Working Paper Series no. 787: House Prices, Mortgage Debt Dynamics and Economic Fluctuations in France: A Semi-Structural Approach

In the last two decades, residential house prices and household debt have continuously increased in France. The joint dynamics of house prices and household credit play a key role in the central banks' assessment of future developments, both from a real economy and  financial stability perspectives. On the real economy side, households' real estate assets constitute a major share of their wealth and the housing debt burden appears particularly sensitive to macro-financial conditions. Any change in housing market or financing conditions could therefore have consequences on the business cycle through their impact on households’ decisions. On the financial stability side, housing assets form an important part of the portfolios of banks and institutional investors and are used as collateral by households or borrowing firms. Hence, any disturbance that affects the housing market could increase the risk of a deflationary spiral between house prices and the amounts of credit granted.

The aim of this paper is to develop a model of house prices and household credit dynamics and assess how it interacts with other macro-financial variables by introducing it into the Banque de France semi-structural model (FR-BDF), which is used mainly for the macroeconomic projection exercises. Our approach focuses on an indicator of stress in the residential housing and mortgage market, which takes into account in particular the purchasing power of households and the credit  financing conditions (interest rates, credit maturity). This indicator is a Debt Service Ratio (DSR) which proves particularly relevant to account for the riskiness of the borrowers in the loan origination. The value added of our approach is two-fold. First, we adopt a modelling of household loans that takes care of distinguishing new loans from repayments of past outstanding amounts, while such a key distinction is largely ignored in previous attempts. Second, by including financial stability considerations in our modelling, we are able to account for the role of macroprudential policy in stabilising risky debt dynamics and simulate the macroeconomic impact of various prudential measures related to household indebtedness.

Our econometric evidence clearly shows the prominent role of interest rates in the mortgage market dynamics, in particular following the Global Financial Crisis. The decline in bank lending rates, which have sharply declined from a peak of more than 5 percent in 2008 to a historical low of 1.2 percent in 2019, is shown to be the main explanatory factor of the continuous increase in both the DSR and house prices. While the increase in house prices in turn support mortgage debt dynamics, loan origination is however limited by debt sustainability considerations.

Our model simulations also show that accounting for household  financial vulnerability in credit supply prevents the economy from going to unsustainable paths in the long term, as the distribution of loans is limited by too high a DSR. However, large credit and asset price  fluctuations may reinforce each other over short- to medium-term horizons, creating potential financial accelerator effects that are detrimental to financial stability. In this context, we show that macroprudential policy measures targeting households (e.g. limiting the DSTI ratio or reducing the length of loan maturity) seem to contribute in stabilising house price and debt dynamics.