Rental price controls in Europe will limit and prolong inflation, but are worth it

The relatively small increase in the cost of rental real estate in Europe in recent years will cause it to last longer, according to the work of the European Central Bank (ECB), which compared the post-Covid dynamics of rental prices in the EU and the USA and its impact on inflation. Restrictions on rent increases have smoothed out price increases in the EU compared to the US due to increased long-term price pressure – however, the ECB believes that the overall effect of the restrictions in the EU will be better.

In the October issue of the ECB’s economic bulletin, Central Bank economists, in the article “Rent inflation in the euro area,” analyze an unusual effect – in the United States, rent growth became one of the main drivers of inflation in 2020-2022, while in the same circumstances in the EU countries, including in the euro area, a similar effect was not observed. The work of Rodolfo Arioli and his colleagues ultimately examines a rarely discussed topic: the effectiveness of the EU’s system of restrictions on rent changes.

Part of the problem, which was previously observed when comparing inflation reports in the EU and the US, is explained quite simply by ECB economists – although the shares of owners (including mortgages) of residential real estate in the euro area and in the US are similar, about 65%, the methods for calculating the contribution to rent inflation varies. In the United States, the calculation of the main inflation indices includes “imputed rent” – the dynamics of the cost of expenses that the homeowner would have incurred if he had rented this living space. As a result, the US contribution of rents to the HIPC index is five times higher than in the EU, and makes up about a third of the index “basket” (the ECB is considering a similar methodology). In addition, the definitions of “dwelling/shelter”—the types of real estate included in the corresponding consumer baskets—differ in the United States and Europe.

However, even without this component, the contrast in the dynamics of rents since 2020 in the euro area and the EU, on the one hand, and in the United States, on the other, is outstanding, and this is mainly due to the greater prevalence in Europe than in the United States of restrictions on local , and sometimes at the national level to increase rents. The ECB review contains several examples: a growth cap of 2% from 2020 to the end of 2023 in Spain, 3.5% until March 2024 in France, the absence of any visible price growth in the sector in Germany in 2020-2022 against a background of quite strong rising rental prices with a peak in 2016. In general, the practical value of the work is in the overall assessment of the “index of price regulation for rental housing.” In a standard situation, it is estimated for the euro area by Arioli and colleagues at 0.31 (one is all possible types of restrictions on changes in rental prices) for the euro area and 0.17 for the United States. Based on the results of contracts in 2019, the index rose to 0.27 in the United States and to 0.6 in the euro area. In the EU, the maximum value of strict price regulation is in Germany, where the current index value is estimated at 0.75 (only 12.6% of prices are directly regulated – in Germany, restrictions of four to six years are more common for increasing rental prices from the rental prices of similar housing in the same region), for Spain it is 0.57, despite the fact that subsidized or social housing makes up a third of the market, for France it is 0.53 (57.1% of the market is subsidized housing).

The result of the restrictions, as stated by the ECB, is a faster growth than previously expected in rental prices in the euro area following the pandemic in 2022–2023, by 0.8 percentage points, 2.7% year-on-year instead of 1.9%. Compared to the US, where it was 8% in 2022 (but rapidly declining in 2023), this is almost nothing. But the inflationary pressure of this component in the euro area will last longer. However, according to Arioli and colleagues, in the end, tenants in Europe will still benefit; the contribution of rent to total inflation over several years will be lower than in the United States.

Dmitry Butrin