The Impact of the ECB's Unconventional Monetary Policy on the Eurozone's Housing Markets: a VAR analysis

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Abstract

Key words: Unconventional Monetary Policy, Vector Autoregression, Asset Purchase Programme, House Price Index, Loans-for-House-Purchase

The European Central Bank (ECB) has entered uncharted waters with its far-reaching unconventional monetary policy measures ever since the ‘whatever it takes’ speech of Mario Draghi. Whilst the impact of these measures on GDP and CPI levels are well documented, this thesis examines the impact of the ECB’s unconventional monetary policy measures on housing markets in the Eurozone. This thesis contributes to the empirical examination of the ECB’s unconventional monetary policy, focussing on the portfolio-rebalancing channel. A Vector Autoregression (VAR) model is used to examine how the ECB’s balance sheet expansion, provoked by its unconventional monetary policies, results in a shock to several variables on Euro Area housing markets. These variables include House Price Indices, interest rates on loans-for-house-purchase and lending-volumes for house purchase. Quarterly and monthly datasets are used, from seven Euro Area Member States and the Eurozone as a whole, in the post-crisis period of 2009-2019. The results show that the ECB’s unconventional monetary policy has heterogenous effects on house price indices in different Eurozone Member States, but overall leads to a general increase in house prices in the long-term. It further shows that unconventional monetary policy eases financial credit standards, as interest rates on loans-for-house-purchase have declined accordingly in almost all countries in the sample. Most importantly, the results empirically show that these effects run through the portfolio-rebalancing mechanism, because a shock of a 10-year government bond yield curve leads to lower levels of loans-for-house-purchase interest rates. The asset purchase programme decreases yield on 10-year government bonds in the Eurozone, which eventually results in easing credit standards on housing markets in the Eurozone, such as lower interest rates on loans-for-house-purchase. To conclude, the thesis finds that monetary policy transmission through portfolio rebalancing is indeed present. Furthermore, the heterogenous effects on house prices in Member States should be taken into account, suggesting that monetary policy is not transmitted uniformly across Eurozone Member States. However, the effects on easing financial credit standards seems more uniformly affected by unconventional monetary policy.

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Acronyms

APP Asset purchase programme

BLS Bank lending survey

CISS Composite indicator of systemic stress

CLIFS Country-level indicator of financial stress

EA Euro Area

ECB European Central Bank

HPI House Price Index

LHP The interest rate on loans-for-house-purchase

LV Lending volume for loans-for-house-purchase in absolute

numbers

QE Quantitative easing

TA Total assets of the ECB’s balance sheet

UMP Unconventional monetary policy

VAR Vector auto-regression

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Chapter 1:

Introduction

In light of the financial crisis, the booming housing market and the upsurge of post-crisis unconventional monetary policy, it is crucial to understand the transmission mechanisms of monetary policy on the housing market. European monetary policy has entered uncharted waters, instigated by Mario Draghi emphasising that he will do ‘whatever it takes’ to preserve the Euro. After the global financial crisis of 2008, central banks made fundamental changes in their monetary policy design (Joyce et al., 2012). Because, unfortunately, it became clear that conventional monetary policy was no longer sufficient to maintain price stability- and financial stability. Conventional monetary policy was supplemented by unconventional monetary policy measures, such as the ECB’s Quantitative Easing (QE) strategy. In the wake of these transformations, large changes and fluctuations in the housing market were also detected. Preceding the crisis, a housing boom took place, followed by sharply declining housing prices. In recent years leading up to 2019, a sharp change has again been noticed in the housing market. Housing prices have increased, financial credit standards have eased, and lending-volumes increased. So, two very intriguing processes have taken place in the Eurozone: the ECB entered uncharted territory with unconventional monetary policy, and Eurozone housing markets have seen easing financial credit standards and soaring housing prices. Could it be possible that these two are connected?

This thesis aims to comprehensively asses the transmission mechanism of the ECB’s balance sheet expansion on the housing market in 7 Euro Area countries, and the Euro Area as a whole. The assessment is done using the macroeconomic tool of Vector Autoregression (VAR) to see whether and how an increase in the ECB’s balance sheet affects the housing market. The differences among these 7 Member States are assessed and evaluated, and a conclusion is drawn on whether and how the ECB’s balance sheet expansion policy has affected the housing market in these 7 countries and the Eurozone. The estimations find that the effects of unconventional monetary policy differ between Member States’ housing markets. However, for most Member States, unconventional monetary policy does indeed lead to a rise in Housing Price Indices (HPI). Taking a further look into the effects of unconventional monetary policy on credit provision for house purchase, this thesis finds that unconventional monetary policy leads to a decline in loans-for-house-purchase interest rates for most Member States, and a small rise in the total lending volumes for house purchase in the Eurozone. In all of these processes, the portfolio-rebalancing channel plays an important role in the transmission

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mechanism of monetary policy. When the 10-year government bond yield curve declines, interest rates on loans-for-house-purchases decline as well, followed by an increase in House Price Indices.

From 2003, the ECB sharply defined its price stability aim as ‘the aim to achieve an inflation rate of below, but close to 2% on the medium term’ (Hartmann & Smets, 2018). The nominal short-term interest rate was the main policy tool for achieving this. However, when the sequence of crises started in 2007, the ECB initiated a phase of new monetary policy action. The ECB managed the crisis firstly with liquidity operations, followed by sharp interest rate cuts, and it was further enhanced by more liquidity operations and the first asset purchase programmes (APP) (Hartmann & Smets, 2018). By then, however, it became clear that conventional monetary policy and financial regulation may not be able to maintain financial stability and prevent asset price bubbles. Post financial crisis, this resulted in several stability pacts such as Basel-III on capital adequacy and liquidity rules. It resulted in central banks across the globe rethinking their conventional monetary policy measures. Central banks began to question the ability of conventional monetary policy to restore their economies and stimulate sustainable recovery, eventually resulting in central banks pursuing unconventional monetary policy to aid their economies towards recovery (Joyce et al., 2012). For the ECB, this meant policy phases characterised by large-scale liquidity operations, further short-term interest rates cuts and asset purchase programmes (Hartmann & Smets, 2018). It was an important moment in 2012, when the former President of the ECB, Draghi, announced that the ECB would do “whatever it takes” to reach their price stability goal (Hartmann & Smets, 2018). From that point forward, the ECB’s monetary policy entered crisis management mode. This meant massive expansion of the ECB’s balance sheet and several attempts aimed at lowering interest rates other than the official short-term rates (Joyce et al., 2012). The ECB hoped, consequentially, that this would boost inflation and economic growth. However, recovery was slow and inflation expectations did not reach the ECB’s goal of 2%. It became clear that the ECB key policy rates had remained impaired and the medium-term outlook for inflation even worsened (Hartmann & Smets, 2018).

Because short-term interest rates continued to decrease, ECB policy rates began to approach their effective zero lower bounds. A common tenet in macroeconomics states that monetary policy cannot increase aggregate demand when short-term interest rates reach zero. When interest rates become negative, market participants would hoard cash instead of spending it (Altavila et al., 2019). Thus, the ECB had to search for an even more far-reaching – unconventional – policy instrument (Gambacorta et al., 2014). The ECB embarked on a comprehensive quantitative easing strategy through open-market purchases. From January 2015 this became the asset purchase programme, with monthly purchases of public and private sector securities of €60 billion (Hartmann & Smets, 2018). The ECB’s balance sheet expanded rapidly, the long-term interest rates declined, and the long-term yield curve flattened. Through the portfolio rebalancing and signalling channel, downward pressure on the slope of

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the yield curve was achieved. There are several transmission mechanisms through which asset purchase programmes affect inflation. Such as the liquidity channel, exchange rate channel, signalling channel and portfolio-rebalancing channel. QE policies increase the money supply through their purchase programmes, which trickles down into consumer prices via these transmission mechanisms. The portfolio-rebalancing channel will be assessed in depth in chapter 4.2.

The “whatever it takes” policy may unintentionally leave marks throughout the Euro-area. A hypothesized effect of the ECB’s balance sheet is the large increase in housing prices throughout the Eurozone. Housing markets can be a major determinant of the broader business cycle, as they affect consumption and investment decisions. They are therefore an important indicator for macroeconomic and macroprudential trends, and an important variable to research. It is especially relevant to study housing prices, as the housing market can be the source of asset booms and busts, with long-lasting economic consequences (Piazessi, 2016).

These developments in the Eurozone are an interesting phenomenon to research. Figure 1 shows the ECB’s balance sheet expansion and the Eurozone’s housing price index. Both seem to have increased substantially over the past 10 years. The dotted line relates to the right-hand y-axis and portrays the ECB’s balance sheet expressed in millions of euros. The blue line represents the left-hand side and portrays the EU House Price Index, expressed as an index number. It seems the two might have some correlation, which is exactly what this thesis will try to unravel.

Figure 1: the ECB’s balance sheet compared with the Euro Area’s Housing Price Index.

Note: This graph shows how the Euro Area’s housing prices seem to run in the same direction as the ECB’s balance sheet expansion. The left-hand y-axis shows HPI index, 2015=100. The right-hand y-axis shows the ECB’s Total Assets in millions of euros. Notably, since the large-scale expansion of the ECB’s APP in 2015, the housing prices have increased substantially.

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Much has been written on the effects of the ECB’s easing monetary policy and its transmission mechanisms and many have done so by using the Vecto Autoregession (VAR) methodology. Especially the articles of Charles Rahal (2016), Boeckx, Dossche & Peersman (2014) and Gambacorta, Hoffman & Peersman (2014) have very similarly researched how unconventional monetary policy has affected macroeconomic variables. However, they seem to share a considerable caveat, which this thesis aims to address. Namely, they mainly study a sample period of before 2015. But, the largest expansion of unconventional monetary policy through the asset purchase programme only started in 2015. So, the most fascinating sample period, in my opinion, is from 2015 onwards. Existing literature has not had the chance to include this sample period, and therefore this thesis will include data up and until 2019 to include the large expansion of the ECB’s asset purchase programme. Additionally, this thesis contributes to the ongoing debate on unconventional monetary policy by adding to a very specific understanding of its transmission mechanism on the housing market. Existing literature, such as the three articles mentioned above, provide a more general understanding of the effects of unconventional monetary policy on the whole economy. They touch upon possible transmission mechanisms in theory, but fail to comprehensively asses the workings of one of these transmission mechanisms in detail. They either only address general macroeconomic variables such as output (GDP) and prices which are applicable to any type of market, or they asses multiple OECD countries (taking the Eurozone as one country) that are all subjected to different central banks and economic structures. This thesis aims to provide a comprehensive, specified account of the Eurozone and the ECB’s policy, on one market type, empirically assessing one transmission mechanism.

The research question of this thesis therefore is: how has the ECB’s unconventional monetary policy

through balance sheet expansion affected housing markets in the Eurozone? The focus is on the

transmission mechanism in the housing markets, especially the portfolio-rebalancing mechanism. Understanding the transmission mechanisms of unconventional monetary policy and its effect on the housing market has special societal relevance, as these are real-world phenomena which affect decisions of financial institutions, policymakers and consumers. The housing market has proven to be an important indicator for stability on financial markets, but also for consumers’ wealth. Houses are considered one of the greatest assets for consumers, which affect their financial position and financial decisions (Piazessi, 2016). And housing markets have proven to be an important investment class for financial institutions (Piazessi, 2016). It is therefore particularly relevant to study policy effects on this important and influential market. Additionally, there is substantial academic relevance to studying this subject because little is known about the effects of these far-reaching unconventional balance sheet policies. As the ECB has wandered into vastly uncharted terrain, academia must explore its impact. As discussed above, existing literature has left some caveats, and this thesis aims to improve on that. A deeper understanding of the effect of the unconventional monetary policy and its mechanism is thus

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essential for academia, financial intermediates, policymakers and consumers, but also essential to construct further theoretical models for analysis of the unconventional monetary policy.

The empirical study uses the VAR model to uncover how unconventional monetary policy has affected Eurozone housing markets, and whether this has happened through the portfolio rebalancing channel. The expectation is that the ECB’s balance sheet expansion will lead to a decreased long-term government-bond yield curve, that leads to a rebalancing of portfolios on the financial market. In this thesis the expectation is that this will eventually lead to easing financial credit standards for housing and increases in lending volumes for house purchases. This might then lead to increased housing prices. However, this thesis bears in mind the variation in the distinct housing markets throughout the Eurozone Member States and expects to see some diverse impacts of unconventional monetary policy as a consequence.

To conduct a more substantial, significant and comprehensive research of the housing market, this thesis does not only focus on housing prices, but includes several financial variables from the housing market. Loans-for-house-purchase and volume-of-loans-for-house-purchase are included as indicators of the housing market and subjected to analyses.

The remaining chapters are structured as follows: Chapter 2 reviews existing literature and explains to which section of academic literature this thesis hopes to contribute. Chapter 3 provides background information on the ECB’s balance sheet policy and the Eurozone’s housing market. Chapter 4explains the theory of transmission mechanism and portfolio rebalancing. A deeper explanation of the concepts of unconventional monetary policy, quantitative easing and the transmission mechanisms is given. Chapter 3.2 includes an extensive explanation of the portfolio-rebalancing channel, and it explains in depth the proposed pass-through channel of the hypothesis. Chapter 5 introduces the VAR methodology. It explains thoroughly how the VAR works, and which variables are chosen and why. It furthermore expands on the identification strategy of all variables included and gives information on the data sets used. Chapter 6 presents the results of the research. It firstly presents the benchmark results, and subsequently shows the results of the Granger Causality test and the Impulse Response Functions.

Chapter 7 concludes. The results of robustness checks form the Granger Causality and Johansen Integration test can be found in the appendix.

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Chapter 2:

Literature

review

There is a large body of literature which researches the effects of unconventional monetary policy across the globe, and there is a collection of articles that uses the VAR methodology to research the impact of conventional monetary policy on macroeconomic variables. These have been an important influence on the methodology and background of this thesis. However, this thesis proposes some additions to the existing literature, believing that there is room for specified and extended research on unconventional monetary policy in the Eurozone.

2.1 Unconventional monetary policy in OECD countries

Much of the empirical work regarding unconventional monetary policy has focused on a collection of OECD countries, of which most are subjected to different central bank regimes. Rahal (2016),

Gambacorta, Hofmann & Peersman (2014), and Goodhart & Hoffmann (2008) have addressed the effects of unconventional monetary policy across OECD countries. Their methods successfully analyses how unconventional monetary policy across the globe is taking on similar forms, and resulting in similar effects. However, it misses a specified assessment of how the transmission mechanism works for a particular central bank regime. Rahal (2016) and Gambacorta et al. (2014) take the Eurozone as one country, in addressing the effects of the ECB’s unconventional monetary policy. This methdology might underestimate the differences among Euro Area Member States and might lead to a generalised conlcusion which lacks specified understanding. Gabriel & Lutz (2017) focus on the United States of America and uncover how unconventional monetary policy has affected financial- and housing markets there. However, as the central banking system of the USA differs greatly to that of the Eurozone, their conclusions are not necessarily directly applicable to the Eurozone. A specified empirical research on the effects of ECB’s unconventional monetary policy on Member States of the Eurozone is therefore needed.

However, these artciles have greatly inspired the VAR methodology for this thesis. For example, Rahal’s (2016) methodology has been a great example, as he uses the VAR model with five variables revolving around a core housing market VAR model. He very similarly looks at the effects of a Total Assets increase on core variables in housing markets. Interestingly, Rahal finds the least effect in the Eurozone, which evokes a challenge to uncover how transmission of unconventional monetary policy is working in the Eurozone. However, Rahal uses data up to 2015. The asset purchase programme of the ECB only started its great expansion from 2015 onwards. This thesis therefore uses Rahal (2016) as inspiration, but expands on this research by adding more recent data. Gambacorta et al. (2014) also

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lack post-2015 data, allowing room for improvement and expansion on their work. However, their measure to condition on financial turmoil, their identifying restrictions and lag-lengths have been of great influence for this thesis.

2.2 General price and output effects

Most existing empirical research focusses on the effects of asset purchase programmes on general price and output effects of an economy. For example, Boeckx, Dossche & Peersman (2014), Gambacorta, Hofmann & Peersman (2014), Pascual & Wieladek (2016) and Eser & Schwaab (2016). These articles, in a sense, focus on the intended consequences of unconventional monetary policy. Central banks aim to increase output and prices through their asset purchase programmes, thus these articles mostly research whether this has been successful. They therefore contribute to a general understanding of the effectiveness of unconventional monetary policy on economies as a whole, but lack the assessment of specified markets and possible unintended consequences such as financial stability risk caused by soaring housing prices or portfolio rebalancing. Additionally, all of them perform analysis on data no later than 2016, which results in the same caveat already described above. For example, Boeckx, Dossche & Peersman (2014) also used the VAR method with a similar sample – meaning it is purely focused on the Euro Area, but only use data from the period 2008M1 to 2013M12, focussing purely on output and prices. This thesis expands and adds to their research with an extended dataset and more specified understanding focused purely on housing markets and the portfolio-rebalancing channel. Interestingly, Boeckx et al. (2014) find that unconventional monetary policy seems to affect individual Euro Area Member States differently. This inspired this thesis to include data for each Eurozone country individually to discover whether a heterogeneous effect is also present with post-2016 data.

2.3 Literature on portfolio rebalancing

There are several researchers who specify their unconventional monetary policy research by addressing the transmission channels through which unconventional monetary policy works on society. Most theoretical articles (for example, Demertzis & Wolff (2016), Goodhart & Hoffman (2008) and Gern, Jannsen, Kooths & Wolters (2015)) agree on several existing transmission channels. The signalling channel, exchange rate channel and portfolio-rebalancing channel, of which the portfolio-rebalancing is conceived to be one of the most influential. Demertzis & Wolff (2016) and Gern et al. (2015) both conclude that unconventional monetary policy definitely has an effect on long-term interest rates, which mostly runs through the signalling and portfolio-rebalancing channels. However, these conclusions have not been tested empirically in these studies. There is literature which empirically tests for the portfolio-rebalancing channel, such as Pascual & Wieladek (2016), Gokmenoglu & Hadood (2018) and

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rebalancing theory is visible in their data, and conclude on the presence of portfolio-rebalancing. For example, by including the long-term yield curve of sovereign bonds in the VAR methodology, Pascual & Wieladek (2016) have found a method for measuring the presence of the portfolio-rebalancing channel. If the portfolio-rebalancing mechanism is behind the reduction in bond yields, one should observe a reaction in the yields at longer maturity by the asset purchase programme. They find evidence for a strong portfolio-rebalancing channel, and slightly weaker evidence for the existence of the signalling channel in the Eurozone. Albertazzi et al. (2016) examine the portfolio rebalancing of broad financial sectors, based on national financial account sectors, in the Eurozone. Their focus is mainly on securities in a broad sense. Interestingly, they find APP-related portfolio rebalancing on the financial markets to be present only for asset holders residing in vulnerable countries. And when looking at whether this has transmitted into the real economy, they see a slight increase in lending volumes only in the countries that are not vulnerable. Presumably, there is no decisive conclusion based on empirical results present about the existence of portfolio rebalancing. Therefore, this thesis would like to participate in the debate, by empirically assessing whether portfolio rebalancing and long-term yield curve dynamics have played a role for the Eurozone housing markets. Furthermore, articles such as Pascual & Wieladek (2016) and Albertazzi et al. (2016) focus their empirical research on the existence of these transmission mechanisms, but lack a comprehensive analysis of the societal effects resulting from this. Therefore, this thesis aims to fill this gap by not only empirically assessing the presence of portfolio rebalancing, but also assessing its possible consequences on housing markets.

2.4 Contribution

Although the articles above are of great inspiration to the methodology, background and approach of this thesis, further research is required for a few reasons and that research forms the basis of this thesis. Firstly, one seemingly shared caveat is that all these articles focus on a sample period before the largest expansion of the ECB’s balance sheet, and before the large increase in housing prices in the Euro Area. As is discussed in chapter 3, the largest expansion of ECB’s balance sheet happened after the introduction of their extended APP in 2015. These articles could not include the impact of the ECB’s extended asset purchase programme. This thesis performs VAR analysis of unconventional monetary policy data until 2020, which includes the period of the largest expansion of the ECB’s balance sheet and therefore contributes to a better understanding of the effects of the asset purchase programme. Secondly, further debate of the portfolio-rebalancing theory is needed, as there have been empirical studies that contradict each other and theoretical studies that hypothesise the evident existence of portfolio rebalancing instigated by the APP. This thesis therefore aims to contribute to the discussion by empirically assessing whether portfolio rebalancing through yield curve dynamics plays a role in Eurozone housing markets. Thirdly, there is not yet a specified assessment of the impact of the asset

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purchase programme on the Euro Area housing markets. There have been studies on the effects on the housing market, focussing on OECD countries (e.g. Rahal, 2016). Or there have been studies focusing on individual Euro Area Member States, but assessing only output and prices (e.g. Boeckx, Dossche, Peersman (2014)). However, a comprehensive study on the effects of the ECB’s asset purchase programme on Eurozone housing markets is lacking. This thesis fills this gap, by giving a specified account on two terms: this thesis specifically assesses the effects on one market – the housing market – instead of analysing the general levels of output and prices. And this thesis empirically researches one transmission mechanism – the portfolio-rebalancing channel – and assesses in depth its societal impact.

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Chapter 3:

Background and

concepts

3.1 Background: ECB monetary policy 2003-2019

Since the introduction of the Euro, the Euro Area has been subject to different periods of economic prosperity and downfall, which can be categorised into four phases. Each phase has seen different policy reactions from the ECB, expressed as different monetary policy decisions. Figure 2 derives from Hartmann & Smets (2018), who assessed the first 20 years of ECB monetary policy. It shows the four different phases that the Euro Area economy has passed through in the last 20 years regarding economic fluctuations and policy measures: there have been crises, economic upturns, downturns and periods of high volatility. And in the last phase, a policy period marked by unchartered terrain. The first graph shows important macroeconomic variables that give insight into European business cycles, like real GDP growth and consumer price inflation index. The second graph shows the subsequent monetary policy reactions per phase. It is interesting to see how phases III and IV clearly display how monetary policy entered uncharted terrain, because it presents the large drop in ECB policy rates and the magnificent increase in monetary policy operations.

In order to assess the impact of the ECB’s balance sheet expansion on the Eurozone housing market, it is useful to understand the background and history of the ECB’s (unconventional) monetary policy. Whether it be the economic upturn between 2003 and 2007, or the low-inflation recovery from 2013 onwards, each phase has known different ECB monetary policy objections. This section shows a few highlights of the monetary policy decisions in the first 20 years of the Euro, which provide a basis for understanding why the ECB started its unconventional monetary policy, and what consequences are possible in terms of transmission mechanisms and impact on the Eurozone’s economy.

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Figure 2: four cyclical phases of ECB’s monetary policy in the first 20 years of the Euro (1999-2018)

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Phase I: Introduction of the Euro

Ever since the establishment of the European Economic Community (EEC) in 1958, Europe has aimed to create an economic integrated market which is able to compete with the USA and Japan (Hamori & Hamori, 2010). Subsequent decades saw willingness to eventually establish an Economic and Monetary Union (EMU), but full integration tookmore than 40 years after the establishment of the EEC. In 1999, the European Central Bank could begin its financial operations and therefore accomplish the aim of an Economic and Monetary Union amongst European nations (Hamori & Hamori, 2010). The introduction of a unified currency for 11 countries in 1999 marked the start of unified monetary policy and the start of the ECB as an important, influential European institution. The ECB’s goal was to achieve price stability for its Eurozone Member States. And for this, it adopted a two-pillar strategy which dominated the first phase of European monetary policy (Hamori & Hamori, 2010). The first pillar was a reference value that aimed for a 4.5% year-on-year growth of M3 money base; the second pillar was price stability which aimed for a harmonised index of consumer price (HICP) growth of less than 2%. However, the ECB revised its two-pillar system in 2003, marking the beginning of the second phase.

Phase II: Growing imbalances

Phase II took place between 2003 and 2007; a period in which the Euro Area experienced an economic upturn. However, suspicion of asset bubbles and a build-up to imbalances was present. At the beginning of this period, the ECB kept interest rates steady for nearly two and a half years (Hartmann & Smets, 2018). The ECB started increasing interest rates steadily around 2006, which can be seen in Figure 2. Balance sheet policies were not used much at that time, and the short-term interest rate was seen as the main monetary policy tool. 2003 was also the period in which the ECB (re)formulated its year-on-year aim for the Harmonised Index Consumer Prices inflation rate to be ‘below, but close to 2%’ in the medium term. The specific formulation of this aim was a result of a compromise that meant a precise definition and aim, whilst not sticking to one unwarranted inflation target (Hartmann & Smets, 2018). Interestingly, a lower bound for the short-term interest rate was not defined. The overall economic outlook was positive during the first half of this phase, with exports increasing because of the new world economy dynamic1_{. By the end of 2005, the first ECB analysis reports suggested that upside risks were}

increasing. As a result, the ECB started raising the policy rate. Overall, this phase was characterised by increasing expansion of economic activity, expansion of the money and credit growth and a long period of relatively low interest rates (Hartmann & Smets, 2018).

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Phase III: European twin crises

Phase III took place between august 2007 and June 2013, and is known for Europe’s twin crises: the financial crisis and the sovereign debt crisis. The European twin crises meant that the financial crisis of 2007-2009 morphed into a sovereign debt crisis in 2010-2013 (Hartmann & Smets, 2018). Both had substantial impact on the ECB’s monetary policy decisions. As can be seen in Figure 2, when the financial crisis hit hard in 2008, the ECB dropped its policy rate very quickly to very close to zero. Shortly after that, the ECB broke new ground by starting the first very-long-term liquidity operations. The European operational framework took centre stage as monetary policy tool. The operational framework consisted of open-market operations, standing facilities, minimum reserve requirements and the first asset purchase programmes (Hartmann & Smets, 2018). Market operations were intended as complementary to conventional interest rate policy, and were not intended to become the dominant tool for monetary policy. From October 2008 onwards, the ECB provided unlimited access to liquidity with a pre-specified interest rate, just as long as the banks could provide collateral (Boeckx et al., 2014). With these decisions, the expansion of the ECB’s balance sheet started to set in (see Figure 3). In the following years, the collateral requirements loosened, allowing banks to refinance less liquid assets and expanding the ECB’s balance sheet even further.

Figure 3: expansion of the ECB’s balance sheet 1999-2018

Note: The figure shows how the ECB’s balance sheet has expanded greatly during the period of the existence of the Euro. € 0 € 500,000 € 1,000,000 € 1,500,000 € 2,000,000 € 2,500,000 € 3,000,000 € 3,500,000 € 4,000,000 € 4,500,000 € 5,000,000 Janu ary 2 000 Janu ary 2 001 Janu ary 2 002 Janu ary 2 003 Janu ary 2 004 Janu ary 2 005 Janu ary 2 006 Janu ary 2 007 Janu ary 2 008 Janu ary 2 009 Janu ary 2 010 Janu ary 2 011 Janu ary 2 012 Janu ary 2 013 Janu ary 2 014 Janu ary 2 015 Janu ary 2 016 Janu ary 2 017 Janu ary 2 018 Janu ary 2 019

ECB CONSOLIDATED BALANCE SHEET: TOTAL

ASSETS 2000-2019

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The emergence of the sovereign debt crisis in 2010 meant a change in the market operations. Before the sovereign debt crisis, the market operations mainly focused on money markets and other bank-funding markets. But, when it became clear that a sovereign debt market was emerging in 2010, the ECB started to address malfunctioning government bond markets and extended the liquidity operations and long-term refinancing operations (LTROs) beyond one year (Hartmann & Smets, 2018). The balance sheet of the ECB continued to expand. Between June 2009 and October 2012, the ECB carried out two Covered Bond Purchase Programs (CBPPs) which meant purchases of €76.4 billion issued by banks in the Euro Area (Boeckx et al., 2014). From 2010 onwards, the ECB started to intervene in the secondary market through its Securities Markets Program (SMP).

The Euro and the Eurozone were experiencing a period of instability and tensions, and there was even talk of some Euro-members, like Greece, having to leave the Eurozone in order to sustain the Euro (Micossi, 2015). However, the ECB was not prepared to let that happen. So, 2012 marked a turning point for European monetary policy, when Draghi, in the height of the European debt crisis, announced that the ECB was prepared to do “whatever it takes to preserve the Euro”2_{. ECB monetary policy entered}

crisis management mode, and conventional monetary policy boundaries were surpassed. With this announcement, the ECB de facto asserted itself as lender-of-last-resort to preserve the Euro, and showed no fear of surpassing convenient matters to do so (Micossi, 2015). There was also a shift in the ECB’s monetary analysis towards identifying and addressing the impairments in the transmission mechanisms of monetary policy (Hartmann & Smets, 2018). There was a need for deeper understanding of the bank lending channel and differences among financial structures. For example, the Bank Lending Survey (BLS) became more important to gain understanding of restrictions in credit markets (Hartmann & Smets, 2018). It became increasingly clear that monetary transmission remained hampered by lingering instability among banks (Hartmann & Smets, 2018). This constrained the flow of credit to the economy and thus imposed obstacles for monetary policy transmission. The main reason being that bank recapitalisation or resolution processes progressed very slowly, especially in fiscally weak Member States (Hartmann & Smets, 2018). A bail-out of two Irish banks followed, for example. These financial tensions and fiscal weakness resulted in a drop in economic and consumer confidence, slowing down the Euro Area economy rapidly.

By the end of phase III, the combination of standard (short-term interest rate) and non-standard monetary policy responses slowly began to show beneficial impact on interbank market spreads and financing conditions, for both the corporate sector and households (Hartmann & Smets, 2018). For example, Euro bank-lending rates to households started to decline, making it easier for households to obtain credit. While this brought some relief, it was not enough to ensure highly needed balance sheet

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repair in many Euro Area banks. The crisis was not yet over.

Overall, phase III was characterised by the ECB entering into uncharted territory of unconventional monetary policy. The ECB showed its will as lender-of-last-resort unafraid to use far-reaching measure to preserve its currency. Meanwhile, recovery was slow and differences between Euro Area Member States became clearer, giving rise to inter-Euro-Area tensions.

Phase IV: Deflationary risk and balance sheet expansion

Phase IV concerns the period between June 2013 and today, 2020. This period is characterised by deflationary risk and slow recovery after the financial crisis, which led to further expansion of unconventional monetary policy and large increases in the ECB’s balance sheet (see Figure 3).

Because the Euro Area was still recovering slowly from the twin crises, ECB’s policy rate remained at an all-time low. While in the pre-crisis period the policy rate seemed to be a robust and workable mechanism to boost inflation, the ECB now found itself in a completely different situation. Phase III had proven that the ECB was not afraid to use unconventional measures and, as it seemed, phase IV would be no different. It became increasingly clear that the transmission of the easing ECB key policy rates remained impaired and considered unable to boost inflation towards its 2% target. Around 2013, the medium-term outlook for inflation continued to worsen, and monetary policy by then had still not been transmitted to households and firms in stressed Euro Area Member States (Hartmann & Smets, 2018). The ECB’s balance sheet even shrank, and credit growth remained negative because of ongoing deleveraging. Thus, a continuation and expansion of unconventional measures was needed.

In phase IV, an anticipated problem arose: the zero-lower bound of interest rates was approaching. The zero-lower bound is a recurring subject in macroeconomics. In Japan in the early 90s, a financial bubble collapsed leaving Japan with low inflation, low growth rates and interest rates close to the zero-lower bound (Gerlach & Lewis, 2013). This meant the central bank could no longer lower the interest rate, and was forced to resort to other – unconventional – measures. According to macroeconomic theory, the zero-lower bound exists to avoid negative nominal interest rates, which might lead to agents holding money in the bank, rather than investing in interest-bearing assets (Gerlach & Lewis, 2013). This way, the easing transmission mechanism of interest rates stops. Investment and economic growth will no longer be stimulated anymore, because agents will just hoard money in the bank and receive interest on that (Gerlach & Lewis, 2013). As discussed above, after the collapse of Lehman Brother in 2008, the ECB sharply reduced its policy rates, and they have remained on a low level ever since (see Figure 2, Hartmann & Smets, 2018). Overcoming the zero-lower bound has been one of the reasons for the ECB to embark on extensive unconventional monetary policy. Because the first round of unconventional policy measures in phase III were not able to erase the looming threats of

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deflation, the ECB extensively increased its unconventional measures in phase IV.

The combined goal of unconventional measures was to lower financing costs for banks and financial markets and ease financial conditions in a broad sense. To achieve this, Draghi announced a comprehensive, far-reaching monetary policy strategy starting in June 2014. It comprised of three important elements: firstly, the ECB would enter the negative interest rate territory. The deposit facility rate reached -0.2% in 2014. Secondly, they embarked on a renewed round of credit easing measures, with Targeted Longer-Term Refinancing Operations (TLTROs). These were complemented by a launch of Corporate Sector Purchase Programme (CSPP) and Asset-Backed Securities Programme (ASBSP) in 2016, through which the ECB directly impacted the term premia of private assets. Thirdly, and most importantly for this thesis, in January 2015 the ECB implemented an expanded Asset Purchase

Programme (APP). This meant monthly purchases of private and public sector securities worth €60

billion (Hartmann & Smets, 2018). The aim was to put downward pressure on the long-term yield curve, via the portfolio-rebalancing channel and the signalling channel. A flattened yield-curve would mean lower long-term interest rates. This meant a new way for the ECB to boost economic activity and hopefully reach their inflation aim. It also meant a steep increase in the ECB’s balance sheet volume. To date, the expanded APP programme exists of four types of securities packages.

• The CSPP: corporate sector purchase programme (€183,611 million holdings, December 2019).

• The PSPP: public sector purchase programme (€2,098,404 million holdings, December 2019). • The ABSPP: asset-backed securities purchase programme (€28,493 million holdings,

December 2019).

• And the CBPP3: covered bond purchase programme (€263,660 million holdings, December 2019).

Figure 4 shows the securities held for monetary policy purposes, and the evolution of the extended APP between 2014 and 2018. A clear and steep expansion of the ECB’s balance sheet followed from the extended asset purchase programme. In 2014, the APP was responsible for €217 billion in securities held by the ECB for monetary policy purposes. This already seems like a substantial amount, however, due to the growth of the APP, the ECB holds €2,651.3 billion in securities in 2018 (ECB commentary balance sheet, 2018). The Euro system total assets augmented to a total of €4,702.7 billion by the end of 2018. As can be seen in Figure 4, the largest growth is due to the public sector purchase programme (PSPP). This programme has seen a tremendous increase from 2015 onwards. Figure 4 thus illustrates that the ECB has purchased securities in many sections of the financial market, enlarging its own balance sheet and pushing more and more liquidity into the financial markets.

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Figure 4: securities held for monetary policy purpose in billion euros, December 2018.

Source: ECB commentary consolidated balance sheet, 2018.

Overall, this period had been characterised by the ECB’s extended unconventional measures to overcome the zero-lower bound on interest rates whilst addressing deflation risks. Though the Euro Area’s economy slowly strengthened, the underlying inflation still did not reach the 2% aim. This resulted in the ECB venturing into unchartered territory, such as lowering the deposit facility rate to negative numbers. One could argue that the ECB is reaching the limits of its monetary tool kit as we know it. The “whatever it takes” stance of Draghi might be turned into the “whatever we can do” policy mandate (Janus Henderson Investors, 2019). Although general inflation is not increasing, the housing market has known some noteworthy changes over the past period. The next section will discuss the changes in the housing market.

3.2 Background: Euro Area Housing Market

From 2014 onwards, the housing prices in the Eurozone increased steadily every year. Figures from Eurostat confirm that housing prices, as measured by the HPI rose by 4.2% in the Eurozone in 2019Q2 compared with 2018Q2 (Eurostat, 2019). In order to fully comprehend the transmission mechanism of ECB’s balance sheet policy on the housing market, it is important to understand what incorporates the Euro Area housing market and which trends have been visible in the sample period. For this thesis, the housing market consists of factors revolving around house price index (HPI), but also factors concerning the financing of the housing market. Factors such as interest rates, mortgage rates and

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loans-for-house-purchase3_{and volume-of-loans-for-house-purchase}4_{are considered proxies that gather}

information on the housing market. The section below will shed light on the macroeconomic relevance of the housing market, what elements the housing market consists of and which will be the focus of this thesis, and the differences in the housing markets of the seven Euro Area.

3.2.1 Macroeconomic relevance of the housing market

The financial crisis and the housing bubble leading up to it serves as a reminder of the importance of the housing market in the macroeconomic discussion. Assessing housing market volatility in light of monetary policy can provide valuable insights into the transmission channel of monetary policy shocks (Piazzesi & Scheinder, 2016). The three most important reasons for this are: firstly, housing-related economic activity represent a large share (between 5 and 10%) of a country’s GDP and employment. Housing-related economic activities are considered elements such as construction, real estate trading and financing, mortgages, notaries, movers etc (Hilbers et al., 2008). Secondly, residential property takes up a large portion of households’ assets. It therefore is an important determinant of households’ wealth, and influences consumption and savings decisions. Housing prices have a substantial impact on consumption and collateral for borrowing (Hilbers et al., 2008). Fluctuations in housing prices may therefore have a significant impact on inflation and demand. When the housing market experiences an upturn period, this might mean that households’ net worth increases (ECB, 2003). Thirdly, volatile housing prices may be a threat to economic and financial stability. The role of the housing market in booms and busts have shown that the housing market has a large influence on shaping the business cycle and financial cycle (ECB, 2003). Fluctuations in the housing market may be an omen for fluctuations in financial stability. When the underlying determining factors of housing prices are better understood, potential over-valuation and price bubbles might be avoided.

Thus, housing prices play a pivotal role in determining the business cycle, which make them a regular subject in macroeconomic debate. For full comprehension, a short assessment of key features of the housing market is essential. These factors are specific to the housing market, which really set the housing market apart from other consumer products. Also, these factors differ greatly between Member

3_{The loans-for-house-purchase definition is used here as it is used by the ECB in several documents, such as all economic}

bulletins and the Bank Lending Survey. Loans-for-house-purchase includes loans for investing in houses, either for personal use or renting. It also includes loans for building houses, refurbishing houses, buying a piece of land or simply buying an existing dwelling. The dwellings may or may not be collateralised in various forms. This definition is derived from: Adilad, R. & Falagiarda, M. (2018). Developments in mortgage loan origination in the euro area. ECB Economic Bulletin, issue 5, pp. 38-40.

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States, which contribute to the difficulty of comparing housing markets over time and across countries. For this research, it is therefore important to understand these underlying factors, and to take them into account.

Hilbers et al. determine the following factors as main aspects of the housing market. Firstly, there is vast heterogeneity in products: no two houses are completely identical, which makes (price) comparison difficult. Secondly, transaction costs are very high and turnover is relatively low. Buying or selling a house is a big decision, which takes time and requires high transaction costs. The infrequency of housing transactions gets in the way of regular market price assessments (Hilbers et al., 2008). Thirdly, the conditions on sales vary: prices result from bilateral negations in which secondary conditions play a role. Fourthly, taxation and subsidies for house ownership differ largely between countries and may affect housing market conditions. Examples are varying real estate taxes, housing subsidies or fiscal deductibility of mortgage interest payments. A study by C. Sahin (2016) found that mortgage rate deductibles generally lead to higher prices on the housing markets (Sahin, 2016). With this, empirical results suggest that interest rate deductibility can be an important monetary policy tool which changes house prices in the real economy. Therefore, differing taxation policies among Eurozone Member States might result in differing housing markets. Lastly, and most importantly for this thesis, financing conditions change over time and across countries. For example, the presence of mortgage finance institutions, options to use real estate as collateral, and regulation on housing finance may differ substantially among Euro Area Member States.

These factors may make comparison across countries and over time more complex, but also allows for interesting analysis in this research. As can be seen in the results below, each Euro Area Member State reacts differently to the same ECB monetary policy. Understanding the differences allows for a better comprehension of the monetary policy transmission mechanism.

As will be discussed in the methodology section, data availability is a common problem in housing market research. Real estate markets are among the less transparent markets, and data availability across countries may differ (Hilbers et al., 2008). This has influenced sample and variable choice of this research as well. The key to researching housing markets is understanding the most important determining factors and transmission mechanisms behind them.

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3.2.2 Determining factors for housing demand

Key determining factors for households’ demand on the housing market are (Hilbers et al., 2008): • Household disposable income;

• Interest rates.

Interest rates affect mortgage rates, which encapsulate financing costs for house purchase. A housing stock’s affordability is often measured as the mortgage as a share of the disposable income (Hilbers et al., 2008). So, mortgages and disposable income determine demand to a large degree. Interest rates, be it short-term or long-term, have an important effect on the affordability of mortgages. Generally, the lower the interest rates go, the lower the costs of obtaining a mortgage will be, which increases demand for house purchase. This makes interest rates an important determining factor for households’ demand on the housing market.

Moreover, like other assets, house prices are interest-rate sensitive and respond to changes in monetary policy (Piazessi & Schneider, 2016). Therefore, house prices and mortgage rates play an important role in the transmission of monetary policy impulses to the economy. In general, a decrease in interest rates should lead to an increase in housing market demand, and thus an increase in housing prices (Piazessi & Schneider, 2016). As will become clear during interpretation of the results, this theoretic statement provides one of the bases for this thesis.

3.2.3 The impact of policies

The functioning of the housing finance sector is thus a key determinant in housing market developments (Hilbers et al., 2008). To a large degree, housing transactions are conducted with credit from banks or other financial institutions. Conditions in the financial sector, such as interest rates and the APP programme, may determine the ease and cost of funding residential property purchase. Monetary policy affects the functioning of the finance sector, and the finance sector affects the price of mortgages and therefore the demand for houses.

There is a range of policies which affect the housing markets: fiscal policy, supervisory policy, competition policy etc. This thesis dives deeper into the effect of monetary policy on the housing market. As discussed above, monetary policy may affect short-term interest rates directly (policy rate), or affect long-term interest rates indirectly via unconventional policy measures (Hilbers et al., 2008). This influences the demand side of the housing market (e.g. mortgage rates), and the supply side (e.g. costs of borrowing for developers).

Each policy has its own channel via which it might affect the housing market. For example, fiscal policy might affect income, which affects demand for housing. The main channel via which

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monetary policy affects the housing market, is the interest rate (Hilbers et al., 2008). Conventional monetary policy influences the short-term interest rate, unconventional monetary policy tends to influence the long-term interest rate. Figure 5 comes from Hilbert et al. (2008) and shows different kinds of policy which might influence housing demand and supply. This thesis focusses on the effect of the monetary policy channel. However, it is important to understand which other policy effects may be present. For example, as briefly discussed above, tax policy might play an important role on the housing market. Many tax policies in OECD countries tend to favour housing over other investments, and therefore offer tax reliefs such as mortgage rate deductibles or subsidies for housing investments (Andrews, 2010). When a country’s tax system favours owner-occupied housing, this might have an increasing effect on housing-demand and therefore on its prices. Lower user costs can account for higher overall home values (Piazzesi & Schneider, 2016). As tax policy on housing markets differs across Eurozone Member States, this might contribute to divergent housing prices whilst subjected to the same Eurozone macroeconomic policy (Andrews, 2010).

Figure 5: key policy effects on housing market demand and supply.

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3.2.4 Different demand and supply factors among Euro Area Member States

As the Euro Area is subject to the ECB’s policy, Euro Area Member States are subjected to the same monetary policy rules. However, Member States can differ largely in their fiscal policy, structural policy, or legal framework and social preferences with regard to home ownership (Hilbers et al., 2008). This accounts to very different housing-demand situations across countries within the same Monetary Union. In order to assess differences in the effect of the ECB’s balance sheet policy on housing markets in the different Euro Area countries in the sample, the following factors are generally considered to contribute to different transmission of unconventional monetary policy on housing markets among Member States.

Firstly, on the supply side, the capitalisation of banks in that country contribute to the success of monetary policy transmission. Taken from previous literature, such as Boeckx et al. (2017), it is generally thought that countries that have weakly capitalised banks will react less to ECB balance sheet expansion. Economic adviser and head of research at Bank for International Settlements (BIS) Song Shin, pointed out the relevance of banks’ capitalisation for monetary policy transmission in 2016. The better a bank is capitalised, the more a bank is able to lend out its own funds (Song Shin, 2016). And, a better capitalised bank is also able to borrow more and on better terms from its creditors, such as from the ECB. So, if the ECB’s objective is to increase loans and credit to consumers, well capitalised banks will be able to do so better than weakly capitalised banks (Song Shin, 2016). The general expectation is therefore that countries with well capitalised banks will experience a larger shock in the housing market as response to the ECB’s balance sheet expansion.

Secondly, the degree of home ownership might have an effect. Wealth effects associated with owning a house might grow during economic upturns, resulting in higher overall housing prices (ECB economic bulletin, 2018). Also, the higher the home-ownership ratio, the greater the exposure to financial volatility and excessiveness of house prices. Koeniger & Ramelet (2018) found, through empirical research, that monetary policy transmission changes across countries with different levels of homeownership. Home ownership has a drastic impact on the balance sheet of households, as it usually presents the largest asset on their balance sheet (Koeniger & Ramelet, 2018). Monetary policy might change the value of these assets, and therefore change households’ consumption decisions. They find that in countries with a high home-ownership ratio, the consumption response of non-housing products is larger than countries with a low home-ownership ratio. This suggests that monetary policy transmission would thus be enhanced in countries with high home-ownership ratios.

Thirdly, on the supply side, housing completions and building permits might affect the supply of housing, which in turn affects the net housing prices. Based on Eurostat calculations, there is a large difference in the amount of housing completions and building permits over the years. Less building permits and housing completions means lower supply of houses, which would generally mean higher

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land and housing prices (Absere & Huffman, 1999). Absere & Huffmann (1999) have empirically shown that land prices increase, as a municipality is more willing to grant building permits. When a municipality, or region, is resistant to the idea of further residential planning and growth, demand decreases and price of land (and subsequentially, of houses) declines. Eurozone Member States are able to individually determine residential growth and building permits, which thus might result in divergent land and housing prices across countries.

As can be seen in Figure 6 housing completions and building permits are lower in Spain and Italy than in Germany or France. This might affect prices because the supply of new dwellings is lower in Spain and Italy, potentially pushing the housing prices upwards if demand is high. However, it might also reveal information about the hampering situation of the Italian and Spanish housing market. A low number of housing completions could mean that investment in the housing market in Spain and Italy is lower than in Germany, France or The Netherlands. This might reveal very relevant information on the differences between the housing market of these Member States. For example, a Member State with low GDP and low aggregate demand might also be subject to a low number of housing completions, because demand for new dwellings is generally low. One could thus read Figure 6 ambiguously: it either provides information on low supply of new dwellings on the Spanish and Italian housing market, or it encompasses low demand and inertia of their housing markets.

Figure 6: building permits and housing completions 1999-2017.

Note: the figure shows the building permits and housing completions for 6 Eurozone Member States, in the period 1999-2017. The figure might reveal that building permits and less housing completions means lower supply of housing, or it reveals minimal economic growth in those countries.

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It is important to note that the factors discussed above are merely consideration factors which provide information on the differences between the housing markets of the Member States in the sample. These factors are not necessarily the cause of demand or supply changes, or the cause of price-changes. It is merely a way of describing the situation on the housing market, and it only expresses a factor which could be taken into consideration in discussing the results As can be read in chapter 6, these factors could provide useful background information when analysing the differing results of the impulse response functions. It is therefore appropriate to have discussed them now, so that the results can be interpreted with greater ease.

3.2.5 Current situation on the housing market: which indicators to follow

The state of the housing market is, by nature, difficult to observe. It can, however, be assessed from different perspectives to gather a complete picture. For this thesis, I consider several elements of the housing market. Not only the house price index, but also interest rates, loans-for-house-purchase and loan-volume shed light on the general economic outlook of the housing market. As all of these measures contribute to understanding the housing market, it is relevant to discuss the current situation (in 2019)5

of these variables. This section will therefore break down the state of the Euro Area’s housing market. The focus will be on the post-crisis situation, and most information is gathered from ECB’s reporting on housing markets and their Bank Lending Survey.

Across the whole Euro Area, house price index growth has been a defining characteristic. Ever since 2013, housing prices have been increasing, with the noteworthy exception of Italy. In Italy, prices have been constantly decreasing since the beginning of the financial crisis (Marek, 2019). The pick-up of residential investment followed a bit later, in 2014 (Marek, 2019). Interestingly, based on the ECB’s standards, the current house price index upturn is relatively mature, as it exceeds half of the average duration of previous upturn (ECB, 2018). The length of the current upturn of residential investment and housing prices is about 4 years in 2018. Prices have surpassed their pre-crisis peak and are expected to continue their peak at a moderate pace (ECB, 2018). In this sample, all countries except for Italy have experienced growth in house prices from 2014 onwards. Ireland and the Netherlands experienced the largest growth rates in the last few years6_.

The ECB annually conducts a Bank Lending Survey (BLS) in which a number of ad hoc

5_{When ‘current situation’ is mentioned, it refers to the situation up to the end of 2019, when this thesis was}

written.

6_{For complete information, see ECB Economic Bulletin 2018, volume 7. Retrieved from:}

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questions are asked to Euro Area respondents, in order to assess the situation on the financial markets, bank lending access and the impact of the ECB’s asset purchase programme (BLS, 2019). One of the noteworthy developments that the Bank Lending Survey reports on, is easing credit standards to loans-for-house-purchase and more favourable funding conditions across the Euro Area, from 2014 onwards. Easing credit conditions is another factor of influence on the state of the housing market, and an important variable of consideration in this thesis. Easing conditions are set by commercial banks, which are in turn influenced by monetary policy. Banks adjust their credit easing standards based on monetary policy developments.

The BLS asks ad hoc questions to banks about the impact of the ECB’s APP on their credit easing standards, every quarter. In 2019Q3, the commercial banks’ response to these questions was that the APP has indeed contributed to an improvement on their liquidity position and market financing conditions (BLS, 2019). This would suggest that the APP affects credit easing standards via the liquidity position of commercial banks. Euro Area commercial banks were also asked about the impact of the APP on bank lending volumes. In 2019Q3 they reported a positive impact of the APP on the volume of loans-for-house-purchase (BLS, 2019). The surveyed banks specifically report that the APP had a positive impact on their liquidity position. In particular, the APP’s impact was largest on easing credit terms for loans-for-house-purchase, and a positive impact on lending-volumes7_{for house purchase. This}

suggests that the ECB’s balance sheet expansion caused by the APP strongly affects the lending volumes and loans-for-house-purchase, as researched by the ECB Bank Lending Survey 2019. This is strong evidence in favour of the hypothesis of this thesis. Namely, that ECB’s unconventional monetary policy affects Eurozone housing markets because increased liquidity is transmitted into greater lending volumes, and decreasing interest rates on loans-for-house-purchase.

The BLS also reports that the number of Euro Area citizen respondents intending to purchase or build a house gradually increased from 2014 in the Euro Area as a whole (ECB state of the housing market, 2018), which means that demand for housing has been increasing. The BLS reports that rising demand for housing has been supported by income developments and favourable financing conditions, such as low interest rates. This can be seen in the declining loans-for-house-purchase interest rates, which have declined more than 130 basis points since 2013 (BLS, 2019). This has given rise to higher demand for mortgages, the main subject of this thesis.

Furthermore, a noteworthy development has occurred which underpins the theory that the portfolio-rebalancing channel of monetary policy transmission contributes to favourable house purchase conditions. BLS reports that housing demand is likely to have been increasing because of investment motives. Housing has become more attractive as an investment class (ECB state of the

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housing market, 2018). This can be seen by the increasing return on housing-related investment in the Euro Area, compared to alternative asset classes. This is in line with the portfolio rebalancing theory, explained in chapter 3. Private and institutional investors are rebalancing their investment portfolio, as a result of the ECB’s balance sheet policy. The ECB’s balance sheet policy decreases long-term yield, forcing investors to seek alternative investments. This resulted in an increase in relative attractiveness of investment in residential property relative to alternative assets (ECB state of the housing market, 2018). ECB’s economic bulletin reports an increasing flow of investment into real estate funds. This directly supports the hypothesis that the ECB’s balance sheet expansion results in portfolio rebalancing, which in turn results in increasing housing demand. Figure 7 shows the increase of investment flows in the real-estate market. This graph comes from the ECB economic bulletin 2018, volume 7.

Figure 7: flows into real-estate funds, 2012-2018.

Note: The figure shows a clear upward trend in investment in real estate from 2014 onwards. This is in line with the hypothesis of portfolio rebalancing.

Source: ECB statistical data warehouse, 2020.

The flow of funds into the real-estate market is also considered as a measure for the situation of the housing market, in this thesis. Regarding the portfolio-rebalancing channel, an important step in the transmission mechanism is the rebalancing of investment portfolios towards more riskier assets. These riskier assets include the real-estate market. The increased flow of investment towards real-estate funds might cause demand on the housing market to increase (Battistini, Le Roux, Roma, & Voudras, 2018).