The price of policy: how low ECB rates fueled house price inequality

By Nektarios Michail Let’s start with a history reminder: following a “peak” at 0.75 per cent in mid-2011, the ECB continued to cut its policy rates until the deposit facility rate reached zero, exactly a year later, and then, in an unprecedented move, pushed the rate below zero around two years after that (June 2014). The cited rationales for such a move were the lowering of borrowing costs and the subsequent encouragement of investment and spending, but ultimately it was the effort to boost inflation and fight deflationary pressures (ECB). The reasons for lower inflation at the time, and throughout the negative interest rate period of 2014-2019 (we exclude the Covid-19 pandemic period for obvious reasons), can be attributed to two factors: first, the stabilization of oil prices to low levels, with fluctuations between $50 and $70 per barrel during the whole period, a very low volatility compared to historical standards. This also aided to the stabilization of food prices which are heavily dependent on fertilizer prices, produced using oil products. The second factor was the stabilization of Non-Energy Industrial Goods (NEIG) prices, driven by an impressive steadiness in import prices over the 2010-2019 period; in fact, the relevant import prices in industry index registered just 3.7 per cent cumulative growth in the 2010-2019 period, and were flat in the 2014-2019 period. This resulted in a low inflation rate, as the relevant data in Table 1 show. Table 1: Contributions to HICP Inflation Food NEIG Energy Services Inflation 2002-2008 0.56 0.24 0.49 1.04 2.32 2009-2011 0.39 0.26 0.36 0.73 1.54 2012-2014 0.40 0.18 0.23 0.62 1.43 2014-2019 0.27 0.07 -0.05 0.61 0.89 2020-2021 0.39 0.21 0.28 0.53 1.42 2022-2025 1.32 0.71 0.82 1.73 4.58 In an effort to push prices higher, the ECB opted to test the limits of monetary policy. Negative interest rates were imposed in June 2014, as previously mentioned, with the ECB further lowering the policy rate three more times until 2016, setting it a -0.40 per cent. A further cut came in September 2019, putting the policy rate at -0.50 per cent. As the above table shows, the efforts of the ECB were not successful. Inflation remained stubbornly low, averaging at just 0.89 per cent over the 2014-2019 period, driven by low energy and NEIG prices. These two categories cannot be meaningfully affected by rate changes, given their dependence on internationally traded prices (including for the main commodities), as well as the peak of the globalization phase that took place over the period, with companies shifting production to low-wage countries including China, India, and Vietnam, resulting in lower import prices, as previously mentioned. At the same time, the lack of extreme, protracted, weather phenomena during the period, as well the continued stability of oil prices which supported stable fertilizer prices, also caused a broad stabilization of food prices. The only remaining category that could potentially be affected by monetary policy was that of services inflation, which was also registering low growth rates, and did not in fact move at all during the period. This was precisely the category that the ECB aimed at, with lower rates aimed to boost lending via the easing of interest rate costs, which would (theoretically) also boost investment. Yet, what occurred in practice was a slow but steady destruction of purchasing power, though not through the usual means. Purchasing power is usually associated with the real wage – a drop in real wages is associated with a decline in purchasing power while an increase in real wages is associated with an increase in purchasing power. Given this, one can calculate the cumulative effect by comparing the total change in wages to the total change in inflation. In the 2014-2019 period, wages did increase comparatively more than inflation, but not to the extent that policymakers expected, registering meagre growth rates. The average spread of inflation over wages was just 1 per cent annually in the 2014-2019 period, for both the euro area and the European Union. Despite the small size of the spread, it was still beneficial to consumer, and thus, in theory, consumers should have been happier. Now, let’s compare that with the cumulative spread between house price and wage growth. Over said 6-year period, the spread between house price and wage growth increased materially, with housing prices growing by around 9.5 per cent more compared to wages, (EU and EA averages). The situation becomes even worse if we include the Covid period (chart below), where the EU and EA average spread between house price and wage growth stood at approximately 22 per cent. Recent data for several European capitals support this, as house price growth was always higher than nominal wage growth. Source: Eurostat, author calculations Was this aided by interest rates? Partly. It should be remembered that interest rates are not the root of all evil but are neither a panacea. Higher interest rates can constrain house price growth but are less effective in the case of supply-side inflation (such as oil price shocks). At the same time, if the underlying economic environment does not appear to be promising, banks may be (understandably) less willing to lend, thus hampering loan growth. These examples suggest that interest rates are a tool to affect investment and savings decisions. Yet not all investments are the same. If the majority of investments go into either the housing or the stock market (the DAX was up 50 per cent in 2014-2019), then it is unlikely that the funds will reach the average consumer, who will see no meaningful increase in his wages – especially so if many of the building materials are imported. It is only when investments are made into productive assets, rather than housing and the stock market, that inflation rises, and this has not been the case in euro area over the previous decade. This appears to be in contrast to the common understanding on inflation, but it is not really the case; it is more of a misunderstanding of the nature of prices. In the 2014-2019 era as well as during the Covid and the 2022-2025 period, all inflationary shocks were external: in the first two periods (2014-2019 and Covid), lower inflation hurt wages; in the second (2022-2025), it assisted them. Similarly, lower interest rates in the first two periods aided housing price growth, while higher interest rates in the 2022-2025 period hindered housing growth. After interest rates increased in 2022, as a response to higher inflation, the cumulative house-wage spread decreased to approximately 19.5 per cent by 2025, due to higher wage growth compared to housing growth. Naturally, in both cases, the fact that the euro area economy continued to grow allowed for these forces to unfold and did not compromise any of the above-mentioned dynamics. While the above appear to have been an exploration of price and interest rate dynamics, it is in fact key to understanding inequality. As the economy does not work in a vacuum, one needs to understand who did the housing price growth benefit and who caused it? As it appears, in both counts the culprit was the top wealth owners in each country, as the EA homeownership rate declined from 67.5 per cent in 2014 to 65.1 per cent in 2025, with only a handful of countries registering mild increases (Ireland, Italy, Latvia, Netherlands, Slovakia). Some studies suggest that higher house prices are beneficial for the bottom 50 per cent of the population. This hinges on the fact that such people already own some kind of property. Actual data, based on the Household Finance and Consumption Survey, comparing net wealth inequality, suggests that the Gini coefficient, the most popular measure of inequality, remained almost identical from the 2014 to the 2021 wave for the euro area (at 0.691 in 2014 to 0.690 in 2021). On the other hand, the Gini coefficient drops to 0.685 in the 2023 wave, showcasing improved inequality, after just 1 year of higher interest rates and higher inflation, confirming the mechanisms previously underlined. To sum up, in a growing economy, an environment of higher inflation, coupled with higher interest rates is better for consumers, given that wages are more likely to increase and house prices will be more restrained, hence improving inequality. On the other hand, in a low inflation and low interest regime, even though economic growth may be strong, lower price growth implies low-wage growth while low interest rates provide incentives for more house price growth, hurting the consumer and increasing inequality. Nektarios Michail, Chief Economist, Bank of Cyprus. Views and opinions are personal. The article is republished from the blog of the Cyprus Economic Society.