The lowering of the interest rate by the Bank of Israel in recent years is responsible for less than 10% of the cumulative rise in housing prices over the past decade, according to a study published today by the Bank of Israel. The study, conducted by Bank of Israel Research Department economist Dana Orfaig, isolates the net effect on real estate prices of the lowering of the interest rate by the Bank of Israel. It found that a 1% cut in the interest rate was responsible for a 1.1% change in real housing prices (2.58% in nominal prices).
It can therefore be concluded that if housing prices have risen by over 100% since 2007, while the Bank of Israel's interest rate fell from 4.25% to 0.1% during this period, the net effect of the lowering of the interest rate on housing prices was marginal, and probably less than factors such as the low supply of housing units and rises in pay and disposable income during those years. The study's findings are consistent with the Bank of Israel's traditional view that it does not bear the primary responsibility for the crisis in housing prices in Israel. Current Governor of the Bank of Israel Karnit Flug, like Stanley Fischer, her predecessor, has consistently argued that the main reason for the rise in housing prices is on the supply side - the pace of housing starts is too low.
"The increase in home prices has thus become a major concern for monetary policy makers. It is important to understand the nature and duration of monetary policy's impact on home prices, based on an understanding of the relationships between these variables and the economy's main macro variables (GDP, inflation, and the exchange rate)," Orfaig writes. Orfaig's analysis shows that an increase of 1% in the monetary interest rate is translated into a decrease of 2.58% in nominal housing prices and 1.1% in real prices. The converse is also true: a 1% interest rate cut causes a 2.58% rise in nominal housing prices and a 1.1% rise in real housing prices. The reason for the gap between the nominal and real prices is the effect of changes in the interest rate on inflation. For example, a rise in the interest rate also lowers inflation (by 1.48% for every 1% increase in the interest rate), and vice versa. This effect conforms to the global pattern, with the effect in other countries in similar studies varying from 0.2% to 4%, with an average of 1.9%, compared with 1.1% in Israel.
The study, which examined housing prices in 1995-2011, found that the effect of lowering the interest rate changes over time: it reaches a peak after two quarters, and then subsides.
A 2014 study by the International Monetary Fund found that housing prices in Israel were 25% higher than could have been expected according to the state of the economy, 26% higher than the price derived from the income of Israeli residents, and 22% higher than the price derived from rents. Half of the gap is explained by a lack of housing units (the supply side), and the other half is attributable to the attractive mortgage interest rate, which encourages taking mortgages (the demand side). Studies in 2012 and 2015 reached the conclusion that a bubble was not developing in the Israeli housing market.
Published by Globes [online], Israel Business News - www.globes-online.com - on September 17, 2017
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