10-22-2013 10:17 AM

The euro zone: A new test for the single currency

IT'S a lede to chill a Spaniard's heart:
The Bundesbank has warned that apartment prices in Germany’s biggest cities could be overvalued by as much as 20 per cent, stepping up its concern about a real estate boom in the powerhouse of the European economy. The warning will feed into German concern that the European Central Bank’s monetary policy is far too loose for the country. The bank’s main refinancing rate is 0.5 per cent, a record low.
The*Financial Times piece, which is splashed across the front page here in London, refers to an analysis in the Bundesbank's latest monthly report. It notes that property price rises across the economy as a whole have been muted, but it notes that flat prices in rural areas are pulling the average down. In Germany's largest cities prices for flats could be 20% above "the level which can be explained by demographic and economic factors alone".
There is no reason to panic. German property prices are famously phlegmatic. Adjusted for inflation, German house prices in 2010 were below their 1975 level. Over that span real prices rose 50% in America, 150% in Britain, and 200% in Spain. Our house-price interactive reckons the ratios of German house prices to rents and incomes remain below their long-term averages. And the Bundesbank itself suggests that a backlog in new construction is partly responsible for the rise. A German economic boom, even one rooted in property, would be a useful thing for the euro-area economy. It should improve the periphery's competitiveness while also, potentially, providing increased demand for peripheral goods and labour.
It is something to keep an eye on, however. The euro crisis had its roots in peripheral property booms. Financial integration made it easy and attractive for nothern capital to seek high returns in southern property. The resulting inflows distorted economic activity, boosted peripheral wages while productivity lagged, and gave some southern governments an overoptimistic sense of their fiscal situation. There will no doubt be broad concern across the euro area that similar dynamics could play out in reverse now, with money flowing toward Germany rather than away from it. Investors are hungry for yield, and struggling euro-area banks are desperate for profitable lines of business. German mortgages could be just the thing.
The real risk is in the euro zone's response, however. Euro-area inflation was down to 1.1% in September. The unemployment rate remains at 12% and is obviously quite a bit higher around the periphery. Monetary policy is too tight for the euro zone as a whole at the moment, and so to tighten further in response to developments in Germany would be disastrous. Though that would seem to be what the Bundesbank has in mind.
Germany could try to lean against capital inflows by tightening fiscal policy, but higher tax rates or reduced spending could prove a tricky sell given that Germany is already running a (growing) budget surplus. It seems probable that it will use regulatory policy to try to reduce the threat that might be posed by soaring home prices (should they keep soaring). If the Bundesbank gets worried and the European Central Bank fails to raise interest rates, the Buba could begin using macroprudential measures to try and calm the market. That could provide an interesting test case for the effectiveness of such rules.
The Bundesbank probably has it right in saying that the latest developments do not pose macroeconomic or financial risks. (It notes that German banks are already tightening lending standards.) I'm not sure that this is a particularly encouraging development from a political economy standpoint, though. I doubt it will do much for the collegiality of ECB meetings.

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