Brussels urged to act on housing bubbles

"There are no incentives from the euro area system for national governments to lean against the wind of housing bubbles," the paper notes, adding "There should be, because housing markets are so large and housing busts are always very disruptive."

As two examples, it refers to the common features of housing markets developments in Ireland and Spain, both from among the lower income countries which joined the euro in 1999.

Since then, the two states have seen a significant increase in income per capita and moved towards the economic levels of other eurozone members, with a sharp reduction in interest rates and greater access to finance from abroad boosting their domestic investments and growth in credit.

But positive demographic factors, a favourable tax treatment of housing as well as speculation over future price hikes generated housing market booms in both countries which gradually led to their overheating - further worsened by the US subprime credit crisis.

"These bubbles have burst and the slump in residential investment from elevated levels threatens to drag both economies from one tail of the growth distribution to the other," notes the study.

As several key factors behind such developments involve the eurozone's "one-size-fits-all" monetary policy, the authors of the paper argue that measures to prevent them in future should also be sought at euro area level.

Their recommendation is the same as included in the European Commission's recent report on the tenth anniversary of the euro: "a more effective surveillance of macroeconomic developments is needed at the euro area level."

"This surveillance should not be concerned by budgetary developments alone, but recognise that housing market bubbles and their consequences can severely hamper the smooth functioning of EMU. For this reason, they are a matter of common concern."

According to Juan Delgado, one of the authors, the issue is all the more pressing with more new fast growing EU member states heading into the monetary union - after Slovenia joined in 2007, Cyprus and Malta in 2008 and Slovakia set to join next year, other poorer but fast-growing countries are expected to join after 2010.

In response to similar trends as seen in Spain and Ireland, national governments should introduce "aggressive reductions in tax breaks on housing" or other countercyclical measures whenever eurozone interest rates fall back to lower levels - as experienced before the current global credit crisis.

"The problem is that national governments are reluctant to admit that they have a real estate bubble so if there is independent surveillance from Brussels this then strengthens the incentive to acte at the national level even before the bubble bursts, commented Jakob von Weiszacker, a co-author.