The implications of our Housing Boom and both praise and criticism for the IMF

After my article yesterday which analysed the speech given by a member of the UK Monetary Policy Committee Kate Barker and questioned her intellectual thoroughness and indeed her credibility my eyes alighted on a report from the International Monetary Fund (IMF). It was written by a Daniel Kanda and is titled Asset Booms and Structural Fiscal Positions. It relates to Ireland but the principles also apply to the UK particularly as Ireland until the credit crunch was affected by a large housing boom, sound familiar anyone? 

Asset booms and sectoral changes can distort traditional estimates of structural fiscal revenue, and could lead to serious fiscal policy errors. This paper extends the estimation of structural revenues to take account of asset prices and sectoral changes, and applies this to the case of Ireland, where a property bust has revealed a large hole in the public finances. It is shown that excluding these factors led to a substantial bias in the estimation of structural revenues and the structural balance prior to the crisis was much larger than earlier estimated.


This paper extends the standard estimation of structural balances for Ireland in a number of important ways, explicitly accounting for asset price cycles, the housing bubble, and changes to the composition of national income. It is found that these factors have had a significant and ongoing impact on Irish fiscal revenues. The effect of the housing bubble is particularly pronounced in the case of indirect taxes like VAT, capital gains, and stamp duty. It also turns out that equity prices have a significant impact on personal income taxes. The analysis also highlights that there have been substantial changes in the sectoral composition of GDP, which have had an impact on the evolution of structural revenues.
The paper also demonstrates that not accounting for asset price cycles, bubbles, or sectoral changes can generate a large bias in the calculation of the structural balance—one moreover that generally cannot be corrected for by changing the estimated output gap. In Ireland’s case, this bias, which made the revenue prospects seem much rosier than they actually were, helped stimulate an expenditure relaxation that created a large hole in the public finances that will take several painful years to close.


Thus, there is a strong case for expanding the standard OECD-based methodology to include the missing elements outlined above, as done in this paper. Indeed, the ECB is already moving in this direction to refine the treatment of asset-based taxes in its disaggregated approach revenues, and the structural balance prior to the crisis was much larger than earlier estimated.  




What does this mean? 

This report can be broken down into several factors 

1. A policy error was made 

2. This error related mostly to the booming housing sector which provided higher VAT, Capital Gains Tax and Stamp Duty Revenues. But the booming equity market also provided higher income taxes. 

3. These larger tax receipts led the Irish government to think that a permanent and not a temporary change in her fiscal deficit had taken place and economic policy was predicated on this. 

4. In other words  public sector expenditure grew too large and when the housing boom ended then Ireland was left with an unsustainable fiscal deficit which will take years of pain to correct. 

5. Pain, debate and hardship will follow. 

6. Mr. Kanda like me but unlike Kate Barker feels that you should learn lessons from this situation and fundamentally change your methodology if necessary. 

7. Regular readers will not be surprised by me pointing out that output gap theory yet again is of little use. 



This analysis for Ireland plainly translates very well into the situation for the UK, and there are lessons for Spain and the impact of her housing boom too. We too felt that the taxation receipts from housing related activity such as Stamp Duty, Capital Gains Tax,Income Tax and so on were permanent changes and made the same policy errors. In both Ireland and the UK this error was added to by having relatively large banking sectors which have been affected by the credit crunch too leading to a fall in corporate taxes as well as personal ones. At its peak the UK financial sector was paying nearly 30% of UK Corporation Tax receipts. With the accumulated losses that this sector now has it will be quite some time before some of these banks have to pay any tax at all. Hence the enormous fiscal deficit that the UK has for this year which is similar to that of Greece. 

An interesting side-effect of this analysis is the way that equity values are seen as significant. Often in the past this concept has been raised (usually in terms of a wealth effect) but studies have not identified it as well as this one and I will look into this as for an economist it has several implications. 

In my view there is a lot to recommend this report as it identifies problems and looks at ways of solving them for the future. This is far better than the Kate Barker approach I identified yesterday and if you forgive the pun Mr. Kanda has shown some candour! 


One rule that underlies this analysis is that human beings seem to always translate favourable changes as permanent even if it is temporary. This seems to particularly apply to politicians (and yes I can hear you saying it some economists too!). 

The IMF and Poland 

Whilst I am praising an individual at the IMF I am interested in the criticism of the organisation as a whole by Poland’s Finance Minister. He accuses the IMF of encouraging Poland to spend more in 2009 and then telling her to cut her budget deficit in 2010. As his criticism is well made I shall quote his interview with the Financial Times. 

Spain is complaining that the same institution which was urging them to increase their budget deficit last year is now telling them what a dreadful mistake it was this year.We were on the end of that same advice but we took a contrarian view… 

Well done to him both on his policy and for pointing out that the IMF is far from the omnipotent organisation that some present it as.


8 thoughts on “The implications of our Housing Boom and both praise and criticism for the IMF

  1. I’m just a humble investor who read Famous Financial Fiascos and The Great Crash 1929, how come these brainboxes running the system couldn’t see that there was the mother of all credit bubbles. It was on the telly nearly everyday.

    I see it as “state sponsored inflation” and the curse of Keynesian economics in the upper echelons of our society.

    The Austrians saw this one a mile off.

    Why can’t we live within our means?

  2. Simon: surely the answer to your question is that the UK cannot “live within its means” because of Socialist politicians? Since Socialist parties were first elected in the UK, their policies have been partly emulated by other parties like the Tories, who originally understood how to control economies responsibly and not to overspend and waste the Publics” money; they introduced quasi-Socialist policies because they feared that they would become unelectable if they did not also offer at least some of the wasteful Socialist gismos prostituted by Labour.

    As a result the UK became a country where both parties implemented Socialist policies, the only difference being that one was more extreme than the other. (many senior civil servants had increasingly Socialist leanings in any case, which like Eric Blair they had acquired in left-wing cells in universities.) Government expenditure therefore rose out of control and successive governments funded the deficits at the worst points by generating inflation. (There are a number of ways in which governments may increase the money supply at a faster rate than real growth, to fund their deficits. It is this which causes inherent and ongoing inflation.) To deceive the public governments arranged for their statisticians to fraudulently manipulate official inflation numbers, so that they seemed lower than they really were.

    If you look back over the period since the 2nd World War and take a number of key staple commodities like housing, beer, bread, petrol, water etc. and see how the prices of these have really risen you can see just how much inflation successive governments have used to fund their deficits. It really is quite frightening when you look at the true numbers, rather than the official fictitious numbers. There is in any case the Leninist intent in all Socialists to use inflation to redistribute wealth according to their Socialist ideologies. Lenin made statements to this effect. It is a stealth tax which no one can escape, if they hold fiat money.

    That I would suggest in a nutshell is why the UK cannot “live within its means”.

  3. Drf,

    Good stuff!

    In my mind we are morphing from UK plc to the UKSSR.

    How do you see the next couple of years panning out for the UK?

  4. The UK cannot live within its means now, as has been pointed out in the article the revenue produced by the various asset bubbles in the economy has been taken for granted and used to increase baseline running costs, many of which are unproductive in terms of wealth creation. There has to be a hard correction coming…….

    • Hi Malcolm

      I feel that this report was interesting for many reasons not least of which was that it was a clear theoretical rebuttal to Kate Barker’s speech. Since then the Bank of England’s Chief Economist Spencer Dale has given a speech in a similar vein to Kate Barker’s where suddenly asset price bubbles appear to be ok as a tool of policy. Those who wonder about the contortions involved in the Monetary Policy Committee’s views on Quantitative Easing might read Spencer Dale’s speech from September 2009 when he warned of a situation where ” the substantial injections of liquidity might result in unwarranted increases in some asset prices that could prove costly to rectify.” Such contortions are hardly reassuring…

  5. I think the whole QE exercise is fiscal manipulation for short term political gain, always a mistake. It comes when your ideology fails, character is tested and there are no other ideas. Had the whole Keynesian intervention been used to actually build the infrastructure the country needs to work its way out of recession OK, but it hasn’t. It has disappeared into one sector deemed too important to fail so now we see efforts (if they have the stoicism needed) to justify breaking that up into smaller pieces which individually can be allowed to fail without the resulting implosive effect. Will be interesting to see how Obama tackles that one given the global nature of the beast these days. Chancellor Brown always did the same raising tax, windfall taxes or even selling assets to then, and with great fanfare, put into the likes of health or education but not into productivity or front line services but into pay increases and increased public sector jobs, thereby increasing the cost overheads and building them in for the future without any resulting productivity gains.
    The whole thing panders to the almost endemic thinking that wealth creation is easy; after all you only have to get onto the housing ladder to see excessive returns and you can pay your mortgage with your credit card!
    UKPLC is running on borrowed time.
    Given I live in a county where the biggest single employer is the council and almost 50% of all jobs are in the public sector the needed correction will be devastating here!

  6. Well the housing prices will drop again due to unfavorable demographics. There are too little young families to fill all the houses, and most of those young famillies are endepted working poor. The Babyboomers spend their parents savings and their childrens credit, but they will have to footh the bill in the end. They will see their savings being inflated away, they will see devalued houses in relative (due to aformentioned inflation) and absolute terms, pension cuts and healthcare cuts. Usefull, real added value productivity (I mean industry here) per working person is far too low to sustain the current system The system is top heavy, it has an inflated head and no legs to carry it.

  7. In 1997/8 Inland Revenue reciepts from residential Stamp Duty on land transactions were £830mm. In 2007/8 this has increased to £6.68bn. I assume the figures in the IR docs are nominal so attaching a 2.5% inflation rate to the 1997/8 reciepts would give £1.06bn by 2007/8. All in all the Inland Revenue raised an additional £27bn from Stamp Duty reciepts between 97-2008 than it would have had the asset bubble not kicked off.
    On almost a seperate point, it may be of interest that throughout the period about 50% of this these reciepts came from London and the Southeast (25% of UK Population) and 10% came from the North East, North West and Yorkshire and the Humber (24% of UK Population). Accordinly the property bubble has increased the tax burden of South East and London taxpayers disproportionatly.

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