Equipos médicos

A fall in housing investment large enough to quickly reduce the housing investment to GDP ratio back to its 1990s average would slow GDP markedly. We shock the intercept of the equation by enough to endogenously induce the fall in the ratio of housing investment to GDP plotted in Figure 1.4.4, and as we can see within 2 years the investment ratio is back at its 1990s level.

Figure 1.4.4: Real Housing Investment as a share of Real GDP

As a result of the fall in the ratio of housing investment to GDP growth would slow by 0.4 percentage points in the first year and by a further 0.2 in the second year and the structural current account will improve, as we can see in Figure 1.4.5 below. Our simulation is run with a policy feedback rule in place for interest rates and with rational expectations in financial markets and labour markets.

Figure 1.4.5: The Impacts of a fall in Housing Investment on the US

0.04 0.042 0.044 0.046 0.048 0.05 0.052 0.054 0.056 199619971998 1999 200020012002 2003200420052006 200720082009 201020112012 proportion G D P Base Simulation -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6 2006 2007 2008200 9 2010 2011 2012201 3 2014 2015 2016 201 7 2018 2019 2020202 1 2022 2023 2024202 5 2026

As demand will slow, the Fed is expected to reduce interest rates, and markets will ‘jump’ in anticipation. The nominal exchange rate falls by 0.8 percentage points immediately, and the long term interest rate will fall by 0.33 percentage points. In the medium term the long term real interest rate also falls by around 0.25 percentage points in the simulation, as housing investment is permanently lower. This raises business investment and helps push output back to baseline. Housing market adjustment is likely to also come through lower house prices and we have simulated the potential impacts by reducing them by 20 per cent as compared to our baseline over 2 years, and leaving them permanently lower than they would have been. House prices feed into housing wealth, and this in turn affects the level of consumption14_{, which falls relative to baseline by more}

than 3 per cent in two years. GDP growth slows sharply and output is almost 1.5 per cent lower than it would have been after two years. As demand will slow, the Fed is expected to reduce interest rates, and markets will ‘jump’ in anticipation, as a result the effective exchange rate falls by two per cent. This raises inflationary pressure, and in the very short run the Fed may raise rates to combat this. However, the lower level of demand means that interest rates are lower in the future and hence long term interest rates fall, and real long term rates fall by 0.7 percentage points. The reduction in domestic demand improves the current account permanently by about 0.7 per cent of GDP, and the impact of the lower real exchange rate on net exports along with the effects of lower long interest rates on investment help push output back toward baseline.

Figure 1.4.6: The Impacts of a 20 Per Cent Fall in US House Prices

-4 -3.5 -3 -2.5 -2 -1.5 -1 -0.5 0 0.5 1 1.5 2006 2007 20082009 2010 2011 2012 2013 2014 2015 201 6 2017 2018 201 9 2020 2021 20222023 2024 2025 2026

Consumption (% diff from base)

Current balance (% points of GDP diff from base) GDP (% diff from base)

If we were to run our model in backward mode, with a fixed exchange rate some of the effects we observe would be different, and in particular the stabilising feedbacks from lower long term interest rates and the exchange rate would be absent. This would also allow us to compare our results to those of the Prometeia international model, Priamo, and we do this in Table 1.4.

The role of housing wealth in consumption is discussed in Barrell, R., and Davis, E.P., (2006) and in Al Eyd, A. Barrell, R, Davis, E.P., and Pomerantz, O., (2005). Housing wealth effects on the model are large and rapidly acting in the US, and are probably 5 times larger than the impacts of financial wealth.

The impacts on consumption in NiGEM in backward and forward mode are virtually the same, and somewhat higher than in Priamo, as we can see, whilst the GDP effects are higher in backward than in forward mode in NiGEM. The shock absorbers that come from the jumps in real exchange rate, long term real interest rates, equity prices and wealth all together reduce the impacts on output in the US by up to 0.5 percentage points in three years. The impacts on US GDP are larger in NiGEM than in Priamo in the same mode of operation, with US imports falling more in the latter model, which helps explain why the impacts on the Euro Area in Priamo are larger, as more of the shock is exported. In NiGEM the impacts on the Euro Area are especially small in the first year. Forward looking model runs give smaller effects after 3 years with lower real interest rates more than offsetting the impacts of the appreciation in the forward mode run. If we import NiGEM interest rates and exchange rates into Priamo then Euro Area output still fall more than in NiGEM initially, but it returns to base after 4 years.

The effects of the shock on the current balance depend in part on the revaluation effects on net assets and IPD flows. In the forward looking NiGEM simulation the US effective exchange rate falls by almost 3 per cent, and the IPD balance improves as a result. The effects of the fall in demand in the US on Euro Area output are larger in Priamo, and they suggest we need to be more cautious about events there than the NiGEM model would indicate.

Table 1.4: Impacts of a 20 Per Cent Change in US House Prices