BOK: "The More Household Debt, the Greater the Consumption Shock When House Prices Fall"

[Image source=Yonhap News]

[Asia Economy Reporter Eunbyeol Kim] The Bank of Korea has released an analysis showing that the greater the household debt, the more severe the economic shocks, such as consumption, when housing prices fall.

On the 20th, the Bank of Korea introduced this in its report titled "Asymmetric Analysis of the Impact of Housing Price Fluctuations on Real Economy and Inflation."

According to the report, first, based on the DSGE (Dynamic Stochastic General Equilibrium) model analysis, if the average household loan-to-value ratio (LTV) is around 75% and housing prices drop sharply by 20% within two years (8 quarters), similar to the foreign exchange crisis period (Q2 1998 year-on-year -17.7%), consumption is estimated to decrease by up to 4% during the same period. Employment is also expected to decline by about 4%. However, assuming an LTV of 40%, the consumption decrease rate was reduced to about 0.2% at most.

As of the end of last year, the average LTV in the banking sector is currently around 45%, and the proportion of LTVs exceeding 75% is about 2%.

In the VAR (Vector Autoregression) model analysis, which includes real variables, housing prices, and financial variables, when housing prices fall, not only the growth rate but also the inflation rate significantly decreased. The Bank of Korea explained that this is because borrowing is constrained due to the shock of falling housing prices, increasing the deleveraging effect, which greatly suppresses consumption.

On the other hand, in both model analyses, there was no clear tendency for consumption or inflation to increase significantly when housing prices rose. The Bank of Korea stated in the report, "Empirical analysis using both models showed that the impact of housing prices on the real economy and inflation was not significant during periods of rising housing prices but was significant during periods of decline," adding, "In particular, the higher the household debt level, the greater the estimated effect of housing price declines on the real economy and inflation."

The Bank of Korea advised, "If the current strong upward trend in housing prices continues, the possibility of housing price adjustments will increase accordingly, which could become a burden on our economy in the future. Therefore, it is necessary to proactively manage risk factors."

This content was produced with the assistance of AI translation services.