[Choi Jun-young's Urban Pilgrimage] Central Bank and the City

Global Housing Price Surge Influenced by Central Bank Liquidity Supply
Liquidity Released Due to COVID-19 Cannot Continue Indefinitely
Central Bank Policy Rates and Housing Prices in Major Cities Are Not Issues Limited to Specific Countries

The currency we use is issued by the central bank. In most countries, the central bank is located in the heart of the capital city. Our country is no exception. The central bank drives the economy through monetary policy, and cities play a spatially central role in the economy.

For a long time, these two entities operated independently, but in the 21st century, they have repeatedly been considering how to solve common problems together. The issue of urban housing prices has become a challenge. The rapid rise in housing prices centered on large cities is a global phenomenon. There are growing calls for central banks to step in to address this problem.

Despite the economic impact of COVID-19, housing prices have continued to rise in most OECD countries, including ours. The rate and speed of increase are very rapid. Although economic recovery is not yet felt and commercial space rents are falling, housing prices in large cities are rising. There is no disagreement that this seemingly magical situation was created by the liquidity supplied by central banks.

Housing prices are closely related to interest rates. When the central bank lowers interest rates, the returns on housing purchases and rentals increase. Therefore, housing prices rise. When interest rates go up, the opposite happens. The simplest way to suppress or reverse rising housing prices is for the central bank to raise interest rates. However, reality is not that simple.

Recently, the UK daily Financial Times (FT) analyzed the sensitivity of interest rates and housing prices in 14 countries over the past 140 years and reported that a 1% increase in interest rates corresponded to about a 4% decrease in housing prices relative to income. Let’s apply this mechanically. To bring Seoul’s housing prices, which have risen 50% based on median prices, back to their original level, interest rates would need to be raised by 12.5%. But this would lead to investment stagnation, export collapse, and high unemployment, resulting in destructive consequences, making it impossible. Traditionally, central banks have considered adjusting interest rates to curb or reduce housing price increases as an excessive measure.

However, it is clear that central banks worldwide bear responsibility for the recent global rise in housing prices. The background to the rise in housing prices in Germany, known for its stable housing prices for a long time, includes a 10-year maturity interest rate of 0.6% and a 100% loan-to-value ratio (LTV) on mortgages. This was possible because of the central bank’s accommodative monetary policy.

At some point, price stability, the central bank’s fundamental mission, was forgotten. Instead, the mission became to stimulate a stagnant economy and combat deflation. Housing price increases arising from this process were regarded as a side effect to be tolerated. However, as housing prices have risen too steeply recently, voices demanding that central banks take responsibility have been strongly raised, especially among political circles worldwide. This dissatisfaction and demand are particularly strong among young people who have few assets.

There is a dilemma that raising interest rates to control housing price increases actually makes things harder for young people. The effects of interest rate hikes appear comprehensively. The resulting economic downturn leads to employment insecurity and higher unemployment among young people. Consequently, purchasing a home becomes even more difficult.

Young people who recently purchased homes with large loans, shocked by rising housing prices, face increased burdens when interest rates rise, as well as the risk of falling housing prices. On the other hand, older generations and high-income groups with sufficient financial assets can easily buy homes whose prices have fallen during periods of rising interest rates, using the increased interest income. This further widens intergenerational inequality.

The ongoing large-scale liquidity supply to respond to the economic downturn caused by COVID-19 cannot continue indefinitely. Central banks have no choice but to raise interest rates to withdraw the excessively released liquidity. The explosive volatility in cryptocurrency prices cannot be explained without liquidity. Leaving this situation unattended could cause greater damage. Ultimately, central banks will raise interest rates despite the side effects. If this period coincides with a time when housing supply begins in earnest due to rising housing prices, the outcome could be fatal. The sharp interest rate hikes by the Bank of Japan in the late 1980s illustrate this well.

In many countries, central banks have been regarded as exalted entities. Although unelected powers, many countries entrusted them with monopoly authority over money and took measures to prevent government interference, trusting their expertise and insight. The central bank, existing in cities but invisible, changed many things in cities through the power of interest rates. However, now the central bank is no longer a mysterious entity hidden behind a curtain but an everyday presence constantly called upon to solve many of the world’s problems.

What is clear is that neither the interest rates set by central banks nor the housing prices in major cities representing countries are problems of any single nation anymore. The fates of many people and cities are determined in the rapidly changing relationships where they influence each other. It makes one wonder which direction our future will take.

Legal Expert, Yulchon LLC