,however,itisanexpensivealternative–despiteinterestexpensebeinglower–becausetheymissoutontheentireloansubsidy.Theborrowers’consumptionofhousingservicesdeclinesbyover6percentandtheconsumptionofgoodsandleisurebyjustshyof1percenteach.Theconsequencesforlendersaremorebeneficial.Consumptionofhousingservicesincreasesbyjustshyof4percent,whileatthesametimetheconsumptionofgoodsandleisureismoreorlessunchanged.However,inordertoperformanaccuratemacroeconomicevaluationofthisalternative,theutilitytohouseholdsprovidedbyhigherpublicconsumptionmustalsobeweighedin.


Table 3. Long-term effects of reducing tax relief on mortgage interest Percent

Transfers to both borrowers and

lenders in proportion to total salary

Transfers only to borrowers

Public consumption

Initialvalueoftaxreliefonmortgageinterest 30.0 30.0 30.0

Endvalueoftaxreliefonmortgageinterest 2.8 −6.5 6.2

Loan-to-incomeratio,change −10.0 −10.0 −10.0

Borrowers

Consumptionofgoods,change −0.1 3.1 −0.8

Consumptionhousingservices,change −7.0 −6.1 −6.4

Leisure,change 0.1 1.8 −0.5

Lenders

Consumptionofgoods,change 0.5 −1.1 0.1

Consumptionhousingservices,change 4.2 3.7 3.8

Leisure,change 0.4 −0.3 −0.1

5.5Whichmeasureisthemosteffectiveinreducinghouseholddebt?Therearedifferentwaysofevaluatingwhichmeasureisthemosteffectiveinreducinghouseholddebtfromamacroeconomicperspective.Inthemodel,householdutilityisanappropriatemeasureforsuchananalysis.Theutilitydependsontheconsumptionofgoods,housingservicesandleisure.Thefactthattheutilityisaffectedbyleisureisanimportantassumptionbecauseitmeansthatanincreaseinconsumptionduetoworkingmoredoesnotnecessarilyincreasehouseholdutility,becauseahigherlaboursupplymeanslessleisuretime.

GDPpercapitaisanothermeasurethatiscommonlyusedtoquantifymacroeconomicbenefitorwelfareinasociety.Itisasimplemeasureandisthereforeoftenusedinpractice.However,adrawbackwithGDPpercapitaisthatwelfaredoesnotonlyconsistofmaterialwellbeing,butalsootherfactorsthataremoredifficulttomeasure,suchasleisureandhealth.

Table4showstheeffectsofreducingtheloan-to-incomeratioby10percentthroughthefourdifferentmeasuresthatweanalysedabove:loan-to-valuecap,


amortisationrequirement,loan-to-incomecapandtaxreliefonmortgageinterest.Forthetaxreliefonmortgageinterest,weshowthesamethreecasesasbefore.Inthefirsttwo,themoneyreleasedfromthetaxreliefonmortgageinterestisusedfortransferstohouseholds,andonlytoborrowersinthesecond.Inthethirdcase,themoneyisusedforpublicconsumption.Asameasureofhouseholdwelfarefromamacroeconomicperspective,householdconsumptionofgoods,housingservicesandleisureisshownontheonehand,andGDPpercapitaontheother.22

Thehouseholds’aggregateconsumptionofhousingservicesisnotchangedbythevariousmeasures,becausethetotalsupplyisconstant.Iftheborrowersandlendersvaluehousingservicesconsumptioninthesameway,theeffectsonhouseholds’housingconsumptionwouldthushavenobearingonjudgingwhichmeasureismosteffectiveforreducingindebtedness.23Thechangetotheconsumptionofgoodsisalsoclosetozeroforthesemeasures,althoughitincreasesbyaround0.2percentforthetaxreliefoninterestincomewhentheGovernmentusesthemoneyreleasedfortransferstobothcategoriesofhousehold.Thechangetohouseholds’leisureisofgreatersignificance,decliningby0.3percentwhenthegovernmentusesthemoneyreleasedfromreducedtaxreliefonmortgageinterestforpublicconsumption,butincreasesby0.6percentwhenthemoneyisinsteadusedfortransferstoborrowinghouseholdsonly.Thechangeinpublicconsumptionfromthesemeasuresalsoappearstobesignificant,particularlywhentheGovernmentusesthemoneyfromthereducedtaxreliefonmortgageinterestpaymentsforpublicconsumption.Inthatcase,publicconsumptionincreasesby2percent.

Theseresultsshowthat,fromamacroeconomicperspective,itisdifficulttodrawanyclear-cutconclusionsaboutwhichmeasurewouldbemosteffectiveinreducinghouseholddebt.Thethreemacroprudentialmeasureshaveslighteffectsonconsumptionofgoods,whileleisureincreasesbyaround0.3-0.4percent,butpublicconsumptiondropsbyaroundasmuch.Intermsofthetaxreliefonmortgageinterest,theeffectsalsodivergeslightly.Ifthebudgetfundsreleasedfromreducingtaxreliefonmortgageinterestareusedfortransferstoallhouseholds,theimprovementwouldhoweverbeclearbecauseconsumptionofbothgoodsandleisureincreaseswhileatthesametimeconsumptionofhousingservicesandpublicconsumptionareunchanged.24

22 Thepopulationisnormalisedtoone,andhencethereisnopopulationgrowthinthemodel,soGDPandGDPpercapitaarethesame.23 Inthemodel,theborrowersgainslightlymoreutilitythanthelendersfromconsuminghousingservices,sothedifferenceintermsofutilityisnotzero.24 ThefactthathouseholdconsumptionofgoodscanincreaseatthesametimeasGDPpercapitadecreasesisduetoareductioninbothcapitalformationandtheconsumptionofentrepreneurs.


IfthemacroeconomiceffectsareinsteadevaluatedusingGDPpercapita,areductionintaxreliefonmortgageinterest,withthereductioninGovernmentexpenditurebeingusedforpublicconsumption,ismosteffective.ThatmeasurewouldincreaseGDPbyaround0.3percent.ItisworthnotingthatallothermeasuresleadtoareductioninGDPpercapita,becausethosemeasuresleadtohouseholdsoptingformoreleisuretime,sothenumberofhoursworkedwillbelower.

Table 4. Long-term effects of reducing the loan-to-income ratio by 10 per cent from a macroeconomic perspectivePercent

Mortgage cap

Amortisation requirement

Loan-to-in-come cap

Tax relief on interest

expense transfers to

both bor-rowers and

lenders

Tax relief on interest

expense transfers to

borrowers only

Tax relief on interest expense

public consumption

Initialvalue 75.0 50 251.2 30.0 30.0 30.0

Endvalue 69.5 44.9 226.1 2.8 −6.5 6.2

Loan-to-incomeratio,change −10.0 −10.0 −10.0 −10.0 −10.0 −10.0

Consumption

Goods,change 0.0 0.0 −0.1 0.2 −0.1 −0.1

Housing services,change 0.0 0.0 0.0 0.0 0.0 0.0

Leisure,change 0.4 0.3 0.4 0.3 0.6 −0.3

Publicconsumption,change −0.4 −0.3 −0.4 0.0 0.0 2.0

GDP per capita, change −0.4 −0.3 −0.4 −0.3 −0.6 0.3


6Whataretheshort-termimplicationsformonetarypolicyofreducinghouseholddebt?Changestothevariousmacroprudentialmeasuresandtothetaxreliefonmortgageinteresthavelong-termmacroeconomiceffects,butcanalsohaveshort-termeffectson,forinstance,demandandinflation.Thetaxreliefonmortgageinterestaffectsdemandintheeconomythroughchangesinpublicsectorincomeandexpenditure,whilevariousmacroprudentialmeasuresaffectdemandthroughhouseholddept.Thecentralbankmayneedtoconsiderthiswhensettingthepolicyrate.

Inordertoevaluatetheimplicationsformonetarypolicyfromreducinghouseholddept,wehavestudiedtheeffectsofintroducingthefourdifferentmeasures(loan-to-valuecap,amortisationrequirement,loan-to-incomecapandtaxreliefonmortgageinterest).Eachmeasureisintroducedatacertainpointintime,andistheninplaceforalongtime,butgraduallyrevertstoitsoriginallevel.Inallcases,thelevelsofthevariousmeasuresaresetsuchthathouseholddeptafter10yearsisaround10percentlowerthanitsinitiallevel.

Weshowthatanimportantfactoraffectingthemeasures’short-termeffectsismobilityonthehousingmarket.Wecomparetwocases.Inonecase,mobilityonthehousingmarketishigh,butlowintheothercase.

Figure6showshowinflationandthepolicyrateareaffectedifhouseholddebtdeclineswhenmobilityishigh.Reducingtheloan-to-valuecaportaxreliefonmortgageinteresthassimilareffectsonthepolicyrateandinflation.Inflationrisesatmostbyjustunder0.2percentandthepolicyrateby0.2percent.Tighteningtheamortisationrequirementhastheoppositeeffectonthepolicyrateandinflation,however,asbothdecreaseswiththismeasure.

Inthecasewhenmobilityinsteadislow,theeffectsonthepolicyrateandinflationaredifferent,asshowninFigure7.Inflationdeclinesirrespectiveofthemeasureandbyuptoalmosthalfapercentagepointwhenamortisationrequirementsaretightened.Thecentralbankthereforecutsthepolicyratetodampenthedropininflation.

Theimpactonmonetarypolicythereforedoesnotonlydependonwhichmeasureisimplemented,butalsotheextentofmobilityonthehousingmarket.Ifmobilityislow,householdsareforcedtocutdownontheirconsumptionofothergoods.Inthatcase,inflationwillbelowerandmonetarypolicymoreexpansionary.However,thisalsoleadstoadropinmortgagerates,whichpartiallycounteractstheeffectsofthemeasuresonindebtedness.Thefindingsthusillustratethatthedifferentmeasureshaveimplicationsformonetarypolicythatmaydiverge,andthatitisimportanttoalsoconsidermobilityonthehousingmarket.


-0.4

-0.3

-0.2

-0.1

0.0

0.1

0.2

0.3

-0.2

-0.2

-0.1

-0.1

0.0

0.1

0.1

0.2

1 4 7 10 13 16 19 22 25 28 31 34 37 40 1 4 7 10 13 16 19 22 25 28 31 34 37 40

Amortisation requirement Mortgage capTax relief on mortgage interest

Figure 6. A tightening of the loan-to-value cap, tax relief on mortgage interest and amortisation requirement with high mobility on the housing market Deviations from long-term levels, in percentage points

Source: Own calculations

Repo rate Inflation

1 4 7 10 13 16 19 22 25 28 31 34 37 40 1 4 7 10 13 16 19 22 25 28 31 34 37 40

Figure 7. A tightening of the loan-to-value cap, tax relief on mortgage interest and amortisation requirement with low mobility on the housing market Deviations from long-term levels, in percentage points

Repo rate Inflation

-0.5

-0.4

-0.3

-0.2

-0.1

0.0

0.1

-0.5

-0.4

-0.3

-0.2

-0.1

0.0

0.1

Amortisation requirement Mortgage capTax relief on mortgage interest



7Howdoestheleveloflong-termdebtaffectmonetarypolicy?TherapidlyincreasingindebtednessofSwedishhouseholdssincethemid-1990shasprobablymademanyhouseholdsmoresensitivetochangesininterestrates.Ifinterestratesrise,thishasadirecteffectonthehouseholds’disposableincome,andbringsaboutaredistributionofresourcesfromborrowerstolenders.Thehighertheindebtedness,thegreatertheeffectofaratehikeonborrowers’interestexpenseanddisposableincome,whichinturnreduceshouseholds’scopeforotherconsumption.However,theextentoftheimpactdependsonseveralfactors,suchashowlongaratehikelasts,andhowthedebtsaredistributedamongthehouseholds.

Accordingtothisargument,theimpactofapolicyratehikeondemand–andhenceoninflation–wouldbegreaternowthanbefore.Inordertoillustratethepotentialextentoftheeffects,wecomparehowtheeffectsdifferdependingonthreedifferentloan-to-incomeratiolevels,seeFigure8.Inallthreecases,thereporateisincreasedby1percentagepointtobethenadjustedbacktotheoriginallevelaccordingtothemonetarypolicyrule(seeequation(7)).Inthefirstcaseweassumethattheloan-to-incomeratioisatthepresentlevel,i.e.closeto180percent,whentheratehikeoccurs.Inthatcase,theaggregateconsumptionofhouseholds(bothborrowersandlenders)declinesbyaround0.7-0.8percentinthefirstyear.Buttheborrowersaretheoneshardesthitbytheratehike.Theirconsumptiondropsbyalmost2percent,whilethelenders’consumptionislargelyunaffected.Wecanalsoseethatinflationdropsbyjustover0.5percentagepoints.

Wecancomparethatcasewithwhattheeffectsonconsumptionandinflationwouldbehadtheloan-to-incomeratioinsteadbeenatthesamelevelaswhentheinflationtargetwasintroducedinthemid-1990s,i.e.around90percent.Inthiscase,theeffectonconsumptionwill,asexpected,besmaller,andinparticulartheeffectontheborrowers’consumptionwillbemuchsmaller.Theirconsumptiononlydropsbyacoupleoftenthsofapercentagepoint.Theeffectoninflationisalsosmaller,althoughthedifferenceisrelativelysmall.

Inthethirdcaseweassumealoan-to-incomeratioof210percent.Thatlevelcouldbereachedwithin10yearsiftheloan-to-incomeratiocontinuestoincreaseatthecurrentratefromtoday’slevel.Withthatdebtlevel,theeffectsofaratehikeonconsumptionwouldbemuchgreater.Forexample,aninterestratethatisonepercentagepointhighercouldleadtoadropinborrowers’consumptionofalmost6percent.Theimpactoninflationwouldalsobegreater.


Thesecalculationsprovideanindicationoftheimportanceofthehouseholdloan-to-incomeratioonthetransmissionmechanismofmonetarypolicy.Thehighertheloan-to-incomeratio,thegreatertheshareofborrowers’incomethatwillbespentoninterestpaymentsandconsumptionofhousingservices,andthelowertheamountthatcanbespentonconsuminggoods.

1 4 7 10 13 16 19 22 25 28 31 34 37 40 1 4 7 10 13 16 19 22 25 28 31 34 37 40

Figure 8. Effects of hiking the repo rate at different loan-to-income ratios Deviations from long-term levels in per cent, in percentage points (repo rate, inflation) and per cent (consumption)


Repo rate Consumption

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

Loan-to-income ratio in the mid-1990sLoan-to-income ratio 2024 if the rate of increase continues at the current rateCurrent loan-to-income ratio

1 4 7 10 13 16 19 22 25 28 31 34 37 40 1 4 7 10 13 16 19 22 25 28 31 34 37 40

Borrowers’ consumption Inflation

-6

-5

-4

-3

-2

-1

0

1

2

-0.25

-0.20

-0.15

-0.10

-0.05

0.00

0.05


8ConcludingremarksWehaveshownthat,overtime,householddebtcouldbereducedbytighteningdifferentmacroprudentialtoolsandreducingthetaxreliefonmortgageinterest.Thiswouldalsoleadtoaredistributionofresourcesfromlenderstoborrowers.Thisredistributioneffectiscontrarytotheconventionalwisdomaccordingtowhichmacroprudentialmeasuresarenegativeforborrowers.ForlatiandLambertini(2014)describesimilarfindings.TheystudytheeffectsofthenewloancontractswithlowerdownpaymentsandloweramortisationrequirementsthatcameintouseintheUSinthelatterhalfofthe1990s.Intheirmodel,easieraccesstocreditpushesborrowerstoborrowmoreanddemandmorehousingservices,withoutconsideringtheimpactoftheirbehaviouronhousingprices.Intheaggregatetheresultinghigherhousingdemandwillpush-uphouseprices.Asaresult,borrowerswillhavetocutdowntheirconsumptionandworkmore,therebyreducingtheirwelfareinthelongterm.

Wehavealsoshownthatareductioninthetaxreliefonmortgageinterestaffectshouseholdsindifferentways,dependingonhowtheGovernmentchoosestousethemoneyinstead.Ifitcompensatestheborrowers,suchameasurecanbepositivefortheirconsumptionotherthanhousing.Hence,thosethatmaybehurtfinanciallyofareductioninthetaxreliefcouldbecompensatedwithothertransfers.

Acaveatofouranalysisisthatwedisregardtheimpactofhouseholddebtontheriskofenteringafinancialcrisis.Themainpurposeofmacroprudentialpolicyisindeedtopreventfinancialcrises,andthatisalsoimportantfromamacroeconomicperspective.Thisishoweversomethingwecannotquantifyinthemodelwehaveused.

Anotherconclusionfromtheanalysisis,notsurprisingly,thatthedifferentmeasureshaveimplicationsformonetarypolicythatcangoindifferentdirectionsandareaffectedbytheextentofmobilityonthehousingmarket.Usingthemodel,wehavealsoillustratedhowthelevelofhouseholddebtaffectstheimpactofmonetarypolicyontherestoftheeconomy.

Alimitationinthisstudyisthatwehavedisregardedforeigntradeandpossibilitiesofcross-bordertransactions.TheresultsinChenandColumba(2016),however,showthatthisdoesnotaffecttheresultstoanyconsiderableextentinamodelsimilartoours.Theyalsoanalysetheeffectsofvariousmacroprudentialmeasuresonhouseholddebt,andtheirfindingsareinlinewithours.

TheNationalInstituteofEconomicResearch(2016)hasrecentlyconductedastudytoassessthemacroeconomicimpactofintroducingaloan-to-incomecap.Assumingthatallborrowersborrowuptothelimit,theyconcludethatthe


introductionofthenewpolicywillleadtoadecreaseinthehouseholdloan-to-incomeratioby11-14percentagepointsafter10yearswhilenominalGDPwillbe0.1-1.7percentlower,andthepricelevelmeasuredbytheCPIF0.1-0.7percentlower.Accordingtoourmodel,realGDPdeclinesby0.4percentinthelongterm.

Anotherstudythatlooksathowhouseholddebtisaffectedbymacroprudentialandfiscalpolicies,i.e.apropertytaxandtaxreliefonmortgageinterest–isAlpandaandZubairy(2016).TheirmodeliscalibratedonUSdataandhasarelativelydetaileddescriptionofthemortgagemarket,butlacksabankingsectorwhichintermediatesfundsbetweenlendersandborrowers.Accordingtotheiranalysis,themostefficientpolicyisreducingthemortgageinterestduduction,followedbytighteningtheloan-to-valuecapandintroducingapropertytax.

Inourmacromodel,wemakethesimplifiedassumptionthatborrowersarealwayslimitedbyaloanrestriction.BothHull(2015)andSvensson(2016)divergefromthatassumptionandstudyeffectsofamortisationrequirementsusing–insomeregards–moredetailedmodelsoftheloancontracts.Hull(2015)studiestheamortisationrequirementintroducedbyFinansinspektionenon1June2016.Inhismodel,besidesamortisationrequirements,householdsmustalsomeetadebtserviceratiocap.Theanalysisisconductedinan“overlappinggenerationmodel”with60generations,inwhichtheloancontractsofthehouseholdsectorarelargelyconsistentwiththeactualdesignofloancontractsinSwedenwithSwedish-stylemortgagecontracts.AccordingtoHull’sanalysis,amortisationrequirementsleadtosomewhatsmallereffectsthaninourmodel(thehouseholdloan-to-incomeratiodecreasesbyjustover2percentagepointsatmost),becausethehouseholdscanoptimallychoosetoregularlyrenegotiatetheirloans.

AccordingtoSvensson(2016)householddebtcould,onthecontrary,increaseratherthandecreaseifanamortisationrequirementisintroduced.Thisisbecausehouseholdscanchoosethesamesavingsaswithoutamortisationrequirementsbyborrowingmoreinitially,investingthesurplusinasavingsaccountandthenmakingwithdrawalsattheraterequiredtomeettheamortisationrequirement.Theaveragedebtwillthereforebehigherthanwithoutamortisationrequirements.AcrucialassumptioninSvensson’sanalysisisthatmortgagesarenotlimitedatthesametimebyloan-to-valuecaps,loan-to-incomecapsorotherfactorsthatpreventborrowersfromfinancingtheiramortisationswithloans,suchasthecostofrenegotiatingloans.

Justlikeinthetheoreticalliterature,theempiricalliteraturecontainsahighdegreeofuncertaintyaboutwhicheffectsvariousmacroprudentialtoolshave.Guibourgetal.(2015)summarisethefindingsofsomeimportantempiricalstudies.Severalofthesestudiesshowthatbothloan-to-valuecapsandloan-


to-incomecapscanbeeffectiveinpreventinghouseholdmortgagesfromrisingtooquickly.Loan-to-valuecapsandloan-to-incomecapsalsoappeartobethemacroprudentialtoolsmostusedtoreducedemandforcredit,andoftenincombinationwitheachother.Housing-relatedtaxessuchaspropertytaxortaxreliefonmortgageinterestalsohaveeffectsonmortgages.Housing-relatedtaxesandloan-to-valuecapsalsoappeartohavesignificanteffectsonhouseprices.

Inthisstudy,wehavequantifiedbyhowmuchdifferentmacroprudentialpoliciesandmortgageinterestdeductionshavetobetightenedinordertoattainacertaineffectontheloan-to-incomeratio.Themacroeconomiceffectsofthesedifferentmeasureswillbefairlyequalforthepopulationonaverage,butdifferbetweenborrowersandlenders.


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